Referring to legislation in finance documents: more than you bargained for?

Edward Cumming KC and Tom Stewart Coats explore the risks associated with the common practice in finance documents of including references to legislation in their article for Lexis®PSL.

This article was originally published in Butterworths Journal of International Banking and Financial Law by LexisPSL on 10 March 2023: Referring to legislation in finance documents: more than you bargained for? (2023) 3 JIBFL 162 

Key Points

• Parties to finance contracts should monitor potential changes to their understanding of their bargain where clauses refer to legislation given the prospect of amendments to, repeal of, or re-enactments of, that legislation.
• If references to categories of legislation are drafted in general terms (for example, concerning economic sanctions or the environment), uncertainty over what legislation is or is not included could give rise to disputes.
• Where references to regulatory duties are included in a finance contract, parties should be alive to the risk that those duties could be said to have been incorporated as contractual duties.

Referring to legislation in finance documents: more than you bargained for?

It is common in both standard-form and bespoke finance documents governed by English law to find references to UK and foreign legislation, particularly within the definitions section of the contract. Common examples include references to regulatory obligations of one or both of the parties, references to economic sanctions regimes, references to UK and US tax regimes, and the use of statutory definitions (for example, definitions of “subsidiary” and “subsidiary undertaking” in ss 1159 and 1162 of the Companies Act 2006). Whilst references of this sort have important functions in banking and finance contracts, parties and their advisors need to be aware of the risks associated with them.

AMENDMENTS TO STATUTES REFERRED TO IN A CONTRACT

Finance documents often include a general provision to the effect that a reference to a provision of law is a reference to that provision as amended or re-enacted. An amendment clause of this sort has the advantage of ensuring that references to legislation do not become out of date without amendment by the parties. Amendment clauses also reduce uncertainty about whether the reference includes updated or re-enacted versions of the legislation. The risk with a clause of this sort is, however, that an amendment to a piece of legislation may substantially change an important aspect of the contract. References to EU legislation in pre- Brexit contracts and to retained EU law in post-Brexit contracts are examples of legislation whose content may change substantially as a result of amendment or re-enactment. In a pre-Brexit finance contract, for example, there may be a reference to the EU Market Abuse Regulation. Following Brexit, the contract must be interpreted to determine whether the parties should be taken to have intended the reference thereafter to be to the EU Market Abuse Regulation or to the on-shored UK Market Abuse Regulation or to both pieces (or, perhaps, neither piece) of legislation.

In a post-Brexit contract, an express reference to the retained version of what was an EU Regulation may end up being interpreted as referring to legislation that varies very substantially over time, whether by reason of: changes as a result of divergences of interpretation among English courts and UK regulators as compared with equivalent interpretations in the EU; express amendments to the retained legislation to adapt to local concerns or policy priorities; and a radical overhaul of retained EU law of the sort envisaged by the Retained EU Law (Revocation and Reform) Bill 2022- 2023 and the Financial Services and Markets Bill 2022-2023.

Another potential amendment to legislation which could have a significant impact on the meaning of a defined term in finance documents can be found in the Economic Crime and Corporate Transparency Bill 2022-2023. Readers may recall that the Economic Crime (Transparency and Enforcement) Act 2022 introduced a registration regime which required overseas entities that own or acquire UK real estate to register on a Register of Overseas Entities at Companies House, to disclose their beneficial owners, and to reconfirm or update their registration annually. An overseas entity that fails to comply with this regime restricts its ability to deal with its UK real estate, which could affect transactions involving, and security over, such real estate.

The Economic Crime and Corporate Transparency Bill, which is currently making its way through the House of Commons, includes a provision that would change the definition of a “registered overseas entity” in the Land Registration Act 2002 in a way that could have important implications for real estate finance documents. If the proposed provision passes, it would mean that the overseas entity would not be treated as a “registered overseas entity” if it failed to respond to a notice from the Registrar of Companies under a new power to require information. Since the failure to respond to a notice would not appear on the face of the Register (unlike the registration status arising out of initial registration and required annual updates), the relative certainty of the current system would be replaced by a system where the lender would have no reliable way to be sure that an overseas entity should be regarded as “registered” at any particular moment in time. This sort of situation was unlikely to be in the contemplation of the parties to real estate finance facilities that were drafted solely by reference to the existing regime.

Finally, we note that amendment clauses of the sort considered in this part of the article impose an important, and often onerous, monitoring obligation on parties and their lawyers to consider whether amendments or re-enactments to legislation referred to in the contract substantially affect the parties’ rights and obligations under the contract (particularly insofar as
a party may enjoy rights of termination or other rights that, if exercised, could improve its position).

REFERENCES TO LEGISLATION IN GENERAL TERMS

At the other end of the spectrum from references to particular provisions in a specific statute are references to legislation in very general terms.
There are good reasons why parties may wish to be as inclusive as possible when it comes to contractual obligations to comply with legislative regimes such as, for example, relevant economic sanctions regimes. It is therefore common in finance documents to find a clause to the effect that an obligor under a facilities agreement will comply with applicable sanctions regimes, often accompanied by a wide definition of what is meant by “sanctions” and express references to regimes imposed by the US, the UN, the EU and the UK. However, difficulties can arise when it is unclear what exactly is encompassed by references to applicable sanctions regimes.

In Lamesa Investments Limited v Cynergy Bank Limited [2020] EWCA Civ 821, an English bank borrowed from a company indirectly owned by a Russian individual who became subject to US sanctions. As a result, the claimant company became a blocked person which meant that those dealing with it became subject to US secondary sanctions legislation. US legislation allows the imposition of secondary sanctions affecting property subject to US jurisdiction that belongs to non-US persons even if those persons were not themselves operating in the US. Under the facilities agreement, the defendant bank was not in default for non-payment if it could satisfy the claimant that it did not make the payment “in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction”. In a decision that has attracted significant comment, the Court of Appeal held that the US secondary sanctions were included within the meaning of “any mandatory provision of law”, on the basis that they amounted to “an effective prohibition” on payment even if they did not, and could not, directly prohibit a payment from the defendant bank to the claimant company.

It is also common to find provisions in finance documents requiring one or both parties to comply with all “environmental laws” or requirements for regulatory disclosure that may be applicable to that party (or otherwise). Given the rapid increase in regulation concerning environmental issues that is applicable to the financial sector, this sort of clause potentially imposes an extremely broad monitoring obligation on the parties and their counsel. By way of example, many large UK companies (including financial institutions) are now subject to mandatory climate-related disclosure obligations that could fall within the meaning of “environmental laws” for the purposes of a finance contract. There may also be scope in some cases to argue that particular environmental duties have become terms of the contract between the parties. This issue is addressed in the next sub-section in the traditional context of references to non-environmental regulatory duties imposed on financial institutions, but given the increased prominence of climate- focussed investors and campaigning groups, such arguments may in future be raised in the context of environmental duties.

UNEXPECTED INCORPORATION OF REGULATORY DUTIES

For various reasons, finance documents often refer to regulatory obligations of one or both of the parties to the contract. A risk associated with this sort of reference is, however, that the duties referred to could be held to be incorporated into the contract as contractual obligations owed to the other party. There have been numerous attempts by clients of financial institutions to argue that references to the applicability of relevant rules or regulations to the financial institution mean that those rules or regulations, if breached, would also be a breach of contract. For example, in Brandeis Brokers Ltd v Black [2001] 2 All ER (Comm) 980, Toulson J held that contracts with a London Metal Exchange broker that were said to be “subject to” the rules of the Securities and Futures Authority incorporated aspects of those rules. To similar effect, In Larussa- Chigi v CS First Boston Ltd [1998] CLC 277, Thomas J held that a document which stated that transactions would be “governed by a Code of Conduct established by the Bank of England” effectively incorporated that code, which was said to apply not merely as a matter of regulation but also as a matter of contract.

In more recent years, attempts to argue that regulatory duties are incorporated into a contract by reference have, however, tended to fare less well: Target Rich International Ltd v Forex Capital Markets Ltd [2020] EWHC 1544 (Comm) at [95].

CONCLUSION

Parties to finance documents often seek to refer to legislative provisions, whether in specific terms or in general terms, for good and understandable reasons. In the haste of contractual negotiation, however, they would be well-advised to look for potential pitfalls that might otherwise leave them – in the event of legislative or constitutional change – with something rather different from that for which they had thought they had bargained.

Barristers

Edward Cumming KC

Tom Stewart Coats