No statutory reform needed for smart legal contracts – takeaways

• 4 March 2022
• News

Towards the end of 2021, the Law Commission published its Advice to Governments: Smart Contracts, concluding that England and Wales’ current legal framework can accommodate smart legal contracts without the need for statutory reform, although there are several potential issues which require further thought.

At 227 pages, the Advice is a bit of a beast although the summary of 33 pages distils it nicely. Here are our takeaways:

• In determining what a smart contract is, lack of human involvement is key. Essentially, a smart contract is a legally binding agreement in which some or all of the obligations are performed by a computer without any human intervention.
• The Advice considers the main contractual issues as they apply to smart contracts, such as contract formation, interpretation and remedies.
• There are varying degrees of smart contracts, i.e. contracts which have written (natural language) terms, hybrid contracts where some terms are written and some are in code and contracts where all terms are in code. The Advice points out that an “incremental development” of common law may be necessary in certain cases (more likely in contracts where all contractual terms are in code).
• Interpretation issues could arise, particularly where all terms are in code rather than written in natural language. As such, the Advice suggests that it may be worthwhile including key terms in writing and making clear which of the written and code terms should prevail if there is conflict. A non-exhaustive list of issues that parties should consider and possibly address in their smart contract is appended to the Advice.
• The expectation is that model clauses and standard terms will develop over time, in a similar way to certain clauses which are often seen in traditional contracts. However, caution is required here for both smart and traditional contracts – a standard term which parties are used to seeing can often remain in a contract without a full understanding of its meaning or whether it is actually required, and this can cause unforeseen difficulties at a later date.
• It is unlikely that a smart deed will be seen anytime soon. While the current legal framework should not cause problems for smart contracts, smart deeds are another matter. The Advice explains that the additional formalities required for a deed can’t be effected through a smart contract.
• Determining the correct jurisdiction of a smart contract could also be tricky, especially where all terms are in code. This will be further considered by the Law Commission in due course (later this year has been mentioned) and the suggestion made that a written jurisdiction clause should be included in any smart contract for certainty.

While the Law Commission is confident that smart contracts can be dealt with under our current contract laws, flexibility will be required, and changes will be afoot. For example, remedies such as injunctions may not lend themselves particularly well to a smart contract and parties may have to be content with a financial remedy. IT/legal specialists may also be needed to understand the terms of the contract, rather than an individual being able to read it for themselves to remind themselves of a point. Could this be the advent of dual-qualified solicitor-coders?

Naomi is a Partner in our Corporate team.

Disclaimer

This note reflects our opinion and views as of 17 February 2021 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.

The Corporate Insolvency and Governance Act 2020: a refresher on termination clauses in supply contracts

• 16 February 2022
• News

Many businesses have been, and continue to be, under financial strain as a result of the pandemic, with some having to resort to liquidation or other insolvency processes.

The Corporate Insolvency and Governance Act 2020 (“CIGA”) was enacted in June 2020 and introduced certain business rescue reliefs and insolvency measures, some temporary and others permanent in nature. Now, 18 months later, as the UK emerges entirely from Covid-related restrictions, the temporary measures have fallen away, but what is the continued impact of CIGA from a supply point of view?

Typically, most supply agreements (whether of goods or services) include provisions regulating when and how the agreement may be terminated, often including the right for a party to terminate if the other party suffers an insolvency event. CIGA aims to assist the rescue of a struggling business by limiting a supplier’s right to terminate supply. Barring certain exceptions, a supplier is unable to exercise its termination rights upon the occurrence of an insolvency event and must continue to supply the goods or services, thereby allowing the business to continue to trade during the insolvency period.

Another important provision of CIGA provides that termination rights which arose prior to the occurrence of an insolvency event but which weren’t exercised at the time they arose, may not be exercised after the insolvency event has occurred for the duration of the insolvency period.

There is a debate about whether CIGA applies to ongoing termination rights, that is termination by way of notice, and in particular whether this pre-existing right would constitute an “event occurring before the start of the insolvency period”. If not, a party could terminate the agreement upon notice, even after the occurrence of the insolvency event, but would have to continue its supply until expiry of the notice period.

CIGA also renders inoperable any other provisions that are triggered by the insolvency event, such as using variation rights to change payment terms or pricing.

While CIGA prohibits a supplier from demanding that outstanding amounts are paid as a condition of its continued supply during the insolvency period, the supplier may take comfort in the knowledge that it will enjoy increased payment priority for the goods or services supplied during this period as these are typically considered to be an expense of the insolvency process. Furthermore, if the supplier is not paid for the supply of goods or services made during the insolvency period, the supplier may then exercise any available termination rights for non-payment on the basis that these were not triggered by the insolvency event. The supplier may also terminate the agreement with the consent of the insolvency practitioner or other applicable office-holder depending on the rescue procedure being used, or with the consent of the court. A supplier who can prove that it would suffer hardship caused by the continuation of the agreement may petition the court for its consent to terminate the agreement. What qualifies as “hardship” is unclear, but the government’s guidance suggests that this exception would be available to a supplier whose own solvency would be threatened by a continuation of the agreement.

So, if CIGA renders insolvency-related termination rights inoperable, why do we still see them in supply agreements? The answer is simply that in certain cases as described above, such as where the supplier suffers hardship or permission is granted by the relevant office-holder or court, termination may still be available to the supplier and failing to include such a provision in the supply agreement would remove that right. Further, termination rights may now capture termination in circumstances where insolvency might reasonably be expected to occur, enabling suppliers to potentially make the call to terminate the agreement prior to the insolvency event taking hold and the CIGA provisions biting.

It is clear that these CIGA provisions are here to stay, so how can suppliers adapt and obtain the comfort they need?

• Undertake enhanced financial due diligence on your customers prior to entering into any supply agreement
• Keep up-to-date on your customers’ financial situation and, where appropriate, consider including information rights or an obligation on the customer to provide you with certain financial information in the supply agreement itself
• Monitor customers with overdue accounts (prior to any insolvency events taking place) and open conversations to allow you to assess the situation and risks
• The best commercial outcome for both parties is usually the rescue and continued trading of your customer in the long-term and so if you are able to continue supply and maintain a good relationship with them during their difficulties, this may be the preferred course of action

Disclaimer

This note reflects our opinion and views as of 15 February 2022 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.

Think twice before your pre-Christmas clear-out

• 14 December 2021
• News

I recently read an article written by a solicitor-turned-barrister which set me thinking about transactions which turn bad. As a transactional lawyer, I am well aware that on occasions, relations between parties sour and disputes arise, so how can parties reduce the risk of time-consuming and costly litigation at the outset?

First, be aware that no matter how good relations are when negotiating and first entering into a transaction, things change. Financial difficulties, tough targets or new personnel, for example, can cause strain and a great relationship now might not always stand the test of time.

Second, instruct lawyers to advise you and document your deal. Agreeing terms on the back of an envelope may save you time and money in the short-term but when things go wrong, it’s very difficult to evidence your original intentions and the terms agreed. Which brings me onto the next point…

Third, don’t throw away potential evidence; physical evidence will often hold more weight in court than a witness statement. A key point in the article I mentioned earlier, it is particularly relevant at the current time when many businesses are downsizing office space and going paperless. Whether you’ve done a property deal and have copies of old plans and photographs of the site or have entered into a loan with security and have finance records and share certificates, don’t be tempted to reduce clutter on the basis they’re no longer needed; they may well be if a deal or term of a deal is called into question.

And finally, as my litigation colleagues would say, don’t wait until the final hour to call in the lawyers if a dispute seems likely. Taking legal advice, for example at an early stage of a disagreement or as soon as you realise a payment cannot be met, can often resolve the issue speedily and amicably.

Naomi is a Partner in our Corporate team.

Disclaimer

This note reflects our opinion and views as of 7 December 2021 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.

Non-Compete: What is Reasonable?

• 18 November 2021
• News

Much like London buses, the Supreme Court must be thinking that restraint of trade cases are coming along all at once. In what was their third restraint of trade case in three years, the Supreme Court has recently handed down its decision in Harcus Sinclair LLP v Your Lawyers Ltd* finding that a restraint of trade clause contained in a non-disclosure agreement between two law firms was not unreasonable in the circumstances and was, therefore, valid. In coming to its decision, the Supreme Court seemingly added further credence to the move away from strict contractual interpretation and towards a focus on the “factual matrix”.

Takeaways

The case serves as a useful reminder of the rules surrounding non-compete clauses and that they can be tricky to get right, demonstrating the importance of such clauses being narrowly drafted and not overly restrictive.

• If you are entering into a contract where a non-compete is necessary, take care to ensure the boundaries of the clause are clear. What exactly is being prohibited? Make sure that the non-compete clause is not too open-ended.
• If the contract is likely to run for any length of time, make sure that you periodically review the non-compete clause to check that it is still of relevance and does not require any updating.
• Always keep a written record of any negotiations when entering into a non-compete; it could be useful in the event of a dispute.
• Remember too that the bargaining position of the parties may affect a court’s decision as to whether a non-compete clause is reasonable or not. In the case of a B2B contract or a contract between experienced businesses where the bargaining power is fairly equal, a non-compete clause is more likely to be considered as reasonable, but if there is a discrepancy between the parties’ bargaining power, then a court may be less willing to uphold the provision.

When considering your non-compete clause do not forget the golden rules:

• Ensure there is a legitimate reason for its inclusion. If there is no reason, it probably doesn’t need to be in there.
• Make sure the length of time the non-compete is due to run is reasonable.

Lastly, and possibly most importantly, always remember there is no substitute for legal advice if you are thinking about requesting, or agreeing to, the inclusion of a non-compete clause.

The Facts

On the back of the Volkswagen emissions scandal, Your Lawyers Ltd (“Your Lawyers“) identified the probability of a large group action case against Volkswagen. Being a small firm, Your Lawyers sought to form an alliance with the larger firm of Harcus Sinclair LLP (“Harcus Sinclair“) and, as a result, the two entered into a non-disclosure agreement (the “NDA“) in respect of information to be provided by Your Lawyers to Harcus Sinclair in connection with the group action. Crucially, the NDA made no mention of the intended collaboration between the parties, but it did contain a non-compete clause that sought to prevent Harcus Sinclair accepting instructions to act “for any other group of claimants in the contemplated group action” without Your Lawyers’ consent for a period of six years. In essence, the clause sought to protect Your Lawyers’ position by preventing Harcus Sinclair from setting up its own group of claimants against Volkswagen which would be in competition with the Your Lawyers’ group of claimants.

The problem arose later down the line, when Harcus Sinclair eventually did establish a separate group of claimants under the group action. In response, Your Lawyers brought a claim against Harcus Sinclair, arguing that they were prohibited from so acting because of the non-compete clause.

The Judgment

The High Court found that the non-compete clause was enforceable and granted Your Lawyers an injunction that required Harcus Sinclair to cease acting in the group action for six years. This decision was subsequently overturned by the Court of Appeal which held the non-compete clause to be unenforceable as an “unreasonable restraint of trade”.

Your Lawyers then appealed to the Supreme Court. In a unanimous decision, the Supreme Court held that the non-compete clause was enforceable. In coming to its conclusion, the Supreme Court set out the two principles to be considered in deciding whether a restraint of trade clause is reasonable:

1. The person seeking the benefit of the non-compete clause (i.e. Your Lawyers) must establish that the clause is reasonable as between the parties by showing that the clause:

• protects their legitimate interests;
• goes no further than is reasonably necessary to protect their legitimate interests; and
• is commensurate with the benefits secured to the other party (i.e. Harcus Sinclair) under the contract.

2. If the person seeking the benefit of the non-compete clause is successful in the above, it is then up to the other party to establish that the restraint of trade goes against the public interest.

Importantly for Your Lawyers, the Court considered whether, in determining the legitimacy of their interests, they could take into account the parties’ “intentions or what they contemplated would occur as a consequence of entering into the contract” (in this case, the intended collaboration) as well as the express terms of the contract. Concluding that they should take into account the parties’ intentions, the Supreme Court found that the judge at first instance had been entitled to decide that “Your Lawyers did indeed have legitimate interests, flowing from the intended informal collaboration, which it was protecting by the non-compete undertaking”. It is likely that if only the express contractual terms had been taken into account, Harcus Sinclair would have been the party walking away with a smile on their face.

The next question was whether the clause was reasonably necessary to protect Your Lawyers’ legitimate interests. Although six years would generally be considered a lengthy period for a restraint of trade clause to last, the Court recognised that in these circumstances it was reasonable as it roughly mirrored the limitation period for claims in the emissions litigation. In addition, the restriction only existed in relation to the Volkswagen litigation; it did not affect Harcus Sinclair’s wider business. As such, the clause did not go beyond what was necessary to protect Your Lawyers’ legitimate interests.

In determining whether the restriction was commensurate with the benefits it afforded to Harcus Sinclair, the Court again relied on its findings that the parties’ intentions could be taken into account rather than just the express contractual terms, i.e. the benefits to Harcus Sinclair included those which were intended or contemplated as a result of the informal collaboration. On this basis, the restriction was commensurate with the benefits.

Finally, the Supreme Court held that enforcing the non-compete clause would not be contrary to the public interest for various reasons, including that there were many other law firms able to act for other claimants in the group action; prohibiting Harcus Sinclair from doing so would not significantly affect the public’s access to justice.

Thoughts

Although this case was very fact-specific, taking into account the parties’ intentions could lead to potential disagreement. Most non-compete clauses do not detail the parties’ intentions and in some cases adding in such intentions would not be possible. Take, for example, the situation where a non-compete clause is included in a confidentiality agreement entered into at the very start of negotiations when the parties’ plans may not be clear.

It will certainly be interesting to see the effects of the decision in the future.

Disclaimer

This note reflects our opinion and views as of 17 November 2021 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.

*Harcus Sinclair LLP v Your Lawyers Ltd [2021] UKSC 32