May 22nd 2015
As you may have heard in the press the Court of Appeal rulled against African Land, and decided that the investment was 'Managed as a whole'.
The FCA also lost their cross appeal, which claimed that African Land had pooled customer returns.
We have now launched an aplication to appeal to the Supreme Court
Here are some extracts:
Section 235 of FSMA provides as follows:
“(1) In this Part “collective investment scheme” means any arrangements with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements (whether by becoming owners of the property or any part of it or otherwise) to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income.
(2) The arrangements must be such that the persons who are to participate (“participants”) do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions.
(3) The arrangements must also have either or both of the following characteristics–
(a) the contributions of the participants and the profits or income out of which payments are to be made to them are pooled;
(b) the property is managed as a whole by or on behalf of the operator of the scheme.
If a scheme is a CIS, then such a scheme cannot lawfully be operated by a person who is not authorised by the Financial Conduct Authority (“FCA”). It is a criminal offence for an unauthorised person to operate a CIS and an agreement made by an unauthorised person in the course of operating a CIS is unenforceable (subject to the Court’s power to allow such an agreement to be enforced if it is just and equitable to do so): see the judgment of the Court of Appeal (“CA Judgment”), §§2-3.
that illustrates the distinction between, on the one hand, a CIS and, on the other hand, a scheme that involves a number of investors but where the scheme falls outside section 235. Chapter 11 of the “Perimeter Guidance” section of the FCA Handbook explains as follows:
“Q12. I run a scheme where each person owns individual properties or parts of properties in the property investment club. … Is this scheme likely to be a collective investment scheme?
No, unless the properties belonging to each person, company, limited liability partnership or limited partnership are managed as a whole by or on behalf of the operator of the scheme. So, the mere fact that the operator is managing a number of properties and achieves economies of scale in his management charges or in things such as insurance cover would not mean that the properties are being managed as a whole. Neither would the fact that the operator may be able to offer reductions in sale price because of bulk discounts negotiated with developers. This is provided the operator is managing each property on an individual basis.
As an example, if a managing agent manages a block of flats on the basis that the only profit or income each individual flat owner obtains is what arises from the management of his property, there is no management as a whole. However, if the managing agent managed the flats in such a way that each individual flat owner received an income from total lettings, regardless of whether that person's flat was let or not, the properties are managed as a whole and the arrangements are likely to be a collective investment scheme.”
The key feature of the African Land scheme for the purposes of this appeal is that investors purchased an interest in a distinct plot of land in Sierra Leone (sold in multiples of 1 acre) and achieved an income from this investment based on the value of the crops (rice) grown on their own plot of land from season to season. Investors did not purchase, for example, a right to a pro rata share of income generated by a large area held view in the alternative investment market that a scheme structured in this manner would not amount to a CIS (see CA Judgment, §§63-64). The FCA appears to have played a role in encouraging such a view to become commonly held, as it provided advice to participants in the alternative investment market over a number of years that was consistent with such a view (and inconsistent with the case it has advanced in the present proceedings): CA Judgment, §§59-64; see also HC Judgment, §§135-143, 192-193.
As a result of this commonly held view, there are many investment schemes in the United Kingdom that involve collective investments in real property and which are structured in a conceptually similar way to the African Land scheme. These include investments in managed student accommodation, managed buy-to-let apartments, and hotel rooms (to assist the Court with the relevant context, a table summarising five examples of such schemes is annexed to this Notice of Appeal
). If the Court of Appeal’s judgment is undisturbed, such schemes will almost certainly be CISs. This could have a devastating impact on the operators, promoters, and investors involved.
In any event, the impact on all those involved in the African Land scheme will be very significant. The scheme was marketed to investors for a number of years with the knowledge of the FCA, during which period over 1,000 investors were attracted and a substantial farming operation was established in Sierra Leone (which had the support of the Government of Sierra Leone): CA Judgment, §9.
The Proceedings Below
The FCA launched proceedings against the Defendants in July 2013. The FCA’s primary case was that (contrary to the African Land scheme’s marketing brochures and contractual arrangements) the returns paid to investors were “pooled” funds, as opposed to income derived from investors’ separately harvested individual plots. Thus, the FCA contended that the scheme was a CIS because there was “pooling” within the meaning of section 235(3)(a) of FSMA and because the scheme was “managed as a whole” within the meaning of section 235(3)(b) of FSMA.
The FCA also advanced a “fallback” argument that the scheme was “managed as a whole” within the meaning of section 235(3)(b) even if there was separate harvesting of investor plots and separate accounting to investors in respect of the income generated by the rice grown on each investor’s plot.
The issue of whether the African Land scheme was a CIS was tried as a preliminary issue before Mr Nicholas Strauss QC, sitting as a Deputy Judge (“the Trial Judge”) on 15-18 and 22-25 October 2013.
The Trial Judge rejected the FCA’s primary case and held that the scheme was operated in accordance with the way it was marketed to investors. In particular, the Trial Judge found that “the effect of the arrangements
was that ACSL bought [the harvested rice] from investors, and paid for it at a standard price. Investors have been paid by ACSL or African Land for the value of the rice grown on their individual plots” (HC Judgment, §111). As such, “the purpose of the arrangements was clearly to provide investors with profit… by the receipt of income from the rice grown on their plots” (HC Judgment, §151). Accordingly, the Trial Judge held that there was no “pooling” of profits for the purposes of section 235(3)(a) of FSMA.
In relation to the FCA’s “fallback” argument on section 235(3)(b) the Trial Judge held that:
The correct test under section 235(3)(b) is “whether the elements of individual management, arising either from attention given by the management to the interests of individual investors, or from participation by the investors themselves in the management of the property, is substantial. If so, the management by or on behalf of the operator is not to be regarded as management “as a whole” (HC Judgment, §198). The Judge accepted that this involved embroidering the language of the statute but considered this to be justified given the ambiguity of that language (HC Judgment, §199).
The relevant “property” was not restricted to the totality of the individual plots allocated to investors but also included ancillary or adjoining areas of land used for the purposes of farming investors’ plots (HC Judgment, §157).
D9 to D11 could not derive assistance from Q12 of the FCA’s Perimeter Guidance (see §5 above
) because that guidance applied only to “property investment clubs” (HC Judgment, §§185-6) and because, in managed buy-to-let schemes, “the investor is likely to take the main commercial decisions himself” and owners would not delegate to a manager “all the main decisions about the property” (HC Judgment, §§187-90).
The FCA’s previous advice in correspondence did appear to be inconsistent with its case against D9 to D11 (HC Judgment, §193).
Applying his preferred test to the facts, the Trial Judge concluded that “the element of individual management in African Land is minimal” (HC Judgment, §200), and that the relevant property was, therefore, “managed as a whole” for the purposes of section 235(3)(b).
The Trial Judge granted D9 to D11 permission to appeal to the Court of Appeal on the issue of whether the African Land scheme is “managed as a whole” because he accepted that this case raised difficult and novel issues on the construction and application of section 235(3)(b). The FCA cross-appealed on the issue of pooling under section 235(3)(a).
The Court of Appeal (the Chancellor, Christopher Clarke LJ, and Vos LJ) dismissed D9 to D11’s appeal and the FCA’s cross-appeal.
On the issue of the meaning and application of section 235(3)(b), the Court of Appeal held that:
The correct test under section 235(3)(b) is to ask whether, on an assessment of the facts, “the nature of the scheme is that, in essence, the property is managed as a whole” (CA Judgment, §72).
The relevant “property” was not restricted to the totality of the individual plots allocated to investors but also included ancillary or adjoining areas of land such as roads and farm buildings (CA Judgment, §§49-50).
D9 to D11 could not derive assistance from Q12 of the FCA’s Perimeter Guidance (see §5 above
) because the draftsman is likely to have had in mind a scheme in which “the final decision as to (i) the identity of the tenant; (ii) the term of the sublease; (iii) the rent; and (iv) the conditions of the sublease rests with the individual investor” (and, in any event, did not have in mind an agricultural scheme): CA Judgment, §§41, 46. Indeed, for a managed buy-to-let apartment scheme not to be “managed as a whole”, it would be necessary for “the letting of each individual flat [to be] undertaken separately in consultation with the individual owner on different and flat-specific terms” (CA Judgment, §120).
The FCA’s previous advice in correspondence did appear to be inconsistent with its case against D9 to D11 (CA Judgment, §§59-64).
Applying its preferred test to the facts, the Court concluded that the African Land scheme is “managed as a whole” (CA Judgment, §§73-4, 121).
GROUNDS OF APPEAL
General Public Importance
The present case raises a point of law of “general public importance”. In particular:
This case is the first time that section 235(3)(b) of FSMA has been considered in detail by any United Kingdom Court. This is a crucial sub-section in a longstanding statutory provision that determines the boundaries of non-regulated economic activity in the United Kingdom. It would be appropriate for the Supreme Court to have the opportunity to consider and rule definitively on this provision.
The Judgment of the Court of Appeal, as it presently stands, will almost certainly result in a large number of existing unregulated investment schemes being unlawful. These include buy-to-let flat schemes, student accommodation schemes, and hotel room schemes (see CA Judgment, §9). The market in buy-to-let developments is huge. It has attracted investors based in the United Kingdom and many overseas investors. A very substantial proportion of these schemes are not arranged in such a way that individual investors are involved in decisions as to the identity of the tenant, the term or conditions of the sub-lease, and the rent (see, e.g., schemes 2 and 3 in Annex I to these Grounds of Appeal and cf. CA Judgment, §§41, 120). The market in purpose-built student accommodation has also expanded substantially in recent years and many of these developments involve individual investors. Such schemes will, in light of the Court of Appeal’s judgment, almost certainly be CISs. The Court of Appeal’s judgment means that the operators and promoters of such schemes may have committed criminal offences and the schemes themselves may collapse.
Prior to this litigation, it was a commonly held view in the market that schemes such as the African Land Scheme would not amount to a CIS: CA Judgment, §63.
The FCA has, in the past, also taken the view that such schemes would not amount to a CIS: CA Judgment, §63. Indeed, the FCA’s previous position is partly responsible for the fact that it is a commonly held view in the market that such schemes would not be unlawful: Judgment, CA §64.
Over the course of this litigation, four competing interpretations of section 235(3)(b) have emerged:
The test adopted by the learned Judge at first instance was whether the individual elements of management were “substantial”: see CA Judgment, §70.
The Court of Appeal’s test asks whether, on an assessment of the facts, “the nature of the scheme is that, in essence, the property is managed as a whole” (CA Judgment, §72).
The FCA’s test requires the Court to identify the collective and individual elements of a scheme and to assess whether the collective elements outweigh the individual: CA Judgment, §69.
D9 to D11’s test focusses on the core profit/income-generating activity and asks whether this involves individualised management activity (i.e. management activity which necessarily requires individualised decisions/actions in relation to an individual investor’s distinct property) or from collectivised management activity (i.e. whereby the management activity does not necessarily require individualised decisions/actions in relation to an individual investor’s particular property): CA Judgment, §69; see also below.
The fact that the Court of Appeal differed from the Trial Judge, and the fact that both Courts rejected the submissions of the FCA and the Appellants, demonstrates that: (1) the correct approach to the application of section 235(3)(b) is a difficult issue that does not admit of an obvious “right answer”; and (2) there are a range of tenable views. Given the significant number of persons who will be affected by the judgment(s) in this case, this is a point of law that it would be appropriate for the Supreme Court to consider.
The FCA (like its predecessor the FSA) is statutorily empowered under FSMA 2000 to “give guidance… with respect to the operation of this Act and of any rules made under it”: see section 157 FSMA 2000 (prior to 31 March 2013) and section 139A of FSMA 2000 (from 24 January 2013).
A decision weather African Land can appeal to the Supreme Court is expected by the end of August.
Again, thank you for your continued support.
AFRICAN LAND LIMITED