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Capitalising a Legal Settlement

Client would like to capitalise the settlement costs of a legal dispute

Hi

My client's previous accountant has capitalised the settlement costs relating to a legal dispute between his company and his old employer. The dispute arose due to a violation of the director's non-compete clause in his employment contract with his old employer. After leaving his employer, the director set up his own company and began doing business with customers of his old employer. To resolve the matter, the new company agreed to pay the previous employer a set amount to settle the matter. 

The terms of the agreement:

- Lift an injuction that the previous company had placed on the company;

- Constitutes full and final settlement of the matter and all related matters;

- Applies a restrictive covenant on the company approaching any further customers of the old employer, excepting a detailed list of the customers that they already have done business with

I would appreciate it if anyone would comment on: -

- whether they feel that this has given rise to an intangible asset (identifiable asset (lift of injuction and access to prescribed set of clients); arrising from legal rights (settlement agreement)). 

- this is a true cost of the company, given the original employment contract was that of the director

Kind regards

Chris

PS - Previous accountant's reasoning -"The settlement costs have been capitalised as an intangible asset/goodwill and are being amortised over 10 years.  The rationale for doing so, rather than expensing the cost in full, is that the £185k settlement payment enables the company to continue trading for the foreseeable future and 10 years is the maximum period allowed in the absence of more reliable method to determine the useful life. A nominal figure of £10k for the goodwill based on clients being able to cancel within 4 weeks has been used on the basis that this would represent the fair market value because the clients have loyalty to you."

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By DJKL
29th Oct 2018 17:27

Not convinced- the payment was not to acquire the clients (goodwill) as the newco already in effect had them but was under attack re its ability to retain them by oldco, it incurred costs defending that attack. To me the cost are more revenue in nature.

The question whether costs incurred w & e for the company not really sure, yes newco benefits from deal but was it legally in the firing line in the first place; against whom did oldco raise the action in the first place?

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to DJKL
29th Oct 2018 18:39

Thanks DJKL. The settlement agreement named the defendants as both the director and the company, and so I have been assuming that the action was against both.

I guess I am hoping that the general principle that expense should be matched against the income that it relates to can some how be applied, given that the settlement will likely give rise to income for the company for a number of years.

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29th Oct 2018 19:46

FRS102 S19

Provided all the tests can be passed then it probably can be capitalised. The detail in the settlement will determine whether the cost belongs to the newco or the director.

"enables the company to continue trading for the foreseeable future" is not really relevant here.

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By DJKL
to MeMyselfI
30th Oct 2018 10:20

Not convinced by s19 either- if newco had grabbed entire business of oldco maybe, but looks like it just grabbed some clients and not sure 19.4 is satisfied, the last sentence being the killer.

" the purchase of some of the net assets of another entity that together form one or more businesses"

Is a group of agreed clients a business?

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to DJKL
30th Oct 2018 12:55

Thanks again DJKL.

I guess the other point is that they have not purchased anything, they have an agreement not to be liable to any further action by oldco as a result of settlement. The old accountant felt that this allowed them to be able to continue to trade into the foreseeable future, and therefore agreement should be capitalised and amortised over its useful life (the likely time that legal action may arrise?).

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to DJKL
30th Oct 2018 12:59

DUPLICATE

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to MeMyselfI
30th Oct 2018 12:49

Thanks MMI. The settlement agreement seems to treat both defendants equally, with nothing specifying that one defendant is more liable than the other.

The main beneficiary of the settlement, however, will be the company as it is the entity which is benefiting from the agreement. The director, however, is now also no longer at risk of legal action as a result of the agreement.

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to MeMyselfI
30th Oct 2018 12:50

DUPLICATE

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By frankfx
30th Oct 2018 18:00

I am uneasy with this one. Any other AWEB members uneasy?

The ex- employee has breached a personal contract.

Civil action has followed . Newco has been joined in the action......... and has accepted to be joined in the action. No doubt ex -employee influenced that decision.

Employer legal team only want a result ,so they would spread their fire to Newco.

Then it seems 100% of the costs are fully borne by Newco.

Zero personal tax effect on ex- employee?

(Possibly as much as £185,000 sitting as a credit on his DCA for funding the action)

This seems too neat ,
given the tax minefield that one often has to negotiate to be compliant on even trivial transactions.

One can see the tax- advantage motives for the transaction being booked as stated by the OP.

Did the ex -employee receive a letter of comfort from previous accountant?
Given the amounts involved the ex- employee was surely a savvy individual and may have sought formal written assurances.

Or did both parties simply agree to cross fingers?

Previous accountant may be somewhat miffed by losing client , if he had successfully ensured the costs to be fully borne by Newco.

Question 1

If someone on this forum revealed that this accounting and tax treatment was not effective , or only effective if particular steps were taken... and provided reasons ... where would that leave you as new accountant?

Question 2

Can any AWEB members explain ,with confidence , that zero costs should be borne by ex-employee / director.... with the wonderful tax advantages that follow.

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to frankfx
31st Oct 2018 05:49

Thanks FrankFX. To me, it would seem correct that at least some of the costs should be bourne by the director, given that (on the face of it) he now has no further liability for breaching his contract. However, I don’t believe that the cost should be 100% his given that the injunction mainly effected the company and the company was under attack for allegedly using confidential information.

The director has at least received some benefit from the action, does this therefore constitute a P11d item, or can it be argued that this incidental?

To simplify the situation, I omitted in the OP that there is a second director who joined the ex-employee in forming the company at the start who is also named in the legal action, but was never an employee of the old employer.

The director originally introduced the client list to the business (whether this constituted confidential information or not), as well as the goodwill he had with the clients. The value of this could potentially be used to offset the part of the settlement amount deemed to relate to his personal liability. An indicator that the market rate of the GW/client list equals the settlement cost is that the second director was aware of all this when he went into business with the ex-employee. An independent valuation of the list could be sought, although the valuation maybe affected by the threat of legal action attached to the list.

The client never received assurances from the old accountant, just the quote I have included in the OP in the email enclosing the accounts. The client does not have faith in the old accountant, given poor advice they received on other matters.

I have spoken to 3 qualified associates about the matter. 1 was adamant that the cost was 100% revenue, 1 had sympathy for the old accountant’s treatment, and the other was unsure.

I feel that my best course of action is to highlight these concerns and considerations to the client in writing and to let them decide whether to continue using the current treatment or seek specialised advice. I am aware that I cannot associate myself with accounts I know to be incorrect, but given the apparent grey area, it seems acceptable to allow the directors to make the decision on how they wish to proceed(?).

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