Thursday, 12 July 2012

Who gets to pay when an innovation-driven project fails?

By: Kingsley Egbuonu, IP Analyst 

Decided last month by Mr Justice Hamblen in the Commercial Division of the Queens Bench, England and Wales, Brown & others v Innovatorone Plc & others [2012] EWHC 1321 (Comm) is a complex but instructive case on the question of who gets to pay when an innovation-driven project fails.

Brown and the other claimants brought this action against the defendants following the failure of a total of 19 schemes (16 of which were LLPs, the other three being regular partnerships), all of which had been promoted by the issue of an information memorandum which invited investors to become paying partners in a vehicle for the acquisition and exploitation of rights to information and communication technology (ICT).  The defendants were, respectively the managing directors and administrators of the partnerships and schemes, the architect of the schemes, a technology vendor, a firm of solicitors and the partners in that firm. The schemes promoted a tax incentive, gearing, profit incentive and a borrowing ability. The partners successfully obtained the full first year tax relief.  This resulted in substantial payment rebates being made.
However, in 2003 the schemes were investigated by the Inland Revenue, which was dissatisfied with the commerciality of the schemes and considered that the technology had not been exploited. The revenue was prepared to settle the matter on the basis that the tax relief would only be available in relation to the capital contribution made by each partner, rather than the grossed up amount of the investment. That offer was accepted by most of the partners -- which meant they had to find funds to repay the revenue.

Brown and his investment-minded colleague argued contended that the schemes were established with a view to defraud as there were no technology rights and the operators had no intention to exploit the technology rights; that fraudulent or negligent misrepresentations were made in the information memorandums and other documents; that their payments of subscription money into the solicitor's client account were subject to a Quistclose -type trust, for their benefit; that the defendants had dishonestly assisted in breaches of trust; that Brown was entitled to recover, under the Financial Services and Markets Act 2000 s.26 or s.30(2), money paid under the agreements; that the defendants owed a duty of care in relation to the promotion of the schemes and that the defendants had breached their fiduciary duty.

After 60 days in court, in a 1,435 paragraph judgment Hamblen J added to the investors' woes by dismissing their action.  In his view:
  • There were genuine technology rights in relation to each scheme, and the fact that there had been a failure to carry out due diligence on the technology vendors' business plans and income figures that did not mean that the technologies had no value. They were of real value, which was more than minimal. The technologies had real exploitation prospects and there was a real intention to exploit the rights. The price negotiations for the acquisition of the technology were genuine negotiations and the acquisition price was agreed as part of an arm's length transaction.
  • There was no actionable misrepresentation of fact, since the defendants' statements on which Brown and the other claimants relied were merely statements of opinion or expectation. In their context they could not be reasonably construed as being anything else.
  • Before Brown and the other subscribers became partners, their subscription money was subject to a Quistclose trust -- but this trust in their favour came to an end when they became subscribers.
  • On the facts there had been no dishonesty on the defendants' apart, and no breach of trust.
  • The schemes were collective investment schemes under s.235(1) of the Financial Services and Markets Act 2000 since they involved  activities and investments that were controlled under that Act -- and the financial promotion restrictions imposed by that Act had been breached.  However, the claimants' monetary claim under ss 26 and 30 of that Act could not be made against anyone other than the LLP.
  • Several factors militated against the imposition of a duty of care: the schemes were commercial in nature; they were not directed at people of modest means; the claimants would have had advice from their independent financial advisors; and there were no actions for breach of statutory duty under the the Financial Services and Markets Act 2000.
  • The  claimants' fiduciary duty argument was upside down since it was not the LLP that owed them a fiduciary duty but the partners who owed a fiduciary duty to the LLP. 
In general terms, the morals of this case can be stated quite simply:  when investing in any new technology, it's as important to do one's due diligence on your prospective partners and their business plans as it is to check out the technology in which you propose to invest; ask yourself clearly whether you are relying on statements of fact or on representations of a vaguer nature -- and think twice before seeking to recover your losses through High Court litigation.

This post by Jeremy Phillips first appeared on the IPFinance blog and is reproduced here with permission and thanks.

For an overview of Amoo Venture Capital Advisory's services to investors click here 


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