Initial Coin Offering

Initial Coin Offering - Legal Aspects

An Initial Coin Offering (ICO) is a low-cost and time-efficient type of crowdfunding which is facilitated through the use of distributed ledger technology. For more information on distributed ledger technology and its most common form, blockchain, read our blog on the topic.

What is an Initial Coin Offering?

In much the same way that an initial public offering involves the issue of shares to investors in exchange for fiat currency, an initial coin offering involves the issue of transferable tokens to investors typically in exchange for cryptocurrency such as Bitcoin or Ether. Some tokens may resemble traditional securities such as shares or debt securities, while others may represent a right to access or receive future services. It is the legal status of such tokens and the cryptocurrency used to purchase them which needs to be explored.

Advantages and disadvantages of an Initial Coin Offering

The rights attaching to tokens vary widely. Some tokens may resemble traditional securities such as shares or debt securities, while others may represent a right to access or receive future services. A key appeal of ICOs is that tokens are easily tradeable. This means that investors can, assuming sufficient liquidity, buy and sell tokens on cryptocurrency exchanges, unlike more traditional venture capital investments, which may not be easily traded.

Other benefits of ICOs compared to more traditional fundraising models are seen to include:

  • The ease and speed with which tokens can be issued and funds raised, in many cases without the use of intermediaries.
  • Low transaction and settlement costs.
  • A perceived lack of regulatory barriers.
  • For many issuers, the formation or augmentation of a wide and motivated user base of the underlying product or service.

Commonly cited disadvantages of initial coin offerings when compared to traditional fundraising models include:

  • The price volatility of the most popular cryptocurrencies. ICO issuers will commonly seek to exchange cryptocurrencies subscribed by investors into fiat currency following the ICO, therefore incurring substantial exchange rate risk. It may be prohibitively expensive or difficult to mitigate this risk effectively.
  • A lack of clarity regarding numerous legal issues relating to the underlying distributed ledger technology, including the enforceability of code-based smart contracts.As you can see in our blog such uncertainty in the UK, although untested in court, is likely to be overcome.
  • An uncertain and evolving regulatory position globally. Combined with the absence of any industry standardisation, this increases the advisory costs and slows the speed at which a compliant ICO may be carried out.
  • Cyber security risks, compounded by the irreversibility of many cryptocurrency transactions.

What ICOs are being used for?

The earliest ICOs were used to launch new cryptocurrencies but increasingly they have been used by early stage companies to fund the development of other projects or services and, in particular, the development of decentralised software applications that run on existing blockchain platforms, such as Ethereum.

However, an ICO can be executed by any company looking to issue tradeable rights to investors in exchange for capital, regardless of the sector in which it operates or the product that it wishes to develop. In September 2017, Kik, an established social media platform, raised approximately $98 million through an ICO of “Kin” tokens to support the development of its existing messaging ecosystem. It remains to be seen whether other non-blockchain centric businesses will use ICOs as a means of raising funds.

How do you launch an ICO?

To launch an initial coin offering, an issuer will generally produce a white paper, which is analogous to the prospectus that a company is required to produce in connection with the admission of securities to trading on the Main Market of the London Stock Exchange. A subscriber will subscribe for tokens by transferring consideration to a specified account, and in doing so it is deemed to have accepted the terms and conditions applicable to that ICO. The tokens themselves are typically created, allocated and distributed through a pre-existing blockchain platform, such as Ethereum, in each case without requiring an intermediary.

Regulation of Initial Coin Offerings

A lack of regulatory barriers is seen by some participants as one of the primary attractions of carrying out ICOs. However, while there is no regulatory framework in the UK which is specific to ICOs, or which refers to the specific technology or terminology used in ICOs, it is a common misconception to say that all ICOs are unregulated. Issuers and their advisers must therefore consider carefully the applicability and effect of the full range of relevant legislation.

Regulatory perimeter

An initial coin offering may or may not fall within the Financial Conduct Authority’s (FCA) regulatory perimeter depending on the nature of the tokens (the terms used by the FCA to denote different types of cryptoassets) issued, and the legal and regulatory position of each ICO proposition must be assessed on a case by case basis.

Although many ICOs will fall outside the regulated space (depending on how they are structured, such as exchange and utility tokens), some ICOs (such as security tokens) may involve regulated investments, and firms involved in an ICO may be conducting regulated activities (such as arranging, dealing or advising on regulated financial investments).

The FCA outlines perimeter issues relating to ICOs in CP19/3 on perimeter guidance on cryptoassets. It explains that the majority of tokens that are issued through ICOs to the market tend to be marketed as utility tokens (non-regulated). The perimeter guidance being proposed by the FCA will focus on this area to make sure that firms are aware when their tokens may be considered securities, and therefore fall within the FCA’s regulatory perimeter. The FCA explains that it will be paying increasing attention, especially where those preparing ICOs attempt to avoid regulation by marketing securities as utility tokens.

Other points to note about the regulation of ICOs include:

  • The features of some ICOs are parallel with initial public offerings (IPOs), private placement of securities, crowdfunding or even collective investment schemes (CISs) which need to be examined individually in order to comply with regulation.
  • Some tokens may also constitute transferable securities and therefore may fall within the FCA's prospectus regime.
  • Digital currency exchanges that facilitate the exchange of certain tokens should consider whether they need to be authorised by the FCA to be able to deliver their services.

Risks if ICO’s outside regulatory perimeter

  • Unregulated space: Most ICOs are not regulated by the FCA and many are based overseas.
  • No investor protection: You are extremely unlikely to have access to UK regulatory protections like the Financial Services Compensation Scheme or the Financial Ombudsman Service.
  • Price volatility: Like cryptocurrencies in general, the value of a token may be extremely volatile – vulnerable to dramatic changes.
  • Potential for fraud: Some issuers might not have the intention to use the funds raised in the way set out when the project was marketed.
  • Inadequate documentation: Instead of a regulated prospectus, ICOs usually only provide a ‘white paper’. An ICO white paper might be unbalanced, incomplete or misleading. A sophisticated technical understanding is needed to fully understand the tokens’ characteristics and risks.
  • Early stage projects: Typically ICO projects are in a very early stage of development and their business models are experimental. There is a good chance of losing your whole stake.

FMLC paper on ICOs

The Financial Markets Law Committee (FMLC) published a paper outlining issues of legal uncertainty arising from ICOs in July 2019. The FMLC outlines how existing laws apply to ICOs and looks at some of the challenges for regulators, providers and market participants. These challenges include a lack of international and regional harmonisation relating to the categorisation of tokens issued in ICOs, as well as in their regulatory treatment.

FCA consumer warnings on ICOs

The FCA has warned consumers of the risks of ICOs. The FCA warns that ICOs are very high-risk, speculative investments due to, among other things, their price volatility, lack of access to UK regulatory protections such as the Financial Services Compensation Scheme (FSCS) or the Financial Ombudsman Service (FOS), potential for fraud, and the lack of adequate documentation.

Financial crime risks of ICOs

The FCA wrote to CEOs of banks in June 2018 warning of the risk of abuse of cryptoassets, which arises from the potential anonymity and the ability to move money between countries that crypotassets allow. Banks were warned to take reasonable and proportionate measures to lessen the risk that they might facilitate financial crimes that are enabled by cryptoassets.

An often unregulated area

Unregulated initial coin offerings are not considered safe investments by the FCA and should therefore always be treated with caution. On the other hand they offer businesses a quicker and easier way to raise capital. If you are looking to invest in an initial coin offering you should always be aware of such risks. If you are a business looking to raise capital through an ICO then the extent to which you may be regulated needs to be considered.

ICO’s is an area likely to develop alongside the recent increase in legal certainty granted to cryptoassets and smart contracts under English law. As it stands, however, ICO’s are yet to be addressed in such a direct manner.

EM law are experts in technology law. Please contact us if you have any question on the above.

EM Law IR 35

IR35 - New Rules

Despite controversy and calls for the government to reconsider their plans, the changes to IR35 will be implemented in April 2020. But what exactly are the IR35 rules, and what can you do to prepare for these changes? This blog takes a look at the IR35 legislation and aims to answer some of your burning questions. 

What is IR35?

Contractors who work through an intermediary, such as a personal service company, enjoy a certain level of tax efficiency. While they are not entitled to employee benefits such as holiday pay or sick pay, their tax status often enables them to take home more net pay than an employee in the same role. The benefit for an employer of hiring an individual in this way is that they don’t have to organise PAYE or contribute to National Insurance. Brought into law in April 2000, IR35 was designed to crackdown on the use of this corporate structure as a means of avoiding tax. 

How does it work?

IR35 effectively determines whether an individual is a bona fide contractor or a ‘disguised employee’ for the purposes of paying tax. If it is concluded that an individual is a ‘disguised employee’, they will be deemed to be inside IR35 and will be subject to National Insurance and Income Tax. If it is concluded that an individual is actually a contractor, then they will be deemed to be outside IR35 and will not be caught by the rules. 

Most of the questions that need to be answered in order to determine whether an arrangement will be caught by the IR35 legislation are relatively straightforward and are set out in the legislation itself. However, one of the key questions that needs to be answered is whether the worker would have been an employee of the client if they had been working directly for it, and this question is less straightforward. HMRC has provided guidance on the factors that it considers to be the most important in determining an individual’s employment status. These factors include whether there is personal service, mutuality of obligation, employee-type benefits and whether the individual provides his or her own equipment. 

What are the IR35 changes?

Extension to private sector

In April 2020, IR35 will be extended to the private sector for large and medium-sized organisations. The 2020 changes will bring IR35 in the private sector into line with the public sector by shifting the liability for defining a worker as employed or self-employed from the individual to the organisation which engages them. The public sector, including major employers such as the NHS, have been responsible for this since April 2017. It will therefore be the private sector end user who will be the subject of any HMRC enquiry and of any demand for tax due. 

Exemption for small companies 

In the public sector, where the IR35 rules already apply, the size of an organisation is irrelevant. However, in the private sector, HMRC has confirmed that small companies will be excluded from the new rules. The government has estimated that, as a result of the exception, 95% of end users will not need to apply the reform. But what is classed as a small company?

In its latest guidance, HMRC has defined a small company as a limited company that meets at least two of the following criteria:

  • An annual turnover of not more than £10.2 million;
  • A Balance Sheet total of not more than £5.1 million; and/or
  • Not more than 50 employees. 

Where a private company satisfies these requirements, the individual will continue to ‘self-assess’ and account for Income Tax and National Insurance where it is concluded that the rules apply. Where a private company does not satisfy these requirements, they will be subject to IR35. Until the draft legislation is published, we cannot say for sure how this exception will be applied to unincorporated entities and limited liability partnerships. 

What can you do to prepare?

The 2020 changes to IR35 are being introduced to make life easier for HMRC. Instead of pursuing thousands of individual workers, HMRC will pursue large employers, at a fraction of the recovery and administration costs. 

Although the changes will not come into force until 2020, organisation is key. Large and medium-sized organisations should consider undertaking a review of their use of contractors, setting out who they are currently contracting with and on what basis. Organisations can also make use of an online tool called CEST, however this should be approached with caution. CEST has come under criticism in the past few months and should not be used as a substitute for a full and proper investigation. 

As part of their review, large and medium-sized organisations should evaluate any contracts that they have in place with individual contractors. In order to limit the risk of IR35 applying, some of the following should be considered:

  • Including a right of substitution clause within the contract. This clause should be drafted so that it is as wide-ranging as possible.
  • Avoiding an obligation to provide and accept work. Including a notice period may point towards a conclusion that there is a mutuality of obligation, so this should be avoided. 
  • Structuring contracts, where possible, by reference to completion of a project or a piece of work, rather than by duration. Similarly, payment should be structured by reference to completion of a project, rather than time worked. 
  • If possible, requiring the individual to provide their own equipment, rather than providing equipment to them. 
  • Integrating the individual into the company no more than is absolutely necessary.
  • Although not determinative, stating in the contract that the relationship is not intended to be one of employment. 

Whilst it is important that contracts are drafted in such a way as to reduce the risk of IR35 applying, it is also important that the practical reality is in accordance with those terms. A carefully drafted contract will not avoid being caught by IR35, unless it also reflects the reality of the situation. IR35 is a complex area of law so speaking to a lawyer or tax specialist early on and before starting your review is recommended.  

Final words

The cases brought against public sector employees have highlighted the fact sensitive nature of the legislation. Currently no easily applicable checklist exists making it difficult for big businesses to apply blanket procedures to ensure adherence to IR35 with multiple contractors. The government promised to improve the employment status tests in the Good Work Plan but is yet to do so. Unfortunately at this time employee status will be best analysed on a case by case basis.

The changes to IR35 will throw up all sorts of administrative challenges for large and medium-sized organisations. Those who start planning now will find themselves ahead of the game and ensure that the right level of resource is in place when needed. If you are a business and you think that IR35 may impact upon your operations then do get in touch.

EM Law Contract Lawyers London

You want to sign a contract before your company is incorporated? Think again!

This blog explains the problems with pre-incorporation contracts and sets out what you can do if you find yourself in this situation.

What is incorporation?

A company does not legally exist until it is incorporated. Incorporation is the process by which a new or existing business registers as a company. Once a company is incorporated, it will receive a certificate of incorporation confirming its existence and showing the company number and date of formation. Before a company is incorporated, it cannot enter into commercial contracts. Consequently, nobody can sign a contract for that company as an agent. A contract entered into by a party on behalf of a company, where that company has not yet been formed, is called a pre-incorporation contract.

The law

general rule relating to pre-incorporation contracts is set out in section 51
of the Companies Act 2006. The section states that:

“A contract that purports to be made by or on
behalf of a company at a time when the company has not been formed has effect,
subject to any agreement to the contrary, as one made with the person
purporting to act for the company or as agent for it, and he is personally
liable on the contract accordingly.”

This means
that anyone who signs a contract on behalf of a company before that company is
incorporated will be liable as if they were the contracting party. Section 51
also has dual effect, as confirmed in the case of Braymist Ltd v Wise Finance.
As well as having personal liability, the person who signs on behalf of a
company can personally enforce the pre-incorporation contract.

What exactly is an "agreement to the contrary"?

There has
been some disagreement over the years as to the exact meaning of “agreement to
the contrary”. Thankfully, case law has provided some clarity. If you can prove
that there is an “agreement to the contrary” you may be able to negate
liability and get yourself off the hook.

Phonogram v Lane, Lord Denning took the phrase “subject to any agreement to the
contrary” to mean that for a person to avoid personal liability the contract would
have to expressly provide for his exclusion.  

In Royal
Mail Estates Ltd v Maples Teesdale, Mr Johnathan Klein took a similar but even
more restrictive approach. Mr Johnathan Klein stated that an “agreement to the
contrary” would only exist if it could be established that, by relevant words
properly construed, the parties intended that the contract would not take
effect as one made with that person. In other words, there was only a contrary
agreement if there was found to be an agreement between the parties by which
they intended to exclude the effect of section 36C(1), which is now section 51
Companies Act 2006.

In the
case the defendant firm of solicitors signed the contract “for and on behalf of
the buyer”. The contract related to the sale and purchase of a property in
London and included a clause which stated that the benefit of the contract was
personal to the buyer. As both parties were unaware that the company in
question had not in fact been incorporated Mr Klein concluded that the contract
was not drafted with section 36C(1) in mind. The terms in question were clearly
intended for a different purpose, which was to prevent or restrict a third
party from becoming a buyer by way of an assignment of sub-sale.

The fact that
the defendants here were a firm of solicitors shows just how easy it is to be
caught out by section 51. Proving that there was “an agreement to the contrary”
is a high hurdle to overcome.

What can I do to avoid liability?

As the
saying goes, prevention is better than cure. As the risk sits with the person
who has signed the contract, it is extremely important for that person to carry
out appropriate checks to confirm that the company in question has been
properly incorporated, and continues its corporate existence, before a contract
is concluded. If you have already signed a pre-incorporation contract on behalf
of a company, and you cannot prove an “agreement to the contrary”, you may
still be able to avoid personal liability as explained below.

  • Novation

A novation
is a three-way agreement that extinguishes one contract and replaces it with
another, in which a third party takes up the rights and obligations of one of
the original parties. In this scenario, the third party taking up those rights
and obligations would be the company. All parties to the original contract, as
well as the company, must consent to a novation for it to be valid. In
addition, consideration must be provided. The various promises between the
parties to the novation are generally regarded as adequate consideration
however some parties may prefer to novate under a deed just to be sure.

  • Ratification

is a process by which a party can give retrospective authority to someone who
has entered into an agreement on their behalf. Although some commentators
suggest that ratification may be of assistance in these circumstances, we do
not consider that ratification is possible in the case of pre-incorporation
contracts. There are a number of conditions that must be met for an action to
be capable of being ratified. One of these conditions is that the principal
(here, the company) must be in existence at the time of the contract. As a
company is not legally in existence before it is incorporated, these conditions
will not be satisfied.

Final words

This blog should serve as a timely reminder of the risks of signing documents on behalf of a company; and in particular where a company itself is not in existence. If you have any questions about pre-incorporation contracts or contractual issues more generally please contact Neil Williamson or Joanna McKenzie or you can find out more about our legal services by clicking here.

Warranty Claim Teoco v Aircom EM Law Photo by Kaique Rocha

Share Purchase Agreement Claim Fails Because It Didn’t Follow Contract Procedure - Teoco UK Ltd v Aircom Jersey 4 Ltd & Anor [2018] EWCA Civ 23 (18 January 2018) 


In November 2013 Aicom and Aircom Global (the Respondents) signed a share purchase agreement in which the Respondents sold their shares in two companies that were part of their corporate group to Teoco for £41 million.

In February 2015 Teoco’s lawyers wrote to the Respondents lawyers claiming damages of approximately £3.4 million for breach of warranty or an indemnity in relation to tax said to be owed by two subsidiaries of one of the companies that Teoco had purchased. The letter was stated to constitute “notification in accordance with clause 24 and Schedule 4 of the SPA of the existence of Claims, being either Warranty Claims or Tax Claims, as further detailed below”, and which went on to set out details of the potential tax liabilities of the subsidiaries in Brazil and the Philippines.

In June 2015 Teoco’s lawyers issued a further letter providing more detail around how the level of damages was arrived at.

In August 2015 Teoco issued proceedings in the High Court.

On 18 December 2015 the Respondents applied to the High Court to strike out Teoco’s claim on the basis that it did not follow the procedure for making claims as set out in the share purchase agreement.

On 28 April 2016 the High Court ruled in favour of the Respondents and dismissed Teoco’s claim.

Teoco appealed.

The Appeal Decision

The Court of Appeal dismissed the appeal.

Lord Justice Newey examined the SPA and noted that Clause 10 of the SPA imposed limitations on the Sellers' potential liabilities. It stated:

“The liability of the Sellers under or in respect of any claim for breach of this agreement shall be limited by, and all claims for breach of this agreement shall be dealt with in accordance with, the provisions set out in schedule 4.”

The key provisions of schedule 4 in the SPA read as follows:

“4. Notice of Claims

No Seller shall be liable for any Claim unless the Purchaser has given notice to the Seller of such Claim setting out reasonable details of the Claim (including the grounds on which it is based and the Purchaser's good faith estimate of the amount of the Claim (detailing the Purchaser's calculation of the loss, liability or damage alleged to have been suffered or incurred)).

5. Time limits for Claims

5.1 No Seller shall be liable for any Claim unless the Purchaser has given notice of such Claim in accordance with paragraph 4, as soon as reasonably practicable after the Purchaser Group becomes aware that the Purchaser has such a Claim, and in any event on or before 31 July 2015.”

Judge Newey reviewed the letters that Teoco’s lawyers had sent to the Respondents’ lawyers and concluded that they did not constitute sufficient notice under paragraph 4 of Schedule 4 of the SPA. He found that the letters did not make specific reference to the warranties that the Respondents had allegedly breached or the grounds upon which the tax indemnity was triggered and therefore could not be considered to have been “setting out” the “grounds” of a claim.


I suspect most non-lawyers would find the decision harsh. In their February and June letters Teoco’s lawyers set out the nature of the claim in detail. Paragraph 4 of Schedule 4 in the SPA did not explicitly state that Teoco would have to make specific reference to the warranties that were breached or how the indemnity in the SPA was triggered in order to bring a claim. Wouldn’t justice be served, you may ask, if the court allowed the claim to be heard and then decided on its merits rather than thrown out on a technicality?

As a lawyer I am not so surprised by the decision (yes, hindsight is a wonderful thing!) because I read court cases all the time. I am used to seeing how somebody not quite getting it right or missing something altogether can lead to a court decision that has serious negative consequences for one of the parties.

Lessons to be learned:

  • don’t let the seller put claims limitation clauses in a share purchase agreement that you, if you are the buyer, are not totally clear on;
  • pay massive attention to detail when you are bringing a claim.

If you are buying or selling a company or need any other help with a share purchase agreement please get in touch.