Sports Direct: No legal privilege for accountant reports, High Court rules
Reports prepared by accountants at Deloitte for Sports Direct regarding a potentially contentious tax structure are not protected by legal privilege and must be turned over to investigators, the High Court has ruled.
The judgment in the case of The Financial Reporting Council Ltd v Frasers Group Plc (formerly Sports Direct International Plc) emerged from an application by the accounting regulator to force Mike Ashely’s sportswear retailer to hand over multiple documents for purposes of review.
The investigation was opened following reports one of Sports Direct’s international subsidiaries, Sportsdirect.com Retail Limited, hired a company to provide delivery services as part of a tax structure adopted on guidance from Deloitte. The FRC’s investigation concerns the issue of related-party transactions in the financial statements of Sports Direct, and it sought disclosure of Deloitte’s VAT tax advice, which was relevant to this issue.
To comply with the order, Sports Direct sent around 2,000 documents to the FRC, but withheld 40 claiming that legal professional privilege applied. The FRC challenged this, and while successful in the High Court, parts of the decision were overturned in favour of Sports Direct at the Court of Appeal in 2018.
The wrangle returned to the High Court earlier this month, where Lord Justice Nugee dismissed Sports Direct’s arguments and said three reports prepared by Deloitte were for the purposes of a tax structure and did not have litigation privilege protection.
Permission to appeal the judgment was refused.
Grant Thornton audit probe
The case stems from an ongoing investigation by the FRC into the conduct of Grant Thornton regarding its audit of Sports Direct in 2016. As part of its audit, Mike Ashley’s firm provided certain legally privileged documents to Grant Thornton on a limited waiver basis.
The FRC took Sports Direct to court to obtain the material in full, as it sought to determine whether Grant Thornton signed off on a business arrangement between the sportswear business and Barlin Delivery, a company owned by Ashley’s brother John, and why the transaction was not disclosed in the accounts.
In 2018, the judge criticised Sports Direct for refusing to comply, accusing it of “obfuscation and delay verging on obstruction”. However, Sports Direct successfully argued that the information was covered by legal protections that keeps certain communications between a client and a lawyer confidential.
The documents include emails and faxes Sports Direct swapped with lawyers but which were subsequently sent to Grant Thornton, its auditor at the time, and Deloitte, which was advising the company.
However, Lord Justice Nugee found that as the reports prepared by Deloitte were not prepared for the sole dominant purpose of litigation, but instead to recommend a new tax arrangement to withstand more robustly a challenge from the tax authorities, they were not covered.
"A taxpayer who takes advice as to how to structure his affairs does not do so for litigation purposes,” Lord Justice Nugee ruled. “He does so because he wants to achieve a particular result for tax purposes. Even if it is contemplated that the particular structure will be likely to be attacked by the relevant tax authorities and that there will be litigation, the advice as to how to implement the new structure – or, if this is preferred, how to revise or enhance an existing structure – is not primarily advice as to the conduct of the future possible litigation. It is primarily advice as to how to pay less tax.”
The FRC exercised legal powers under its Audit Enforcement Procedure (AEP) for the first time to issue the notices to Sports Direct requiring the disclosure of the documents
Experts said the guidance on dealing with disagreements over privilege claims in FRC audit investigations will be crucial and may lead to earlier settlement of such disputes.
“The courts’ decisions may also lead to corporate entities entering into more explicit limited waiver agreements with their auditors over important legally privileged material that they would not want to end up being used as evidence before a public FRC tribunal,” said Chiraag Shah of law firm Morrison & Foerster LLP. “It is important to note that the FRC has powers to require a corporate entity, as audit client, to provide any material relevant to its investigation.”
The case has ramifications for the entire accounting and auditing sector. Back in 2018, lawyers said it could impact the willingness of listed companies to hand over privileged material to their own auditors.
Challenger firm BDO wrote to the ICAEW, concerned about the “significant public interest issues” of the case last year, stating it was worried the judgment could restrict auditors’ access to privileged advice and prevent them from completing full company audits.
However, there is “nothing new” in the fact that in the relationship between a business and its auditor privileged material often has to be passed along to allow for a full understanding of the financial risks to the business, said Shah.
“This decision is a useful reminder of the strict requirements that must be satisfied in order for an assertion of litigation privilege to be successful,” said Michele Cheng of Travers Smith. “In particular, it highlights the importance of being clear about the purpose when commissioning or creating a piece of work in connection with litigation or regulatory investigations and distinguishing between litigation and commercial purposes.”
Ongoing issue at Frasers
At last year’s Annual General Meeting in September 2019, Frasers admitted it had no auditor after Grant Thornton quit over a €674m tax bill Mike Ashley’s firm had coming from Belgian authorities. A year on, with RSM hired and the repayment negotiated down, another showdown with investors erupted earlier this month.
Reports that workers at Sports Direct had been asked to work stores while on furlough were widely condemned by shareholders as representative of a negative corporate culture.
The group also warned that many of its House of Fraser department stores will be forced to shutter unless the government changes the business rates system.
Speaking at the company’s AGM, chief financial officer Chris Wootton said the business rates scheme needed to be reviewed, or many more high street names would go bust.
Following the coronavirus pandemic, retailers were given a holiday in business rates payments this financial year, but in April 2021 the system will restart with payments based on valuations from 2015.
However. current valuations do not account for a fall in property values, said Wootton, who said the next revaluation should be pushed forward from 2023.
“We have House of Fraser stores that even though they pay zero rent, still lose money – largely because of [business] rates,” he said. “Unfortunately, a number of House of Fraser stores will have to close, unless the government gets on with making the business rates system fit for purpose.”