There are a number of ethical issues posed by the PCP v Barclays case which Richard summarised yesterday. If you’ve read the summary you will know that two sets of transactions are in issue.
1. The $3bn loan made by Barclays to Qatar’s Ministry of Finance as part of a significant equity injection to shore up its capital position. Did Barclays and its lawyers’ dress this up as something other than financial assistance; a breach under Section 151 of the Companies Act 1985 (now section 677-683 of the Companies Act 2006)? Financial assistance is potentially punishable by up to two years in prison.
2. The payments made under ASAs to Qatar that would have fallen foul of the 10% cap in Section 97 of the Companies Act 1985 if they had been formally paid as commissions on the share purchase. Again, were these payments effectively disguised, with legal assistance with the intention of avoiding falling foul of this rule?
We can assume, indeed see, from some of the detail in the judgment, that the lawyers papering these deals are carefully trying to avoid the loan being seen as financial assistance and the ASA payments being seen as commissions. Reading the judgment, it is difficult to escape the conclusion that he believed that Barclays sailed pretty close to the winds of illegality: the approach to ASAs looked ‘smelly’ and ‘dodgy’ (paragraph 366) and that the circumstances around Barclays’ $3bn loan to Qatar were ‘highly suspicious’, with the resignation of Linklaters as ‘a serious warning sign’to Barclays and its internal and external legal advisers(paragraph 505).
Barclays survived on point 1, it seems to us, because Mr Justice Waksman could not find evidence that the loan money was used to fund the share purchase and it was not central to the claimant’s case to so prove. Conscious that it was an incendiary issue, and that the SFO had dropped financial assistance as a charge against Barclays, he didn’t spend too much time considering these questions. If the activity had been unlawful, and the lawyers had knowingly or recklessly assisted it, then we think that would be professional misconduct; but we are going to assume this threshold has not been passed.
Second, even if the activity wasn’t unlawful, was it ethical for lawyers to devise routes by which Barclays could effectively ‘dress up’ arrangements as a matter of form, disguising substance, so as to avoid breach of these rules? Lawyer ethics is not simply an abstract question for the moral philosophers; solicitors have ethical duties under the SRA’s codebook, including, for example, to act with integrity and to protect the rule of law and the administration of justice.
An excruciating passage where a senior Barclays in-house lawyer, Judith Shepherd, (jokily?) warns about being up before the fraud squad, and running away to Brazil (paragraph 355), adds to a sense that in-house and external lawyers bent over backwards to find a way to ‘structure around’ legal obstacles. The judgment reveals what looks like ‘creative compliance’ (a phrase coined by Doreen McBarnet and Christopher Whelan). One tactic is to apply literal interpretations of the rules emphasising the form of a transaction over its substance, to avoid the spirit of the rule. A recent example where the court deprecated such an approach might be the Uber judgment (and see here for another example as well as the Rolls Royce case where artificial consultancy agreements featured as bribes).
Structuring around Financial Assistance?
The pressure surrounding these transactions was patently intense: post Lehman’s collapse, senior Barclays executives were worried about their jobs and bonuses should the bank be bailed out by the government. For the law firms involved, the bank would remain, however, a strategically critical client.
It appears that Mr Justice Waksman was satisfied that all involved knew the $3bn loan to Qatar was “smelly”, and that they were aware that a breach of Section 151was a criminal offence, and that this was a risk they could try to mitigate but not fully erase (see, for example, paragraph 50).
First of all, this loan was highly unusual. In the midst of the rapidly unfolding global financial crisis where banks had effectively ceased lending activities, including to each other, because their liquidity (their sources of funding) had mostly dried up. An exception to the financial assistance prohibition allows banks to make loans in the ordinary course of their business (otherwise banks would never be able to lend to a prospective investor). However, this doesn’t seem to apply to the $3bn loan. The evidence suggests that the loan was instead rather extraordinary. Barclays felt it could not underwrite a loan of this scale on its own (paragraphs 40, 489), the best it could do was to work with Qatar to arrange a ‘club’ of banks to collectively offer the loan. The loan also exceeded Barclays’ normal lending limits and required an extraordinary approval from the CEO, Bob Diamond (see paragraphs 48-50, 501). In the end, Qatar insisted that Barclays provide the $3bn loan on a bilateral basis, a demand to which Barclays reluctantly acceded as part of the price for the injection of share capital, a sign of the weakness of its bargaining power but also the extraordinary lengths it was prepared to go to secure the equity injection by Qatar.
Given the levels of concern about breaching Section 151, it is worth exploring the pretty much singular reliance on the loan agreement’s purpose clause to create a contractual, formal, but not a substantive, separation of the loan from the share subscription. This raises the question of what due diligence was undertaken to ensure the loan proceeds were not applied to fund the equity subscription: in other words, who was checking that Barclays was not lending the money to Qatar so that Qatar could then use the loan proceeds, either directly or indirectly, to fund the equity investment in Barclays, in breach of Section 151? It appears the lawyers that ultimately advised Barclays (after Linklaters had resigned, which we discuss further below) were ultimately prepared to let their satisfaction as to the separation issue – and therefore Barclays’ compliance with Section 151 – rest on the inclusion of a contractual prohibition on using the loan funds to fund the subscription, without looking behind the contractual form to satisfy themselves as to what was really going on. It appears from the judgment, that Barclays never established what the loan was for(paragraph 492). It is at least arguable that lawyers’ duties to the rule of law and the administration of justice in the SRA’s rulebook require them to go further in situations such as these.
Mr Justice Waksman concluded that it was clear to Barclays, and so it seems to us it would have been apparent to its internal and external lawyers, that the loan was in reality a condition of Qatar’s participation in the share subscription (paragraph 497). Seemingly conscious of this, Barclays took steps designed to make the loan look, at least in legal form, if not in substance, like a separate transaction from the share subscription. The borrowing entity was changed, and became Qatar’s Ministry of Finance, so it wasn’t the same as the share issuing entity, which was expected to be QIA (paragraph 89).
Finding the subscription effectively, if not expressly, conditional on the loan is not the same as saying the loan funded the subscription. However, as money is fungible, the loan remained a suspect transaction for financial assistance purposes, given the context and timing of it alongside the capital raising and the fact that the loan proceeds were – according to the SFO at least – paid into the same bank account from which Qatar’s subscription monies were drawn (paragraph 506), albeit this was challenged by expert evidence produced by Barclays (paragraph 507). Even if the funds from the loan were not directly applied in funding the capital raising by Qatar, the loan may have still provided indirect financial assistance by enabling funds earmarked for another purpose to be released to fund the equity subscription, a possibility acknowledged by My Justice Waksman in paragraph 289, although he did not think this would constitute a breach of Section 151. Because the SFO dropped its charges and taking into account Qatar was ‘cash rich’ (paragraph 508), Mr Justice Waksman concluded that the case that Section 151 had been breached could not be made out (paragraph 510). It would have been good to hear a bit more on this point, given that Section 151 prohibits financial assistance given both directly and indirectly.
We can only speculate as to what caused Linklaters to resign. It appears they wanted to clearly establish where the funds for the equity subscription were coming from, and so be satisfied the loan was not being used for this purpose (paragraph 114). Perhaps they insisted on seeing a proper ‘funds flow’ showing how the loan funds would be used, and/or documentary evidence (payment instructions, evidence of funds being remitted to their ultimate destination) etc. to evidence the use of the loan proceeds for a purpose unrelated to the share subscription. Or maybe Linklaters insisted that the loan only be entered into and/or funded after the funding of the share subscription. We are left wondering why Clifford Chance felt able to take up the engagement, following Linklaters’ resignation, which Mr Justice Waksman described as a ‘serious warning sign’ (paragraph 505). On the case as described in the judgment, the apparent financial assistance risk had increased not abated.
Structuring around the 10% cap on Commissions for Share Subscription
Michael Todd QC had advised Barclays that a proposed £280m commission to be paid to Qatar for the share subscription (on top of existing 2% and 4% commissions) would breach the 10% cap in Section 97 of the Companies Act 1985 (paragraph 71). The 10% cap issue is not dissimilar to the financial assistance point; Section 97 is effectively an exception to the prohibition on a company offering financial assistance for the purchase of its own shares in Section 151. Consequently, breaching Section 97 by exceeding the 10% cap is a similarly serious matter.
It appears that Clifford Chance advised Barclays that the commissions could instead be paid under a separate agreement in return for ‘other services’ not connected with the capital raising (paragraph 72). An Advisory Services Agreement (ASA2) was therefore entered into pursuant to which Qatar was paid the £280m fee, but with little discernible service of any value being performed by Qatar in return. Responsibility for drafting of ASA2 within the in-house legal department of Barclays was moved to New York, for reasons that are unclear. It is possible this was motivated at least partly by a desire to bolster the presentation of ASA2 as a separate transaction from the subscription, which was being handled in London.
First, let’s look at what the judgment tells us about the role of the in-house lawyers at Barclays.
The drafting of the ASAs was handled internally by in-house lawyers at Barclays, it seems. Judith Shepherd is quoted as saying, “you’ve got to have something that looks as if on the face of it, it works” and “there’s a limit beyond what I’m prepared to go.” (paragraph 355). The senior in-house lawyers most closely involved with the drafting of the ASAs appear to have expressed reservations about whether they were bona fide agreements for the provision of services in return for which Qatar was entitled to a fee. Shepherd observed that ASA1 provided Barclays with ‘nothing more than cultural awareness’ (paragraph 350) and was a ‘(legally worthless) “agreement to agree”’ (paragraph 356).
And after it was entered into it appears there was little evidence that ASA1 had led to Barclays receiving much benefit either. A subsequent ASA (ASA 1.5) included a clause to the effect that ASA1 had been a ‘great success to date’ for Barclays and yielded the bank ‘enormous benefits’ (paragraph 419). Roger Jenkins acknowledged in his evidence that this provision did not reflect reality, and said that this wording was ‘lawyer language’, inserted by Barclays’ in-house lawyers (see para 420). Mr Justice Waksman concludes this language was a ‘way of suggesting that there was significant value’ in extending ASA1, when it appears that was not the case. (paragraph 423).
It appears that Mark Harding, Barclays’ Group General Counsel had initially sought advice from Clifford Chance on the disguised commissions issue with respect to ASA2 (paragraph 72, 393, 394). He then shared that advice with another senior in-house lawyer, Matthew Dobson, who originally planned to draft, or at least review, ASA2 but then changed his mind about doing it overnight for reasons unexplained, though Mr Justice Waksman was not prepared to draw an inference from this ‘volte-face’ that this was evidence that ASA2 was a sham (paragraph 440).
There is a suggestion that the in-house lawyers at Barclays believe they were misled by senior employees of Barclays about whether Barclays derived any actual value from ASA2. It is unclear if Judith Shepherd’s claim against Barclays, mentioned in paragraph 441, proceeded and she was not called as a witness so we are unable to evaluate this any further, although it is noted by Mr Justice Waksman that the extent of Judith Shepherd’s actual knowledge of events at least remains a subject of dispute (paragraph 442).
Did or should these in-house lawyers have taken further steps, such as reporting their concerns to the full board? We have previously advocated stronger ties between in-house lawyers in large business organisations and the full board, particularly the non-executive directors, to address situations such as these.
Now let’s turn to what the judgment reveals about the involvement of Clifford Chance, which advised Barclays on the share subscription and the ASAs.
Clifford Chance expressed concern to Barclays that ASA1 could fall foul of Section 97 (paragraph 357). In initial drafts a series of obligations were placed on Qatar under the ASAs but these were struck out almost in their entirety by Latham & Watkins (advising Qatar). Clifford Chance were asked to review the reduced agreement and raised the concern that consequently no value was effectively being offered by Qatar for the payment, so that the payment by Barclays under the ASA might be considered as a disguised commission, in breach of Section 97. Judith Shepherd told them she had received assurances that services under the agreement to be provided were “genuine and valuable” (paragraph 357). Clifford Chance then took no further action, effectively leaving it to the client to determine if, in its reduced form, Barclays would be receiving any value under the ASA. Although in the end Mr Justice Waksman concluded that the ASAs did not meet the legal test for a ‘sham’ transaction, he clearly found the decision on ASA2 difficult. Even on ASA1 after he observed that the transaction was ‘smelly’, he said:
“… it’s manifestly the case, this [ASA1] was adopted as a way to conceal from other investors that Qatar was in effect receiving a higher fee and that ASA one was clearly part of the package deal for Qatar along with the subscription agreement. Concealment is not, without more, the same as a sham.” (paragraph 366)
Did or should Clifford Chance have taken further steps, such as reporting its concerns to the full board, or advising Barclays’ in-house lawyers to do so? And if Clifford Chance had taken steps such as these, and been dissatisfied with the response, should it have then resigned, as Linklaters had done with respect to the loan? These are all questions on which it would be good to hear answers and bear investigation.
The broader issue with creative compliance
There is a broader point too. The central issue of the PCP case was whether Amanda Staveley was misled by Roger Jenkins of Barclays. The case does not suggest the lawyers directly misrepresented the situation to her. There is some, inconclusive, evidence that the representation of the deals may have not been fully or clearly presented to the board. If lawyers were involved in facilitating that, they would have, in effect, been misleading their own clients but we do not see direct evidence of that in the judgment. There is a more general point though. What we have discussed above essentially asks the question: have the lawyers in-house and outside properly balanced their obligation to protect the best interests of the client with their obligations to the rule of law and to act with integrity? Were the deals legitimately characterised as loans and commissions? The judgment cast significant doubt on that, of course. But, as ever, we have not heard the full story even after this protracted litigation. As we have already noted, one of the senior in-house lawyers involved has threatened litigation against Barclays on the basis that executives in Barclays misled them, for instance.
The allegation that the board may have been misled about the nature of the deals is an interesting extra signal of the problems of creative compliance. Lawyers know that such work carries the risk that clients will misuse careful legal characterisation to mislead constituencies within their own organisations or outside of them. There is, in other words, a foreseeable risk that such work will lead to the governing bodies of clients or counterparties being misled. Is that what went on here? The judgment, long as it is, provides considerable food for thought on that. It might be argued that there have not been any findings that the Companies Act has been breached, and the judge is not concerned directly, nor does he opine specifically, on whether professional obligations have been breached. In that sense the creative compliance has worked, subject to the decision pending with the FCA about their own investigation. There have been no successful prosecutions, and no damages paid to Staveley. The dirty work of lawyering has perhaps won the day, but at a tremendous price both in terms of the actual costs of legal cases that have ensued, and costs to the lawyers involved (we are guessing not all have got away scot-free and that there has been a great deal of attendant stress and misery for them as a result of bending in the wind of the financial crisis). But there can be little doubt, can there, that this is a case which the SRA should have been, should be, will be investigating if they are not already?
Trevor Clark and Richard Moorhead
Trevor was a partner at Linklaters but has no personal knowledge of the events. We draw purely on the information provided in Mr Justice Waksman’s judgment, and other publicly available materials about the case.
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