Business guardians

MARTIN EDWARDS IDENTIFIES THE MAIN EMPLOYMENT LAW ISSUES TO BE CONSIDERED BY SOLICITORS WHEN ADVISING COMPANIES SETTING UP OR EXPANDING.Wherever there are workers there is usually a need for employment advice.

It is important for a company's solicitor to respond to that need effectively; if they do not, accountants and self-styled 'industrial relations consultants' (often not equipped to give the best advice) will be quick to step in.In order to be able to advise effectively, one must have a sound grasp not only of domestic rules, but also of relevant European principles.

If a general practice based in a small town does not have the requisite skills in-house, it may be possible to obtain expert input on a retainer basis from a larger firm having its own specialist employment law department.An early question to consider will be whether the business prefers to engage staff as employees or as independent contractors -- or perhaps a combination of the two.

A self-employment relationship can have attractions to both parties, but it is vital that any such relationship is adequately documented.

It is also essential to ensure that the form of the agreement reflects the reality of the relationship.

Often, so-called 'self-employed' workers may be regarded by courts and tribunals as employees for many purposes; see Lee Ting Sang v Chung Chi-Keung [1990] ICR 409.

To get the label wrong may be costly.

An employer who mistakenly believes that a worker is self-employed will seldom follow a fair proc edure when terminating an engagement.

There are other risks: for example, if freelancers are by law employees, not only will statutory job protection rights apply, but the client may also be faced with a substantial demand from the Inland Revenue for PAYE and National Insurance contributions.Clients will need to take care from the outset, even during the recruitment process.

A badly worded advertisement can prompt a discrimination claim.

The client needs to understand that the risks associated with discrimination claims are much more than academic, not least since the cap on the compensation that may be awarded in sex and discrimination cases has been removed.

The employment provisions of the Disability Discrimination Act 1995 came into force on 2 December 1996 and are sure to present further challenges to businesses of all kinds.

Whilst small employers, (those with fewer than 20 employees), are excluded from the scope of the employment provisions in the Act, it is important to note that freelancers may count towards the total head count of staff.The foundation of an employment relationship is the contract and the precise terms of the contract need to be thought through and accurately documented.

All employees, irrespective of the number of hours worked each week, who have one month's continuous employment are entitled to a written statement of terms and conditions of employment within two months of the commencement of employment; see s.1 Employment Rights Act 1996.

The Act sets out the matters which must be covered.

However, it is worth remembering that the statutory statement is not the same as the contract; see Aparau v Iceland Frozen Foods plc [1996] IRLR 119.

An employer will often be well-advised to ensure that employees sign up to appropriate contracts rather than merely issuing them with statutory statements.In a growing business, there may be scope for a variety of atypical employment arrangements.

A fixed term contract is one possibility which carries the potential advantage that, if certain conditions are met, the right to claim unfair dismissal or a statutory redundancy payment may be waived by the employee.

Annual hours contracts may help to achieve flexibility for the business, whilst preserving security and a regular monthly income for employees.

Such contracts set out the total number of hours to be worked over the year, rather than the number of hours to be worked each week.

The hours can then be adjusted by the employer according to need and the employee will usually receive the same monthly salary regardless of the actual hours worked, with holidays and other contractual benefits accruing in the usual way; see Ali and others v Christian Salvesen Food Services Ltd [1995] IRLR 624.Zero-hours contracts, whereby the employer may be under no obligation to give the employee work at certain times, are more controversial.

Prior to winning the General Election the Labour Party expressed considerable reservations about the use of such contracts.Finally, it will be sensible to advise the directors of a company that they too should have suitable service agreements.

The financial implications for the company of a lengthy notice entitlement on the part of a director need to be considered, especially in view of the award of £3 million to a dismissed executive in a recent wrongful dismissal case in the High Court.The contract should deal with confidentiality obligations; see Faccenda Chicken Ltd v Fowler [1986] ICR 197 and Lansing Linde Ltd v Kerr [1991] IRLR 80.

The eternally vexed issue of restrictive covenan ts will also need to be addressed.

The business will wish to guard against unfair competition as the poaching of employees and clients is not uncommon.

However, restrictions imposed on an ex-employee need to be reasonable and should go no further than is necessary to protect the legitimate commercial interests of the business.

The classic solicitors' mistake in this area is to pull a 'standard clause' out of a precedent book and to introduce it into a standard form contract without thinking about its implications and discussing fully with the client the relevant circumstances.

There is a steady flow of reported cases in this area; one of the most recent being Rock Refrigeration Ltd v Jones and another [1996] IRLR 675.

In addition to undertaking the necessary drafting work, a capable solicitor will usually offer practical advice to the client on ways and means of guarding against unfair competition.Even in its early days, the company will also benefit from having written disciplinary rules and procedures (not withstanding the existence of another 'small employer' exemption in the legislation), a health and safety policy and an equal opportunities policy.

The company should also set out its policy for allegations of sexual harassment; see Insitu Ltd v Heads [1995] IRLR 4.Because of the professional standards by which they are themselves bound, solicitors are well-suited to advising clients on the increasingly important issue of ethical employment practices.

There is little doubt that courts and tribunals now expect employers to adopt higher standards of behaviour towards their staff than in the past.

There are numerous illustrations of this trend in the case law concerning the interpretation of the implied contractual duty of mutual trust and confidence and in claims involving allegations of workplace bullying or sexual or racial harassment; for a dramatic recent example, see Burton and Rhule v De Vere Hotels [1996] IRLR 596.

Again, it is foreseeable that even a relatively small business will require advice on a number of equality issues, especially now that part-time workers have, in effect, the same rights as full-timers.The issues covered above are in some respects the tip of the iceberg.

The subject of dismissal law, for example, is beyond the scope of this article.

But enough has already been said to indicate the potential in this field for developing a mutually beneficial relationship with the business client.

And if the client has the confidence and foresight to seek advice from its solicitors before taking steps which may result in a dismissal, expensive mistakes should be avoided.JOHN LOOSEMOORE EXPLAINS WHY SOLICITORS SHOULD HOLD CLIENTS' HANDS WHILE LOANS ARE BEING NEGOTIATED WITH BANKS.Solicitors need to educate clients to take their advice prior to and during negotiations as opposed to merely have the solicitor check documents after a negotiation has been concluded by the client.

A bank will almost certainly have two or three people at the negotiating table and a solicitor's presence will greatly assist the client, both financially and psychologically.

It is also much easier for a solicitor to influence negotiations as they proceed.UNDERSTANDING HOW BANK MANAGERS THINK.Banks give you an umbrella when it is fine and take it away when it starts to rain.

The aim of a successful negotiation with the bank it to minimise the customer's vulnerability if the bank takes the umbrella away.

The most common form of umbrella is the overdraft.

Yet this plays into the hands of banks because the overdraft can be recalle d at any time, interest is more expensive than for term borrowing, they tend to grow and partners are jointly liable for them.When negotiating terms at the outset, clients should not wait to see what the bank will offer but should specify clearly what terms they are seeking.

A bank likes to control all a customer's business.

The chances of negotiating attractive terms are therefore increased by spreading borrowing between two or more lenders.

In particular, the proprietor's personal banking should be kept separate from business banking.PRE-NEGOTIATION PREPARATIONBankers look primarily to the strength of the borrower's business as opposed to the security.

Find out, in advance, what mandate a particular manager has.

If it is insufficient, go to a bigger branch or deal direct with the bank's specialist business unit.

Break down the total borrowing requirement into separate term loans for specific needs.

Try to spread these between several banks.

Term loans should therefore be in place before negotiating the overdraft facility.

Decide what security, if any, your client is prepared to offer the bank.

If a property is to be offered, obtain a valuation and provide a copy for the bank.

Decide what documents to give the bank, prepare them thoroughly and take them to the negotiation.-- The client's business plan should cover two or three years.

More long term plans are often highly speculative.-- A cashflow projection is a monthly comparison of anticipated receipts and expenditure of both an income and capital nature.

It enables clients to project their borrowing requirement on a monthly basis.-- Existing businesses often face a dilemma over the production of their accounts to the bank.

When preparing accounts for taxation purposes, the aim is to minimise profit whilst keeping on the right side of the law.

It is now accepted business practice for customers to present 'management accounts' to the bank.

These can include items which may have been omitted from the account for the Inland Revenue.

For example, many professional firms do not include work in progress in their accounts for the Revenue, but this can be included in management accounts for the bank.

When producing management accounts, make sure to label them as such to avoid any suggestion of misrepresentation.-- Limited companies will also need to produce the memorandum and articles, certificate of incorporation, and a board minute authorising the borrowing.THE NEGOTIATIONExplain clearly what terms your client is seeking.-- Borrowing requirement: be specific as to the overdraft or term loan required.

In the case of the latter, agree the term and monthly repayments.

Make sure that it is a genuine term loan and that the bank cannot recall the loan before the expiry of the term, except where the customer defaults on the repayments.-- Rate of interest: always link this to the base rate as this prevents the bank having grounds to renegotiate terms when the base rate changes.

Term loan rates are usually lower than overdraft rates, but the latter can be minimised by reducing the overdraft requirement through selective term borrowing elsewhere.-- Security: withstand the bank's attempts to push financial services-linked lending.

For term borrowing, a repayment mortgage is usually better with perhaps a mortgage protection policy.

For overdraft borrowing, the bank may well be prepared to rely only on stock in trade or work in progress.

If possible, resist 'all monies' security by linking the security to the specific numbered bank account.

If the client has several borrowings with the same bank, delete the bank's right of consolidation in case the client wishes to repay one of the loans early.-- Clearance: this is important for businesses with large takings which may be able to earn interest on current account.

Clearance for interest must be distinguished from clearance for fate or drawing against.

The former is more important and the period you can negotiate will vary between two and four working days.Bank charges: distinguish these from interest.

Banks seek to charge on a variety of different transactions.

They may also seek an arrangement fee, often payable annually.

The practice is also creeping in of charging customers for manager's time.

Banks have been known to make errors when debiting customers' accounts with bank charges -- clients should always ask for a detailed breakdown and check it thoroughly.Reach agreement face to face and do not leave matters to be resolved in lengthy correspondence.

When agreement is reached, the client should sign the papers needed to open the account there and then.AFTER THE NEGOTIATIONIt is essential to write to the bank with confirmation of the agreed terms as opposed to waiting for the bank's documentation to arrive.

If clients split their banking as a result of the negotiation, this is the time to attempt to renegotiation with their original bank.

Banks will not allow customers to renegotiate more favourable terms unless they fear they might lose their business.PAUL MANSER EXPLAINS HOW THE NEED TO RAISE EXTRA CAPITAL CAN HAVE IMPLICATIONS FOR THE STRUCTURE OF THE GROWING BUSINESS.Your client wishes to discuss with you proposals to build on current success and proceed to the next stage of business development.

For those purpose the client may need additional capital.Capital may be provided from several sources.

First, borrowings: the ability of the company to borrow will depend upon the level of its existing borrowings, the relative costs of loan finance and equity capital and the availability of suitable assets acceptable as security.

Also, if the company has an overdraft already guaranteed by existing shareholders, it may not wish to increase its exposure.If borrowings and internally generated capital are unavailable, the existing shareholders should consider whether they are both willing and able to provide extra capital themselves.It is possible that outside equity investors may be the only viable alternative.

Although there would then be a number of options available to the company, these depend on whether the company wishes to remain private, with outside investors, or to become a public company, the shares in which are available to the public.If it wishes to remain a private company and seek additional shareholders, sources of funds include venture capital organisations and business angels.

In any event, the introduction of outside investors will result in the dilution of the existing shareholders' interests.

The right balance between desire for growth the relinquishing of total control must be found.When outside investors are introduced into the company, it is likely that they will be minority shareholders.

They will want additional protections to supplement their rights under company law including, for example, s.459 of the Companies Act 1985 which provides protection for shareholders against unfair prejudice.

A shareholder with less than 25% of the voting rights will not have power to block special resolutions and a shareholder with less than 50% will have no power to block ordinary resolutions; see s.378 of the Companies Act.

For this purpose, different classes of shares will be created and special class rights will be incorporated into the company's articles of association and substantial modifications will be made to Companies Act 1985 Table A SI 1985/805, schedule, as amended by SI 1985/1052.

Additional protection will also be set out in a shareholders' agreement so that a minority shareholder will have a right of veto on key matters.As a result of investment by a third party, the board will need to be restructured to accommodate the investor's likely requirement of at least one seat on the board, perhaps as chairman.After consideration of these key points, the company will wish to contact prospective investors.

For this purpose, compliance with the Financial Services Act 1986 will be essential.

Section 57(1) of the Act prohibits the issue of an 'investment advertisement' in the United Kingdom, except by an authorised person or unless it has first been approved by an authorised person.

The definition of an 'investment advertisement' in s.57(2), in conjunction with its definition in s.207(2), is extremely wide.

The sending of a business plan or other management information to a prospective investor, if it is likely to result in an investment in the company, would fall within s.57(1).There are exemption in s.58 and statutory instruments SI 1995/1536 and SI 1996/1586.

If there are no relevant exemptions from s.57, the investment advertisement will require the approval of a person authorised to carry on investment business who must comply with the rules of the self-regulating organisation of which that person is a member.As an alternative to remaining a private company, the company may wish to enhance its status by becoming a public company with an enlarged number of shareholders and an increased capital base.

In order to become a public company, the company would have to comply with the requirements of Part II of the Companies Act relating to inter alia, amendments to its memorandum of association and the size of its allotted and paid up share capital.

There are a number of markets from which funds may be raised by a public company including the London Stock Exchange, the Alternative Investment Market (AIM) and OFEX.The strategy selected by the company will depend on its long term objectives but whichever proposals are selected, the legal adviser will be able to assist on business, technical and other legal issues.JANIS LAW DESCRIBES THE WIDER ROLE WHICH THE SOLICITOR MUST PLAY WHEN ADVISING ON A MANAGEMENT BUY-OUT.You have received a call from a client who is buying the business he or she manages.

What can you expect and how do you prepare for it?Most lawyers can advise on the law and put in place documents recording the agreed deal.

However, a good lawyer recognises that in a management buyout (MBO) transaction he or she must play a wider role.The MBO is a complex transaction.

You have to negotiate a sale agreement with the vendor and funding documentation with the venture capitalist and the bank.

You will need to 'project manage' the transaction to ensure that it completes on time with minimum costs being incurred.You should also recognise that most clients will never have been involved in an MBO before.

MBOs generally move very quickly -- your clients will emerge at the end feeling completely shell-shocked.

A good MBO lawyer helps clients to feel in control by keeping them informed about what to expect.

Managing the management's expectations is the key to success.INITIAL STEPSEstablish what stage clients have reached in the process: -- Have they appointed a financial advisor and/or approached venture capital houses and banks for finance? Will they ask you for recommendations?-- Have they approached the vendor or were they approached by the vendor? This can dictate your negotiating position.-- Was the deal with the vendor put together by the management or by the venture capitalist (a bought deal).

If the latter, check how involved the venture capitalist's lawyers will be -- they may negotiate the sale with the vendor.-- Have terms been agreed with the vendor, venture capitalist and banks? Ensure that you fully understand the terms agreed and the rationale behind them.

If in doubt ask why this structure is proposed.

Prepare a timetable.

Itemise each step of the MBO and allow realistic periods of time in which to complete them, while keeping the pressure on to bring the transaction to a swift conclusion.

Include a list of parties, with work and home contacts, and a list of documents.

Be prepared to revise the timetable if a problem arises causing the allocated times to slip.Manage clients' expectations.

Warn them that:-- They are employed by the vendor to run the business that they are buying.

If they devote too much time to the buyout, the business could suffer or they could be in breach of their service contracts if the deal aborts.

Get the vendor's agreement to them neglecting their duties to effect the MBO.-- The documentation will be drafted to protect the venture capitalist and the bank.

Present this as positively as you can; build in protections and keep the management focused on the real prize -- owning their own business.Is an acquisition vehicle needed ('Newco')? The venture capitalist will expect a company which has not traded previously to acquire the business.

Your clients can obtain tax relief for interest paid on money borrowed to invest in ordinary share capital of a close company; see s.360, Income and Corporation Taxes Act 1988.

Can you structure the investment to achieve this?Identify the financial assistance issues in the transaction (usually where the bank requires security for its debt finance) and explain them and the whitewash procedure to clients.KEY ISSUES ARISING FROM THE DOCUMENTATION-- Sale agreement: this records the sale of the business to Newco.-- Warranties: the vendor will argue that the management should know all there is to know about the business and therefore no warranties need to be given.

Explore the truth of this with your clients.

In most groups some functions are centralised -- tax and accounting are prime examples.

Clients would not have control over these and therefore could legitimately expect warranty protection from the vendor.-- Investment agreement: the terms on which the venture capitalist invests.-- Information: the venture capitalist will expect full information throughout its investment -- annual business plans, cashflow forecasts, management and audited accounts and access to board papers.-- Controls: there will be clauses preventing the management or the business taking certain actions without the consent of the venture capitalist.

These will cover, for example, appointing directors; granting charges over the business; changing the nature of the business as well as financial covenants -- undertaking not to incur capital expenditure over a certain amount.

These clauses can be negotiated.-- Warranties: the venture capitalist will seek warranties from the management to protect its investment.

The management will have corresponding protection from the vendor but the solicitor can pro tect them by conducting a thorough disclosure process and by negotiating acceptable limitations.

Most venture capitalists will allow liability to be capped at their investment and you can negotiate other limitations; a de minimus; credit for third party claims etc.

Similar provisions will also be found in the finance documentation produced by the bank.NEWCO'S ARTICLES OF ASSOCIATIONThis records the share types and rights.-- Share types: it is common for the venture capitalist to acquire preference shares, whilst management hold ordinary shares.

The shares held by the venture capitalist will provide for the right to appoint at least one director of the company.-- Ratchet: there may be ratchet that allows the management to acquire a greater share of the ordinary share capital if the company performs well.

This can be structured in many ways: for example the venture capitalist may hold preferred ordinary shares that convert to worthless deferred shares if a certain market capitalisation is achieved on exit, or a certain level of profit is reached.

The ratchet must be carefully drafted to record the parties' intentions.-- Share transfers: the venture capitalist will seek to limit the persons to whom the management can transfer shares, to incentivise them through their share ownership.

It is also common to see detailed pre-emption provisions and forced transfers on employment ceasing, sometimes with different provisions for 'good' and 'bad' leavers.

These provisions substantially restrict the management and you must negotiate the best position that you can for them.-- Service agreements: venture capitalists want to see reasonable notice periods and restrictive covenant protection in the management's service agreements.There are pitfalls in an MBO transaction for the general practitioner, especially as they are up against MBO specialist lawyers acting for the venture capitalist and the bank.

However, the MBO can also be one of the fastest paced, exhilarating and rewarding corporate transactions for both management and their lawyers.CAROLINE DERSELY REVIEWS THE VARIOUS OPTIONS TO BE CONSIDERED BY A SOLICITOR WHEN A BUSINESS RUNS INTO FINANCIAL DIFFICULTIES.A company seeking insolvency advice will doubtless already be experiencing serious financial difficulties.

It may also have funds tied up in obsolete stock.A company may continue trading while insolvent.

There is a practical issue here of establishing whether the company is, in fact, insolvent.

Under the Insolvency Act 1986, a deficiency of assets and the inability to pay debts as they fall due constitute 'insolvency'.

The state of insolvency does not in itself have any legal consequences.

Only when the company is subject to a formal insolvency procedure does the question of civil or criminal liability arise, and transactions previously entered into may become liable to be set aside.

If the company is insolvent, its directors may instigate proceedings themselves in order to stay possible action by creditors and allow the company to be restructured with a view to trading its way to solvency, or in order to minimise potential loss to creditors to whom at this stage the directors owe their primary duty.INSOLVENCY PROCEDURESThere are four principal insolvency regimes, some of which are open to the company and some of which are only open to its secured creditors:-- Receivership is a self-help remedy for secured creditors.

Generally, a bank will appoint a receiver because it is quicker and cheaper than involuntary liquidation proceedings.

A receiver's function is to rea lise the assets and property charged and to repay the chargeholder after deduction of the receiver's fees and costs.-- The company may approach its creditors to reach an informal agreement by which the creditors agree not to take action and the company agrees to pay its debts at a specified rate.

These would be ad hoc contractual arrangements set up with each creditor.Otherwise a formal agreement or scheme is needed.

Such an agreement can take one of two statutory forms: a scheme of arrangement ('scheme') under s.425 of the Companies Act 1985 and a corporate voluntary arrangement (CVA) under Part I of the Act.

Both will be supervised by an insolvency practitioner.

The CVA is a flexible procedure, suitable for smaller companies being less complex and costly.

It is effective from its approval at a creditors' meeting whereas a scheme requires court approval to be binding.

But, the CVA will not bind any creditor who has had no notice of the creditors' meeting; or secured or preferential creditors (without their consent).

Neither a scheme nor a CVA imposes a freeze on action by creditors.

In short, the viability of a scheme or CVA will depend on the positive attitude of the creditors.-- Administration is a court-based, reorganisation procedure for which an application can be made by the company directors or by a creditor.

An administration must demonstrate any of four purposes, being: the survival of the company, or part of its business, as a going concern; the making of a CVA or a scheme; or if nothing else, a more advantageous realisation of the assets than could be achieved in a liquidation.

The administrator, appointed by the court, would effectively displace the directors in running the company.

From the presentation of the administration petition until the order is made there is a freeze on creditor action without leave.

The only enforcement of security which may take place is that a creditor entitled to appoint an administrative receiver may do so.

It would therefore be important to secure the support of the bank to an administration.-- Liquidation is a procedure for winding up companies.

It is a procedure of last resort and a liquidator would be appointed to take control of the company and to collect, realise and distribute its assets where there was no prospect of reorganisation.

There are two statutory routes to liquidate an insolvent company: a creditor's voluntary liquidation and a compulsory liquidation.THE POSITION OF DIRECTORSIf the court finds that acts and omissions of the company's directors have had a detrimental effect on the company's financial position, it may declare them personally liable to contribute to the company's assets.

The main areas of concern for directors include:-- A director's liability for wrongful trading under s.214 of the Insolvency Act 1986.

If the company were to go into liquidation and, prior to the start of liquidation, the directors knew or ought to have concluded that there was no reasonable prospect of it avoiding insolvent liquidation, they may be liable for wrongful trading unless they can show that they took every step to minimise the potential losses to the company's creditors.-- There are both civil and criminal sanctions for fraudulent trading under s.213 of the Act, which apply only in a liquidation if a director was knowingly and actively a party to company business carried on with intent to defraud its creditors.-- There is also the risk of disqualification.

The court will make disqualification order of between two and 15 years against a director of an insolvent com pany where it is satisfied that his or her conduct is such that he or she is unfit to be concerned in the management of a company.

In general terms, a court is looking for evidence of a lack of probity not just commercial misjudgment.-- A breach of the common law fiduciary duties owed by directors to their company which once the company is insolvent, are owed to the creditors rather than the shareholders.ADJUSTING ANTECEDENT TRANSACTIONSIf the company goes into liquidation or administration, certain categories of transaction previously entered into may be examined, set aside, and the resulting benefits received by third parties may be clawed back.

The intention is that an insolvent company should not be able to benefit a person, particularly a 'connected' person and thereby reduce the assets generally available to unsecured creditors.

Such transaction are governed by s.238-s245 and s.423-s455 of the Act and include transaction at an undervalue, preferences and extortionate credit transactions.