Sources of corporate governance rules and practices
Primary sources of law, regulation and practice
What are the primary sources of law, regulation and practice relating to corporate governance? Is it mandatory for listed companies to comply with listing rules or do they apply on a ‘comply or explain’ basis?
The United Kingdom’s corporate governance regime consists of laws, rules and practices that ensure that companies operate with integrity and that those responsible for their management are accountable for their actions. Its purpose is to encourage investor and public confidence in UK companies and thus to promote economic stability. The main sources of corporate governance in the UK are as follows:
The Companies Act 2006 (CA 2006) is the principal statute relating to corporate governance in the UK. CA 2006 codifies and replaces certain common law duties of directors (CA 2006, section 170(3)) (see ‘Common law’). The statutory duties of directors under CA 2006 are as follows:
- to act within powers (ie, in accordance with the company’s constitution) (section 171);
- to promote the success of the company (section 172);
- to exercise independent judgement (section 173);
- to exercise reasonable care, skill and diligence (section 174);
- to avoid conflicts of interest (section 175);
- not to accept benefits from third parties (section 176); and
- to declare any interest in a proposed transaction or arrangement with the company (section 177).
However, these statutory duties must be interpreted and applied in accordance with the common law duties that are discussed below (CA 2006, section 170(4)). Indeed, in respect of directors’ duties that have not been codified under CA 2006 (such as the duty to keep the affairs of the company confidential) the common law rules remain the only relevant law. CA 2006 contains further provisions relevant to corporate governance, which are discussed at various points in this chapter.
Statutes including the Corporate Manslaughter and Corporate Homicide Act 2007, the Financial Services and Markets Act 2000 (FSMA 2000), the Criminal Justice Act 1993, the Insolvency Act 1986, the Bribery Act 2010, the Financial Services Act 2010 and various statutory instruments also contain provisions relating to corporate governance.
Company directors have a range of fiduciary, or common law, duties derived from a long line of case law dating back to the early nineteenth century. These fiduciary duties include a requirement:
- to exercise skill and care;
- to act in good faith in the best interests of the company;
- to act within the powers conferred by the company’s constitution and to exercise these powers for proper purposes;
- not to fetter discretion;
- to avoid interests that conflict with those of the company and to avoid duties that conflict with the director’s duties to the company;
- not to make a secret profit; and
- to keep the affairs of the company confidential.
Some of these common law duties have now been codified and replaced by CA 2006, sections 171 to 177 (see ‘Statute’).
The listing regime
The Listing, Prospectus, Disclosure Guidance and Transparency Rules (the LPDT Rules) play a significant part in regulating UK-listed companies. They form part of the Financial Conduct Authority’s (FCA) Handbook, which contains the rules and guidance made under FSMA 2000, the principal statute relating to financial services in the UK. The LPDT Rules comprise the following sets of rules, which are mandatory for those companies to which they apply:
- the Listing Rules (LRs) apply to companies that have applied for their securities to be listed, or whose securities are already listed, on the Official List (maintained by the FCA), and set out:
- the requirements a company must meet for its securities to be admitted to listing;
- rules relating to listing particulars;
- certain obligations with which a company must continue to comply after its securities have been admitted to listing (known as ‘continuing obligations’); and
- apply only to companies with a premium listing and not to those with a standard listing;
- the Prospectus Rules (PRs), which implement the Prospectus Directive and require UK-listed companies, subject to certain exemptions, to publish a prospectus if they offer their shares to the public or make a request for their shares to be admitted to trading on a regulated market in the UK. The PRs contain rules on the contents of a prospectus and the approval process for such a document; and
- the Disclosure Guidance and Transparency Rules (DTRs), which apply to a company that has applied for its securities to be admitted, or whose securities are already admitted, to trading on a regulated market in the UK (this includes companies whose shares are admitted to the Official List and are traded on the London Stock Exchange (LSE), but not companies whose securities are listed on the Alternative Investment Market).
Perhaps the two most important elements of the LPDT Rules are the Listing Principles set out at LR7 (which assist UK-listed companies in understanding their duties under the LPDT Rules and encourage them to take their role in maintaining market confidence and ensuring fair and orderly markets seriously) and the continuing obligations contained in the LRs and DTRs with which a UK-listed company must comply in order to maintain its listing. Broadly speaking, in terms of complying with corporate governance disclosure obligations, UK-listed companies must ensure that they comply with DTRs 7.1 and 7.2, and LR9.
The UK has a two-tier listing regime, which, as of 6 April 2010, is divided into a premium listing and a standard listing (before this date the two tiers were referred to as a primary listing and a secondary listing). UK-listed companies with a premium listing must comply with super-equivalent standards (standards that exceed the minimum standards set down by the relevant EU directive). UK-listed companies with a standard listing need only comply with the minimum standards of EU legislation.
The UK Corporate Governance Code
The UK Corporate Governance Code (the Code) represents key corporate governance recommendations of best practice for UK-listed companies. The Financial Reporting Council (FRC) first published the Code on 28 May 2010 when it superseded the existing Combined Code on Corporate Governance (Combined Code). A new version of the Code was published in September 2012, applying to accounting periods beginning on or after 1 October 2012; a revised version was published in September 2014 applying to accounting periods beginning on or after 1 October 2014; a further revised version was issued in April 2016 applying to accounting periods beginning on or after 17 June 2016; the most recent version was published in July 2018 applying to accounting periods beginning on or after 1 January 2019. The old versions of the Code will continue to apply to the historic accounting periods to which they relate. This chapter concentrates on the application of the current version of the Code.
The Code is applicable to all companies with a premium listing of equity shares in the UK, regardless of whether the company is incorporated in the UK or elsewhere. The Code is divided into principles and provisions. The Code does not have statutory force, rather it establishes principles of good governance and provides recommendations and guidance. Companies with a premium listing of equity shares incorporated either in the UK (LR9.8.6R(5)) or overseas (LR9.8.7R) are required to include a statement in their annual financial report that explains how the company has applied the ‘main principles’ of the Code in a manner that would enable shareholders to evaluate how the principles have been applied. The reference to main principles in this rule relates to the 2016 version of the Code (as further explained below), however the rule should now be read as referring to the principles of the 2018 version of the Code. Companies with a premium listing of equity shares must also set out in the annual financial report whether or not they have complied with all the provisions (including the principles) of the Code over the course of the accounting period and give reasons for any non-compliance (the comply or explain regime) (LR9.8.6R(6)).
UK-listed companies are not obliged to comply with the Code and the board may explain why it has not complied, but failure to comply with the Code could damage investors’ confidence in a company if good governance has not been adhered to. This could ultimately lead to its shareholders voting against resolutions proposed by the company or even selling their shares. The FRC acknowledges that a listed company may wish to deviate from the provisions of the Code: the intention of the comply or explain approach is to encourage engagement with the shareholders and to ensure good governance, perhaps in a different guise.
According to the FRC, the 2018 version of the Code places greater emphasis on the relationships between companies, shareholders and stakeholders, as well as promoting the importance of establishing a corporate culture that is aligned with the company purpose and business strategy, and which promotes integrity and values diversity.
Some of the crucial principles and provisions that the Code encompasses are:
- effective board management in the long-term interests of the company;
- definitions of the role of the board, the chair and the non-executive directors of a company;
- the separation of the roles of the chair and the chief executive officer (CEO) of a company;
- the role of the chair in leading the board and ensuring effectiveness;
- the role of non-executive directors in constructively challenging strategy, scrutinising performance and offering specialist advice;
- the composition of the board, especially in terms of ensuring a combination of skills, experience and knowledge of the company;
- open and rigorous procedures for the appointment of directors with due regard for the benefits of diversity (of gender, social and ethnic backgrounds, cognitive and personal strengths);
- formal evaluation of the performance of boards, committees and individual directors (demonstrating whether each director continues to contribute effectively);
- the proportion of independent non-executive directors that a company must have on its board;
- the role of a company’s audit committee in monitoring the integrity of its financial reporting, reinforcing the independence of the external auditor and reviewing the management of financial and other risks; and
- executive remuneration being clearly linked to the successful delivery of the company’s long-term strategy.
In July 2018, the FRC published an updated version of the Code, applying to accounting periods beginning on or after 1 January 2019. The Code is shorter than the previous version, with the number of provisions reduced by one-third. The Code consists of five sections:
- Section 1: Leadership and Purpose;
- Section 2: Division of Responsibilities;
- Section 3: Composition, Succession and Evaluation;
- Section 4: Audit, Risk and Internal Control; and
- Section 5: Remuneration.
The revised Code includes the following changes:
- the board establishing a method of gathering the view of the workforce through a director appointed from the workforce, a formal workforce advisory panel or a designated non-executive director;
- means for the workforce to raise concerns in confidence and anonymously and an emphasis on engagement with the workforce;
- consideration by companies of their responsibilities to shareholders and stakeholders and the contribution made to wider society;
- the establishment of a nomination committee to lead the process for appointments to the board to ensure succession planning that develops a more diverse pipeline;
- where 20 per cent of votes have been cast against a resolution, the company should explain, when announcing voting results, what actions it intends to take to consult with shareholders to understand the reasons behind the vote with an update to be published not later than six months after the vote; and
- regular engagement by the chair with major shareholders to understand their views on governance and performance against strategy.
The Code is supplemented by the following published guidance, and it is considered good practice to comply with this guidance, although it has no formal status:
- FRC Guidance on Board Effectiveness, which replaced the Good Practice Suggestions from the Higgs Report following a review undertaken by the Institute of Chartered Secretaries and Administrators (ICSA), and was last updated in July 2018;
- FRC Guidance on Audit Committees, which was updated by the FRC in December 2010, September 2012 and April 2016; and
- FRC Guidance on Risk Management, Internal Control and Related Financial and Business Reporting, published in September 2014.
The UK Stewardship Code
The FRC first published the UK Stewardship Code (the Stewardship Code) on 2 July 2010 and it came into immediate effect. This version of the Stewardship Code was replaced by a new version published on 28 September 2012 and effective from 1 October 2012. The Stewardship Code is applicable to those firms who manage assets on behalf of institutional shareholders, including pension funds, insurance companies, investment trusts and other collective investment vehicles. The Stewardship Code, like the Code, operates a comply or explain approach and the FRC recommends that a company publishes a statement of compliance on its website. At present, there is no requirement to disclose whether or not a relevant company has complied with the Stewardship Code principles, though this is set to change. All institutional investors are encouraged to observe the Stewardship Code and to observe the comply or explain approach, on the same basis as asset managers. The Stewardship Code is complementary to the Code and replaced Schedule C of the Code, which was removed with effect from 1 August 2010. The intention of the Stewardship Code is to promote greater engagement between institutional shareholders and company boards and to encourage greater transparency about the way in which institutional investors oversee the companies they own. The FRC believes that good governance is underpinned by high-quality dialogue between boards and investors. The principles of the Stewardship Code are that institutional investors should:
- publicly disclose their policy on how they will discharge their stewardship responsibilities;
- have a robust policy on managing conflicts of interest in relation to stewardship, which should be publicly disclosed;
- monitor their investee companies;
- establish clear guidelines on when and how they will escalate their stewardship activities;
- be willing to act collectively with other investors where appropriate;
- have a clear policy on voting and disclosure of voting activity; and
- report periodically on their stewardship and voting activities.
The Stewardship Code is based upon the Code on the Responsibilities of Institutional Investors, published by the Institutional Shareholders’ Committee, which is discussed further below.
In December 2011, the FRC published a report on the impact and implementation of the Code and the Stewardship Code, revealing a broadly positive reception to the Stewardship Code. The later published version of the Stewardship Code, which applies to relevant companies with accounting periods beginning on or after 1 October 2012, does not represent a change in policy or direction, but attempts to create a common understanding of the term ‘stewardship’, with greater clarity on the roles and responsibilities of asset owners and managers. The revised Stewardship Code also takes into account changes in market practice, such as the issuance of standards on assurance reports, and the FCA’s requirement that firms authorised to manage funds on behalf of others disclose the nature of their commitment to the Code.
In 2016, the FRC introduced a tiering system, whereby signatories to the Stewardship Code are categorised according to the quality of their statements, in an effort to improve standards of reporting. The FRC believes that the quality of reporting has improved substantially as a result of the exercise. In November 2016, of the nearly 300 signatories to the Stewardship Code, over 120 were placed in the highest tier (of three for asset managers and two for other signatories), representing an increase from approximately 40 at the beginning of the exercise. Although those with weaker reporting standards were encouraged to engage with the FRC to discuss improvements, asset managers that did not achieve at least Tier 2 were removed from the signatory list in August 2017, on the basis that their reporting failed to demonstrate the level of commitment expected by the FRC to the objectives of the Stewardship Code.
Sir John Kingman’s independent review of the FRC in December 2018 has called the ongoing existence of the Stewardship Code into question, noting that a fundamental shift in approach was required in order to focus outcomes on effectiveness rather than boilerplate reporting. In addition, the Investment Association (IA) has stated that now is an opportune time for the Stewardship Code to be fully refreshed and focused on best practice. Accordingly, a draft version of the revised Stewardship Code (which is set to be finalised in the summer of 2019) has been published by the FRC. Under the prospective regime, in order to become a signatory to the Stewardship Code, entities will be required to submit a policy and practice statement. This statement will set out which category of signatory-status the entity is applying for (from a choice of asset owner, asset manager or service provider), and confirm how the entity’s policies and practices enable it to apply the applicable principles and comply with the applicable provisions of the Stewardship Code. Where the entity is not compliant with a provision, a meaningful explanation of an alternative approach will be required. After becoming signatories, entities will be further required to produce an annual activities and outcomes report. This report would require signatories to:
- detail their compliance with their policy and practice statement and any departures from that statement;
- describe the activities they have undertaken to implement the provisions of the Stewardship Code in the preceding 12 months; and
- provide an evaluation of how well stewardship objectives have been met and have enabled clients to meet theirs, or both, and the outcomes achieved.
The FRC also proposes a new definition of stewardship, defined as the ‘responsible allocation and management of capital across the institutional investment community to create sustainable value for beneficiaries, the economy and society. Stewardship activities include monitoring assets and service providers, engaging UK-listed companies and holding them to account on material issues, and publicly reporting on the outcomes of these activities’. In addition, the draft Stewardship Code makes explicit reference to environmental, social and governmental concerns. For example, it obliges signatories to demonstrate how they take into account material environmental, social and governmental factors in their investment approach.
City Code on Takeovers and Mergers
The City Code on Takeovers and Mergers (the Takeover Code) regulates takeovers and mergers of certain companies in the UK, the Isle of Man and the Channel Islands, including companies whose shares are listed on the LSE. It consists of six general principles that set out the standards of behaviour expected of companies engaged in a merger or takeover and 38 rules (with accompanying notes) that expand on the general principles and provide detailed guidance on the conduct of takeovers and mergers.
Broadly, the aim of the Takeover Code is to ensure that:
- shareholders of the same class in a target company are treated equally and have adequate information so that they can reach a properly informed decision about whether to approve the proposed takeover or merger;
- a false market is not created in the securities of the offeror or the target company; and
- the management of the target company do not take any action that would frustrate an offer for that company without the consent of its shareholders.
The Takeover Code has statutory force and the Panel on Takeovers and Mergers (the Takeover Panel) has statutory powers in respect of transactions to which the Takeover Code applies. Breach of any Takeover Code rules that relate to the consideration offered for a target company could lead to the offending party being ordered to compensate any shareholders who have suffered financial loss as a result of the breach. A person who breaches any Takeover Code rules relating to the content requirements of offer documents and response documents may be guilty of a criminal offence and liable to a fine (subject to certain exceptions) (CA 2006, section 953(2), (3), (4) and (6)). The Takeover Panel may also issue rulings compelling parties who are in breach of the Takeover Code to comply with its provisions. Such rulings are enforceable by the court (CA 2006, section 955(1)). In addition, the Takeover Panel may require a party who is in breach of the Takeover Code to remedy such breach and may withdraw or impose conditions on any exemption from the Rules that it has granted and issue a private or public reprimand to companies in respect of any breach.
Institutional investor guidelines
Bodies representing institutional investors, most notably the Association of British Insurers (ABI) and the Pensions and Lifetime Savings Association (until October 2015 known as the National Association of Pension Funds (NAPF)), issue guidelines to their members advising them how to vote in relation to certain resolutions proposed by companies. The ABI, for example, has published guidelines relating to the level of authority to allot shares that should be granted to directors, which it updated in December 2009. The ABI’s Investment Affairs division merged with the Investment Management Association (IMA) on 30 June 2014 to form a body called, since January 2015, the Investment Association (IA), which is now responsible for issuing guidance that used to be issued by the ABI. Before it was renamed, the enlarged IMA issued updated guidelines on share capital management in July 2014. The Pre-Emption Group, a body consisting of listed companies and their investors, has issued guidance as to how its members should vote on resolutions to disapply shareholders’ pre-emption rights. This guidance, originally published in May 2006, was updated in July 2008 and again in March 2015.
The Pension and Lifetime Savings Association (PLSA)’s corporate governance policy and voting guidelines (the PLSA Guidelines) aim to assist its members to interpret the Code when considering how to vote on certain resolutions proposed by the company. The PLSA Guidelines are updated on a regular basis to reflect amendments made to the Code, and the most recent PLSA Guidelines were published on 29 January 2019. The PLSA Guidelines cover the following matters, among others:
- how to vote if the chair is not sufficiently independent (on appointment);
- the separation of the role of the chair and the CEO (and how shareholders should vote if these roles are not properly divided);
- the independence of non-executive directors;
- how shareholders should vote if the board contains insufficient non-executive directors;
- how shareholders should vote if the company’s audit, remuneration and nomination committees are improperly constituted;
- the standards to which the board should hold itself, to ensure pay is aligned to long-term strategy and the desired corporate culture throughout the organisation;
- how to vote if a company fails to properly disclose its strategic objectives or fails to properly report on its risk management and internal control principles;
- the processes that a company should have in relation to appointments to the board, including the need to disclose its diversity policy and its application of that policy;
- how to vote in relation to the remuneration report and new share scheme proposals;
- the re-election of directors;
- the ability of companies to hold meetings at short notice;
- how to vote when a company fails to comply with the Code and does not provide an adequate explanation;
- how shareholders should vote on proposed changes to the company’s memorandum and articles of association;
- how shareholders should vote if their approval is not sought for final dividends;
- how shareholders should vote on share issues and share purchases;
- how to vote if shares have been issued in excess of the Pre-Emption Group guidelines; and
- the payment of political donations.
The PLSA notes the growing trend towards shareholder resolutions in recent years and encourages their use only where engagement has failed.
In October 2009, the ABI Investment Committee published updated guidance on various provisions that it believes public companies should include in their articles of association. This guidance covers the following areas, among others: corporate representatives; directors’ fees (the guidance recommends that a company’s articles of association should contain a cap on the fees paid to directors); and penalties for shareholders who fail to comply with CA 2006, section 793 (which relates to notice given by a company requiring information about interests in its shares). The ABI published a position paper in relation to directors’ remuneration on 15 December 2009, and a full set of Principles of Remuneration in September 2011, following the implementation of the Code. These principles were updated in November 2013 to reflect changes to the CA 2006 (see question 28), and following the merger of the ABI’s Investment Affairs division with the IMA were updated in October 2014, again in November 2015 and November 2017 under the IA name and most recently in November 2018.
The key changes to the IA Remuneration Principles made in 2018 to reflect the shifting culture and shareholder expectations of shareholders were clearer provisions on clawback and malus provisions; reduction of executive director pension contribution rates over time to equal the rate received by the majority of the workforce; and improved guidance on leaver provisions, including post-employment shareholding periods.
These principles set adherence to the CA 2006, the LRs and the Code as a minimum standard to be followed, and call for remuneration policies to be set up so as to promote value-creation through transparent alignment with agreed corporate strategy. They call for remuneration principles to have a long-term focus and incentive structures to be based on a similar approach. It is advised that attention be paid to market environment, company performance, and the possibilities of divergence between executive and shareholder interest in relation to remuneration strategy. Further, in September 2011, the ABI had also published a paper on Board Effectiveness, highlighting the need for succession planning, and diversity on boards, and setting out best practice in this regard, including reporting and monitoring progress. This paper was updated in December 2012 to reflect additions made to the Code.
The ABI and the then NAPF also issued a joint statement entitled ‘Best Practice on Executive Contracts and Severance’, which was last updated in February 2008.
In November 2009, the Institutional Shareholders’ Committee, of which the ABI and the PLSA were members, published its Code on the Responsibilities of Institutional Shareholders (the ISC Code). The ISC Code is based on a statement of principles that was originally published by the ISC in 2002 and revised in 2007. The statement of principles highlights the corporate governance duties of institutional investors in relation to the companies in which they invest, and these principles are supplemented by additional guidance. The ISC Code operates on a comply or explain basis. The principles of the ISC Code that institutional investors should adhere to have been largely replicated in the Stewardship Code, and for that reason they are not repeated here. The Institutional Shareholders’ Committee was renamed and reconstituted as the Institutional Investor Committee on 18 May 2011 and was dissolved in 2014 after the merger of the Investment Affairs division of the ABI and the IMA.
The ICSA, although not a body representing institutional investors, is an important authority on corporate governance. It has published guidance on a range of corporate governance matters including corporate representation at general meetings, matters reserved for the board, voting at general meetings and model terms of reference for audit, remuneration and nomination committees. Its terms of reference for audit committees were updated in June 2013 and then again in March 2017 (see question 25). On 16 April 2012, the ICSA Registrars Group published guidance on the practical issues of voting at general meetings. The aim of the guidance is to address the perceived misconceptions in the market regarding management of general meetings, and it covers areas such as proxy voting, notice of meetings and voting periods. The guidance recommends, among other things, that all UK-listed companies with CREST shareholders announce meetings via CREST, encourages electronic voting and states best practice for proxy voting. The ICSA also launched a consultation document in October 2012 on stewardship titled ‘Improving Engagement Practices by Companies and Institutional Investors’ designed to examine the efficiency of investor-director communications. On 14 March 2013, the ICSA published its guidance ‘Enhancing Stewardship Dialogue’. This guidance provides four key messages for how to improve engagement practices: the need to develop an engagement strategy; the importance of getting housekeeping issues right; strengthening the conversation on strategy and long-term sustainable performance; and providing feedback in a way that adds value for all participants. Finally, in September 2017 the ICSA, jointly with the IA, published practical guidance aimed at assisting boards to understand and engage effectively with the views of employees and other stakeholders. This guidance identified 10 principles to guide the way boards approach these issues.
The Pensions Investments Research Consultants (PIRC) is an independent body that publishes guidance of relevance to institutional investors. The PIRC’s UK Shareholder Voting Guidelines, published yearly, set out its views on issues such as board structure, remuneration policy and the management of social and environmental issues, applying these to the listed companies it covers in the UK market. Notably, the 23rd edition of the guidelines, published in 2016, gave support for the recommendation in Lord Davies’ final report on improving gender balance on boards. The report, which was published on 29 October 2015, recommends that a target of 33 per cent of board positions in FTSE 350 companies be held by women by 2020. The 2017 version of the guidelines reiterates this position, and states that the PIRC will not support the re-election of the nomination committee of a FTSE 350 company where current female representation on the board falls below these expectations, and there are no clear and credible proposals for reaching these objectives.
In January 2015, Institutional Shareholder Services (ISS) published its first stand-alone UK and Ireland Proxy Voting Guidelines: 2015 Benchmark Policy Recommendations. These guidelines constitute a codification and update of ISS’s approach and align with the NAPF Guidelines but do not represent a materially different approach to the previous one. These were updated in December 2018 and effective for meetings on or after 1 February 2019.
The guidance issued by bodies representing institutional investors does not have statutory force but failure to comply with it could lead to institutional investors voting against any resolutions proposed by it or selling their shares in the company.
Articles of association
A company’s articles of association will contain provisions as to what its directors may and may not do in respect of the company. Directors who do not comply with the provisions of their company’s articles of association may be in breach of their statutory duty to act within their powers under CA 2006, section 171. A company may place additional corporate governance requirements on the board of directors, beyond the scope of CA 2006 and the statutory framework.
In May 2003, the European Commission released an action plan on company law and corporate governance (entitled ‘Modernising Company Law and Enhancing Corporate Governance in the EU’). The action plan’s main objectives are to strengthen shareholders’ rights and protection for third parties who deal with companies and to encourage companies to improve their efficiency and competitiveness.
A number of corporate governance measures have already been implemented under the action plan, including:
- the Company Reporting Directive (2006/46) (which has been implemented in the UK by DTR7);
- the Shareholder Rights Directive (2007/36) (which was implemented in the UK on 9 July 2009 by the Companies (Shareholders’ Rights) Regulations 2009 (SI 2009/1632) (the Shareholders’ Rights Regulations) as amended by Directive ((EU) 2017/828) (SRD II) (which member states must transpose into national law by 10 June 2019);
- a recommendation aimed at enhancing the role of non-executive directors; and
- a recommendation aimed at giving shareholders greater control over directors’ remuneration (which has been implemented in the UK by the Directors’ Remuneration Report Regulations 2002 (SI 2002/1986) and schedule 8 of the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410)).
At present, the European Union does not intend to introduce its own corporate governance code but hopes that the measures implemented under the action plan will increase consistency between national corporate governance codes. The European Commission published a Green Paper on 5 April 2011 and launched a consultation into the effectiveness of the existing EU corporate governance framework for listed companies, with a view to improving the way in which companies are run. The questions in the Green Paper deal with issues of executive remuneration, diversity, risk management, shareholder cooperation and minority-shareholder protection. A feedback statement summarising the results was published in January 2012, and a non-legislative resolution was adopted by the European Parliament in March 2012, which, among other things, welcomed the European Commission’s proposed revision of the EU corporate governance framework initiated by the Green Paper of April 2011.
In March 2012, the European Commission published a consultation paper on gender imbalance in corporate boards in the EU, which resulted in the publication of a proposal for a directive on improving gender balance among corporate boards of listed companies in November 2012. In November 2013, the European Parliament adopted the directive (with amendments), which, among other things, sets an objective for listed companies to increase non-executive directors of the under-represented gender (usually women) to 40 per cent by 1 January 2020 (see question 23).
In December 2012 the European Commission published an additional action plan on European company law and corporate governance, which included proposals such as:
- amending the Accounting Directive to increase disclosure of company board diversity policies and non-financial risks;
- creating an initiative to improve corporate governance reports, focusing specifically on the quality of explanations to be provided by companies departing from the corporate governance code of their jurisdiction;
- new legislation to improve visibility of listed company shareholdings;
- creating new initiatives, for example, by amending the Shareholder Rights Directive to improve disclosure of voting and engagement policies and voting record by institutional investors; transparency on remuneration policies and grant shareholders a vote on remuneration policy and the remuneration report; shareholder control of related-party transactions; and the transparency and conflict of interest frameworks applicable to proxy advisers; and
- increasing legal certainty on shareholder cooperation concerning concert party issues.
The European Commission has started to implement these proposals:
- in April 2014, it adopted a draft recommendation on the quality of corporate governance reporting;
- in December 2014, it implemented Directive (2014/95) on disclosure of non-financial and diversity information (amending the Accounting Directive) which had to be transposed by member states into national legislation by 6 December 2016. This Directive requires certain large companies to disclose relevant environmental and social information in the management report, and was implemented in the UK by DTR 7.2.8A (see question 23); and
- in May 2017, it adopted SRD II, which requires member states to give companies the right to identify their shareholders. Given Part 22 of the CA 2006 already permits public companies to investigate the identity of their shareholders, specific UK transposition measures will be limited to proposed amendments to the FCA handbook in respect of institutional investor and asset manager engagement policies, institutional investors’ investment strategies and arrangements with asset managers, and transparency of asset managers.
The UK voted to leave the European Union on 24 June 2016 and triggered the negotiation process for withdrawal on 29 March 2019 (as subsequently extended to 30 October 2019). It is too early to speculate on the potential consequences for corporate governance in the UK; however, with effect from 30 October 2019 (at the time of writing), the UK will cease to be a member of the European Union and will cease to be bound by EU legislation, except to the extent that EU legislation has been incorporated into domestic legislation (by virtue of section 3 of the European Union (Withdrawal) Act 2018) and not repealed.
What are the primary government agencies or other entities responsible for making such rules and enforcing them? Are there any well-known shareholder groups or proxy advisory firms whose views are often considered?
Until 1 April 2013, the FSA was responsible for regulating the UK’s financial services industry and was also the competent authority for the purposes of FSMA 2000 Part IV, which relates to the listing regime (although it was referred to as the United Kingdom Listing Authority (UKLA) in this capacity). The UKLA was responsible for, among other things, maintaining the Official List and administering the LPDT Rules. However, as a response to the perceived failings of this regulatory regime in preventing the financial crisis, the government enacted The Financial Services Act 2012, abolishing the FSA and replacing it with a new UK financial regulation regime consisting of three separate entities: the Financial Conduct Authority, the Financial Policy Committee and the Prudential Regulation Authority. The Financial Services Act 2012 received Royal Assent on 19 December 2012 and the majority of its provisions came into force on 1 April 2013. Pursuant to the legislation:
- the Financial Policy Committee is a macro-prudential authority within the Bank of England;
- the Prudential Regulation Authority (PRA) is a micro-prudential regulator with responsibility for ensuring effective prudential regulation of banks, insurers and designated investment firms; and
- the FCA is a conduct of business regulator and the micro-prudential regulator of firms not supervised by the PRA. The FCA also includes the UKLA function and is responsible for enforcing the market abuse regime. (In February 2019, the FCA announced that it would be phasing out the UKLA name, and would instead refer to the FCA’s primary market functions).
The Takeover Panel is responsible for administering the Takeover Code (see question 1). It has various duties and powers conferred by CA 2006, Chapter 1 of Part 28 and by the Takeover Code itself. The Takeover Panel has the power to make rules allowing it to modify or dispense with certain Takeover Code provisions in particular cases (CA 2006, section 944(1)(d)). The Takeover Panel therefore has a degree of freedom to decide how to apply the Takeover Code, notwithstanding that this code now has statutory force.
Other entities that play a significant role in corporate governance include the FRC (which is responsible for administering the Code) and various bodies representing institutional investors and other parties with an interest in the operation of UK-listed companies, including the PLSA, IA, ICSA and PIRC (see question 1).
In December 2018, Sir John Kingman published his independent review of the FRC, which recommended its abolition and replacement by an independent statutory regulator with stronger powers. The Secretary of State for Business, Energy and Industrial Strategy, Greg Clark, confirmed that the government would replace the FRC with a new regulator. Given that the outgoing FRC’s effective custody of the Code was commended in the review as one of the organisation’s few strengths, it seems unlikely the new regulator’s approach to the Code will materially depart from that of the FRC.
Rights and equitable treatment of shareholders
What powers do shareholders have to appoint or remove directors or require the board to pursue a particular course of action? What shareholder vote is required to elect or remove directors?
Shareholders can appoint directors to the board by way of an ordinary resolution (that is, a resolution that requires a simple majority of shareholders to vote in favour of it) passed at a general meeting. If more than one director is to be appointed, separate resolutions must usually be passed in respect of each appointment, unless a resolution permitting a single resolution is passed (CA 2006, section 160(1)). All directors are expected to be put up for annual re-election by shareholders (the Code, provision 18). This requirement is likely to focus directors on the concerns of the company’s shareholders, though as with all provisions of the Code, companies do not strictly have to comply with this requirement as long as they explain the reasoning behind any decision not to comply.
Shareholders can also remove directors by way of an ordinary resolution under CA 2006, section 168(1), notwithstanding any provision to the contrary in any agreement between the company and the director. Special notice (notice given at least 28 days before the general meeting of the company at which the resolution will be considered) of a proposed resolution to remove a director must be given to the company by the shareholders proposing that resolution (CA 2006, sections 168(2) and 312(1)). The board must then decide whether to place the resolution on the agenda of the company’s next general meeting. If the resolution is placed on the agenda, the company must notify its shareholders of this in the same manner and at the same time as it gives them notice of the general meeting (CA 2006, section 312(2)). If this is not practicable, the company must notify its shareholders of the resolution at least 14 days before the general meeting through an advertisement in a newspaper with appropriate circulation or in any other manner allowed by its articles of association (CA 2006, section 312(3)).
The company must notify a director of any proposed resolution to remove him or her (CA 2006, section 169(1)). Any written representations made by the director in respect of his or her proposed removal should, at the request of that director, be circulated to shareholders or, failing this, be read out at the general meeting at which the resolution is to be considered (CA 2006, sections 169(3) and (4)). The director, whether or not he or she is a shareholder of the company, also has the right to be heard on the resolution at the general meeting (CA 2006, section 169(2)). The director may be entitled to compensation if his or her removal from office pursuant to CA 2006, section 168(1) amounts to a breach of the terms of his or her service contract (CA 2006, section 168(5)(a)).
There is a dual voting requirement for electing independent directors where a listed company has a controlling shareholder. Under the Listing Rules the election of independent directors must be approved by a vote of all shareholders, as well as a separate vote of the independent (ie, non-controlling) shareholders only (LR9.2.2ER). However, if either vote is defeated, the company may propose a single further vote of all shareholders to elect the proposed independent directors after waiting for at least 90 days (LR9.2.2FR). In such circumstances, a separate vote of independent shareholders is not required. The effect is to impose a 90-day cooling off period to allow shareholders to engage in discussions to try to reach a solution acceptable to both the controlling and independent shareholders. However, if the controlling shareholder is not minded to accept a compromise candidate, it will be able to use its voting power to support the election of its chosen independent director.
Shareholders have the right to requisition meetings of the company to deal with matters that they wish to be considered and have historically used this power to require resolutions to be put for the purpose of removing or appointing directors (see question 7 for further information on shareholders’ power to requisition meetings). Shareholders may also compel the board to pursue a particular course of action by passing a special resolution (that is, a resolution requiring at least three-quarters of shareholders to vote in favour of it), which either alters or overrides the company’s articles of association (CA 2006, section 21(1)).
What decisions must be reserved to the shareholders? What matters are required to be subject to a non-binding shareholder vote?
Shareholder approval is required in respect of many matters. Such matters include the following.
Alterations to the company’s articles of association
A company’s articles of association may only be amended by way of a special resolution passed by its shareholders (CA 2006, section 21(1)).
Change of name
In order for a company to change its name, it is necessary for the shareholders to pass a special resolution (CA 2006, section 77(1)(a)). This is subject to the company’s articles of association allowing the company to change its name by other means (CA 2006, section 77(1)(b)). Many companies’ articles of association therefore permit the board to change the name of the company, although some shareholder groups do not approve of the board having such power.
Re-registration of a public company as private limited company
In order for a public company to re-register as a private company, the shareholders must pass a special resolution to that effect (CA 2006, section 97(1)). This is subject to certain other conditions being satisfied.
A company that is subject to the Takeover Code may only be acquired by another company if shareholders holding at least 50 per cent of the voting rights in the target company agree to sell their shares to the offeror, although in exceptional circumstances the Takeover Panel may be willing to waive this requirement subject to prior consultation and appropriate safeguards (Takeover Code Rule 10). In certain cases, shareholders holding more than 50 per cent of the voting rights in the company may need to consent to the takeover (for instance, a condition that shareholders holding 90 per cent of the voting rights in the company must consent to the takeover is often imposed, in order to allow the offeror to take advantage of certain provisions relating to the acquisition of minority shareholders’ interests) (see question 13).
Class 1 transactions
The Listing Rules require companies with premium listings to classify certain transactions by comparing the size of the proposed transaction with the size of the company. This classification requires specific tests (relating to the gross assets, profits, the consideration payable and gross capital of the company) to be applied to the proposed transaction, which result in a percentage ratio. The purpose of this classification is to ensure that shareholders are informed of certain transactions entered into by the company, and to enable shareholders to vote on larger proposed transactions (LR10.1.2G). If any of the tests produces a ratio of 25 per cent or more, the transaction will be a class 1 transaction for the purposes of the LRs and shareholder approval must therefore be obtained in a general meeting before the transaction can proceed (LR10.5.1R and annex 1 to LR10). Any agreement giving effect to a class 1 transaction should be conditional on shareholder approval being obtained (LR10.5.1R(3)).
A company with a premium listing may only enter into a transaction with certain related parties if authorised to do so by its shareholders (LR11) (see question 36). Related parties include the company’s directors and substantial shareholders (defined as those controlling more than 10 per cent of the voting rights of the company, disregarding those voting rights held for a period of five trading days or less, during which the voting rights are not exercised and no attempt is made to exert influence on the management (see question 36)). The related party and its associates must not vote on the resolution to authorise the proposed transaction (LR11.1.7R(4)). The object of these safeguards is to prevent a related party from taking advantage of its position, and also to prevent any perception to that effect (LR11.1.2G(2)).
Allotment of shares
A director must not allot shares, nor grant rights to subscribe for or to convert any security into shares, unless authorised to do so by the company’s articles of association or by an ordinary resolution passed by its shareholders (subject to certain exceptions) (CA 2006, sections 549(1) and 551(1)). Any such resolution must state the maximum amount of shares that may be allotted under it and specify the date on which it will expire, which must not be more than five years from the date on which the resolution was passed (CA 2006, section 551(3)). Shareholders may renew, revoke or vary this authorisation by a further resolution (CA 2006, section 551(4)). Such a renewing resolution must state the maximum amount of shares that may be allotted under the authorisation, or the amount remaining to be allotted under it, and specify the date on which the renewed authorisation will expire (CA 2006, section 551(5)). If a director fails to comply with these provisions they may be guilty of an offence and liable to a fine (CA 2006, section 549(5)). It is also necessary for a copy of the resolution to be forwarded to the Registrar of Companies House within 15 days after it is passed, and failure to do this will also result in the company and its officers committing an offence (CA 2006, sections 551(9) and 30).
Disapplication of pre-emption rights
A company’s shareholders may, by way of special resolution, authorise a director who is generally authorised to allot shares under CA 2006, section 551 to allot such shares as if their rights of pre-emption (that is, rights of first refusal of any freshly issued shares in the company) under CA 2006, section 561 did not exist (CA 2006, section 570(1)). Shareholders may also resolve by way of special resolution that CA 2006, section 561 may be disapplied only in respect of a specified allotment of shares, or applies to such allotment with such modifications as may be specified in the resolution (although such a resolution may only be passed if recommended by a director in accordance with CA 2006, sections 571(5) to (7)) (CA 2006, section 571(1)) (see question 11).
Variation of class rights
If a company’s articles of association do not contain any provisions as to how the rights attaching to a particular class of shares may be varied, then those rights may only be varied if the written consent of the holders of at least three-quarters in nominal value of such shares is obtained, or a special resolution approving such variation is passed at a separate general meeting of the holders of such shares (CA 2006, sections 630(2) and (4)).
Reduction of share capital
A public company that wishes to reduce its share capital may only do so by way of a special resolution passed by its shareholders that is confirmed by the court (CA 2006, section 641(1)(b)).
Alteration of share capital
A company may subdivide, consolidate and redenominate its shares, or reconvert its shares into stock only if authorised to do so by a shareholder resolution, subject to certain rules and exceptions (CA 2006, sections 617 to 628). A company may purchase its own shares, provided that after such purchase there are still members who hold shares other than redeemable shares (CA 2006, section 690 (1) and (2)).
A public company may purchase its own shares either ‘on-market’ (that is, on a recognised investment exchange) or ‘off-market’ (CA 2006, section 693) by way of an ordinary shareholder resolution (CA 2006, sections 701(1) and 694(2) respectively). It should be noted that private companies are able to purchase their own shares out of capital in certain circumstances, whereas public companies are not (CA 2006, sections 692 (1) and 709 to 722).
Ratification of directors’ conduct
Shareholders may ratify conduct by a director that would otherwise amount to negligence, default or breach of duty or trust by way of ordinary resolution (unless the company’s articles of association require a higher majority of shareholders to approve the resolution) (CA 2006, section 239(1) and (2)). The resolution must be passed without including any votes attached to shares held by the director whose conduct is being ratified or by any person connected with him or her, as defined in CA 2006, section 252 (CA 2006, section 239(4)) (see question 32 for further information on the ratification of directors’ conduct).
Directors’ service contracts
Shareholder approval is required for any director’s service contract, which is, or may be, for a period in excess of two years (CA 2006, sections 188(1) and (2)) (see question 28).
Transactions with directors
A company may not enter into substantial property transactions with its directors or their connected persons (as defined in CA 2006, section 252), nor may it make loans or quasi-loans to its directors or their connected persons, nor enter into credit transactions with its directors or their connected persons, unless authorised to do so by way of an ordinary resolution of its shareholders, subject to certain rules and exceptions (CA 2006, sections 190 to 214) (see question 28).
Directors’ remuneration report and policy
A UK-listed company with a financial year ending before 30 September 2013 was required to give its shareholders the opportunity to pass an ordinary resolution to approve its directors’ remuneration report at the general meeting of the company before which its annual accounts for the year were to be laid (CA 2006, section 439(1) and (4)). The vote was advisory only and the directors’ remuneration was not conditional upon such a resolution being passed (CA 2006, section 439(5)). For UK-listed companies with financial years ending on or after 30 September 2013, the directors’ remuneration reports are now required to be prepared and put to the shareholders in two distinct parts:
- the annual report on remuneration, which sets out remuneration payments made to directors in the year under review and a statement describing how the company intends to implement the approved remuneration policy in the next financial year. This report is required annually and is subject to an advisory vote; and
- the directors’ remuneration policy setting out the company’s policy on remuneration of directors. This is subject to a binding shareholder vote at least every three years (CA 2006, section 439A(1)). Once the policy is approved, the company is not permitted to make remuneration payments to a person who is (or is to be or has been) a director unless the payment is consistent with the approved policy (CA 2006, section 226B). Any payments that are inconsistent with the remuneration policy must be otherwise approved by shareholders (CA 2006, section 226B) (see question 37).
Payment to a director for loss of office
If a company wishes to make a payment to a director or past director to compensate him or her for loss of office, for example owing to retirement, then the shareholders must authorise such a payment by way of an ordinary resolution (CA 2006, sections 215 and 217). This is subject to certain other requirements.
For UK-listed companies, the new framework on directors’ remuneration requires any loss of office payments to be consistent with the approved remuneration policy (described above) or separately approved by a shareholder resolution (CA 2006, section 226C).
Appointment of auditors
The directors of a newly incorporated company, or of a company in respect of which the role of auditor has become vacant, will appoint an auditor before the annual general meeting at which the company’s accounts for the relevant financial year are considered (CA 2006, section 489(1) to (3)). A company’s articles of association may impose restrictions on its ability to act without first obtaining shareholder approval.
The company’s shareholders may appoint an auditor at the ‘accounts meeting’ (usually the AGM), if the company should have appointed an auditor but failed to do so or where the directors had the power to appoint an auditor under CA 2006, section 489(1) to (3) but failed to do so.
Disproportionate voting rights
To what extent are disproportionate voting rights or limits on the exercise of voting rights allowed?
UK-listed companies may issue classes of shares with different voting rights if their articles of association permit such an issue, but the FCA will not grant such companies a listing (although it will admit companies with non-voting preference shares to standard listing but not premium listing). A few companies that have shares with different voting rights and were listed many years ago still exist but are disappearing. The general rule, therefore, is ‘one share, one vote’. The UK investment community is particularly averse to structures that deliberately block takeover bids (‘poison pills’). An issue of disproportionate voting rights is one means of challenging a takeover bid, and the FCA and the Takeover Panel would object to such a structure.
The FCA consulted on (in its consultation paper CP12/25) and decided to proceed with (as expressed in CP13/12, its feedback to CP12/25) a new listing principle requiring all equity shares of a class admitted with a premium listing to carry an equal number of votes, as implemented in May 2014 under a revised LR7.2.1.
Shareholders’ meetings and voting
Are there any special requirements for shareholders to participate in general meetings of shareholders or to vote? Can shareholders act by written consent without a meeting? Are virtual meetings of shareholders permitted?
All ordinary shareholders of a company have a right to receive notice of and to attend and vote at its general meetings. An AGM of a public company that is not a traded company must be called by notice of at least 21 days, while any other company meeting must be called by notice of at least 14 days, unless the company’s articles of association require a longer notice period than this (CA 2006, section 307(A1)(a), (2) and (3)). A meeting of a public company that is not an AGM may be called by shorter notice than that otherwise required if its shareholders agree to this (CA 2006, section 307(4) to (7)). These provisions also apply to a traded company that is an opted-in company (as defined by CA 2006, section 971(1)) in certain circumstances set out in CA 2006, section 307(A1)(b).
CA 2006, section 307A provides that the default notice period for general meetings of traded companies (which includes companies that trade on the LSE) may be reduced from 21 days to 14 days provided that certain conditions are met. However, the notice period for an AGM of a traded company may not be reduced in this way (CA 2006, section 307A(2)). The company’s articles of association may provide for a longer notice period (CA 2006, section 307A(6)).
The 2016 version of the Code recommends that the companies to which it applies give at least 20 working days’ notice of an AGM and 14 working days’ notice of any other general meeting (the Code, provision E.2.4). This requirement has been removed from the 2018 version of the Code; however, the recommendation is retained in the FRC’s accompanying guidance (Guidance on Board Effectiveness, paragraph 36). Despite the fact that this notice requirement has fallen outside the scope of the comply or explain obligation, it is anticipated that UK-listed companies will continue to comply with it.
A shareholder may appoint a proxy to exercise his or her rights to attend, speak and vote at meetings of the company on his or her behalf (CA 2006, section 324(1)). A shareholder may appoint more than one proxy, although each proxy must exercise their powers in respect of a different share, or a different £10 or multiple of £10 of stock held by that shareholder (CA 2006, section 324(2)). However, a company’s articles of association may permit shareholders to appoint more proxies than would be possible under CA 2006, section 324(2).
In relation to a meeting of a traded company, the appointment of a proxy must be notified to the company in writing by the relevant shareholder (CA 2006, section 327(A1)(a)). The company may also require certain evidence to be provided in respect of the appointment of the proxy (CA 2006, section 327(A1)(b)). Shareholders must notify the company of any proxy appointments before any cut-off point set by the company. However, the company may not make this cut-off point earlier than: in the case of a meeting or adjourned meeting, 48 hours before the relevant meeting; and in the case of a poll taken more than 48 hours after it was demanded, 24 hours before the time appointed for the taking of the poll.
CA 2006 has enhanced the rights enjoyed by proxies under the Companies Act 1985 as follows:
- proxies now have a right to speak, rather than to simply attend and vote, at general meetings of the company (CA 2006, section 324(1));
- proxies now have an automatic right to one vote on a show of hands, rather than only having an automatic right to vote on a poll (CA 2006, section 285(1));
- on a vote on a show of hands, a proxy will have one vote for and one vote against a resolution if they have been appointed by more than one shareholder and have been instructed by one or more of those shareholders to vote for a resolution and by one or more of those shareholders to vote against it (CA 2006, section 285(2));
- if a shareholder appoints multiple proxies, each will have one vote on a show of hands (CA 2006, sections 285(1) and 324(2)); and
- on a poll, all or any of a shareholder’s voting rights may be exercised by one or more proxies (CA 2006, section 285(3)).
Sections 285(1) and (2) are subject to any provisions of the company’s articles (CA 2006, section 285(5)).
Shareholders that are companies have the right to appoint one or more individuals to act as their corporate representatives at company meetings as an alternative to appointing proxies (CA 2006, section 323(1)). It is not necessary to notify the company of the appointment of a corporate representative, although evidence of the corporate representative’s authority will be required when voting at a general meeting. Corporate representatives are able to exercise all the powers that the corporate shareholder could exercise if it were an individual member of the company and may therefore: speak at a general meeting; vote on both a poll and on a show of hands; and appoint a proxy if permitted to do so by the corporate shareholder (CA 2006, section 323(2)).
If two or more corporate representatives appointed by the same corporate shareholder purport to exercise that shareholder’s powers in relation to the same shares, in conflicting ways, then that power will be treated as not having been exercised (CA 2006, section 323(4)(b)).
On 2 February 2010, the PIRC published best-practice principles for proxy voting and voting advisory organisations to encourage such organisations to be more open and accountable. The latest version of the advice was published in March 2014.
Shareholders of a private company can also pass written resolutions that would have the effect of resolutions passed by the company in a general meeting (CA 2006, section 288), except for resolutions to remove either a director or auditor before the expiry of their term, which would require a general meeting to be held. The resolutions can be proposed by either the directors or the shareholders. It is not, however, possible for shareholders of a public company to pass a resolution without a meeting. A resolution of the shareholders of a public company must be passed at a meeting of the shareholders (CA 2006, section 281(2)).
Subject to any restrictions found in a company’s articles, there is no statutory prohibition on holding electronic or ‘virtual’ meetings by, for example, teleconference. A company holding such a meeting need only ensure that persons who are not present together at the same place may by electronic means attend and speak and vote at it (CA 2006, section 360A(1)). In the case of traded companies, the use of electronic means to enable shareholders to participate in meetings can only be subject to such restrictions and requirements as are necessary to ensure the identification of the participants of the meeting and the security of the electronic communication. Any such restrictions and requirements must be proportionate to the achievement of those objectives (CA 2006, section 360A(2)).
Shareholders and the board
Are shareholders able to require meetings of shareholders to be convened, resolutions and director nominations to be put to a shareholder vote against the wishes of the board, or the board to circulate statements by dissident shareholders?
Shareholders holding at least 5 per cent of the voting rights of a company may require its directors to call a general meeting (CA 2006, sections 303(1) and (2)(a)). Such a request for a general meeting to be called must state the general nature of the business to be dealt with at the general meeting and may include the text of a resolution that the shareholders requesting the general meeting wish to be moved at that meeting (CA 2006, section 303(4)). However, the company’s directors may not be required to move the requested resolution at the general meeting if it would be ineffective or if it is defamatory, frivolous or vexatious (CA 2006, section 303(5)). The company’s directors must call a meeting requested by its shareholders under CA 2006, section 303 within 21 days from the date on which they became subject to the requirement to call the meeting and the meeting must be held not more than 28 days after the date of the notice convening the meeting (CA 2006, section 304(1)). If the request by the company’s shareholders for a meeting to be convened included the text of a resolution, then the notice of the meeting must include notice of the resolution (CA 2006, section 304(2)).
If a company’s directors fail to call a meeting requested by its shareholders under CA 2006, section 303 in accordance with the provisions of CA 2006, section 304, then the members who requested the meeting, or any of them holding more than half of the total voting rights of all of them, may themselves call a general meeting (CA 2006, section 305(1)). This meeting must be called for a date no later than three months after the date on which the company’s directors became subject to the requirement to call a general meeting (CA 2006, section 305(3)). If the request to the company’s directors to call a general meeting included the text of a resolution intended to be moved at that meeting, then notice of this resolution must be included in the notice of the meeting to be called by the shareholders themselves (CA 2006, section 305(2)). This resolution may then be dealt with at such a meeting (CA 2006, section 305(5)). The shareholders calling such a meeting may recover from the company any expenses incurred owing to the directors’ failure to call the meeting (CA 2006, section 305(6)). These expenses shall be retained by the company out of any sums due or to become due from the company to the directors who were in default (CA 2006, section 305(7)).
Further, a company’s shareholders and directors may request the court to call a general meeting if it is impracticable for one to be held otherwise (CA 2006, sections 306(1) and (2)).
The rules relating to public companies and traded companies are somewhat different. Where a public company is concerned, shareholders may require it to give notice of a resolution that is intended to be moved at the next AGM to members of the company entitled to receive notice of that AGM (CA 2006, section 338(1)). The company must give such notice if it receives requests to do so from shareholders holding at least 5 per cent of the total voting rights of all members who have a right to vote on the resolution at the AGM, or from at least 100 members who have a right to vote on the resolution at the AGM and who hold shares on which an average sum of not less than £100 per shareholder has been paid up (CA 2006, section 338(3)). The request must identify the resolution of which notice is to be given, it must be authenticated by the person or persons making the request and it must be received by the company not later than six weeks before the AGM to which the request relates, or if later, the time at which notice is given of that meeting (CA 2006, section 338(4)(b) to (d)). However, the company need not circulate the resolution if it would be ineffective, or if it is defamatory, frivolous or vexatious (CA 2006, section 338(2)).
The company will not be required to comply with a request from shareholders to circulate such a resolution if it does not receive a sum reasonably sufficient to meet the cost of doing so at least six weeks before the AGM, or if later, the time at which notice is given of that meeting (CA 2006, section 340(2)(b)). The shareholders requesting circulation of the resolution will be required to meet these costs unless the company provides otherwise, or requests sufficient to require the company to circulate the resolution are received before the end of the financial year preceding the meeting (CA 2006, section 340(1) and (2)(a)).
Shareholders may require a company to circulate a statement of not more than 1,000 words to shareholders entitled to receive notice of a general meeting in respect of any business to be dealt with at that meeting, including a matter referred to in a resolution to be dealt with at that meeting (CA 2006, section 314(1)). The company must circulate such a statement if it receives requests to do so from shareholders holding at least 5 per cent of the total voting rights of all shareholders who have a relevant right to vote (that is, who have a right to vote on any resolution to which the statement refers or, in respect of any other statement, a right to vote at the meeting to which the request relates), or from no fewer than 100 members with a relevant right to vote and holding shares on which an average sum per shareholder of not less than £100 has been paid up (CA 2006, section 314(2) and (3)). The shareholders’ request to circulate a statement must identify the statement to be circulated, it must be authenticated by the person or persons making it and it must be received by the company at least one week before the meeting to which it relates (CA 2006, section 314(4)(b) to (d)).
The public company will not be required to comply with a request from shareholders to circulate a statement if it does not receive a sum reasonably sufficient to meet the cost of doing so at least one week before the company meeting (CA 2006, section 316(2)(b)). The shareholders requesting circulation of a statement will be required to meet these costs unless the company provides otherwise, or the meeting to which the request relates is an AGM and requests sufficient to require the company to circulate the statement are received before the end of the financial year preceding the meeting (CA 2006, section 316(1) and (2)(a)).
Failure by the public company’s directors to circulate a statement, if required to do so by CA 2006, section 314, in the same manner as the notice of the meeting and at the same time as, or as soon as reasonably practicable after, it gives notice of the meeting, will constitute an offence (CA 2006, section 315(1) and (3)). However, a company will not be required to circulate a shareholders’ statement if it persuades a court that the rights conferred on its shareholders by CA 2006, sections 314 and 315 are being abused (CA 2006, section 317(1)).
Where a traded company is concerned, shareholders may request a traded company to include in the business to be dealt with at an AGM any other business that may properly be dealt with at that meeting other than a proposed resolution (CA 2006, section 338A(1)). The company must include such a matter once it has received requests to do so from shareholders holding at least 5 per cent of the total voting rights of all shareholders who have a right to vote at the meeting, or from at least 100 members who have a right to vote at the meeting and hold shares in the company on which there has been paid up an average sum per member of at least £100 (CA 2006, section 338A(3)). Such a request must identify the matter to be included in the business of the meeting, as well as being accompanied by a statement setting out the grounds for the request being authenticated by the person or persons requesting it (CA 2006, section 338A(4)(b) to (d)). It must be received by the company at least six weeks before the meeting, or if later, the time at which notice is given of the meeting (CA 2006, section 338A(5)). However, a company need not include such business in the business of the company’s AGM if it is defamatory, frivolous or vexatious (CA 2006, section 338A(2)).
The traded company will not be required to comply with a request from shareholders to include the relevant business in the business to be dealt with at the company’s AGM if it does not receive a sum reasonably sufficient to meet the cost of doing so at least six weeks before the AGM to which the request relates, or if later, the time at which notice is given of that meeting (CA 2006, section 340B(2)(b)). The shareholders requesting the inclusion of such business in the business of the AGM will be required to meet these costs unless the company provides otherwise, or the meeting to which the request relates is an AGM and requests sufficient to require the company to include the business are received before the end of the financial year preceding the meeting (CA 2006, section 340B(1) and (2)(a)).
Failure by the traded company’s directors to give notice of any such business to each shareholder entitled to receive notice of the AGM, in the same manner as the notice of the AGM and at the same time as, or as soon as reasonably practicable after, it gives notice of the AGM, will constitute an offence (CA 2006, section 340A(1) and (3)). The company must also publish notice of such business on the same website as that on which the company publishes certain information required by CA 2006, section 311A (CA 2006, section 340A(1)(b)).
Controlling shareholders’ duties
Do controlling shareholders owe duties to the company or to non-controlling shareholders? If so, can an enforcement action be brought against controlling shareholders for breach of these duties?
If the rights of non-controlling shareholders are unfairly prejudiced by controlling shareholders voting in accordance with their own self-interest, the non-controlling shareholders may petition the court for a remedy (CA 2006, sections 994 to 999).
Non-controlling shareholders may also bring a claim against controlling shareholders on behalf of the company if an act of the controlling shareholders amounts to a fraud on the non-controlling shareholders. This is an exception to the rule established by the case of Foss v Harbottle (1843) 2 Hare 461, in which it was held that the proper claimant in an action for a wrong done to a company is the company itself.
Can shareholders ever be held responsible for the acts or omissions of the company?
Shareholders in a company limited by shares are generally not liable for its debts beyond the amount paid up (or to be paid up) on the shares held by them. However, there are some exceptions to this principle, including that where shareholders know or have reasonable grounds for believing an unlawful distribution has been made to them, they are liable to repay it to the company (CA 2006, section 847(1) and (2)).
Are anti-takeover devices permitted?
Article 11 of the EU Directive on Takeover Bids (2004/25) (Takeover Directive) prevents a company from using certain measures, including restrictions on the transfer of shares and restrictions on voting rights, to defend itself from a takeover bid. The Takeover Directive provides that once a bid for a company is made public, the offeror will be able to override or ‘breakthrough’ such defensive measures. The Takeover Directive allows member states to opt out of the provisions of article 11, with the effect that companies registered within that member state’s territories do not have to apply article 11. However, member states that take this route must give companies the option to opt back in (Takeover Directive, article 12). The UK government has opted out of article 11 but provisions allowing UK traded companies to opt back in by way of special resolution (and to opt back out again by way of special resolution) are set out at CA 2006, sections 966 to 973. The effect of opting in for a UK company is that any pre-bid defensive measures that have been put in place will be invalid once the bid is made public (CA 2006, section 968(1) and (2)).
Companies should also ensure that any anti-takeover devices that they deploy do not breach the following provisions of the Takeover Code and CA 2006:
- the board of a target company must afford the shareholders sufficient time and information to enable them to reach a properly informed decision on the bid; where it advises the shareholders, the board must give its views on the effects of implementation of the bid on employment, conditions of employment and of the company’s places of business (General Principle 2 of the Takeover Code);
- the board of a target company must act in the interests of the company as a whole and must not deny the holders of its securities the opportunity to decide on the merits of the bid (General Principle 3 of the Takeover Code);
- the board of a target company must not, without shareholder approval, engage in any ‘frustrating action’ as set out in rule 21.1 of the Takeover Code;
- each document or advertisement published, or statement made, during the course of an offer must be prepared with the highest standards of care and accuracy and the information given must be adequately and fairly presented (rule 19.1 of the Takeover Code);
- parties to an offer or potential offer (and their advisers) must not make statements that, while not factually inaccurate, mislead shareholders and create uncertainty in the market (rule 19.3 of the Takeover Code) (directors should also be aware of the common law prohibitions against negligent misstatement and the prohibitions against misleading statements contained in the Financial Services Act 2012, sections 89 to 91);
- a target company cannot withhold information about itself from any offeror who requests such information where that information has already been given to any other offeror or potential offeror (rule 21.3 of the Takeover Code);
- a director must act in accordance with the company’s constitution and only exercise his or her powers for the purpose for which they are conferred (CA 2006, section 171); and
- a director must act in the way he or she considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (CA 2006, section 172(1)).
Issuance of new shares
May the board be permitted to issue new shares without shareholder approval? Do shareholders have pre-emptive rights to acquire newly issued shares?
The board of directors may generally only issue shares without prior shareholder approval if permitted to do so by the company’s articles of association or by resolution of the company (CA 2006, section 551(1)). Any such provision contained within a company’s articles of association must be renewed at least every five years (CA 2006, section 551(3)(b)(i)).
The board of directors may also allot new shares without shareholder approval if those shares:
- relate to an employee share scheme (CA 2006, section 549(2)(a));
- are allotted pursuant to a right to subscribe for, or to convert any security into, shares in the company (CA 2006, section 549(3)); or
- are allotted after the directors’ authority to allot has expired but are allotted pursuant to an authorisation or agreement entered into before that authority expired, provided that the authorisation allowed the company to enter into agreements that may require shares to be allotted after it had expired (CA 2006, section 551(7)).
The board of directors does not require authorisation, pursuant to CA 2006, section 551, to sell or transfer treasury shares (CA 2006, section 727), as this will not constitute an allotment of shares.
The board of directors generally must not issue new shares unless it has given the company’s existing shareholders an opportunity to exercise their rights of pre-emption (that is, their right of first refusal of any freshly issued shares in the company) in relation to these newly issued shares (CA 2006, section 561(1)). However, this right of pre-emption does not apply to: shares that relate to an employees’ share scheme (CA 2006, section 566); subscriber shares (CA 2006, section 577); bonus shares (CA 2006, section 564); or an allotment of shares or securities if these are, or are to be, wholly or partly paid up otherwise than in cash (CA 2006, section 565). Existing shareholders must also be afforded the opportunity to exercise their pre-emption rights in relation to the sale or transfer of treasury shares, in accordance with CA 2006, section 561 (CA 2006, section 560(3)).
If the board of directors has a general authority to allot shares pursuant to CA 2006, section 551, then they may be empowered by the company’s articles of association, or by a special resolution passed by the company’s shareholders, to allot shares under that authority as if the pre-emption rights set out under CA 2006, section 561 did not apply (CA 2006, section 570(1)). These pre-emption rights may also be disapplied in relation to a specified allotment of such shares only, although this requires a special resolution to be passed (CA 2006, section 571(1)). It is also possible for directors to sell treasury shares free from pre-emption rights, provided that the directors are authorised to do so by the company’s articles of association or by special resolution (CA 2006, section 573(1) and (2)). Where treasury shares are being sold and a disapplication of pre-emption rights is being relied upon, that disapplication should expressly allow directors to sell treasury shares.
LR9.3.11R also requires that when a company with a premium listing issues equity securities for cash, or sells treasury shares that are equity securities for cash, these equity securities must first be offered to holders of that class of equity shares and holders of other equity shares who are entitled to be offered them. However, LR9.3.11R does not apply:
- to issues of shares in respect of which pre-emption rights have been disapplied under CA 2006, section 570 or 571;
- in certain circumstances relating to a rights issue or open offer;
- to a sale of treasury shares for cash by a listed company to an employee share scheme;
- to an overseas company with a premium listing that has obtained the consent of its shareholders, subject to certain conditions being met; or
- to an open-ended investment company (LR9.3.12R).
Institutional investors should have regard to guidance published by the IA and the Pre-emption Group when deciding whether to vote in favour of resolutions to grant directors the authority to allot shares and to disapply pre-emption rights (see question 1).
Restrictions on the transfer of fully paid shares
Are restrictions on the transfer of fully paid shares permitted and, if so, what restrictions are commonly adopted?
It is a cardinal principle of the Listing Rules that fully paid shares in listed companies must be freely transferable (LR2.2.4R(1)). Shares must be fully paid up and free from any restriction on the right of transfer (except for any restriction imposed for failure to comply with a notice given under CA 2006, section 793) if they are to be listed (LR2.2.4R(2)).
Compulsory repurchase rules
Are compulsory share repurchases allowed? Can they be made mandatory in certain circumstances?
It is not generally permissible for a public company to require its own shareholders to sell their shares back to the company. Following a takeover offer, an offeror may compulsorily acquire the shares of a target company that are held by minority shareholders if it acquires, or unconditionally contracts to acquire, 90 per cent of the shares in the company to which the offer relates and 90 per cent of the voting rights carried by those shares (known as ‘the squeeze-out’ procedure) (CA 2006, section 979(1) and (2)). Minority shareholders whose shares are acquired under CA 2006, section 979 must be offered the same consideration as was offered under the terms of the original offer, although special provisions apply if the original form of consideration offered is no longer available (CA 2006, section 981(1), (2) and (5)). The compulsory acquisition of the minority shareholders’ shares will become mandatory once the offeror has given notice of his or her intention to acquire these shares in accordance with CA 2006, section 979(2) (CA 2006, section 981(2)).
A minority shareholder who receives notice that their shares are to be acquired pursuant to CA 2006, section 979 may apply to the court in respect of this acquisition within six weeks from the date on which the notice was given (CA 2006, section 986(1) and (2)). The court may order that the offeror is not entitled and bound to acquire the shares to which the notice relates, or that the terms on which the shares are to be acquired shall be such as the court thinks fit (CA 2006, section 986(1)). However, the court may not require consideration of a higher value than that specified in the terms of the offer to be given for the shares to which the application relates unless the holder of the shares shows that this value would be unfair, nor may it require consideration of a lower value than the offer value to be given for the shares (CA 2006, section 986(4)). A party who brings an application before the court in respect of CA 2006, section 979 must comply with certain notice requirements (CA 2006, section 986 (6) to (10)).
CA 2006, section 983 gives the minority shareholders of a target company the right to have their shares compulsorily acquired by an offeror if that offeror has acquired or unconditionally contracted to acquire some (but not all) of the shares to which the offer relates and those shares amount to not less than 90 per cent in value of all the voting rights in the company (or would do but for certain circumstances) and carry not less than 90 per cent of the voting rights in the company (or would do but for certain circumstances) (CA 2006, section 983(1) and (2)) (known as ‘the sell-out procedure’). CA 2006, section 983 also gives minority shareholders who hold non-voting shares and minority shareholders who hold shares of a certain class the right to have their shares compulsorily acquired in certain circumstances by an offeror (CA 2006, section 983(3) and (4)).
The offeror must acquire these shares on the terms of the offer that it has made for the target company, or on such other terms as may be agreed (CA 2006, section 985(1) and (2)). Special provisions apply if the original form of consideration offered is no longer available (CA 2006, section 985(5)).
Both a minority shareholder whose shares are acquired pursuant to CA 2006, section 983 and the offeror required to purchase such shares in accordance with this section can apply to the court for an order that the terms on which the offeror is entitled and bound to acquire the shares be such as the court thinks fit (CA 2006, section 986(3)). The restrictions set out in CA 2006, section 986(4) apply to any order that the court may make in respect of the acquisition of these shares (see above). A party who brings an application in respect of CA 2006, section 983 must comply with certain notice requirements (CA 2006, section 986(6) to (10)).
Do shareholders have appraisal rights?
A dissenting shareholder whose shares are acquired pursuant to CA 2006, section 979 or 983 may ask the court to make an order in respect of this acquisition under CA 2006, section 986(1) or 986(3) respectively. On such an application, the court may require consideration of a higher value to be given for the dissenting shareholders’ shares than that specified in the terms of the offer if the dissenting shareholder can show that the offer value would be unfair (CA 2006, section 986(4)(a)) (see question 13).
Responsibilities of the board (supervisory)
Is the predominant board structure for listed companies best categorised as one-tier or two-tier?
The board structure for UK-listed companies is best categorised as one-tier. UK companies do not have separate executive boards and supervisory boards. Instead, both executive directors and non-executive directors (who exercise a supervisory function) act as one board. This places greater emphasis on the composition of the board and the balance of independent and non-independent directors. The Code specifically addresses the issue of board composition, and bodies such as the PLSA have issued influential guidance on this topic (see questions 1 and 23).
Board’s legal responsibilities
What are the board’s primary legal responsibilities?
The board must discharge its statutory duties under CA 2006, sections 171 to 177 (see question 1). In addition, the board has a number of legal responsibilities, including:
- keeping the company’s statutory books up to date;
- filing certain documents with Companies House, such as the company’s annual return;
- preparing the company’s accounts and reports (including a directors’ report and a directors’ remuneration report for each financial year);
- ensuring that the company complies with its statutory obligations under, among other things, CA 2006, FSMA 2000, health and safety legislation, environmental legislation and competition legislation;
- ensuring that the company complies with its obligations under the LPDT Rules, particularly the disclosure requirements and continuing obligations contained within those rules;
- monitoring the company’s compliance with the Code and reporting on its performance in this regard in accordance with LR9.8.6R(5) and (6);
- ensuring that the company complies with the Takeover Code if it becomes subject to takeover discussions; and
- ensuring that the provisions of the Insolvency Act 1986 are complied with if the company falls into financial difficulty.
Whom does the board represent and to whom does it owe legal duties?
The board represents and owes its legal duties to the company (ie, to its shareholders as a whole) rather than to any individual shareholder or group of shareholders (CA 2006, section 170(1)). However, when discharging his or her duty to promote the success of the company, a director must have regard to the interests of stakeholders in the company including its employees, suppliers and customers and the local community and environment, as well as considering the need to act fairly as between members of the company (CA 2006, section 172). The idea that the directors must consider not simply the interests of its members is known as ‘enlightened shareholder value’, and it has been enshrined in statute through CA 2006.
The directors of a company that is in financial difficulty will be obliged to act in the best interests of its creditors, rather than in the interests of the company itself (CA 2006, section 172(3)).
Enforcement action against directors
Can an enforcement action against directors be brought by, or on behalf of, those to whom duties are owed?
Shareholders may bring a derivative claim (ie, an action brought by a shareholder on behalf of the company and in respect of a cause of action vested in the company) (CA 2006, section 260(1)). The cause of action must arise from an actual or proposed act or omission involving negligence, default or breach of duty or trust by a director of the company (CA 2006, section 260(3)). The cause of action may be against the director or another person or both (eg, a third party who has knowingly benefited from a director’s negligence, default or breach of duty, etc) (CA 2006, section 260(3)).
The person bringing the claim must be a member of the company but need not have been a member at the time that the cause of action arose (CA 2006, sections 260(1) and (4)). Concerns have arisen that this may lead to activists acquiring shares in certain companies in order to obtain the right to bring a derivative claim against that company and thus disrupt its activities (for example, animal rights activists may consider buying shares in a company involved in vivisection). However, the requirement for shareholders seeking to bring a derivative claim to establish a prima facie case for that claim should be sufficient to prevent the rights granted by CA 2006, section 260 from being abused in this way (see below).
A shareholder seeking to bring a derivative claim under CA 2006, section 260 must obtain the court’s permission to continue that claim (CA 2006, section 261(1)). To obtain such permission, the shareholder must convince the court that it has a prima facie case against the director (or other relevant person) (CA 2006, section 261(2)).
A shareholder may also apply to the court to continue as a derivative claim a claim that has been brought by the company, the cause of action for which could be pursued as a derivative claim under CA 2006, Chapter 1 of Part 11 (CA 2006, section 262(1)). The shareholder may apply to the court to continue such a claim as a derivative claim on the ground that:
- the manner in which the company commenced or continued the claim amounts to an abuse of the process of the court;
- the company has failed to prosecute the claim diligently; and
- it is appropriate for the member to continue the claim as a derivative claim (CA 2006, section 262(2)).
As with claims brought under CA 2006, section 260, the shareholder must convince the court that it has a prima facie case before they will be permitted to continue the claim (CA 2006, section 262(3)).
If a shareholder seeking to bring a derivative claim or seeking to continue a claim as a derivative claim, under CA 2006, sections 261 or 262 respectively, fails to make a prima facie case for their claim, the court must dismiss their application for permission to continue such a claim and make any consequential order it considers appropriate (CA 2006, sections 261(2) and 262(3)). If the court does not dismiss their application on this ground, then it may:
- seek evidence in respect of the claim from the company;
- give permission to continue the claim on such terms as it thinks fit;
- refuse permission and dismiss the application; or
- adjourn the proceedings on the application and give such directions as it thinks fit (CA 2006, sections 261(3) and (4) and 262(4) and (5)).
CA 2006, section 263 sets out the factors that the court must have regard to when deciding whether to grant permission to bring a derivative claim under CA 2006, sections 261 or 262. In particular, the court must dismiss such a claim if it is satisfied that: a person acting in accordance with the general duty to promote the success of the company under CA 2006, section 172 would not seek to continue the claim (CA 2006, section 263(2)(a)); or an act or omission giving rise to the cause of action has been authorised or ratified by the company (either before or after that act or omission occurred) (CA 2006, section 263(2)(b) and (c)). Additional factors that the court must take into account when considering whether to grant permission to bring a derivative claim under CA 2006, sections 261 or 262 are set out at CA 2006, section 263(3). Notably the member bringing the derivative claim must be acting in good faith (CA 2006, section 263(3)(a)). When deciding whether to grant permission, the court must have particular regard to the views of members who have no personal interest in the matter (CA 2006, section 263(4)).
A shareholder may also apply for permission to continue a derivative claim that has been brought or continued by another shareholder of the company if: the manner in which the proceedings have been commenced or continued by the shareholder amounts to an abuse of the process of the court; the shareholder has failed to prosecute the claim diligently; and it is appropriate for the applicant shareholder to continue the claim as a derivative claim (CA 2006, section 264(1) and (2)). Once again, the shareholder seeking to continue the derivative claim must establish a prima facie case (CA 2006, section 264(3)). If the court is satisfied that the claim should not be dismissed on this ground then it may give the same directions under CA 2006, section 264(4) and (5) as those mentioned above in relation to CA 2006, sections 261(3) and (4) and 262(4) and (5).
It should be noted that, where the cause of action for a derivative claim arose before 1 October 2007, the court may allow an application made under CA 2006, sections 260 to 264 to proceed if it would have been allowed to proceed as a derivative claim under the common law rules that applied before that date.
If any proceedings for negligence, default, breach of duty or breach of trust are brought against a director, the court can relieve that director either wholly or partly of his or her liability to the company if it finds that he or she acted honestly and reasonably and that, having regard to all the circumstances, he or she ought fairly to be excused (CA 2006, section 1157).
If a shareholder has suffered unfair prejudice, the shareholder is able to petition the court in accordance with CA 2006, section 994. However, a shareholder who sues under the unfair prejudice provision is claiming in his or her own capacity, whereas a shareholder who claims under the derivative action provisions claims on the company’s behalf.
Care and prudence
Do the board’s duties include a care or prudence element?
Company directors must exercise reasonable care, skill and diligence, that is, the level of care, skill and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by that director in relation to the company, and the general knowledge, skill and experience that the director has (CA 2006, section 174(1) and (2)).
The first limb of this test of the level of care and skill required from a director is objective and sets a minimum standard of behaviour that all directors must meet. The second limb is subjective and requires directors with superior knowledge, skills and experience to meet a higher standard of care and skill than would be expected under the first limb (for example, a director with an accountancy qualification may be expected to demonstrate a higher standard of skill and care in certain circumstances than would be expected of a director who did not have such a qualification).
Board member duties
To what extent do the duties of individual members of the board differ?
The statutory duties set out at CA 2006, sections 171 to 177 are owed to the company by all of its directors (CA 2006, section 170(1)). A ‘director’ is defined as including any person occupying the position of director, by whatever name called: this includes executive directors, non-executive directors and its de facto directors (CA 2006, section 250). These statutory duties currently only apply to shadow directors where, and to the extent that, they were held to so apply at common law (CA 2006, section 170(5)). However, the Small Business, Enterprise and Employment Act 2015 amended the CA 2006 from May 2015, such that the general duties apply to shadow directors to the extent that they are capable of applying.
A more skilled and experienced director may be required to demonstrate a higher level of care and skill than a less skilled and experienced director, in accordance with the subjective test of the level and care of skill owed by a director set out at CA 2006, section 174(2)(b) (see question 19).
ICSA guidance published in January 2013 suggests that it is not reasonable for non-executive directors to be expected to have the same knowledge and experience of a company’s affairs as executive directors. However, under the objective test in CA 2006, section 174(2)(a) when determining whether a non-executive director has breached his or her duty to exercise reasonable care, skill and diligence, a court would consider the steps a reasonably diligent non-executive director in the same position would have taken to familiarise themselves with the company’s business and operations.
See question 22 for further information on how the roles of executive and non-executive directors differ.
Delegation of board responsibilities
To what extent can the board delegate responsibilities to management, a board committee or board members, or other persons?
In practice, a company’s board will delegate responsibility for the day-to-day operations of the company to its management. In July 2013, the ICSA issued updated guidance on matters that should be reserved for the board, rather than delegated to executive management. These matters include strategy and management, structure and capital and financial and reporting controls. The 2016 version of the Code required the board to publish a formal schedule of matters specifically reserved for its decision and to include in its annual report a high-level statement of which types of decisions are to be taken by the board and which are to be delegated to management (the Code provision A.1.1). This provision has been removed from the 2018 version of the Code, and is now instead reflected in the FRC’s accompanying guidance (Guidance on Board Effectiveness, paragraph 28). Despite the fact that this reporting requirement has fallen outside of the scope of the comply or explain obligation, it is anticipated that UK-listed companies will continue to comply with it.
In addition, the board will delegate responsibility for certain matters to its audit, remuneration and nomination committees (see question 25). A company may also have additional committees to which the board delegates responsibility for matters such as risk, health and safety, corporate social responsibility and share plans. Some of these committees may be formally constituted by the board while others may be management committees. The FRC has suggested in its Guidance on Board Effectiveness that boards can minimise the risk of poor decisions by investing time in the design of their decision-making policies and processes, including the contribution of committees (Guidance on Board Effectiveness, paragraph 27).
Many companies’ boards appoint an executive committee, which typically comprises the executive directors and the most senior members of the management team. The executive committee will usually be formally appointed by the board as the chief executive’s forum for major operational decisions. An ICSA guidance note published in July 2013 suggests that the executive committee should report back to the board and have written terms of reference and delegated authorities, which are agreed by the board in advance as a matter of good practice.
Many companies’ articles of association also include provisions allowing directors to appoint alternate directors to act for them in their absence.
Non-executive and independent directors
Is there a minimum number of ‘non-executive’ or ‘independent’ directors required by law, regulation or listing requirement? If so, what is the definition of ‘non-executive’ and ‘independent’ directors and how do their responsibilities differ from executive directors?
The Code recommends that at least half of the board, excluding the chair, should be made up of independent non-executive directors (the Code, provision 11) such that no individual or small group of individuals can dominate the board’s decision-making process. Criteria for assessing the independence of a non-executive director are set out at provision 10 of the Code. The PLSA also publishes guidance on this matter in its ‘Corporate Governance Policy and Voting Guidelines’, most recently published in January 2019, and it helps institutional investors in determining whether a director is indeed independent (see question 1). The PLSA suggests that voting sanctions could be warranted in the event that the appointment of a non-independent non-executive director compromises the composition of key committees or the board itself.
CA 2006 does not distinguish between the duties owed to a company by its executive directors and its non-executive directors (see question 20). However, executive directors owe special duties arising out of their contracts of employment over and above these statutory obligations. These contractual obligations are generally different to the supervisory responsibilities discharged by non-executive directors. Executive directors, for example, are responsible for the day-to-day running of the company, while the role of the non-executive director is to challenge, review and monitor the performance of the board. The FRC’s Guidance on Board Effectiveness (paragraph 74) states that constructive challenge from non-executive directors is an essential aspect of good corporate governance, and it should be welcomed by the executive directors.
The standard of skill and care owed to the company by its directors and its non-executive directors is also likely to be different owing to the subjective test of the level of skill and care owed by a director to their company that is set out at CA 2006, section 174(2)(b) (see question 19). As non-executive directors are less involved with the day-to-day management of the company, they may not be expected to demonstrate a standard of skill and care that is as high as the standard of executive management (see question 20). It is accepted that non-executive directors are likely to devote significantly less time to a company’s affairs than an executive director and that the detailed knowledge and experience of a company’s affairs that could reasonably be expected of a non-executive director will generally be less than for an executive director. However, if a non-executive director serves on a board committee, they will be expected to exercise greater skill and care in relation to matters within the remit of that committee than would directors who are not members of the relevant committee.
The Code advises that the board should appoint one of the independent non-executive directors as senior independent director. The role includes leading a meeting of the non-executive directors to appraise the chair’s performance (without the chair being present) at least annually and on such other occasions as deemed appropriate. The senior independent director should also hold meetings with the non-executive directors without the executives present (the Code, provision 12). The senior independent director should also be available to shareholders if they have concerns that contact with the company through the normal channels of chair, CEO or other executive directors has failed to resolve or for which such contact is inappropriate (Guidance on Board Effectiveness, paragraph 35). In addition, non-executive directors are advised to meet managers and non-managerial members of the workforce, and should use these conversations to better understand the culture of the organisation and the way things are done in practice, and to gain insight into the experience and concerns of the workforce (Guidance on Board Effectiveness, paragraph 75).
Board size and composition
How is the size of the board determined? Are there minimum and maximum numbers of seats on the board? Who is authorised to make appointments to fill vacancies on the board or newly created directorships? Are there criteria that individual directors or the board as a whole must fulfil? Are there any disclosure requirements relating to board composition?
It is a company law requirement that public companies have at least two directors (CA 2006, section 154 (2)). At least one of these directors must be a natural person (CA 2006, section 155(1)), though in practice listed companies will have considerably more. Note that this requirement will be superseded if section 87 of the Small Business, Enterprise and Employment Act 2015 (SBEEA 2015) comes into force. This will repeal CA 2006, section 155 and replace it with a new provision prohibiting the appointment of corporate directors and requiring all company directors to be natural persons. Although the Secretary of State will have the power to provide for exceptions and a transition period of a year will apply for companies with corporate directors already in place, an appointment made in contravention of this section will be void and it will be an offence to breach the prohibition. There is no set implementation date for this section of the SBEEA 2015 (having initially been planned for October 2016), and there has been no indication from the government as to when this will come into force.
Subject to certain exceptions, a person may not become a director of a company unless he or she has attained the age of 16 years (CA 2006, section 157(1)), although an appointment can be made before the individual reaches 16 years provided that the appointment does not take effect until that time (CA 2006, section 157(2)).
In certain circumstances, the courts of England and Wales may make a disqualification order against a person, to the effect that for a defined period that person must not be a director of a company (Company Directors Disqualification Act 1986, section 1(1)(a)). A court may make such an order for a number of reasons, such as the person being convicted of certain offences or being persistently in default in relation to companies legislation.
Except for the CA 2006 requirement stated above, and subject to the comments made below, there is no specified minimum or maximum number of seats on the board, although the size of the board may be determined by the company’s articles.
The Code specifically addresses the issue of board composition:
- Principle G of the Code states that the board should include an appropriate combination of executive and (independent) non-executive directors, such that no one individual or small group of individuals dominates the board’s decision-making;
- Principle J of the Code states that appointments to the board should be subject to a formal, rigorous and transparent procedure. Regard should be had to merit and objective criteria, and should promote diversity of gender, social and ethnic backgrounds, and cognitive and personal strengths. The Guidelines for Board Effectiveness emphasise that diversity in board composition is an important driver of a board’s effectiveness, creating a breadth of perspective among directors and countering a tendency for ‘group think’ (paragraph 88) and that developing a more diverse executive pipeline is vital to increasing levels of diversity among those in senior positions (paragraph 89);
- Principle K of the Code states that the board (and its committees) should have a combination of skills, experience and knowledge, and that consideration should be given to the length of service of the board as a whole and membership regularly refreshed; and
- Principle L of the Code states that there should be an annual evaluation of the board that considers its composition, diversity and how effectively members work together to achieve objectives. Provision 21 of the Code states that the chair should consider having a regular externally facilitated board evaluation, and that this should happen every three years in the case of FTSE 350 companies.
The nomination committee, usually led by the chair, should be responsible for board recruitment, and should ensure that plans are in place for orderly succession to both the board and senior management positions (the Code, provision 17). This should be a continuous and proactive process and should take into account the company’s agreed strategic priorities (Guidance on Board Effectiveness, paragraph 86). According to the Code, the annual report should include the following (provision 23):
- the process used in relation to appointments, the nomination committee’s approach to succession planning and how both support developing a diverse pipeline;
- how the board evaluation has been conducted, the nature and extent of an external evaluator’s contact with the board and individual directors, the outcomes and actions taken, and how it has or will influence board composition;
- the policy on diversity and inclusion, its objectives and linkage to company strategy, how it has been implemented and progress on achieving the objectives; and
- the gender balance of those in the senior management and their direct reports.
Institutional investors have also considered the topic of board composition. As mentioned in question 1, the guidelines set out by entities such as the IA and the PLSA are not enshrined in statute but it remains ill-advised to ignore their suggestions. In particular, the PLSA has produced its corporate governance policy and voting guidelines. The PLSA expects to see proper disclosure of the steps being taken towards bringing diversity to the boardroom. Where disclosure is poor, or where there is a lack of board succession planning, or there is a lack of due consideration of diversity and the balance of skills on the board, the PLSA suggests that investors may vote against the re-election of the chair of the nomination committee.
The ABI published its second Report on Board Effectiveness in December 2012. It emphasises that diversity of perspective should be a key objective when appointing board members, and that companies should disclose the steps they are taking to promote a diversity of perspective in their boardroom, as well as the challenges they face in seeking out relevant skills and experience. In addition, the chair should widen the search for non-executive directors, broadening traditional talent pools, when making board appointments. This is now partially reflected in provision 20 of the Code, which states that open advertising and an external search consultancy, or both, should generally be used for the appointment of the chair and non-executive directors.
When the Code is interpreted together with the Guidance on Board Effectiveness and the Report on Board Effectiveness, it is apparent that, practically speaking, companies listed in the UK must give due consideration to attaining the appropriate balance of skills, experience, independence, knowledge and diversity. Although strictly speaking a company can decide how well it applies the principles of the Code, it will have to make a statement in its annual financial report as to the application of the principles and comply or explain in relation to the provisions, and it is unlikely that shareholders will allow poor application to persist, in the absence of alternative justification.
Gender representation and diversity
Monitoring gender representation and diversity on boards has become a particular focus in recent years. As advised by the Davies Report (February 2011) ‘Women on Boards’, the FRC has consulted on the issue of gender diversity at an executive level. Lord Davies had recommended that FTSE 350 boards should aim for a minimum of 25 per cent female representation by 2015. In May 2011, the FRC published a consultation document, concerned with whether further steps were required to reach the goal of more diverse boards, what, if any, these changes should be and when they should be introduced. In March 2015, Lord Davies released his fourth annual progress report on this matter, reporting on the progress that FTSE 350 companies have made towards reaching the 2015 targets. The report states that progress had been positive, with women accounting for 23.5 per cent of FTSE 100 and 18 per cent of FTSE 250 board directors at that time.
Lord Davies’ final report was published on 29 October 2015. It noted that there were no male-only boards in the FTSE 100 and that women held 26.1 per cent of board positions in those companies, and that in FTSE 250 companies, women held 19.6 per cent of board positions and there were 15 male-only boards. It also made five recommendations, including that the voluntary, business-led approach to improving the number of women in board positions should be continued until 2020, targeting 33 per cent female board representation in FTSE 350 companies in that time frame.
This voluntary target has been reiterated in the latest report on board diversity, the Hampton-Alexander Review, published on 8 November 2016. The review highlights increases in female board representation for the FTSE 100 and 250, to 26.6 per cent and 21.1 per cent respectively - an overall increase to 23 per cent for the FTSE 350, up from 21.9 per cent in the previous year. Further recommendations included, for example, that FTSE 350 companies should voluntarily publish details of the number of women on the executive committee in their annual reports or on websites.
The Equality and Human Rights Commission published in March 2016 its ‘Six Step Guide to Good Practice’ on how to improve board diversity. This is a guide for companies and executive search firms to improve the diversity of company boards within the frameworks set out by the Equality Act 2010 and the Financial Reporting Council. The six steps are as follows:
Making an appointment:
- Define the selection criteria in terms of measurable skills, experience, knowledge and personal qualities.
- Reach the widest possible candidate pool by using a range of recruitment methods and positive action.
- Provide a clear brief, including diversity targets, to your executive search firm.
- Assess candidates against the role specification in a consistent way throughout the process.
Ongoing action to improve diversity:
- Establish clear board accountability for diversity.
- Widen diversity in your senior leadership talent pool to ensure future diversity in succession planning.
Gender diversity on boards has also become an area of legislative change. In October 2013, the Companies Act (Strategic Report and Directors’ Report) Regulations 2013 was implemented for companies with financial years ending on or after 30 September 2013. The regulations contain a requirement for listed companies to make three separate disclosures on the proportion of women and men who are, respectively, directors, senior managers and employees of the company (CA 2006, section 414C(8) and (9)).
DTR 7.2.8A has been introduced to implement EU Directive 2014/95 on disclosure of non-financial and diversity information, applicable to large UK-listed companies for financial years commencing on or after 1 January 2017. Affected companies’ corporate governance statements must now include an additional description of the diversity policy applied to their administrative, management and supervisory bodies, and how it has been implemented. If no diversity policy is applied, then the statement must contain an explanation as to why this is the case. As described earlier in this question, these requirements are now reflected in the Code, which requires the board to promote diversity (of gender, social and ethnic backgrounds, cognitive and personal strengths) (Principle J), to annually evaluate its diversity (Principle L) and to publish the nomination committee’s policy on diversity and inclusion, how it has been implemented and the progress made in achieving its objectives (provision 23).
Is there any law, regulation, listing requirement or practice that requires the separation of the functions of board chair and CEO? If flexibility on board leadership is allowed, what is generally recognised as best practice and what is the common practice?
The Code states that the positions of chair and CEO should not be occupied by the same person, to ensure that no one individual has unfettered decision-making powers (the Code, provision 9). Most UK-listed companies separate the roles of chair and CEO. Major shareholders should be consulted in advance of the appointment and the reasons for not separating the two roles should be set out at the time of the appointment and in the company’s next annual report (the Code, provision 9).
The Code encourages a clear division of responsibilities between the leadership of the board and the executive leadership of the company’s business (the Code, Principle G). The Code further provides that the chair should meet the independence criteria set out at provision 10 which apply to non-executive directors (the Code, provision 9).
The PLSA Guidance has reiterated that the division of the roles of chair and CEO is a cornerstone of good governance in the UK, a position supported by the PIRC in its Shareholder Voting Guidelines 2019, which recommend opposing the re-election of a CEO holding the position of chair except in exceptional circumstances. The PLSA Guidance also suggests that the succession of the CEO to chair would only be acceptable in exceptional circumstances (for example, to ‘bridge the gap’ between the departure of a CEO and the appointment of his or her successor), and should be accompanied by significant engagement with shareholders. In the absence of a convincing explanation, the PLSA Guidance recommends that shareholders should consider voting against the chair in the event of the role being combined with that of the CEO.
What board committees are mandatory? What board committees are allowed? Are there mandatory requirements for committee composition?
A company’s directors may delegate certain powers and responsibilities to board committees if permitted to do so by its articles of association. The FRC’s Guidance on Board Effectiveness states that, notwithstanding a board’s delegation of decision-making to committees in relation to audit, risk and remuneration, the board retains responsibility for, and makes the final decisions on, all these areas (Guidance on Board Effectiveness, paragraph 62).
The Code provides that a listed company should establish the following committees, the chair and members of which should be identified in the annual report:
- A nomination committee comprising a majority of independent non-executive directors to recommend new appointments and reappointments to the board and senior executive offices (the Code, provision 17). Its aim is to promote objectivity in the appointment of directors and to ensure that a company’s board is balanced and is not dominated by a particular individual or group of individuals.
- A remuneration committee made up entirely of independent non-executive directors, comprising at least three members, or two in the case of smaller companies. The chair of the board can only be a member if he or she was independent on appointment, and cannot chair the committee. The chair of the committee must have 12 months’ experience serving on a remuneration committee (the Code, provision 32). The remuneration committee has increased prominence under the 2018 version of the Code, as it should now be responsible for determining the policy for executive director remuneration and setting remuneration for the chair, executive directors and senior management (the Code, provision 32). In the previous version of the Code, the committee occupied only a supervisory role in relation to these responsibilities (see question 28).
- An audit committee made up entirely of independent non-executive directors, comprising at least three members, or two in the case of smaller companies. The chair should not be a member, and the committee should include at least one individual with relevant financial experience (the Code, provision 24). The purpose of the committee is to comply with Principle M of the Code, which requires policies and procedures to ensure the independence and effectiveness of internal and external audit functions and the integrity of financial and narrative statements. The main roles and responsibilities are set out in detail in provision 25 of the Code, and include providing advice to the board on the annual report and accounts, reviewing the company’s internal audit function and conducting the tender process of external auditors. On 16 November 2009, the FRC published ‘Challenges for Audit Committees Arising from Current Economic Conditions’, which sets out issues that audit committees should take into account in view of the global financial crisis when preparing corporate reports. In September 2012, the FRC published a new version of its Guidance on Audit Committees, which is intended to assist listed companies in implementing the relevant provisions of the Code, although the guidance itself is non-binding. The Guidance was updated in April 2016. UK-listed companies are legally required to establish an audit committee by DTR7.1, which provides that such a committee should have at least one independent member and a member that has competence in accounting or auditing, or both (DTR7.1.1R). In September 2014, the Competition and Markets Authority made an order relating to statutory audit services for large companies (the CMA Order) on 26 September 2014. The CMA Order, among other things, requires the terms of the statutory audit services for a FTSE 350 company to be negotiated and agreed by the audit committee only. In June 2013, the ICSA published guidance on the terms of reference for the nomination, remuneration, audit and risk committees of a company seeking to comply fully with the provisions of the Code, following the latter’s publication in September 2012. The guidance note on terms of reference for the audit committee was updated in March 2017 to reflect revisions to the Code made in April 2016 and the FRC’s updated Guidance on Audit Committees.
Is a minimum or set number of board meetings per year required by law, regulation or listing requirement?
According to the FRC’s Guidance on Board Effectiveness, meeting regularly is essential for the board to discharge its duties effectively and to allow adequate time for consideration of all the issues falling within its remit (paragraph 28). However, this will be subject to the company’s articles, which may specify a minimum number of board meetings that must be held per year. The Code provides that a company should set out in its annual report the number of meetings of the board and its committees that took place, as well as the level of individual attendance by directors (the Code, provision 14).
Is disclosure of board practices required by law, regulation or listing requirement?
Annex I of Appendix 3 to the PRs requires a UK-listed company to include details of certain aspects of its board practices in any prospectus that it publishes, including information about its audit and remuneration committees and a summary of the terms of reference of these committees (PR Appendix 3, Annex I, item 16.3).
Throughout the Code there are provisions relating to the disclosure in a company’s annual report of the board’s practices. The annual report should include descriptions of the following:
- how the board has considered and addressed risks to the future success of the business, the sustainability of the company’s business model and how its governance contributes to the delivery of its strategy (provision 1);
- the board’s activities, and any action taken, in relation to the board’s assessment of the company’s culture, including an explanation of the company’s approach to investing in and rewarding its workforce (provision 2);
- where 20 per cent or more votes have been cast against the board recommendation for a resolution, the impact that the resulting feedback has had on the decisions the board has taken, and any actions or resolutions proposed (provision 4);
- how the interests of the company’s stakeholders (other than shareholders), as described in CA 2006, section 172 have been considered in board discussions and decision-making (provision 5);
- each non-executive director that the board considers to be independent (provision 10);
- the number of meetings the board and its committees have had, and the individual attendance by directors (provision 14);
- the reasons behind significant appointments (eg, to the board, or as chair) (provision 15);
- the work of the nomination committee (provision 23), the audit committee (provision 26) and the remuneration committee (provision 41);
- the board assessment of the company’s emerging and principal risks, what procedures are in place to identify emerging risks and an explanation of how these are being managed or mitigated (provision 28), and the outcome of the board review of the effectiveness of the company’s risk management and internal control systems (provision 29); and
- whether the board has a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due (provision 31).
Remuneration of directors
How is remuneration of directors determined? Is there any law, regulation, listing requirement or practice that affects the remuneration of directors, the length of directors’ service contracts, loans to directors or other transactions or compensatory arrangements between the company and any director?
In the case of a UK-listed company, a remuneration committee will be tasked with determining the remuneration for the chair, executive directors and senior management (the Code, provision 33) (see question 25). The following are the most important provisions of the Code applicable to remuneration:
- executive remuneration should be aligned to the company purpose and values, and be clearly linked to the successful delivery of the company’s long-term strategy (Principle P);
- a formal and transparent procedure for developing policy on executive remuneration and determining director and senior management remuneration should be established (Principle Q);
- no director should be involved in deciding his or her own remuneration outcome (Principle Q);
- directors should exercise independent judgement and discretion, and take into account company and individual performance when authorising remuneration outcomes (Principle R);
- the remuneration committee should take into account workforce remuneration and culture when setting the policy for executive director remuneration (Provision 33);
- remuneration for all non-executive directors should not include share options or other performance-related elements (provision 34), thereby ensuring that remuneration does not risk compromising non-executive independence and objectivity; and
- share awards granted for the purpose of promoting long-term shareholdings by executive directors should be subject to a total vesting and holding period of five years or more (provision 36). This is an increase of the three-year requirement in the previous version of the Code.
It is a requirement that the directors of a UK-listed company prepare a directors’ remuneration report for each financial year of the company (CA 2006, section 420(1)). It is also a requirement for directors of UK-listed companies with a financial year ending on or after 30 September 2013 to prepare a remuneration policy to be set out in a separate part of the report (CA 2006, section 421(2A)). The shareholders of the company must be given the opportunity to approve the remuneration report (annually) and remuneration policy (at least every three years) by ordinary resolution (see questions 4 and 36). The requirements as to the form and content of the directors’ remuneration report and remuneration policy are outlined in Schedule 8 to the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008.
Legislative changes in relation to executive remuneration came into effect on 1 October 2013. The Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013 implemented new content requirements for directors’ remuneration reports, including the requirement for companies to publish in their remuneration report a single figure for total remuneration for each person that has held the office of director in that financial year. In addition, sections 79 to 82 of the Enterprise and Regulatory Reform Act 2013 (ERRA 2013) added the following requirements to CA 2006:
- an amendment to section 421 to allow for regulations to be published setting out the content requirements of a directors’ remuneration policy regarding future remuneration payments and payments for loss of office, which will be set out in a separate part of the directors’ remuneration report;
- the introduction of section 439A, which requires a binding ordinary shareholder resolution to approve the remuneration policy at least every three years; and
- the introduction of sections 226A to 226F, which restrict remuneration payments and payments for loss of office to directors to those specified within the approved remuneration policy. Section 226E is particularly noteworthy as it requires any directors who approve payments that contradict the approved remuneration policy to indemnify the company, jointly and severally, against any losses that arise from the payment (although relief is available to directors who can show that they acted honestly and reasonably).
Pursuant to the Listing Rules, a listed company incorporated in the UK must include in its annual financial report a board report addressed to the shareholders containing details of the unexpired term of the director’s service contract of a director proposed for election or re-election at the forthcoming annual general meeting, and, if any director proposed for election or re-election does not have a director’s service contract, a statement to that effect (LR9.8.6R(7) and LR9.8.8R).
Executive remuneration has been the focus of various discussion papers and industry guidance in recent years. Most recently, in November 2018, the IA updated its guidance on directors’ remuneration in its ‘Principles of Remuneration’. The guidance provides that remuneration committees should have regard to risk management when setting executive remuneration and also deals with matters including base pay, bonuses, pensions and performance criteria. The guidance focuses on 16 principles, which together relate to remuneration policies, remuneration committees, remunerations structures and levels of remuneration. (See question 41 for requirements relating to disclosure of CEO pay ratios.)
A company must not enter into a director’s service contract containing a guaranteed term of employment that is, or may be, more than two years unless authorised to do so by a shareholder resolution passed during a general meeting of the company (CA 2006, sections 188(1) and (2)). Contravention of this requirement will result in the relevant provision being void and the service contract being deemed to contain a term entitling the company to terminate it at any time by giving reasonable notice (CA 2006, section 189). The Code provides that service contracts should be no more than 12 months in duration. If it is necessary to offer longer contract periods to new directors, these should reduce to 12 months or less after the initial period (the Code, provision 39).
CA 2006 provides that, subject to certain rules and exceptions, a company must not, unless authorised to do so by shareholder resolution:
- make loans or quasi-loans to directors or persons connected to a director, nor provide any guarantee or security in respect of a loan or quasi-loan made to a director or persons connected to a director (CA 2006, sections 197 to 200, 203 to 214 and 223 to 225);
- enter into a credit transaction as a creditor for the benefit of a director or persons connected with a director, nor provide any guarantee or security in connection with a credit transaction entered into by a director (CA 2006, sections 201 to 214 and 223 to 225);
- enter into substantial property transactions with directors or persons connected with directors (CA 2006, sections 190 to 196 and 223 to 225); nor
- make certain payments to a director in respect of a loss of office (CA 2006, sections 215 to 225, noting that, where the company is a UK-listed company, the restrictions in CA 2006, section 226C as described above would apply by virtue of CA 2006, section 215(5)).
If a company enters into a transaction with one of its directors or a person connected with such a director and in doing so exceeds any limitations placed on its powers by its articles of association or any shareholder resolutions then, subject to certain exceptions:
- the transaction is voidable at the instance of the company; and
- the director who is party to the transaction (or any person connected with the director and who is party to that transaction) and any director of the company who authorised the transaction will be liable to account to the company for any direct or indirect gain he or she has made from the transaction and to indemnify the company for any loss or damage that it may suffer as a result of the transaction (CA 2006, section 41).
Company directors must also declare the nature and extent of any interest that they have in proposed or existing transactions or arrangements with the company. However, they need not declare such an interest: if it cannot reasonably be regarded as likely to give rise to a conflict of interest; if, or to the extent that, the other directors are already aware of it; or if, or to the extent that, it concerns terms of his or her service contract that have been or are to be considered by a meeting or committee of the directors (CA 2006, sections 177 and 182).
Company directors should also have regard to their duty to avoid conflicts of interest when entering into transactions with the company (CA 2006, section 175). They should also ensure that such transactions do not put them in breach of their obligations not to abuse any inside information that they have about the company, particularly during a ‘close period’ (that is, the period surrounding the announcement of the company’s most recent results) (see also question 36).
Remuneration of senior management
How is the remuneration of the most senior management determined? Is there any law, regulation, listing requirement or practice that affects the remuneration of senior managers, loans to senior managers or other transactions or compensatory arrangements between the company and senior managers?
The remuneration of a UK-listed company’s senior management should be set by its remuneration committee (the Code, provision 33) (senior management being defined, for the purposes of the Code, as the executive committee or the first layer of management below board level, including the company secretary). Companies should also have regard to the IA’s Principles of Remuneration when determining the remuneration of their most senior managers (see question 28).
D&O liability insurance
Is directors’ and officers’ liability insurance permitted or common practice? Can the company pay the premiums?
Companies are permitted to maintain directors’ and officers’ liability insurance (D&O liability insurance) by CA 2006, section 233 although they are not obliged to do so. D&O liability insurance protects directors and officers from financial liability for any claims made against them in respect of the performance of their duties to the company. A typical D&O liability insurance policy will provide cover for directors, officers, managerial and supervisory employees and the company itself, to the extent that it has indemnified such persons (see question 31). D&O policies generally cover losses such as court costs and damages in respect of claims brought for the wrongful acts of the insured. However, certain types of claim will not be covered by a D&O liability insurance policy, such as those for fraud and dishonesty or property damage or personal injury.
The ICSA, in its January 2013 guidance (ICSA guidance on liability of non-executive directors: care, skill and diligence), recommends that D&O liability insurance should include ‘run-off’ cover for a period after the director’s resignation. It suggests that six years might be considered an appropriate period.
Indemnification of directors and officers
Are there any constraints on the company indemnifying directors and officers in respect of liabilities incurred in their professional capacity? If not, are such indemnities common?
A company generally may not exempt a director from liability for any negligence, default, breach of duty or breach of trust in relation to the company, nor indemnify him or her in respect of such behaviour (CA 2006, sections 232(1) and (2)). However, a company may maintain insurance for a director in respect of such liability (see question 30) and provide directors with an indemnity in respect of such liability by way of a qualifying third-party indemnity provision (QTPIP) or a qualifying pension scheme indemnity provision (QPSIP) (CA 2006, section 232(2)).
A QTPIP indemnifies a director in respect of liability incurred to a third party (that is, a liability that is not incurred by the director to the company itself or to an associated company) (CA 2006, section 234(2)). However, a QTPIP must not indemnify a director in respect of fines imposed in criminal proceedings, regulatory penalties, the liabilities incurred in defending the director against criminal proceedings in which he or she is convicted, the liabilities incurred in defending civil proceedings brought by the company in which judgment is given against him or her or certain applications for relief in which the court refuses to grant him or her relief (CA 2006, section 234(3)).
A QPSIP indemnifies a director of a company that is a trustee of an occupational pension scheme against liability incurred in connection with the company’s activities as trustee of the scheme (CA 2006, section 235(2)). A QPSIP must not indemnify a director in respect of fines imposed in criminal proceedings, regulatory penalties or liability incurred by the director in defending criminal proceedings in which he or she is convicted (CA 2006, section 235(3)). The existence of either a QTPIP indemnity or a QPSIP indemnity must be disclosed in the directors’ report (CA 2006, section 236(1)).
A company may also provide directors with funds to pay for their expenses in defending any criminal or civil proceedings in connection with:
- any alleged negligence, default, breach of duty or breach of trust in relation to the company or an associated company; or
- making applications for relief under CA 2006, sections 661 and 1157 (CA 2006, sections 205(1) and (5)). Shareholder approval is not required (CA 2006, section 205(1)). These funds must be repaid if the director is convicted, receives an adverse judgment or is refused relief in respect of the proceedings (CA 2006, section 205(2)).
A company may also advance funds to a director to meet the costs of defending any regulatory investigation or action concerning him or her. Unlike loans made to a director to fund the costs of defending criminal and civil proceedings, loans made in respect of defending regulatory proceedings or action by a regulatory authority do not need to be repaid if judgment is given against the director. Shareholder approval is not required (CA 2006, section 206).
Exculpation of directors and officers
To what extent may companies or shareholders preclude or limit the liability of directors and officers?
Generally, any provision that purports to exempt a company director from liability that would otherwise attach to him or her in connection with negligence, default, breach of duty or breach of trust in relation to the company, is void (CA 2006, section 232(1)). As mentioned in questions 30 and 31, there are exceptions to this rule for the provision of insurance, QTPIP indemnification and QPSIP indemnification provisions (CA 2006, section 232(2)).
A company’s board may pre-authorise a director to enter into an arrangement that would otherwise amount to a conflict between the director’s interests and those of the company, provided that the board is explicitly permitted to authorise such a conflict by the company’s constitution (CA 2006, sections 175(4)(b) and (5)(b)). This authorisation will only be effective if:
- the meeting at which such authorisation is granted is capable of being quorate without the participation of the director to whom the authorisation relates; and
- the resolution granting this authorisation is passed without him or her voting on it (CA 2006, section 175(6)). If such authorisation is granted, the transaction will not be liable to be set aside by any common law rule that requires the company’s shareholders to consent to such an arrangement (CA 2006, section 180(1)(a)).
Directors will also not be liable for entering into an arrangement that could amount to a breach of their duties to avoid conflicts of interest and to not accept benefits from third parties under CA 2006, sections 175 and 176, if the company’s shareholders have approved that arrangement under CA 2006, chapter 4 of part 10 (which relates to transactions between a company and its directors requiring shareholder approval (see question 4)), or in respect of which that chapter provides that approval is not required (CA 2006, section 180(2)).
A company may also preclude the liability of a director for a breach of his or her duty to avoid conflicts of interest by including provisions in its articles of association under which a director may enter into certain arrangements that would otherwise amount to a breach of this duty (CA 2006, section 180(4)(b)). Further, the company may pre-authorise a breach of duty by a director in accordance with a relevant rule of law (for example, by the common law rule that a company may authorise a breach of duty if full and frank disclosure is made of all material facts (although, a company may not authorise an unlawful act)) (CA 2006, section 180(4)(a)).
Companies may also relieve their directors of liability for any negligence, default, breach of duty or breach of trust in relation to the company by ratifying such conduct after it has occurred, by way of a shareholder resolution (CA 2006, sections 239(1) and (2)). This resolution will only be effective if it passed without the director or any shareholder connected with him or her voting in favour of it (although, such persons are not prevented from counting in the quorum for the meeting) (CA 2006, section 239(4)). However, it is unlikely that shareholders will be permitted to ratify unlawful acts (CA 2006, section 239(7)).
What role do employees have in corporate governance?
Employees do not have a formal role in corporate governance; however, in practice, the most senior employees will be involved in the formulation of board practices and policies. A company’s directors must have regard to the interests of its employees when discharging their duty to promote the success of the company (CA 2006, section 172(1)(b)).
A key focus of the latest version of the Code is increasing engagement between the board and employees (referred to in the Code as the workforce). Principle D requires the board to ensure effective engagement with, and encourage participation from, shareholders and stakeholders (including employees). The Code has rowed back on the initial aspiration of mandating employee representation on the board; however, the Code does require the following:
- the board to set out in the annual report how the interest of stakeholders listed in section 172 CA 2006 (including employees) have been considered in board discussions and decision-making (provision 5);
- means for the workforce to raise concerns in confidence, and arrangements for proportionate and independent investigation of matter as required (provision 6); and
- the implementation of one or a combination three methods for engagement with the workforce: a director appointed from the workforce, a formal workforce advisory panel and a designated non-executive director. If the board does not choose one or more of these methods, it should explain what alternative arrangements are in place and why it considers that they are effective (provision 5).
UK-listed companies appear to be adopting different approaches to satisfying provision 5 of the Code. A limited number have stated that they plan to appoint a workforce director, meanwhile ‘alternative arrangements’ are likely to prove popular, at least initially, as this method of compliance will enable companies to build on the existing mechanisms they have developed to take soundings from their workforce, such as opinion surveys, employee forums and internal reporting from senior human resources managers to the board.
The Code’s provisions in relation to workforce engagement are supplemented by new reporting requirements introduced by secondary legislation (the Companies (Miscellaneous Reporting) Regulations 2018). Pursuant to these regulations, for financial years beginning on or after 1 January 2019:
- Regulation 11 of the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 now requires companies with more than 250 employees to contain a statement in their directors’ report (or strategic report, as appropriate) summarising how the directors have engaged with employees and how the directors have had regard to employee interests, and the effect this regard has had including on the principal decisions taken by the company during the financial year; and
- CA 2006, section 414CZA now requires large companies (defined in CA 2006, sections 465-467) to publish a statement in their strategic report of how the directors have complied with their duty to have regard to the matters in section 172(1)(a)-(f) that, as stated above, includes having regard to the interests of employees.
A company’s auditor may also demand such information from the company’s employees as he or she requires to perform his or her duties as an auditor (CA 2006, section 499(1) and (2)).
Board and director evaluations
Is there any law, regulation, listing requirement or practice that requires evaluation of the board, its committees or individual directors? How regularly are such evaluations conducted and by whom? What do companies disclose in relation to such evaluations?
Principle L of the Code addresses the effectiveness of the board, requiring the board to undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors. Evaluation of the board should consider the balance of skills, experience, independence and knowledge of the company on the board, its diversity (including of gender), how the board works together as a unit and other factors relevant to its effectiveness.
The board should state in the annual report how performance evaluation of the board, its committees and individual directors has been conducted. Evaluation of the board of FTSE 350 companies should be externally facilitated at least every three years (the Code, Principle 21). The chair should act on the results of the performance evaluation by recognising the strengths and addressing the weaknesses of the board (the Code, Principle 22). This may involve the proposal of new directors or seeking the resignation of existing directors.
Disclosure and transparency
Corporate charter and by-laws
Are the corporate charter and by-laws of companies publicly available? If so, where?
The memorandum and articles of association of companies incorporated in England and Wales are publicly available from Companies House in Cardiff or London and can be accessed online without charge. Many companies also make their articles of association available on their websites.
What information must companies publicly disclose? How often must disclosure be made?
The principal information that companies must disclose is as follows (however, this list is not exhaustive).
From 3 July 2016, the UK’s market abuse provisions in FSMA 2000 were replaced by a new regime under the Market Abuse Regulation (596/2014/EU) (MAR) and the Market Abuse Regulation Instrument 2016. There are implications regarding, among other things, inside information, share dealings and market manipulation.
People with significant control register
Section 81 and Schedule 3 of the SBEEA 2015 added a new Part 21A into the CA 2006, pursuant to which companies were required from 6 April 2016 to identify and record the people with ‘significant control’ (PSC)over the company in a public register (PSC Register). Part 21A applies to all companies other than those to which chapter 5 of the DTRs applies. Limited liability partnerships and UK Societates Europaeae are not caught by the revised CA 2006 but must abide by the same requirements as they are carried across by the Limited Liability Partnerships (Register of People with Significant Control) Regulations 2016, which came into force on 30 June 2016. A PSC Register must be kept in addition to existing registers such as the register of directors and register of members. The PSC information must be filed with the central public register at Companies House.
A PSC is an individual who meets one or more of the following conditions in relation to a company:
- directly or indirectly holds more than 25 per cent of the shares;
- directly or indirectly holds more than 25 per cent of the voting rights;
- directly or indirectly holds the right to appoint or remove the majority of directors (this is defined as the directors holding the majority of voting rights);
- otherwise has the right to exercise, or actually exercises, significant influence or control over the company; or
- has the right to exercise, or actually exercises, significant influence or control over the activities of a trust or firm (not being a legal person, such as a partnership), which itself satisfies one or more of the first four conditions.
If any of the conditions listed above is met by a trust or firm, statutory guidance assists in identifying who should be in the PSC Register.
Financial and operating results of the company
A listed company is required to make public an annual financial report containing its audited financial statements, a management report and responsibility statements by the persons within the company who are responsible for its accounts. The annual financial report must be made public at the latest four months after the end of each financial year, and it must remain publicly available for at least 10 years (DTR4.1.3R, DTR4.1.4R and DTR4.1.5R).
A listed company must also make public a half-yearly report containing a condensed set of financial statements, an interim management report and responsibility statements. The half-yearly financial report must cover the first six months of the financial year and should be published as soon as possible but no later than three months after the end of the period to which the report relates, and it must remain publicly available for at least 10 years (DTR4.2.2R and DTR4.2.3R). A company may be liable to compensate any person who has acquired securities and suffered loss as a result of any untrue or misleading statement in or omission from the company’s financial reports (section 90A FSMA 2000).
Share capital and voting rights
A person must notify the company of the percentage of the company’s voting rights held by him or her (including voting rights held through that person’s holding of financial instruments) if that percentage reaches, exceeds or falls below the following thresholds: 3, 4, 5, 6, 7, 8, 9, 10 per cent and each 1 per cent threshold thereafter up to 100 per cent (DTR5.1.2R). On receiving such a notification, a company must as soon as possible, and in any event by not later than the end of the trading day following receipt of the notification, make public all information contained in that notification (DTR5.8.12R(1)).
If a listed company acquires or disposes of its own shares, it must make public the percentage of voting rights attributable to those shares it holds as a result of the transaction as a whole where the percentage reaches, exceeds or falls below the threshold of 5 per cent or 10 per cent of the voting rights. This must be done as soon as possible, and in any event not later than four trading days after the acquisition or disposal of these shares (DTR5.5.1R). A listed company must also, at the end of each month during which an increase or decrease has occurred, make public the total number of voting rights and capital in respect of each class of issued shares and the total number of voting rights attaching to the shares that it holds in treasury (DTR5.6.1R). In addition, a listed company must also disclose the total number of voting rights as soon as possible (and no later than the end of the following business day) after an increase or decrease in the total number of voting rights following the completion of a transaction - unless the fluctuation in voting rights is deemed to be immaterial (DTR5.6.1AR). It is for the company to decide if an increase or decrease in the total number of voting rights is immaterial, but the FCA views a fluctuation of 1 per cent or more to be material both to the UK-listed company and the public (DTR5.6.1BG).
Members of the board and key executives
A company must disclose certain information relating to its board and senior managers, including their names, addresses, functions, experience and expertise, previous directorships, criminal convictions and certain details of bankruptcies, receiverships or liquidations with which that person was associated (PR annex I of appendix 3, paragraph 14.1). A company must make similar disclosures when a new director is appointed (LR9.6.13R). A company must also notify a regulated information service (RIS) of any change to its board, including the appointment of a new director, the resignation, removal or retirement of an existing director or when there are important changes in the role, functions or responsibilities of a director (LR9.6.11R). A company must also notify an RIS of a current director’s new directorships in any other listed company and of certain changes in a current director’s circumstances (LR9.6.14R). Question 27 deals with the disclosure requirements of listed companies in relation to board practices under the Code.
The Directors’ Remuneration Report Regulations 2002 require UK-listed companies to publish a report on their directors’ remuneration, which must include specified information and be approved by the board of directors. These provisions are restated by CA 2006, sections 420 to 422.
For companies with financial years ending on or after 30 September 2013, the directors’ remuneration reports are now required to be prepared and put to the shareholders in two distinct parts: the annual report on remuneration, which sets out remuneration payments made to directors in the year under review and a statement describing how the company intends to implement the approved remuneration policy in the next financial year; and the directors’ remuneration policy setting out the company’s policy on remuneration of directors. Copies of the report, which forms part of the annual report and accounts, must be sent to the registrar of companies (CA 2006, section 441).
The company must give its shareholders the opportunity to approve the remuneration report, including the remuneration policy, by way of an ordinary resolution (CA 2006, sections 439 and 439A) (see questions 4, 28 and 37). The report on directors’ remuneration is subject to an advisory vote by shareholders on an annual basis; the remuneration policy is subject to a binding shareholder vote at least every three years and, once approved, sets the boundaries in which the company can remunerate its directors.
The annual report on remuneration must contain, inter alia, a single total figure of remuneration paid in the financial year being reported on for each person who served as a director at any time during that year, broken down to show salary, benefits and performance-related pay. The remuneration policy must contain, inter alia, description of each of the components of the remuneration package for directors, including the maximum amount payable under each component of remuneration, and details of performance measures (if applicable).
MAR prescribes a regime for the disclosure and control of inside information (with further guidance contained in Chapter 2 of the DTRs). Inside information is defined as precise information, which has not been made public, relating, directly or indirectly, to the company, and which, if it were made public, would be likely to have a significant effect on the price of the company’s listed securities. Information is likely to have a ‘significant effect’ on price if it is information that a reasonable investor would be likely to use as part of the basis of his or her investment decisions. The definition of ‘inside information’ is wider under MAR than the previous regime, capturing inside information relating to spot commodity contracts.
A listed company (and one whose securities are the subject of an application for admission to listing) must disclose publicly as soon as possible any inside information that directly concerns it (article 17(1) MAR). There is an exception to the general obligation of disclosure, whereby the company may delay the public disclosure of inside information so as not to prejudice its own legitimate interests, as long as the omission would not be likely to mislead the public and the company can ensure the confidentiality of the information (article 17(4)). Immediately upon delayed inside information being publicly disclosed, the company must inform the FCA that disclosure was delayed, and, if requested by the FCA, provide a written explanation of how the above conditions were satisfied in respect of the delay.
A UK-listed company may also be able to delay immediate public disclosure of inside information where it is a financial institution and disclosure of the information (for example, that relating to a liquidity problem) entails a risk of undermining the financial stability of the UK-listed company and of the financial system (article 17(5)).
Under article 19 MAR, which has replaced Chapter 3 of the DTRs and the Model Code, persons discharging managerial responsibilities (PDMRs) and any ‘persons closely associated’ with them must notify a UK-listed company, and the FCA, of the occurrence of all transactions conducted on their own account relating to the shares or debt instruments of that UK-listed company (or derivatives or other financial instruments linked thereto). This provision is only applicable once transactions of a value totalling at least €5,000 have been carried out in respect of that company’s shares within a calendar year. Notifications must be made promptly and no later than three business days after the date of the transaction, and should set out details relating to the transaction, including, inter alia, the name of the person concerned, the reason for the notification, and the price and volume of the transaction. The company must then ensure that the information notified to it is made public promptly and no later than three business days after the transaction (in practice, this would occur via a RIS).
Furthermore, a PDMR must not conduct any transactions relating to the financial instruments of the relevant UK-listed company during a closed period of 30 calendar days before the UK-listed company releases any interim financial report or year-end report required by national law or the rules of the relevant securities exchange. MAR does not, however, retain the Model Code’s requirement that PDMRs seek to prohibit their ‘connected persons’ from dealing in the UK-listed company’s securities in close periods.
There are limited exemptions to the closed period rule. These include certain transactions relating to employee share schemes, transactions where the beneficial interest in the relevant security does not change, and where there are exceptional circumstances that require the immediate sale of shares. Certain exemptions that were available under the Model Code are not reproduced in MAR, however, such as those that permit certain dealings connected to a rights issue or a takeover or dealings under a trading plan where the PDMR has no influence or discretion.
Governance structure and policies
Companies with a premium listing are required to include a statement in their annual report setting out how they have applied the main principles of the Code (LR9.8.6R(5)) (see question 1). This statement must be made in a manner that would enable shareholders to evaluate how these main principles have been applied.
The annual report must also include a statement as to whether the premium listed company has complied throughout the accounting period with all relevant provisions set out in the Code and provide reasons for any non-compliance (LRs 9.8.6R(6) and 9.8.7R) (see question 1). The Code also requires a number of other disclosures, and these are outlined in question 27. The DTRs require listed companies to make a corporate governance statement in the directors’ report (DTR7.2.1R). This statement must outline which corporate governance code the company is subject to and whether it has complied with its provisions, or alternatively it must explain any reasoning for non-compliance (DTRs 7.2.2R and 7.2.3R).
Companies with a premium listing should adhere to the Code (see question 1), and by applying the Code’s comply or explain approach a company will also satisfy the DTRs (DTR7.2.4G). However, companies with a standard listing are not subject to the Code and DTR7.2.1R creates an additional disclosure requirement to comply or explain, albeit separate from the Code.
Audit committees or bodies carrying out equivalent functions
Companies with a premium listing or a standard listing must make a statement available to the public disclosing which body it has appointed to carry out the audit committee functions set out in DTR7.1.3R and how it is composed (DTR7.1.5R). This statement should include the names of the chair and members of the audit committee and the qualifications of all members of the audit committee during the relevant period. It may be included in the corporate governance statement that the company is required to make under DTR7.2 (DTR7.1.6G).
If the company is a FTSE 350 company, a statement of compliance with the provisions of the CMA Order 2014 (article 7.1 CMA Order 2014), which applies to financial years beginning on or after 1 January 2015, is required.
The Listing Rules classify transactions by reference to a number of different percentage ratios that are set out in annex 1 to LR10 (the class tests) (see question 4). Under LR10 there are two classes of transactions: class 1 and class 2. The disclosure requirements for these two classes of transaction are currently defined as follows:
A premium listed company must, in relation to a class 1 transaction (where any percentage ratio is 25 per cent or more), send an explanatory circular to the company’s shareholders requesting prior shareholder approval in a general meeting. Any agreement effecting the transaction should be conditional on obtaining that approval (LR10.5.1R). The company must notify an RIS in accordance with the provisions of LR10.4.1R (LR10.5.1R(1)). This notification should be made as soon as possible after the terms of the transaction have been agreed (LR10.4.1R).
A supplementary notification must be made to an RIS as soon as possible if there is a significant change affecting any matter in the announcement, or a significant matter arises that should have been mentioned if it had arisen at the time of preparation of the notification (LR10.4.2R). This supplementary notification must comply with the provisions of LR10.4.2R. LR10.5.4R, which came into force on 1 October 2012 (as amended in April 2013 to reflect the changes to the UK regulatory framework), also requires a supplementary circular to be sent to shareholders if, before the date of the general meeting to approve the transaction, a listed company becomes aware of a material change affecting the matter that required disclosure in the explanatory circular, or of a new matter that would have required disclosure in a circular. It should be noted that in certain circumstances, where the listed company is in severe financial difficulty and is making a class 1 disposal, the FCA may waive the requirement for an explanatory circular and shareholder consent if certain requirements are met (LR10.8).
Where this is a material change to the terms of the transaction (which the FCA generally considers to be an increase of 10 per cent or more in the consideration payable (LR10.5.3G)), the requirements of LR10.5.1R must be complied with again, separately (LR10.5.2R). The FCA amended LR10.5.2R, effective from 1 October 2012, so that it only applies to material changes occurring after shareholder approval has initially been obtained. This is intended to avoid overlap with LR10.5.4R.
A premium listed company must, in relation to a class 2 transaction (where any percentage ratio is 5 per cent or more but each is less than 25 per cent), notify an RIS. This notification must be made as soon as possible after the terms of the transaction are agreed (LR10.4.1R). The information that must be included in the notification (which is the same information that must be included in a class 1 transaction notification) is set out in LR10.4.1R(2). A supplementary notification must also be made where a significant change or significant matter arises (LR10.4.2R).
Owing to concerns about reverse takeovers being used as a ‘back-door’ listing route, the requirements for reverse takeovers that were previously contained in LR10.6 were removed and replaced with requirements under a new LR5.6 as of 1 October 2012. These requirements are aimed at incorporating concepts from the UKLA Technical Note: Reverse Takeovers. LR5.6 has increased the scope of the acquisitions defined as reverse takeovers, and made the requirements of the reverse takeover regime more proportionate and less onerous. To facilitate these changes a broader definition of ‘reverse takeover’ has been inserted at LR5.6.4R. The existing exemption from the reverse takeover regime has also been restricted such that only a listed company acquiring a company that is listed in the same listing category will be exempt (LR5.6.2R). In addition, companies with standard listings now fall within the reverse takeovers regime (LR5.6.1R(2)).
In particular, the rules now require a company to contact the FCA as early as possible before announcing a reverse takeover, that has been agreed or is in contemplation, to discuss whether a suspension of listing is required (LR5.6.6R(1)). Where a leak of transaction details has occurred a UK-listed company must contact the FCA to request a suspension as early as possible (LR5.6.6R(2)). In December 2012 the FSA published new guidance on when a suspension of listing would be necessary under new LR5.6.6R and LR5.6.7G (UKLA Technical Note: Reverse Takeovers). This guidance suggests that a reverse takeover would be in contemplation where an approach has been made to the target’s board, or an exclusivity period has been entered into with the target, or the UK-listed company has been given access to begin due diligence. If the FCA is satisfied that there is sufficient publicly available information about the proposed transaction and the UK-listed company, then a suspension will not be required (LR5.6.8G). LR5.6.10G to LR5.6.18R set out circumstances in which the FCA will generally be satisfied that a suspension is not required (LR5.6.9G); however, RIS announcements will be required from the UK-listed company under LR5.6.10G, LR5.6.12G and LR5.6.15G.
A UK-listed company with a premium listing must in relation to a reverse takeover comply with the requirements of class 1 requirements in LR10.5 for that transaction (preparation of a class 1 circular and shareholder approval) (LR5.6.3).
Related-party transactions are classified by the nature of the relationship between the parties to the transaction. Definitions of a ‘related party’ and of a ‘related-party transaction’ can be found under LR11.1.4R and LR11.1.5R respectively and include directors and substantial shareholders. A substantial shareholder means any person who holds or controls the exercise of 10 per cent or more of the voting rights in a company (LR11.1.4AR). The definition of ‘substantial shareholder’ includes a carve-out that allows the voting rights of shares to be disregarded when calculating this percentage if the shares are held for a period of five days or less, the voting rights are not exercised during this period, no attempt has been made directly or indirectly to influence the management and the shares are held in the ordinary course of business (LR11.1.4AR(2)). The definition of an ‘associate’ of a related party has been expanded to include partnerships in which a related party holds or controls a voting interest of 30 per cent or more in the partnership (LR appendix 1).
The FSA also published a consultation paper CP12/25 (Enhancing the Effectiveness of the Listing Regime and Feedback on CP12/2), which proposed additional requirements for premium-listed companies with a ‘controlling shareholder’. A controlling shareholder is a shareholder who itself, or together with persons acting in concert with it, holds, either directly or indirectly, 30 per cent of the shares or voting power in the UK-listed company or its parent, or both. Feedback to this consultation resulted in a further consultation, CP13/15 (Feedback on CP12/25: Enhancing the Effectiveness of the Listing Regime and Further Consultation), published in November 2013. CP13/15 confirmed that the FCA intends to proceed with the requirement that ‘relationship’ agreements be mandatory for all premium-listed companies with a ‘controlling shareholder’, and feedback to CP13/15 was published in May 2014, following which this requirement became effective subject to transitional provisions.
LR15.5.3G provides that closed-ended investment funds are also covered by the related party transaction provisions of LR11 and LR15.5.4R provides that an investment manager of a closed-ended investment fund is a related party for the purposes of LR11. However, closed-ended investment funds and the investment managers of such funds are exempt from the provisions of LR11.1.7R to LR11.1.11R in certain circumstances set out in LR15.5.5R. In the context of a related-party transaction, a premium listed company must notify an RIS of the transaction in accordance with the provisions of LR10.4.1R (notifications of class 2 transactions) and also provide the name of the related party and the details of the nature and extent of the related party’s interest in the transaction or arrangement (LR11.1.7R(1)). An explanatory circular, approved by the FCA and containing the information required by LR13.3 and LR13.6, should also be sent to shareholders (LR11.1.7R(2)). Under LR8.2.1R(7) a sponsor is required to provide the confirmation needed under LR13.6.1R(5). Shareholder approval is required before the transaction is entered into or, if obtaining shareholder approval is a condition of the transaction, prior to completion. The related party and its associates should not vote on any resolution to approve the transaction (LR11.1.7R(4)).
LR11.1.7AR has included the material change requirement referred to under ‘Class 1’ in LR11 so that shareholders are also protected for related party transactions. In addition, the exemptions from the requirements of related party transactions in LR11 annex 1R have been expanded to include loans to fund defence and regulatory investigations, as these operate in a similar way to indemnities and are permitted under CA 2006, section 206.
Gender and ethnicity pay gap reporting
In parallel with the increased focus on diversity at board level discussed in the response to question 23, there have been recent government efforts, via regulations enacted under section 78 of the Equality Act 2010, to improve transparency in respect of gender pay in both the private and public sectors. Under the Equality Act 2010 (Gender Pay Gap Information) Regulations 2017 (SI 2017/353), which came into force on 6 April 2017, private and voluntary sector employers with 250 or more employees must analyse their gender pay gap as at the ‘snapshot date’ of 5 April each year, and publish relevant pay information at any time within 12 months of that date, both on the employer’s website and a designated government website. The first reports were therefore due to be published by 4 April 2018, and must include information detailing the difference between the average earnings of male and female employees, expressed as a percentage of male earnings. (See question 42 for more detail.)
To help employers adapt to the new regime, the Government Equalities Office and Acas (the Advisory, Conciliation and Arbitration Service) have published non-statutory guidance, entitled ‘Managing Gender Pay Reporting’.
In January 2019, the Department for Business, Energy & Industrial Strategy (BEIS) concluded a consultation on a similar ethnicity pay reporting regime. Responses received in the course of the consultation (which focused on seeking companies’ views on precisely what information should be disclosed to gauge the extent of ethnic pay disparities) will be used to inform how the government takes forward its stated policy aim to introduce mandatory ethnicity pay reporting.
Modern Slavery Act Transparency Statement
A further notable development has been the introduction of the Modern Slavery Act 2015. In accordance with section 54 of the Modern Slavery Act 2015, certain commercial organisations must disclose (including on their website) steps (or a lack thereof) taken to ensure that slavery and human trafficking are not taking place in their supply chains or any part of their business. This applies to organisations that carry on a business in the supply of goods or services in the UK and have a total annual turnover of not less than £36 million and applies to financial years ending on or after 31 March 2016. Relevant entities must publish the statement as soon as reasonably practical after the end of the financial year, with Home Office guidance recommending publication within six months of this date.
Do shareholders have an advisory or other vote regarding remuneration of directors and senior management? How frequently may they vote?
A UK-listed company must give its shareholders the opportunity to approve its directors’ remuneration report once a year by way of an ordinary resolution at its annual general meeting and must notify its shareholders of its intention to move such a resolution at that meeting (CA 2006, sections 439(1) and (4)). The company must also notify its shareholders of its intention to move, as an ordinary resolution, a resolution approving the directors’ remuneration policy at least every three years (CA 2006, section 439A(1)) (see questions 4 and 28 for further detail). Shareholders holding 5 per cent or more of the share capital carrying voting rights may requisition a vote on any matter under the general meetings requisition procedure outlined in CA 2006, section 303, potentially resulting in a vote on the directors’ remuneration policy outside the three-yearly cycle.
Sections 227B and 227C CA 2006 prohibit a UK-listed company from making a remuneration payment or payment for loss of office unless the payment is consistent with the approved remuneration policy, or such payment is otherwise approved by the shareholders. Long-term incentive plans and employee share schemes for listed companies generally require separate shareholder approval (LR9.4.1R).
Failure to comply with the requirements of CA 2006, sections 439 or 439A (ie, to give proper notice of the relevant resolutions) means an offence is committed by every director in default (CA 2006, section 440(1)). Failure to put the resolutions to a vote at the meeting means an offence is committed by each existing director (CA 2006, section 440(2)). An offence under CA 2006, section 440 could lead to the company’s directors being subject to a fine not exceeding £1,000 (CA 2006, section 440(1), (2) and (4)).
Do shareholders have the ability to nominate directors and have them included in shareholder meeting materials that are prepared and distributed at the company’s expense?
In practice, shareholders do on occasion suggest possible directors to boards and boards sometimes seek shareholder views on proposed directors. However, the only manner in which a shareholder can nominate a director without the recommendation of the board is by requiring the board to put a resolution on the agenda at the company’s annual general meeting or to convene an extraordinary general meeting to consider such a resolution (see questions 3 and 7).
Do companies engage with shareholders? If so, who typically participates in the company’s engagement efforts and when does engagement typically occur?
Traditionally, directors engaged with shareholders at the annual general meeting and delegated shareholder engagement to the company’s investor relations team. The increasing powers accorded to shareholders in relation to directors’ remuneration has led to increasing interaction between directors and shareholders outside AGM season. Most companies will have an investor relations team and will set up calls with investors that will be attended by directors or senior management.
In general, the largest shareholders expect regular updates on company performance and strategy as well as consultation on major changes to the business, such as large corporate transactions, analysis of the company’s response to major events that could have a serious impact on the business and meetings instigated by the shareholder to discuss particular issues (as is now required by the Code, provision 3). Smaller shareholders may make use of their membership of an investment organisation in order to gain access to information and analysis, which would otherwise only be available to larger shareholders. It is not uncommon for institutional shareholders to criticise a company’s approach in the media.
The 2018 version of the Code includes provisions aimed at increasing the obligations for companies to engage with their shareholders more on matters such as executive remuneration (see question 28). For example, remuneration arrangements should be transparent and designed to promote effective engagement with shareholders, and there should be a description of the work of the remuneration committee in the annual report, including what engagement has taken place with shareholders and the outcome that this has had on remuneration policy and outcomes. In addition, where 20 per cent or more of votes have been cast against a board recommendation for a resolution, provision 4 of the Code specifically requires the company to explain what action it intends to take to consult shareholders in order to understand the reasons behind the result.
Are companies required to provide disclosure with respect to corporate social responsibility matters?
Some companies are required to disclose information about their environmental impact owing to the duty to prepare a strategic report under section 414A of the Companies Act 2006 (the CA 2006). Unlisted large companies (ie, not small companies under section 383 or medium companies under section 465 of the CA 2006) are required, as set out in section 414C(4)(b), to include in their strategic report a fair review of the company’s business including analysis, using key non-financial performance indicators, including information relating to environmental matters. ‘Key performance indicators’ is explained, in section 414C(5), as meaning factors by reference to which the development, performance or position of the company’s business can be measured effectively.
UK-listed companies, whether medium or large, must include within their strategic report, as set out in section 414C(7)(b)(i) of the CA 2006, to the extent necessary for an understanding of the development, performance or position of the company’s business, information about environmental matters including the impact of the company’s business on the environment. The strategic report must also include information about any policies of the company in relation to those matters and the effectiveness of those policies.
A company that is a traded company, a banking company, an authorised insurance company, or carrying out insurance market activity must also include a non-financial information statement, including environmental matters, in its strategic report, under section 414CA CA 2006. This does not apply to companies that are small or medium, as defined by the CA 2006, or that have no more than 500 employees.
The FRC has published guidelines on non-financial reporting to explain the difference between the requirements of section 414C and section 414CA CA 2006.
Additionally, Schedule 7 of Part 7 of The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410) (the Accounts and Reports Regulations) requires disclosures for large and medium-sized UK-listed companies concerning greenhouse gas emissions. This requires the directors to include in their report:
- the annual quantity of emissions in tonnes of carbon dioxide equivalent from activities for which the company is responsible including the combustion of fuel and the operation of any facility;
- the annual quantity of emissions in tonnes of carbon dioxide equivalent resulting from the purchase of electricity, heat, steam or cooling by the company for its own use;
- the methodologies used to calculate the disclosed emissions information;
- at least one ratio that expresses the company’s annual emissions in relation to a quantifiable factor associated with the company’s activities; and
- the information as disclosed in the report in the preceding financial year.
The directors must only give the above emissions information to the extent that it is practical for the company to obtain the information in question but where it is not practical for the company to obtain some or all of that information, the report must state the information that is not included and explain why.
Social, community and human rights reporting
UK-listed companies, whether medium or large under section 385 CA 2006, must include within their strategic report, as set out in section 414C(7)(b)(iii) CA 2006, to the extent necessary for an understanding of the development, performance or position of the company’s business, information about social, community and human rights issues. This must include information about any policies of the company in relation to those matters and the effectiveness of those policies.
A corporate governance statement must be included in the directors’ report for UK-listed companies whose transferable securities are admitted to trading and qualify as a company within the meaning of section 1(1) CA 2006. DTR 7.2.8A requires this corporate governance statement to include a description of:
- the diversity policy applied to the UK-listed company’s administrative, management and supervisory bodies with regard to aspects such as, for instance, age, gender or educational and professional backgrounds;
- the objectives of the diversity policy;
- how the diversity policy has been implemented; and
- the results in the reporting period.
If no diversity policy is applied by the UK-listed company, the corporate governance statement must contain an explanation as to why this is the case. However, this diversity reporting requirement set out in DTR 7.2.8R does not apply to a company that qualifies as a small or medium-sized company under DTR 1B.1.7R (which applies the same standards as sections 382 to 383 and 465 to 466 of the CA 2006 for determining if a company qualifies as a small or medium company).
Additionally, provision 23 of the Code states that a separate section of the annual report should describe the work of the nomination committee, including the board’s policy on diversity, including gender, objectives and the success of these objectives.
As discussed in further detail in questions 36 and 42, the Equality Act 2010 (Gender Pay Gap Information) Regulations 2017 require all private and voluntary sector employers with 250 or more employees to publish gender pay gap data, including the mean and median gender pay gap and the proportion of men and women in an organisation receiving a bonus. In January 2019, BEIS concluded a consultation on a similar ethnicity pay reporting regime.
Schedule 7 of Part 3 of the Accounts and Reports Regulations require disclosure concerning the employment of disabled persons. This requirement applies to companies where the average number of persons employed by the company in each week during the financial year exceeds 250. The directors’ report must in that case contain a statement describing the company’s policy for giving full and fair consideration to applications for employment made by disabled persons having regard to their particular aptitudes and abilities, the continuation of employment of those employees who have become disabled and for the training, career developments and promotion of disabled employees of the company.
The 2018 version of the Code encourages boards to actively consider the needs and views of all their stakeholders. Principle D states that ‘in order for the company to meet its responsibilities to shareholders and stakeholders, the board should ensure effective engagement with, and encourage participation from, these parties’. This principle is supported by provision 5, which obliges the board to understand the views of the company’s key stakeholders and describe in the annual report how their interests and the matters set out in CA 2006, section 172 have been considered in board discussions and decision-making.
The FRC’s Guidance on Board Effectiveness notes that a business’s stakeholders are likely to include its workforce, customers and suppliers (paragraph 42), and may also include other stakeholders specific to a given company’s circumstances such as regulators, government, bondholders, banks and other creditors, trade unions and community groups. It is for the board to identify and prioritise key stakeholders, recognising that it may be faced with complex decisions whose impacts will benefit some stakeholders but disadvantage others. Such decisions should be made in the long-term interests of the company, and therefore in the interests of the company’s most important stakeholders - those with a vested interest in the long-term future of the company (paragraphs 43 and 44).
The Code’s provisions in relation to stakeholders are supplemented by new reporting requirements introduced by secondary legislation (the Companies (Miscellaneous Reporting) Regulations 2018). In respect of large companies (defined in CA 2006, sections 465-467), and for financial years beginning on or after 1 January 2019:
- Regulation 11B of the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 now requires such companies to include in their directors’ report a statement summarising 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 this regard, including on the principal decisions taken by the company during the financial year; and
- CA 2006, section 414CZA now requires such companies to publish a statement in their strategic report of how the directors have complied with their duty to have regard to the matters in section 172(1)(a)-(f), which includes the need to foster the company’s business relationships with suppliers, customers and others and the impact of the company’s operations on the community and the environment.
CEO pay ratio disclosure
Are companies required to disclose the ‘pay ratio’ between the CEO’s annual total compensation and the annual total compensation of other workers?
The Green Paper on corporate governance reform (see question 1), published in August 2017, included a proposal to introduce mandatory CEO pay ratio reporting. The government stated in the paper that it intends to introduce secondary legislation to require UK-listed companies to report annually the ratio of CEO pay to the average pay of their UK workforce, along with a narrative explaining changes to that ratio from year to year and setting the ratio in the context of pay and conditions across the wider workforce.
The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (as amended by the Companies (Miscellaneous Reporting) Regulations 2018), require, in respect of financial years beginning on or after 1 January 2019, companies with more than 250 employees to include in their remuneration report the ratio of the total pay of their chief executive to the median, 25th and 75th percentile remuneration of their UK employees. UK-listed companies are also obliged to set out in their remuneration reports what amount (or estimate thereof) of a director’s pay awarded as a result of the achievement of certain performance measures and targets is attributable to an increase in share price and, where discretion has been exercised in respect of such a pay award, how the resulting level of award was determined and whether that discretion was exercised as a result of share price appreciation or depreciation. The remuneration reports of UK-listed companies are required to contain a statement in respect of each executive director indicating the maximum remuneration such a director might receive in the event of a 50 per cent appreciation in the company’s share price over the performance period of any target to which that director is subject (which relates to more than one financial year).
Gender pay gap disclosure
Are companies required to disclose ‘gender pay gap’ information? If so, how is the gender pay gap measured?
Mandatory gender pay gap reporting for organisations (including private companies) was introduced on 6 April 2017 by the Equality Act 2010 (Gender Pay Gap Information) Regulations 2017 (SI 2017/353) (the Regulations). Organisations with 250 or more employees are required to report and publish their ‘gender pay gap’ information. Organisations with fewer than 250 employees can publish and report voluntarily but are under no obligation to do so.
The gender pay gap is the difference between the average earnings of male and female employees, expressed relative to men’s earnings. This is calculated by working out the difference between the average pay of all male employees, the average pay of all female employees and dividing that number by the average pay of all male employees. The figures must be calculated using a specific reference date called the ‘snapshot date’, being 5 April for businesses and charities. Organisations must publish their figures within a year of the snapshot date (ie, by 4 April).
The legal entity that is the ‘relevant employer’ (ie, the organisation with 250 or more employees) for the purposes of the Regulations must register with and report to the Gender Pay Gap Reporting Service. If an organisation runs multiple payrolls, the relevant data from the payrolls must be merged and just one set of figures reported for the organisation. Private sector organisations that are part of a group must report individually if they are ‘relevant employers’. Additionally, corporate groups can voluntarily also report combined figures for the entire group.
The information that must be published on the reporting organisation’s public-facing website and reported to government is the:
- mean gender pay gap in hourly pay;
- mean gender pay gap in hourly pay;
- mean bonus gender pay gap;
- median bonus gender pay gap;
- proportion of males and females receiving a bonus payment; and
- proportion of males and females in each of four pay quartiles based on the employer’s overall pay range.
This information must be submitted alongside a written statement, signed by a senior individual within the business, confirming that the published pay gap information is accurate.
In order to help companies with the new requirements, the Government Equalities Office and Acas have published non-statutory guidance, entitled ‘Managing Gender Pay Reporting’.