Supreme Court affirms FCA’s guidance on CISs

The judgement was in relation to an appeal against the Court of Appeal’s decision that Asset Land Investment Plc’s land investment scheme amounted to a CIS within the meaning of section 235 of the Financial Services and Markets Act 2000 (FSMA).

Asset Land acquired potential development sites that it sub-divided into plots for sale to investors. Its offering was to procure the re-zoning of the sites and thereafter arrange their sale to a developer, with the investors sharing in the sale proceeds.

The FSA (now the FCA) initially attempted to restrict Asset Land’s activities and, when this was unsuccessful, began proceedings against the firm on the basis it did not have FCA permission to operate an unregulated CIS. So what is a CIS?

A CIS is defined under section 235 of FSMA. Broadly, it is any arrangements with respect to property of any description, the purpose or effect of which is to enable the participants in the arrangements to receive a financial return from that property. The participants must not have day-to-day control over the management of the property, and either or both of the following characteristics must be present:

a) Pooling of the contributions of the participants or the income from which payments are to be made to participants; and/or

b) Management of the property as a whole by, or on behalf of, the operator of the scheme.

The Supreme Court issued two judgements: the leading judgement by Lord Carnwath and a further judgement by Lord Sumption clarifying the CIS definition. Lord Sumption stated that ‘arrangements’ [in the definition] comprises any understanding shared between the parties about how the scheme would operate, whether legally binding or not, and any consequences from that understanding or from the commercial context in which it was made. The parties’ intention at the outset of the arrangements is the crucial factor, not what happened later.

Lord Sumption believed it necessary to create a distinction between a CIS and the provision of management services by an intermediary Aidan Campbell and James Marshall, CMS Cameron McKenna LLP

On the issue of ‘day-to-day control’, Lord Sumption stated that control of property means the ability to decide what happens to it, which not only encompasses the legal ability to decide but also that the investor will, in practice, be able to do so.

The question is who would exercise control. This illustrates the importance of investors having day-to-day control of the management of scheme property to avoid a scheme being a CIS.

In considering what constitutes ‘management activity’, Lord Sumption drew a distinction between:

• Investors controlling the property and employing a service provider to operate it; and

• Investors surrendering control to the operator of a scheme so that it can be pooled or managed in common, in return for a share of the profits.

Lord Sumption believed it necessary to create a distinction between a CIS and the provision of management services by an intermediary. He considered Asset Land’s role in selling the site was an act of management if it was empowered to effect a sale on the investors’ behalf, rather than simply putting an offer before them for their approval.

Lord Sumption held that the arrangements amounted to a CIS as the investors’ control over their plots was illusory given the scheme could not work if the investors exercised their right to sell their plot independently.

This is the first Supreme Court judgement considering the CIS definition. It is now clear that the Court will look behind any contractual documentation to examine the true nature of the relationship between the parties, including any pre-contractual representations by sales people.

This is in keeping with Lord Sumption’s statement that technical distinctions must not frustrate the purpose of a regulatory statute, such as FSMA.

The FCA has long taken this approach in relation to CISs. It is notable that the Supreme Court explicitly approved part of the FCA’s guidance on CISs.

This case is helpful in clarifying the CIS definition but largely affirms the existing approach to what constitutes a CIS.

Aidan Campbell is a partner and James Marshall is a lawyer at CMS Cameron McKenna LLP