Large private limited companies have been subject to political scrutiny for some time as the Government has tried to assess what regulatory framework should apply to them. The catalyst for this move being that it is not just publicly listed companies that should be subject to governance codes and have responsibility to relevant stakeholders. Several large-scale corporate failures (which included non-listed corporates) led to a parliamentary Select Committee being established in 2016 to review corporate governance reform. This has resulted in:
- the Companies (Miscellaneous Reporting) Regulations 2018 (the 'Reporting Regulations') which came into force on 1st January 2019; and
- a new code for the corporate governance of large private companies was launched on 10th December 2018 (the 'Wates Principles') which such companies may choose to apply.
Private limited companies need to consider whether these new arrangements apply to them and if they do; what do they require and when.
What are the new matters that large Private Limited Companies must Report on?
The Reporting Regulations essentially set out four new matters that large private limited companies must report on annually. We summarise each of the four below, with the table summarising the qualifying conditions ('Qualifying Conditions') applicable to each:
1. Employee Engagement
Where this Reporting Requirement applies then the Directors Report must include a statement which describes "the action that has been taken during the financial year to introduce, maintain or develop arrangements aimed at:
- providing employees systematically with information on matters of concern to them as employees;
- consulting employees or their representatives on a regular basis so that the views of employees can be taken into account in making decisions which are likely to affect their interest;
- encouraging the involvement of employees in the company's performance through an employee share scheme or by some other means; and
- achieving a common awareness on the part of the employees of the financial and economic factors affecting the performance of the company."
The report must summarise "how the directors have engaged with employees and how the directors have had regard to employees interests and the effect of that regard including on the principal decisions taken by the company during the financial year."
The statement does not need to cover persons employed wholly or mainly outside of the UK.
2. Engagement with other Stakeholders
Where the Qualifying Conditions are met the Directors Report must set out "how the directors have had regard to the need to foster the company's business relationships with suppliers, customers and others, and the effect of that regard, including on the principle decisions taken by the company during the financial year."
3. Section 172(1) Statement
Companies who meet the Qualifying Conditions must provide a statement in their Strategic Report describing how directors have had regard to the matters set out in section 172 (1) (a) to (f) of the Companies Act 2006 when performing their duty under section 172 for the financial year.
For ease of reference section 172 states that: "a director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to:
- the likely consequences of any decision in the long term;
- the interests of the company's employees;
- the need to foster the company's business relationships with suppliers, customers and others;
- the impact of the company's operations on the community and the environment;
- the desirability of the company maintaining a reputation for high standards of business conduct; and
- the need to act fairly as between members of the company."
Note that if a parent company and its subsidiaries do not meet the Qualifying Conditions separately but the parent meets the threshold on a consolidated basis then, the parent company must prepare a section 172 (1) Statement.
4. Corporate Governance Statement
Where the Qualifying Conditions are met, the Directors' Report must include a statement on its corporate governance arrangements which should confirm:
- which corporate governance code, if any, the company applied in the financial year;
- how the company applied that code; and
- if the company departed from such code, the respects in which it did so, and its reasons for so departing.
Corporate governance is defined as:
- the nature, constitution or functions of the organs of the company;
- the manner in which organs of the company conduct themselves,
- the requirements imposed on organs of the company;
- the relationship between different organs of the company; and
- the relationship between the organs of the company and the members of the company.
If a company meeting the Qualifying Conditions has not applied any corporate governance code for a financial year, the statement of corporate governance arrangements must explain the reasons for that decision, and explain what arrangements for corporate governance were applied for that year. This is in line with the Reporting Regulations 'comply or explain' approach.
The Wates Principles were developed by the Government to offer large private companies a suitable code for complying with the new Reporting Requirement. The Wates Principles set out six key principles and companies that adopt the Wates Principles are likely to be expected to provide supporting statements for each of the six principles. The Principles are 'flexible and high-level' so that they can be tailored to each organisation; reflecting that a 'one size fits all' approach to corporate governance is not appropriate.
In the words of James Wates CBE:
"Boards should apply each Principle by considering them individually within the context of the company's specific circumstances. They should then be able to explain, in their own words, how they have addressed them in their governance practices."
Overview of the new Reporting Requirements and Qualifying Conditions for Large Private Limited Companies
The table below provides a useful overview, including the Qualifying Conditions:
Questions that the firm is regularly asked
When do I need to be taking action?
The Reporting Regulations apply for accounting periods starting 1st January 2019. This means that affected companies are not likely to issue the new reports until sometime in the second half of 2020 (this is on the basis that accounts are due to be filed by such companies within 9 months after the year-end). However, companies need to be acting now so that they have positive details to report on.
What companies/entities are affected?
The Regulations apply to UK companies, including UK subsidiaries of overseas companies and subsidiaries of listed PLCs if they meet the Qualifying Conditions. The Reporting Regulations do not apply to Limited Liability Partnerships.
Subsidiaries of parent companies that are already subject to a governance code (i.e. the UK Corporate Governance Code) may choose to confirm that it did not apply a code as its parent entity applied the UK Corporate Governance Code, which was applied throughout the group. In these cases, the subsidiary would still need to issue a statement to explain how that code was applied.
What needs to go on the Website?
If a private limited company meets the Qualifying Conditions then the statement must be published on a website that is maintained by or on behalf of the company and must be capable of being downloaded at no cost. Failure to do so amounts to an offence by the officers of the company.
Why is it important?
Failure to comply may impact significantly a company's brand, reputation and value. Compliance should also help ensure an organisations long-term viability and success.
The Department for Business Energy & Industrial Strategy have published a paper with useful Q&A on the Reporting Regulations. See the appendix for links to the content.
The Wates Principles
Read The Wates Corporate Governance Principles for Large Private Companies in full for an in-depth overview. In short, the principles are:
1. Purpose and Leadership - An effective board develops and promotes the purpose of a company and ensures that its values, strategy and culture align with that purpose.
This is at the heart of good governance and is supported by the following two Principles:
2. Board Composition - Effective board composition requires an effective chair and a balance of skills, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution. The size of a board should be guided by the scale and complexity of the company.
3. Board Responsibilities - The board and individual directors should have a clear understanding of their accountability and responsibilities. The board's policies and procedures should support effective decision-making and independent challenge.
The following specific Principles are the foundation of good governance
4. Opportunity and Risk - A board should promote the long-term sustainable success of the company by identifying opportunities to create and preserve value and establishing oversight for the identification and mitigation of risks.
5. Remuneration - A board should promote executive remuneration structures aligned to the long-term sustainable success of a company, taking into account pay and conditions elsewhere in the company.
6. Stakeholder Relationships and Engagement - Directors should foster effective stakeholder relationships aligned to the company's purpose. The board is responsible for overseeing meaningful engagement with stakeholders, including the workforce, and having regard to their views when taking decisions.
Each Principle is subject to supporting Guidance to assist companies.