Talking Point September 2015

A succinct discussion of selected topical, legal matters

Dear Friends and Colleagues

I take great pleasure in submitting the September 2015 edition of Talking Point to you.

Welcome to our new website visual structure layout.  We have updated the front-end code and implemented responsive code.  If it all works first time, our website visual structure layout will automatically adapt to the screen size of your device (be it a full size computer or an Android Tablet, iPad, iPod, Laptop, Smart Phone, or the like).  As programming the code of a website is seldom perfect first time, please forgive any teething problems.

Oscar Wilde (1854 –1900) was an Irish-born novelist and playwright.  In literature, he is best known for the wonderful play The Importance of Being Earnest, and for being the master of the epigram (an ingenious and witty expression).  In law, the trials of Oscar Wilde are one of the best examples of how lying to one’s lawyer can literally cause one’s bankruptcy, imprisonment, and even death.  The 1997 biographical film Wilde, with Stephen Fry in the main role, was widely acclaimed.

Oscar Wilde is still today one of the most quoted persons in English.  The following epigrams are a mere small sample:

  • I can resist everything except temptation.”

  • The truth is rarely pure and never simple.”

  • A man cannot be too careful in the choice of his enemies.”

  • The public have an insatiable curiosity to know everything, except what is worth knowing.”

  • Education is an admirable thing, but it is as well to remember that nothing that is worth knowing can be taught.”

  • There is no sin except stupidity.”

The famous legal cases discussed in this issue are the trials of Oscar Wilde.

We have many foreign clients, and perforce have to acquire some knowledge of their domestic legal arrangements.  Whilst we cannot accept responsibility in relation to a client’s position under foreign law (refer to our Terms of Engagement Policy on our website), we are on occasion called upon to express a view on foreign law and documents governed by foreign law, and to prepare documents to be governed by foreign law.  As a once off only, this issue:

  1. deals with recent foreign judgments, all of which may in future have a bearing on South African law; and
  2. favours technical matters over the more remarkable.

Competition law: European competition law is influential in South Africa.  We discuss a European Court of Justice case dealing with the concept of “umbrella pricing” and concomitant damages.

Constitutional law: The Canadian Charter of Rights and Freedoms (1982) is the document that most influenced the drafting of the South African Constitution.  We discuss Canadian constitutional law cases dealing with race and religion.

Insolvency law: The 2008 Lehman Brothers bankruptcy filing was the largest in history (both its assets and liabilities well exceeded USD 600 billion), and has led to much litigation.  We discuss the ‘safe harbour’ against counterparty bankruptcy provisions that apply to master agreements.

Insurance law: UK insurance law is influential in South Africa.  We discuss an insurance case with regard to an aggregation clause.

Tax law: In the context of a UK tax case dealing with a USA limited liability corporation, we discuss the local position in respect of synchronisation of international tax treatment of hybrid entities.

As always, I would greatly appreciate your feedback on Talking Point. Please email me at charlt@walkers.co.za.

Regards

Charl Theron

In this issue:

LEGAL MATTERS

To pray or not to pray

Jerome smallby Jerome Veldsman

Mouvement laïque québécois v. Saguenay (City), a judgement of the Canadian Supreme Court on 15 April 2015, dealt with freedom of conscience and religion (section 3 of Quebec Charter of Rights and Freedoms).  Such freedom includes freedom of conscience, freedom of religion, freedom of opinion, freedom of expression, freedom of peaceful assembly, and freedom of association; and is in part similar to its counterpart in the South African Constitution.  However, the latter also contains a qualification that contradicts the notion of a secular state.

At the start of every public municipal council meeting in the City of Saguenay, the mayor recited a Christian prayer.  A person who regularly attended the municipal meetings asked the mayor to stop the practice, as the prayer made him, as an atheist, feel isolated and excluded because of his religious views.  The mayor refused.  The appellant, a non-profit organization supporting secularisation, filed a complaint to the Human Rights Tribunal, and the matter progressed to the Supreme Court.

The Court set out the state’s duty of religious neutrality, which results from an evolving interpretation of freedom of conscience and religion in Canada:

“… the state must not interfere in religion and beliefs. The state must instead remain neutral in this regard, which means that it must neither favour nor hinder any particular belief, and the same holds true for non‑belief.”

The Court found that the Christian prayer was in breach of the state’s duty of neutrality:

“The prayer … resulted in a distinction, exclusion and preference based on religion – that is, based on S’s sincere atheism – which, in combination with the circumstances in which the prayer was recited, turned the meetings into a preferential space for people with theistic beliefs. The latter could participate in municipal democracy in an environment favourable to the expression of their beliefs. Although non‑believers could also participate, the price for doing so was isolation, exclusion and stigmatization. … The attempt at accommodation provided for in the by‑law, namely giving those who preferred not to attend the recitation of the prayer the time they needed to re‑enter the council chamber, had the effect of exacerbating the discrimination.”

The South African Supreme Court of Appeal, and a few lower courts, has in passing described South Africa as a secular state.  In the National Policy on Religion and Education (2003), the then Minister of Education stated in his foreword: “We do not have a state religion. But our country is not a secular state where there is a very strict separation between religion and the state.”  The South African Constitutional Court painstakingly avoids the question.  In the light of the latter’s general reverence for theistic beliefs, the Constitutional Court may well in similar circumstances come to a different finding.

Umbrella pricing

Roxy 5Jerome casualby Roxanne Ker and Jerome Veldsman

Kone AG and Others v ÖBB-Infrastruktur AG, a judgement of the European Court of Justice on 5 June 2014, dealt with umbrella pricing.

In the context of competition law, umbrella pricing occurs if, as a result of the activities of a cartel, firms (innocent firms) that are not members of the cartel, intentionally or unintentionally, also set their own prices higher than they would otherwise have done, because of the cartel maintaining such high prices.  As long as the innocent firms charge prices less or equal to that of the cartel, they will be able to find buyers, despite not charging their ‘best’ prices.  The cartel, as a by-product of its unlawful anti-competitive behaviour, creates an umbrella under which innocent firms can lawfully charge anti-competitive/inflated prices.

Over a period of decades, in numerous EU Member States, several well-known companies implemented cartels relating to the installation and maintenance of elevators and escalators.  Such conduct was in contravention of Article 101(1) of the Treaty on the Functioning of the European Union, which prohibits horizontal and vertical restrictive practices.  The South African counterpart is sections 4 and 5 of the Competition Act.

ÖBB-Infrastruktur sued certain cartel members in Austria for alleged damages as a result of ÖBB-Infrastruktur buying elevators and escalators from innocent firms at a higher price than it would have paid but for the existence of the cartel.

However, under Austrian law, a person who makes a claim for damages based on non-contractual liability must establish an adequate causal link and a link of unlawfulness.  In effect, such provision non-suited ÖBB-Infrastruktur.  In the Austrian Court, the question arose whether such provision was (or was not) consistent with (overriding) EU Law.  The Austrian Court referred the question to the European Court of Justice.  The latter answered in the negative.  Consequently, ÖBB-Infrastruktur would be entitled to damages, if it could prove its case.

In terms of section 65(6) of the South African Competition Act, a person who has suffered damage as a result of a prohibited practice may sue for damages.  There is no local precedent, but we are of the view that, if the case can be proven, a plaintiff will succeed with a claim under umbrella pricing.

 

Masked discrimination

Jerome casualby Jerome Veldsman

Kahkewistahaw First Nation v Taypotat, a judgement of the Canadian Supreme Court on 15 June 2015, dealt with the right to equality (section 15(1) of Canadian Charter of Rights and Freedoms).  Such right to equality prohibits discrimination based on race, national or ethnic origin, colour, religion, sex, age, or mental or physical disability; and is substantially similar to its counterpart in the South African Constitution.

The appellant was an Aboriginal community.  The community spent 13 years developing an election code, which included a Grade 12 education requirement for candidates who wished to be Chief.  The respondent had been Chief during such period.  The respondent was 76 years old and had a Grade 10 education.  He challenged the educational requirement (and his disqualification) on the basis that it was analogous to discrimination based on race and age.

The Court affirmed the two tier approach to section 15(1):

– Does a rule create a distinction on the basis of a listed or analogous ground?

– If so, does the rule impose a burden that reinforces or perpetuates disadvantage and/or discrimination?

The Court further affirmed that a seemingly neutral rule, like an education requirement, may well be a proxy for, or mask, a discriminatory impact.  However, as the erstwhile Chief had failed to present evidence about the relationship between age and education levels in the community, he already lost on the first tier:

“Statistical evidence is not always required to establish that a facially neutral law infringes s. 15. In some cases, the disparate impact on an enumerated or analogous group will be apparent and immediate… the evidentiary burden need not be onerous, the evidence must amount to more than a web of instinct.”

The South African Constitutional Court may well in similar circumstances find a discriminatory impact in the “web of instinct”.

To tax or not to tax

Belinda 2Jerome casual by Belinda van der Vyver and Jerome Veldsman

Anson v Commissioners for Her Majesty’s Revenue and Customs, a judgement of the UK Supreme Court on 1 July 2015, dealt with the question whether the (UK) taxpayer was entitled to double taxation relief (in the UK) under the UK/USA Double Taxation Agreement with regard to his profits (in the USA) as a member of a Delaware limited liability corporation (LLC), for a period of seven UK tax years.

The LLC concerned was HarbourVest Partners, a leading global private equity investment firm for more than 30 years.  George Anson became its Managing Director, and has been described as a “private equity star” and “third most influential individual in private equity“.  The amount of money concerned is not disclosed, but is rumoured to run into many millions of Pounds.

The USA levied federal and state taxes on Anson’s share of the LLC’s profits, and Anson remitted the balance to the UK.  The respondent (HMRC) levied UK income tax on the balance at the rate of 40%.  The question was whether such tax was being levied on the same profits on which the USA tax had already been levied.

HMRC argued for a negative answer; on the basis that the USA tax had been levied on income of the LLC (a separate company), and not income of Anson.  Anson argued for a positive answer, on the basis that his share of the profits of the LLC belonged to him personally.

Anson won in the tax court.  HMRC appealed to the tax appeal court, and won.  Anson appealed to the Court of Appeal (the second most senior court in the English legal system), and lost.  He then appealed to the Supreme Court, and won.  The Supreme Court held that on a proper analysis of the Delaware LLC Act and the constitutional agreement between the members regarding the LLC, Anson (personally) became entitled to his share of the LLC’s profits, as the profits arose.

A South African Court may well well in similar circumstances come to the same finding under the South Africa/USA Double Taxation Agreement.

We also address a ‘reverse’ of the facts in South Africa.  How must SARS tax the South African profits of, for instance, a Delaware LLC?

The constitutional document of a Delaware LLC is an agreement entered into by (only) its members, and such agreement may provide for the conduit principle to apply with regard to the income of the LLC (so that such income is regarded as the income of the members).  Then, under USA federal income tax law, the LLC is not subject to tax.

The definition of a “person” in the South African Income Tax Act excludes a “foreign partnership“.  The definition of a “foreign partnership” in such Act includes (simplified) a foreign entity (such as an LLC) if, under its domestic tax law, relating to its receipts and accruals:

– its members (personally) are required to account for such receipts and accruals when they are received by or accrue to the entity; and

– the entity (consequently) is not liable for tax on its income.

In terms of section 24H(1) of the Income Tax Act, the usual conduit principle that applies to local partnerships also applies to foreign partnerships.  Accordingly, for South African income tax purposes, a foreign partnership is not a ‘taxable person’.  However, in respect of, for instance, PAYE and VAT, a foreign partnership must register with SARS.  In addition, the members of an LLC are likely to be liable for South African income tax (in the stead of the LLC) on SA sourced profits of the LLC, and consequently have to register with SARS.

An LLC is a good example of what is called a ‘hybrid entity’, displaying some of (but not all) the characteristics of both a company (juristic person) and a partnership or similar entity (not a juristic person).  Note that under the Companies Act, an LLC that conducts business in South Africa must register as an external company.

The South African income tax legislation is intended to achieve that a foreign hybrid entity that is treated as transparent for tax purposes in its domestic country is treated in the same manner in South Africa.  Insofar as we are aware, such legislation has not been tested in a Court.

Master agreements and bankruptcy

Amien casualJerome casualby Amien Hoosain and Jerome Veldsman

The following will be of interest primarily to finance wizards.  Apologies to the readers not concerned with OTC derivatives, securities lending, and the like.

Sections 35B of the South African Insolvency Act, and 136(2A) of the Companies Act, provide a ‘safe harbour’ against counterparty bankruptcy in respect of master agreements; such as under ISDA and GMSLA standard documents, and similar agreements.  The USA counterpart is section 560 of the Bankruptcy Code.

The respective ‘safe harbour’ mechanics are:

South Africa:

– business rescue proceedings have no effect, so the non-defaulting party may exercise remedies under the master agreement; and

– upon winding-up, all unperformed obligations under the master agreement terminate automatically, the values of such obligations must be calculated at market value as at the winding-up, the values so calculated must be netted, and (only) the net amount becomes payable.

–  USA: the usual bankruptcy rules do not apply to the exercise by the non-defaulting party of the contractual right to cause the liquidation, termination, or acceleration of transactions under the master agreement.

No South African Court has to date dealt with the local sections.  However, in the USA, section 560 of the Bankruptcy Code has received judicial attention, including in the on-going Chapter 11 (similar to business rescue proceedings) cases in the New York Bankruptcy Court regarding the bankruptcy of Lehman Brothers.

On 19 December 2013, in Michigan State Housing Development Authority v Lehman Brothers Derivatives Products, Inc., et al, the Court considered the practical meaning of the contractual right of the non-defaulting party to cause the liquidation, termination, or acceleration of transactions; and, in particular, whether such right includes the contractually prescribed procedures under the master agreement for calculating amounts due and owing (from one party to another).

Under an ISDA Master Agreement, the parties had entered into 20 interest rate swap Transactions.  The Housing Development Authority, as the non-defaulting swap counterparty, and ISDA, as an amicus brief, argued that upon the occurrence of an Event of Default, the values of the unperformed obligations must be determined pursuant to the protocol in the Master Agreement and Schedule, as contracted by the parties; in this instance, the Market Quotation method.  Lehman Brothers argued for an alternative calculation methodology.  The calculation method used made a difference of approximately USD 23 million.

The Court found in favour of the Housing Development Authority:

– ‘The liquidation method, regardless of amounts realized, is fully “baked” into the very concept of what it means to liquidate.’

– “… the protected right to liquidate must include a way to execute the liquidation in order to infuse the safe harbored right with meaning.”

We find the reasoning in the judgment convincing.  However, applying a foreign judgment locally has its challenges.  There is a subtle but substantial difference between the South African and USA ‘safe harbour’ mechanics.  The former prescribes post winding-up close-out netting “at market value“.  It may seem available to a local insolvent to argue that “market value” is something different from the agreed protocol in the relevant master agreement.  However, for the reasons stated in the case under discussion, we hope a South African Court will in similar circumstances come to a similar finding.  Such reasons include that the methodology for close-out netting should be predictable, and allow the parties, without needless delay or uncertainty, to determine the amounts payable under the master agreement with clarity.  Lawyers debating the meaning of “market value” will introduce delays and uncertainty into what is designed to be a swift and predictable procedure. 

Aggregation in insurance

Jerome casualby Jerome Veldsman

Insurance policies usually bristle with exclusions and limitations, and, especially regarding professional indemnity insurance, contain an aggregation clause.  The latter provision applies the per claim cap on insurance cover to a series of claims arising from one originating cause or source, so as to consider them to be one occurrence.  As examples:

– if two or more persons collectively commit the wrong deed; or

– one or more persons commit a series of wrong deeds,

it remains one claim in aggregate subject to the per claim cap on insurance cover.

AIG Europe Limited v The International Law Partnership LLP and Others, a judgement of the UK High Court on 14 August 2015, dealt with an aggregation clause.

A client of a firm of solicitors planned to build holiday home developments in Morocco and Turkey.  The firm advised the client with regard to an elaborate scheme with a view to protecting the interests of the investors in the developments, and thereby encouraging them to invest.  The client went bankrupt (the Global Financial Crisis may have played a role), and the scheme was put to the test.  Allegedly, the scheme did not hold up, and the investors claim to have lost in excess of £10m.  Hundreds of investors submitted claims against the firm for breach of escrow agreements, breach of fiduciary duty, negligence, and more; all, one way or another, linked to the alleged failure of the scheme to protect the interests of the investors.

In this case, the insurer who provided professional indemnity insurance to the firm sought a declaratory order that all the claims of the investors must be aggregated, and thus considered a single claim (with a claim cap of £3m).  The relevant policy included in its aggregation clause “similar acts or omissions in a series of related matters or transactions“.  The insurer’s main argument was that the claims brought by the investors arose from similar acts or omissions in a series of related matters or transactions.

The Court found in favour of the insurer that the claims arose from “similar acts or omissions”.  However, in respect of “in a series of related matters or transactions”, the Court:

– stated: “This phrase serves to limit the scope of the aggregation clause which would otherwise be very wide. The phrase embodies the unifying factor (or an important part thereof) which makes it appropriate to aggregate claims.”; and

– held: “… but the acts or omissions are not in a series of related transactions because the terms of the transactions are not conditional or dependent upon each other. The acts or omissions are not therefore in a series of related matters or transactions.

We do not find the reasoning in the judgment convincing, and a South African Court may well in similar circumstances come to a different finding. 

The trials of Oscar Wilde

In the first trial, which commenced on 3 April 1895, Wilde was the complainant in a (private) prosecution of the Marquess of Queensberry for (criminal) libel.  Queensberry had left an un-enveloped card with a porter at a private members club in London, of which Wilde was a member, with an instruction to give the card to Wilde.  When Wilde next attended at the club, the card was handed to him.  On the card Queensberry had written: “To Oscar Wilde posing as a somdomite” (a misspelling of ‘sodomite’ – a term for a person who practices sodomy).  At the time, sodomy was a crime in England, with a penalty of life imprisonment.

The antecedent to the card was a long-standing relationship between Wilde and Queensberry’s one son.  Queensberry had previously taken desperate measures to end the relationship, but had only succeeded in alienating his son.

As a married man and a leading literary figure, Wilde took umbrage, and consulted a solicitor.  On direct questioning by the solicitor, Wilde insisted that the allegation was untrue.  Wilde also instructed a barrister.  The latter required of Wilde to assure “on his honour as an English gentleman” that the allegation was untrue.  Wilde responded that the allegation was “absolutely false and groundless.”

The basic facts regarding the card were not in issue.  The first trial really started with the cross-examination of Wilde.  He managed well with the questions regarding alleged homosexual themes in his books and plays, but not regarding his relationships with named young men.

Queensberry and his legal team were well prepared.  They had statements from 32 witnesses, containing corroborated explicit evidence regarding Wilde and many young men, including male prostitutes.  Queensberry’s barrister informed late on the first day that he intended to call many of these young men as witnesses.  That evening Wilde’s legal team advised him to concede defeat.  Wilde agreed.

The next day at Court the police arrived and requested the Magistrate to issue a warrant for Wilde’s arrest.  Queensberry’s legal team had provided their witness statements to the authorities.  Queensberry (the ‘father’ of the rules of amateur boxing) won the first round.

In the second trial, which commenced on 26 April 1895, Wilde was the accused.  He was charged under the Criminal Law Amendment Act, 1885 of gross indecency (undefined, but essentially a ‘milder’ version of sodomy).  The evidence was damning.  Wilde’s barrister was brilliant.  The result was a hung jury.

Accordingly, the State was entitled to start the trial afresh.  There were influential persons on both sides of the debate whether, or not, to do so.   The ruling Liberal Party chose to proceed.  There are ‘conspiracy theories’ regarding why.  One relates to allegations regarding the then Prime Minister (Archibald Primrose) and one of Queensberry’s other sons.

The third trial commenced on 22 May 1895, with the same charges, and the damning evidence fine-tuned.  The jury convicted, and Wilde received the maximum penalty – two years hard labour.  Life in prison was very different from Wilde’s previous comfortable existence.  He suffered from illness, and ruptured his right eardrum in a fall.

Wilde was released on 19 May 1897, bankrupt and in ill health.  He soon after went into self-imposed exile in Europe.  He died in penury on 30 November 1900 of cerebral meningitis.  His physicians attributed the condition to an old bacterial infection of his right ear.