Dealpoint is a regular briefing on issues relevant to corporate transactions, notably M & A and reconstructions. Each edition of Dealpoint will focus in detail on one area of law and practice which may be of interest to principals and practitioners in the corporate transactions area.

In this issue of Dealpoint we focus on the reform (in the Fraud Act 2006) of the law relating to fraud.

The Fraud Act 2006

The Act, which came into force earlier this year, was introduced with the aim of simplifying a very fragmented and complicated area of law. It is also the first time fraud has been given a proper statutory footing, perhaps signifying the Government’s increasing desire to try and combat business crime. Whilst the Act will hopefully increase the chances of making successful prosecutions for fraud it could, potentially, also have unintended consequences. The breadth of the new fraud offences created by the Act criminalises a broader range of conduct, which has implications in the financial investment and corporate transactions arenas.

The Act creates three main offences of fraud, all of which carry a maximum sentence of 10 years and/or an unlimited fine. The offences are as follows:

In each of these instances the prosecution must establish that it was the intention of the accused to make a gain from his or her fraudulent actions. It is no longer necessary to establish that a gain or loss was actually made. As such, the “victim” no longer has to actually rely on, be deceived by or even be aware of the fraudulent activity for it to be caught by the Act.

The Act covers any representation made knowingly or with awareness that it might be false or misleading. In corporate dealings, any inaccurate warranty or representation (whether made under a share sale agreement, investment agreement or otherwise) could be prosecuted as a false representation if made dishonestly with the necessary intent. In terms of businesses and their directors and officers generally, it could also mean that it will be far easier for authorities to prosecute not only blatant fraud but also “dishonesty” in the boardroom.

Also for the first time there is liability for fraud by omission, albeit that it only applies where there is a legal duty to disclose. However, all professionals, companies and their officers are under a wide range of duties to disclose information to a number of people, including to their clients/customers, the market if they are listed, under contracts (e.g. insurance contracts) and to shareholders, creditors and regulators. It could mean, for example, that directors may be on the hook if they are aware that figures or statements being put out to the market or submitted to HMRC are or might be inaccurate and do nothing about it.

Further, although slightly more extreme, it could cover the scenario where information is, dishonestly, left out of company publications or announcements under the listing rules or deliberately gives an incomplete picture. This all adds up to Boards now having an additional reason for ensuring that their published announcements or circulars are complete and accurate. If not, they may all be criminally liable, even those who were bystanders, rather than perpetrators of the misrepresentation or manipulation of information.

The consequences of being liable for fraud by omission don’t stop there. More widely, for example, anyone who provides "creative" responses when applying for keyman insurance, completing a self-certified health report to insurers on a management buyout, and fails to disclose relevant details, or doesn't provide a complete picture could also face prosecution.

It is also quite possible to imagine that an offence could be committed where a fiduciary relationship exists. Take, for example, a director who diverts business opportunities to himself. Under normal circumstances he could certainly be subjected to civil proceedings to recover the benefit. However, now, if it can be proven he had the relevant element of dishonesty, he could be prosecuted under the Act.

Although the Act is unlikely to have any immediate impact on businesses - due to the crippling lack of police investigation resources - businesses would do well to revisit their position on fraud. Its wide scope means that Boards need to take action to understand their obligations and minimise the risks for the company and themselves. They should consider introducing appropriate protocols with, perhaps, some form of internal reporting procedure and investigating process set up in the event that fraud is suspected.

Additionally, although the risks of prosecution may be low, it will be easier to make accusations of fraud under the new Act arising from representations or warranties made by act or omission in the course of corporate transactions. The accusations can themselves also be a useful negotiation tool in warranty or indemnity disputes.

April 2007