The Intelligent Quarterly from the publishers of The Insurance Insider

Summer 2018

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Trouble in paradise

Mark Sutton and Karen Boto

Yet again tax avoidance is making headline news. The latest scandal, the so-called Paradise Papers, saw over 13.4 million documents leaked to the German media. These leaks are revealing the offshore investment arrangements of corporate entities and the rich and famous. They are also putting increasing pressure on governments to increase their regulatory powers to force companies to review their business practices.

The Criminal Finances Act
The UK government is strongly attuned to changing public expectations regarding corporate behaviour, and indeed the UK Criminal Finances Act 2017 came into law on 30 September just before this latest incident.

The key change introduced by the act is that it enables companies and partnerships, as well as individuals, to be held accountable for incidents of tax evasion.

The act introduces two new corporate criminal offences, namely the failure of a corporate body to prevent the facilitation of both UK and overseas tax evasion by an "associated person" - an employee, agent or any other person performing services for or on behalf of the corporate body.

This in turn forces directors and officers (D&Os) to maintain better control of their businesses' conduct, wherever in the world they operate.

Before the new act, it was very difficult to hold a corporate body liable for tax evasion - a notable example being HSBC's Swiss banking arm, which allegedly helped wealthy clients to evade taxes but was never called to account by the City regulator.

Under the new legislation, corporate bodies will be required to establish appropriate procedures to prevent any personnel or agents operating on their behalf from deliberately facilitating criminal tax evasion.

The penalties that can be brought against a corporate body found to have committed one of these new offences are tough. They include an unlimited financial penalty and possibly ancillary orders, including confiscation orders or serious crime prevention orders.

In addition, the conviction will be on public record, so if the media furore surrounding the Paradise Papers is any indication of the national mood (where the important distinction between legal avoidance and evasion is often blurred) the company will also suffer considerable reputational damage.

A successful prosecution may also prevent a business from bidding for public contracts.

The new offences apply to all UK companies and partnerships no matter what size, and are modelled on the "failure to prevent" bribery offence contained in the Bribery Act 2010.

Like the Bribery Act, the new Criminal Finance Act imposes "strict liability", which means there is no requirement to prove involvement of the "directing mind" of the corporate body. This approach is designed to overcome the previous difficulties encountered when trying to bring businesses to account for corporate offences.

For a company to be found liable three elements of the offence must be established:

  • Criminal evasion of tax by a taxpayer (either an individual or a firm)
  • Criminal facilitation of the tax evasion by an associated person of the relevant corporate body, acting in that capacity.
  • Failure by the corporate body in preventing the associated person from facilitating the criminal act.

A complete statutory defence is available to corporate bodies alleged to have committed one of the facilitation offences, if they can show that they implemented reasonable preventative procedures (expected in the circumstances) or where it would have been unreasonable or unrealistic, in the circumstances, to have expected such procedures to be implemented.

What should businesses do?
The onus is on the owners and senior managers of a company to put the appropriate prevention and detection measures in place. The new offences will therefore create the need for further internal investigations to be conducted by large companies to ensure that appropriate measures are in place, which might also encourage both whistleblowing and self-reporting.

This creates a heightened risk of claims being brought against D&Os who may be in breach of their duties to the corporate body if it is determined that the procedures they have in place are inadequate.

The new act also permits the use of deferred prosecution agreements (DPAs), which are a discretionary tool enabling prosecutors to potentially allow culpable companies to avoid a criminal conviction and receive a reduced fine if the corporate body admits any wrongdoing and cooperates, to the satisfaction of the prosecutor and the court.

Although going down the DPA route would spare the guilty corporate body a conviction, one concern is that often the DPA will involve the corporate agreeing to assist and cooperate with the prosecutor's ongoing investigation into particular individuals, which could lead to a greater number of requests for costs indemnity under D&O policies.

The evidence and cooperation obtained from a DPA are also likely to increase the number of convictions against directors. Last month we saw this in action with the former executives of Rolls Royce pleading guilty to bribery and corruption of foreign government officials.

This action may have been influenced by the significant DPAs that Rolls Royce entered into with various regulators.

Implications for insurers
In response to this situation, insurers may want to review their policy wordings to exclude liability for claims that arise out of an approved DPA, in order to avoid paying costs upfront and then having to claw them back post-conviction.

Insurers may also want to consider reviewing the criminal conduct and (given the potential for claims brought by the company against directors) insured versus insured exclusions in their policy wordings.

In particular, brokers and insureds may expressly seek confirmation that cover is extended to this new legislation, as they did following the introduction of the Bribery Act.

Internal investigation costs will be another key consideration for insurers as the new offences will increase the need to conduct complex internal enquiries.

D&O insurers may want to review their policies to see if they will be expected to meet the costs of any such investigation, before a prosecution is initiated. They also might want to consider if they are prepared to provide cover for these investigations for the corporate entity as well as the individual D&Os.

Watch this space
The risk of corporate prosecution is only going to rise. The introduction of the Criminal Finances Act will undoubtedly make it easier to prosecute corporate bodies in relation to tax evasion offences. The recent decision in Ivey v Genting Casinos, which changed the criminal test for dishonesty and is widely tipped to make it easier to prosecute tax evasion facilitation offences, will also lower the bar.

More broadly, this change comes at a time when corporates are readying themselves for the introduction in May 2018 of the general data protection regulations (GDPR), which will bring cyber risk and the management of sensitive data to the forefront of the risk landscape for companies both in the UK and across the EU, further increasing exposures for D&Os.

For financial services and market authority-approved firms, the scrutiny will be unprecedented as they get to grips with the extension of the Senior Managers and Certification Regime to all authorised firms in 2018.

This means that D&Os and their insurers and brokers will need to stay alert, particularly as the government looks set to tighten corporate governance further with the suggestion that more "failure to prevent" offences for other forms of economic crime may be introduced soon.

With this changing regulatory environment in mind, insurers may wish to review the breadth of their D&O policy cover. Over the past few years they may well have seen their wording "creep" in response to intense competition in the market.

Brokers should also be alert to the current situation and ensure that insureds have the appropriate insurance protection in place.

Could the perfect storm of new revelations of potential tax avoidance on an unprecedented scale, changing public attitudes to corporate governance and more onerous regulation be the trigger that finally turns the D&O market? All we can say is "watch this space".

Mark Sutton is a partner at Clyde & Co.

Karen Boto is legal director at Clyde & Co

This article was published as part of issue Winter 2017

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