In April 2014, the FRC published a consultation document proposing further changes to the UK Corporate Governance Code. The document is part of the FRC's two-yearly review of changes to the Code.
Main principle D.1 will be amended to make it clear that remuneration policies must be designed to deliver long-term benefits to the company and not just short-term benefits to management, and to ensure that performance related elements should be rigorously applied. Provision D.1 will be amended to allow companies to establish arrangements to withhold or retrieve pay where appropriate following support from the investment community. The FRC does not propose that the Code should set out in detail when these arrangements will apply nor how they should operate. Provision E2.2 of the Code will be amended to require a company which has (in the board's opinion) received a significant vote against any resolution to announce the action it intends to take to understand the reasons behind the vote. The FRC's stated intention is that companies should set out how they intend to go about engaging with those shareholders who express their concerns rather than describing how they intend to reply to those concerns. Risk management and going concern Provision C.2 relating to principal risks and monitoring risk management will be amended to require companies to assess their principal risks. Rather than just rely on an annual review, boards will be required to monitor internal control and risk management systems on an ongoing basis. Following the earlier consultation process, the FRC has significantly revised its proposals on assessing and reporting a company's future viability. It is consulting again on a number of issues, including: Amendment of principle C.13, which requires the directors to report in financial statements that the business is a going concern, to make it clear that this refers to “going concern” for accounting purposes; and Adding a new requirement for a statement on the board's broader assessment of the company's viability. This will require directors to explain how they have assessed the company's prospects, taking account of its current position and principal risks, and whether they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities.Fried Frank Client Memorandum 2 Audit committees and audit tendering In its final report on the market for audit services, the Competition Commission made a number of recommendations which, if adopted, would lead to changes to the Code. The Commission's final work on this topic has been deferred. The FRC will now decide whether or not to amend the Code in its 2016 review. Corporate governance disclosures The FRC is considering whether to allow the various disclosures on corporate governance required by the Code to be made available on a company's website rather than in the annual report. If there is support for this, amendments will be put forward in 2016.Fried Frank Client Memorandum 3 COMPANY LAW: GOVERNMENT RESPONSE TO BIS TRANSPARENCY AND TRUST DISCUSSION PAPER Following on from measures agreed to at the summit of G8 leaders in June 2013, the UK Government published a discussion paper "Transparency and trust: enhancing transparency of UK company ownership and increasing trust in UK business”. The main points raised in the paper include: creation of a registry of beneficial owners of UK companies; introduction of new powers enabling companies to identify beneficial owners and obliging beneficial owners to notify companies of their status; prohibiting the use of nominee and corporate directors; the abolition of bearer shares; adding to the list of factors to be taken into account in directors' disqualification proceedings and allowing UK directors to be disqualified where they have been guilty of misconduct in relation to overseas companies; where a director has been fraudulent or reckless, to enable creditors to be compensated; increasing or removing the time limit for disqualification proceedings in insolvency cases; and offering additional training and education to disqualified directors. The Government’s response on the key points appears below. Registry of beneficial ownership The Government has decided to proceed with the idea of a central registry of beneficial interests in shares. The definition of beneficial owner will mirror that used in the UK's anti-money laundering regime. This defines a beneficial owner by reference to an ultimate interest in 25 per cent of the shares or voting rights of a company, or as an individual who exercises control over the management of the company. All UK companies (including companies limited by guarantee and LLPs) which currently file information about members at Companies House will be required to obtain, hold and file beneficial ownership information at Companies House. Companies whose shares are traded on a regulated market will fall outside this requirement since they currently fall within the FCA’s Disclosure and Transparency regime. Companies will be required to update this information. The provisions of the Companies Act 2006 which allow public companies to investigate their beneficial ownership will be extended to private companies. Individuals with a qualifying beneficial interest will also need to disclose this to the company. In limited circumstances, the Government will allow beneficial owners to apply to the Registrar to prevent information about them from being made publicly available. Where a request of this type is granted, the Government is considering whether this should be stated on the register. Criminal sanctions will apply to breaches of the rules by companies and individuals.Fried Frank Client Memorandum 4 Bearer shares The proposed prohibition on the creation of new bearer shares will come into force. Existing bearer share warrants will need to be surrendered for conversion to registered shares within a set period. This is proposed to be nine months. Corporate and nominee directors The use of corporate directors will be prohibited, subject to exceptions where their use is valuable and thought to be of low risk. These are likely to include group structures and charities. A one-year transitional period is proposed. It is not yet clear whether the proposal will apply to LLPs. In relation to nominee directors, the proposals for a new Companies House register of nominee directors and their appointees, and to make it a criminal offence for a director formally to divest himself of his powers, have been dropped. However, the Government intends to take forward a number of other measures, including steps to increase awareness of directors' duties and potential breaches, the introduction of legislation to allow individuals to be contacted to ensure that they understand their duties, and considering if any individual controlling one or more directors should be made legally liable and subject to directors' duties. Directors' disqualification The Company Directors Disqualification Act 1986 will be amended to: replace the current grounds for disqualification to include broader, non-generic provisions; increase the time limit for bringing proceedings from one to three years; enable the courts to take misconduct overseas into account in deciding whether to disqualify a director in the UK; and allow an individual to be disqualified in the UK when he has been convicted of a criminal offence in connection with formation, promotion or management of a company abroad. Comment Many of these proposals were set out in the Small Business, Enterprise and Employment Bill. It was recently published and has received its first reading in Parliament.Fried Frank Client Memorandum 5 SUPREME COURT RULING: IS A MEMBER OF AN LLP A "WORKER"? In Clyde Co v. Bates van Winkelhof, the Supreme Court considered whether a fixed share equity partner of a limited liability partnership was a "worker" for the purposes of the Employment Rights Act 1996 (ERA), thus enabling the "whistleblowing" protections of that Act to be invoked. Facts B was a partner in a limited liability partnership who was remunerated by a fixed share of profits and an extra percentage. In November 2010, she was suspended from the partnership. She was expelled two months later following an investigation. B subsequently made complaints involving whistleblowing and discrimination. In particular, she claimed that her expulsion from the partnership was as a result of reports made by her to the firm's money laundering officer alleging criminal activity on the part of the managing partner of a firm connected with the LLP. The merits of B’s complaints have not yet been considered because at a preliminary stage, the LLP argued that an employment tribunal lacked jurisdiction to hear B's claim because she was not a "worker" and fell outside the protection offered by s.47B ERA to certain categories of worker. Essentially, the legal definition of “worker” in s.230(3) ERA applies to: (a) a contract of employment; or (b) any other contract whereby the individual undertakes to perform personally any work or services for another party to the contract whose status is not that of a client or customer of any profession or business undertaking carried on by the individual. S.4(4) of the Limited Liability Partnership Act 2000 (LLPA) was relevant in assessing B’s status because it covers her engagement and employment status. It provides that: "... a member of a limited liability partnership shall not be regarded for any purpose as employed by the limited liability partnership unless, if he and the other members were partners in a partnership, he would be regarded for that purpose as employed by the partnership." Decision The Supreme Court acknowledged that s.4(4) LLPA has caused confusion. In its view, the key to understanding the provision is to recognise that the LLPA applies throughout the UK. There had previously been a lack of clarity as to whether partners in a Scottish partnership could also be employed by a partnership. Looked at in this context, the provision can be understood as meaning that whatever the position would be if the LLP members were to be partners in a conventional partnership, then that position is the same in an LLP. Also, the words "employed by" in s.4(4) are used in their conventional sense, meaning "employed under a contract of service," and it is not possible to construe the words by reference to an extended definition in an earlier Act, i.e. the ERA. The law currently distinguishes between two categories of self-employed people: those carrying on a profession or business on their own account and entering into contracts with clients and customers to provide work or services for them; andFried Frank Client Memorandum 6 those who provide services as part of a profession or business carried on by another person. Only the latter category are “workers” within the meaning of s.230(3)(b) ERA. If Parliament had wished to include workers in this category with s.4(4), it would have done so, although this would inevitably have raised the question of whether partners in a traditional partnership can also be workers. This led the Supreme Court to conclude that it is not the case that members of an LLP can only be workers for the purposes of s.230(3)(b) if they had been workers and had been partners in a traditional partnership. The Court also said that while the concept of subordination in the relationship between a worker and an employer can be useful in defining worker relationships, it is not conclusive, and each case should be considered on its facts and by construing the relevant legislation. Comment Although the LLPA made it clear that LLP members are not employees, their status as workers had been unclear, and this case has resolved that uncertainty. However, the drafting of s.4 LLPA is widely regarded as defective, and it remains difficult to understand. The effect of the decision is that LLP members are now entitled to some statutory rights which are available to workers, including paid annual leave, limits on working hours and protection from less favourable treatment for part time workers. It is unclear whether they can also be categorised as "job holders" for the purposes of the Pensions Act 2008, with the result that affected individuals would need to be enrolled into a suitable occupational pension scheme. This will depend on the individual’s circumstances, in particular their “qualifying earnings”. The decision has also been welcomed by those campaigning for greater whistleblowing protection and means that further legislation to confer that protection on LLP members is not required.Fried Frank Client Memorandum 7 COMPANIES’ RIGHTS TO OBTAIN INFORMATION ABOUT SHAREHOLDERS: RECENT CLARIFICATION FROM THE COURT OF APPEAL Background In JKX Oil & Gas plc v Eclairs Group Limited, the Court of Appeal considered the issue of what information a company can properly seek in a notice under s.793 Companies Act 2006, and when it can do so. Part 22 of the Companies Act 2006 allows a public company to give notice to anyone who the company knows or reasonably believes is interested in the company’s shares (or has been interested in them in the last three years), requiring them to provide information about their holding. Failure to comply with a notice under s.793 is a criminal offence. The company may then apply for a court order imposing restrictions on the transfer and voting of the shares and blocking any dividends payable in relation to them. Provisions similar to these are often included in companies’ articles to avoid the delay and expense of court proceedings. In this case, the directors of JKX believed that the beneficial owners of two shareholdings in the company (one representing 27 per cent. of the shares and the other 11 per cent.) had plans to change the composition of the board of directors. As a result, they served s.793 notices seeking information about the persons interested in the shares and whether they were acting in concert. The notices were served shortly before the company’s AGM was due to be held. When the directors received information in response to the notices, they concluded that it was incorrect and invoked provisions disenfranchising the shares. This meant that they could not be voted at JKX’s AGM. These restrictions were challenged by the shareholders on the grounds: that the notices were invalid because they sought information not permitted by the Companies Act or by the company’s articles; that the directors were not entitled to impose the restrictions because the directors did not have reasonable cause to believe that the shareholders’ responses were incorrect; and the directors had imposed the restrictions for an improper purpose (specifically, to ensure that the resolutions proposed by them at the AGM were passed rather than to enforce the demand for information sought by the notice). The company counter-claimed that the claimants lacked standing to bring their claims because they had chosen to hold their shares through nominees. At first instance, the judge ruled against the claimants on the validity claim and the reasonable cause claim, but in their favour on the improper purpose claim. He also ruled against the company in relation to the issue on standing.Fried Frank Client Memorandum New York Washington, DC London Paris Frankfurt Hong Kong Shanghai friedfrank.com 8 Decision of the Court of Appeal The company appealed the decisions on improper purpose and standing and the claimants appealed on the validity claim and the reasonable cause claim. By a majority, the Court upheld the decisions on validity, reasonable cause and standing. However, and critically, the decision on improper purpose was reversed. At first instance, the judge concluded that the directors had been motivated by an improper purpose (i.e. improving the chances of the resolutions being carried at the AGM rather than to compel production of the information which had been requested in the second round of s.793 notices). This had a “separate and dominant purpose” not linked to the extraction of information or the protection of the company. However, the Court of Appeal held by a majority that the sanctions under the s.793 notices were not applied unilaterally by the directors and that the recipients of the notices could avoid the imposition of the sanctions by providing full and correct information in the disclosure notices. The fact that the choice of providing full and correct replies rests with the recipients, not the senders, is the key point. In the other cases on the directors’ improper use of powers, the powers used by the board were unilateral. In this case, the recipients of the s.793 notices could undo the effect of the notices by telling the truth. On this basis, the Court held that this misuse of power doctrine has no significant place in this context. The judges thought it unlikely that Parliament intended that a detailed inquiry into the minds of the directors of the company should be undertaken before the sanctions could be imposed. They also argued that it would be difficult for s.793 to operate in what could be a rapidly changing scene if the directors had to give evidence of their dominant purpose in imposing sanctions. Comment The Court of Appeal’s judgment provides some comfort to directors of companies trying legitimately to use Part 22 to gather information about nominee shareholdings. However, leave to appeal to the Supreme Court has been granted to the claimants. Further scrutiny of these points will therefore follow. * * * Authors: Richard May Helen Shilling This memorandum is not intended to provide legal advice, and no legal or business decision should be based on its contents. If you have any questions about the contents of this memorandum, please call your regular Fried Frank contact or the attorney listed below: Contact: Richard May +44.20.7972.9624 firstname.lastname@example.org