Issue number 2 of 3
A number of provisions of the Companies Act 2006 (the Act) are coming into force on October 1 2007. This alert gives a brief overview of the changes to be introduced by the Act on that date which provide for:
- an enhanced business review for quoted companies
- a new safe harbour for the protection of directors of all companies in relation to the narrative reports in accounts.
What is the current position?
All companies (except small companies) must, for financial years ending on or after March 31 2006, produce a business review forming part of the directors’ report and including the following information:
- a fair review of the business
- a description of the principal risks and uncertainties facing the company
- a balanced and comprehensive analysis of the development and performance of the business during the year and the position at the year-end
- an analysis (where appropriate) of certain key performance indicators including information relating to environmental and employee matters.
What about the changes?
The changes (contained in section 417 of the Act) come into force on October 1 2007 and apply to accounting periods beginning on or after that date.
The same basic requirements for the business review will continue to apply as at present (with small companies remaining completely exempt and medium sized companies benefiting from partial exemptions).
There is, however, a new enhanced requirement for quoted companies. A quoted company is one whose shares are listed on the main market of the London Stock Exchange, or on certain overseas markets (but not a company quoted on AIM).
As well as meeting the requirements of the basic business review, quoted companies must report on the following, to the extent necessary for an understanding of the development, performance or position of the company’s business:
- the main trends and factors likely to affect the future development, performance and position of the company’s business
- information about environmental matters, the company’s employees and social and community issues together with information about any policies of the company relating to these matters and the effectiveness of such policies
- information about persons with whom the company has contractual or other arrangements which are essential to the business of the company, except where disclosure would be seriously prejudicial to the third party or contrary to the public interest.
Information regarding impending developments or matters in the course of negotiation need not be disclosed at all if this would be seriously prejudicial to the company.
The new enhanced reporting requirements give the business review a forward-looking focus and have led to concerns about the potential liability of directors. In response, a new safe harbour has been introduced for their protection (further details below).
Are other types of companies affected by the changes?
There is a direct link, applicable to all companies, between the business review and the statutory duty of directors under the Act to promote the success of the company. There are six specific statutory factors to which, among other things, a director must have regard when discharging this duty. These include: the interest of the company’s employees; the need to foster the company’s business relationships with suppliers and customers and the impact of the company’s decisions on the community and the environment.
Section 417(2) of the Act provides that the purpose of the business review is to help shareholders assess how directors have performed in relation to this duty
What about the safe harbour?
The Act limits the liability of directors in respect of the contents of the directors’ report, the directors’ remuneration report and the summary financial statement reports derived from them (the Reports).
Under the Act, directors have no liability to shareholders or third parties in respect of information contained in the Reports. Directors are liable to their companies for false or misleading statements or omissions in the Reports but only where the director knew or was reckless as to the misstatement or omission (section 463 of the Act).
This provision, applicable to all companies, was implemented on January 20 2007 and applies to any Report issued after that date. It does not, however, cover statements made in a voluntary operating and financial review (OFR).
The Act does not affect a director’s potential liability for criminal offences or regulatory censure or penalties.
What practical steps should companies be taking to prepare for these changes?
Practical measures include:
- all companies: set up procedures to ensure that the steps taken by directors to promote the success of the company are reflected, as appropriate, in the business review
- quoted companies which prepare a voluntary OFR should consider cross-referring to this in the directors’ report with the aim of bringing the voluntary OFR within the protection of the safe harbour.