Modernising Company Law

The main corporate governance change that the Government is thinking to bring about in accordance with the FR of the Review is that directors’ general duty to the company should be codified in statute. The introduction of a statutory statement of directors’ duties will mean that directors must take account of both the long and short term consequences of their actions and recognise the importance of relations with stakeholders other than just shareholders. It is also very important that the WP has adopted the same approach as the case law  in evaluating the directors’ duties of care, skill and diligence which is to be assessed objectively.

However, two reservations are expressed by the WP in relation to insolvency matters where the Government has felt that weight of the argument goes against incorporating into the statutory statement a duty based on s.214 of the Insolvency Act 1986. Directors have obligations under many headings apart from company law. The Government does not believe it appropriate to single out one requirement from insolvency law and include it within the codification which will unhelpfully conflate company and insolvency law.

To make company law more accessible to the directors, the Government has proposed that in future, new directors will receive a detailed guidance summarising the legal requirements placed by company and insolvency legislation. The WP advocates that there could be two versions of the guidance, one aimed at directors of smaller private companies and another at directors of public companies. 

Another important issue that the WP discusses is directors’ conflicts of interest. Part X CA controls directors’ fiduciary duties to their contract by regulating potential conflicts of interest. The provisions were introduced to tackle abuse, which the law failed to prevent. The interests are regulated in a number of ways. Some transactions with directors are prohibited outright; some transactions with directors require the prior approval of the general meeting; disclosure is required of transactions undertaken with or by the directors.        

Detailed recommendations were made for updating Part X. It was proposed that the maximum permitted period of directors’ employment contracts, currently permitted by s.319 CA, should be reduced from five to three years for initial terms of employment and to one year thereafter. This would enable earlier review for determining the appropriateness of re-election. However, companies should be able to authorise directors to permit longer terms in appropriate cases by ordinary resolution.

A significant conflict of interest flowing from Part X which directors face is in their setting of remuneration. The Government considers it essential to have effective disclosure and accountability to shareholders. It has therefore laid down a statutory instrument before Parliament which will require quoted companies to publish a report on directors’ remuneration as part of their annual reports. However, the WP believes it inappropriate to require such a formal approval procedure in respect of private companies.

Shareholders and Decision-making

According to the Report of the Cadbury Committee, “…the shareholders as owners of the company elect the directors to run the business on their behalf and hold them accountable for its progress.” The shareholders’ role in governance is to appoint the directors as well as the auditors and to satisfy themselves that an appropriate governance structure is in place.

The decision-making process has been restructured and simplified by the WP. The Government agrees with the proposal for the replacement of the memorandum and articles with a separate single model constitution for private and public companies as the split between them serves no useful purpose. Companies’ members will be able to amend the constitution by special resolution. However, it is also proposed in the WP that members will be able to make it difficult to bring about changes by requiring a higher majority or even unanimity. This could possibly be problematic for the purpose of future amendments due to the loss of flexibility.

All companies are required by law to hold an Annual General Meeting (AGM). S.366A provides that private companies may opt out of the AGMs if they approve unanimously. This is understandable as the directors and the shareholders are usually the same people in a private company. The WP agrees with the proposed Bill, which will remove the requirement for private companies to hold AGMs by ordinary resolution. Under s.366(A)(3), any single member is empowered to require an AGM. This rule is proposed to be present in the Bill under clauses 136-139, Volume II. However the Government believes that there are serious disadvantages to this, as this would allow a single dissenting member to require AGMs every year, adding an extra layer of complexity to the provisions on private companies. It is seeking views on whether the draft clauses should be retained.

The WP agrees with the draft Bill that the notice period of 21 days for both special and extraordinary resolutions should be replaced with one of 14 days for special resolution, bringing it into line with the proposal for the minimum notice for general meetings which is also 14 days. Now the companies can make effective use of time by holding meetings at shorter notice.

Proxies are another vital part in governance and decision-making. Accordingly, the WP proposes to enhance the existing powers of proxies so that in the future they will be able to speak, vote on a show of hands as well as on a poll, and join with others in demanding a poll. A new right for a sufficient body of members is proposed by the WP to require a scrutiny of any poll. By scrutinising the voting procedure, it will be possible to hold a fair and impartial election.  

Currently, the circulation of any members’ resolution is at the members’ expense. The Government welcomes the idea of the Steering Group that in future such material received in time should be circulated to all members with the notice of the meeting at the companies’ expense. This will help reduce the advantage that the board currently has in relation to distribution of circulars before the AGM using all the companies’ facilities and funds in putting their views across.

The draft Bill also provides a procedure whereby private companies may pass a written ordinary resolution with a simple majority of the eligible votes and a written special resolution with 75% of the eligible votes. This step, combined with the abolishment of the AGM for private companies will not only relieve many small companies from having to hold formal general meetings, but also help them to take quick and effective decisions.

Reporting and Auditing

As more information is not necessarily better information, the Government is firmly committed to improving the quality rather than the mere quantity of company reporting. Timely, effective access to high quality information is fundamental to the proposals for effective governance coupled with mechanisms that enable shareholders to respond appropriately on the basis of that information.

S.226 imposes on the directors of every company the duty to prepare for each financial year of the company a balance sheet and a profit and loss account. The companies may also prepare an optional summary statement, which summarises the financial statements and reports. Under s.234, the directors must, in addition, prepare a report for each financial year.

The WP agreed with the FR recommendations that the form and content of the annual financial statement and reports should be delegated to a new Standards Board which will allow the detailed requirements now in the Act to be brought together with accounting standards into a comprehensive single body of rules. The Government supports the view that the profit and loss account should become a wider performance statement, this time, reporting all gains and losses, as well as setting out requirement for companies to prepare a cash flow statement. Both of these will too, be determined by rules made by the Standards Board. The review recommended abolition of the narrative directors’ report. In its place there would either be a short supplementary statement and for the most economically significant companies only, an OFR. 

The Steering Group was confident that the OFR would improve the quality, usefulness and relevance of information available to the markets and to everyone with an interest in the company. It would lead to improved understanding of business performance and prospects and provide accountability and encouraging responsiveness and high standards of business practice. The OFR would be subject to audit, focusing on the process of its preparation and not its content.

The supplementary statement must still be prepared by companies preparing an OFR. A defect is that it will be up to companies to decide in which of the documents information would be disclosed. This potentially defeats the purpose of the OFR as the question of which of the two would be read more widely is raised.

The Government agrees with the Review’s recommendation that the definition of a small company for accounting purposes will be increased to the E.U. maximum. This will enable more private companies to enjoy the concessions already given to small companies. Again, the WP agrees in reducing the time period for filing annual reporting documents for private companies from ten to seven months from the financial year-end due to the current environment of rapid global communication. Furthermore, small companies will not be required to provide a cash flow statement, but will produce a simpler supplementary statement which will allow for simpler accounting.

Conclusion

Although the WP may remedy many of the problems with the corporate governance system, these might be altered in the future due to the truly harmonising governance codes proposed by the European Commission. In order not to become quickly outdated, it is important to have flexibility to react to future developments. The radical changes to the corporate governance system as discussed above will raise awareness of the need for a flexible system that will not hamper the proper functioning of the company’s internal systems. They ensure directors will act in accordance with the duties enshrined in the codified statement and have regard to wider interests as part of their corporate social responsibilities; the shareholders will also have more residual power to ensure directors are accountable for their actions. Thus, the companies, both private and public, will be able to carry on their respective businesses smoothly. This is what company law is mainly about, to make it easy to start and run businesses by balancing various interests, including those of shareholders, directors, employees, creditors and customers without imposing unnecessary or inappropriate burdens . One feels that this WP will go a long way in solving the existing problems with the corporate governance system in UK company law.

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Bibliography

Legislation

British Companies Legislation, 2001. Sweet and Maxwell.

Books

Davies, P, Gower’s Principles of Modern Company Law, Sweet and Maxwell, 6th edition, 1997.

Farrar, J and Hannigan, B, Farrar’s Company Law, Butterworths, 4th edition, 1998.

Hicks, A and Goo, S, Cases and Materials on Company Law, Blackstone Press, 3rd edition, 2001.

Articles

Arden, M, ‘Reforming the Company’s Acts - The Way Ahead’, [2002] Journal of Business Law 570.

Faber, D, ‘Companies Bill: A Vehicle for the New Millennium’, (2002) 23(1) Company Lawyer 2.

Rider, B. A. K., ‘White Paper and Draft Companies Bill Published’, (2002) 23 Company Lawyer 308.

Sheikh, S, ‘Company Law for the 21st Century: Part 2: Corporate Governance’, (2002) 13(2) International Company and Commercial Law Review 88.

Government Reports

Final Report of the DTI Company Law Review Steering Group, Modern Company Law for a Competitive Economy, 2001.

Modern Company Law for a Competitive Economy: Completing the Structure (URN 00/1335), 2000.

Modern Company Law for a Competitive Economy: Developing the Framework (URN 00/656), 2000.

White Paper, Modernising Company Law, Cm 5553-1, 2002

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