Corporate Law Update: 13 - 19 February 2021

19 February 2021

In this week’s update: Supreme Court guidance on parent company liability for the operations of a subsidiary, guidelines on diversity in the private equity and venture capital sectors, a director did not need to declare his interest in a proposed contract at every meeting it was considered, the Pensions Schemes Act 2021 receives Royal Assent, the BVCA responds to the European Commission’s consultation on the AIFM regime, a launch date for the FCA’s new major shareholding notification portal and the FRC publishes its priorities for 2021/2022.

Covid-19 is affecting the way people conduct their business, retain their staff, engage with clients, comply with regulations and the list goes on. Read our thoughts on these issues and many others on our dedicated Covid-19 page.

Parent company may have assumed direct liability for subsidiary’s operations

The Supreme Court has held that it was at least arguable that the ultimate holding company in a well-known international group of companies had assumed direct liability for losses resulting from the operations of one of its subsidiaries.

What happened?

Okpabi v Royal Dutch Shell plc [2021] UKSC 3 was an appeal from a previous judgment in the Court of Appeal, itself a decision on an appeal from a previous judgment of the High Court.

In the original High Court claim, constituents of the Ogale Community and the Bille Kingdom (the Claimants), both located in the Niger Delta in Nigeria, wished to bring legal proceedings against the Shell group of companies for damage allegedly caused by nearby spills from oil pipelines operated by a Nigerian subsidiary within the Shell group (SPDC).

The Claimants wanted to sue SPDC in the UK, where they had already brought legal proceedings against Royal Dutch Shell plc (RDS), the ultimate holding company of the Shell group. In short, in order to serve proceedings on SPDC, the Claimants needed to show that they had a real prospect of success in their claim against RDS.

The focus of the appeal was therefore on the plausibility of the Claimant’s claim against RDS, which is what is most interesting from a corporate law perspective.

The Claimants had argued that RDS had intervened in, and exercised such a degree of control over, SPDC’s affairs that it had assumed a direct duty of care to persons affected by SPDC’s operations. If correct, that would mean that, in this case, RDS would be directly liable to the Claimants for any losses caused by spillages that occurred on SPDC’s watch.

Importantly, the court was not being asked to decide whether RDS was in fact liable. That would be a matter for a full trial on the facts. Rather, it was merely being asked to decide whether the Claimants had a real prospect of succeeding at that trial. If they did not, SPDC would not be a “necessary and proper party” to the English proceedings and so the court would refuse permission to serve the English proceedings on it.

Can a parent company be liable for a subsidiary’s operations?

The proceedings in Okpabi are one of three recent cases in which the courts have considered whether a holding company can, in law, assume direct liability for the actions of its subsidiary.

The claims are significant, because the general position under English law is that the members (usually, shareholders) of a limited liability company cannot be held responsible for that company’s liabilities. This is because, in law, the company is a legal person separate from its members, with its own property, debts and liabilities. The liability of each member is limited to the amount it has agreed to contribute in the event the company is wound up. This applies equally where the company is a subsidiary of another company, its holding company, or “parent”.

However, it is possible, in certain circumstances, for a parent to assume liability directly to persons dealing with its subsidiary.

In 2018, in AAA v Unilever plc [2018] EWCA Civ 1532, the Court of Appeal held that Unilever plc was not liable for losses suffered when one of its subsidiaries allegedly failed to take measures to protect its workers and local residents from violence during the run-up to the 2007 Kenyan presidential election. It found that the subsidiary had managed its own affairs independently, and that Unilever plc had not intervened enough to establish a direct duty of care to the workers and residents.

However, the court did say that a parent can assume a direct duty of care where it takes over the management of its subsidiary’s activities or it gives advice to its subsidiary about how to manage a particular risk. For more information, see our previous Corporate Law Update.

In 2019, in Vedanta Resources plc v Lungowe [2019] UKSC 20, the Supreme Court said that it is possible for a parent to assume liability for the activities of its subsidiary, provided it assumes a duty of care to third parties in relation to those activities. That hearing was also concerned with jurisdictional issues and so was not conclusive.

However, importantly, the court rejected the idea that a duty of care could arise only in the specific circumstances cited in Unilever. Instead, it said that a parent is at risk of assuming a duty of care where it administers and implements group-wide policies for its subsidiaries, expanding the circumstances in which a parent can incur liability. For more information, see our previous Corporate Law Update.

What did the court say here?

In short, the Supreme Court found that the High Court and the Court of Appeal had focussed too heavily on the substantial volume of evidence presented to them. This led them both to conduct a “mini-trial”, instead of simply examining whether the claim had a prospect of success, and to discount the possibility of further evidence that might substantiate the claim. For more information, see our in-depth article on the case.

From a corporate perspective, what is interesting are the Supreme Court’s comments on when a parent can incur a duty of care in relation to its subsidiary’s operations. The Court made the following observations:

  • Whether a parent assumes a duty of care in relation to its subsidiary’s operations depends on the extent to which it participates in the management of some or all of the subsidiary’s operations.
  • A parent does not need to “control” a subsidiary to participate in its management. Control and management are different things. A subsidiary can maintain legal control over its activities, but nonetheless delegate management of them to “emissaries of its parent”.
  • As noted in Vedanta, a parent may incur liability to third parties if it holds itself out as exercising supervision and control of its subsidiaries, even if it does not in fact do so.
  • It is not true that simply laying down group-wide policies or standards without actively enforcing them can never create a duty of care. As noted in Vedanta, group guidelines may contain systemic errors which, when routinely implemented by a subsidiary, cause harm to third parties.
  • The fact that a parent has set up a network of subsidiaries, or that the parent heads an international group of some size, are not relevant to whether it can assume a duty of care.
  • Where a group of companies establishes vertical reporting and business lines that operate across entities and distinctly from the corporate status of the different group companies, this could be an indication of control or participation in management.
  • A parent is also more likely to be exerting operational control where it imposes internal corporate policies and procedures on its subsidiaries. It is necessary to look at the particular procedures. In this case, the subsidiary sent compliance confirmations, health and safety audits and remediation plans produced to the parent so it could supervise how its policies were implemented.

The Supreme Court therefore allowed the appeal, effectively clearing the way for the claim to proceed to a full trial.

What does this mean for me?

As with the judgment in Vedanta, this decision does not create any binding law regarding a holding company’s liability for its subsidiary’s operations. But it certainly cements the Supreme Court’s comments in Vedanta and adds some useful context.

The decision reinforces certain existing points that commercial groups should bear in mind.

  • A parent can (and often would be expected to) promulgate policies, including health and safety, risk and environmental policies, to its entire group. However, a parent should be careful not to effectively administer those policies on behalf of its subsidiaries.
  • Equally, a parent should ensure that any group-wide policies are comprehensive and contain no errors. Where a policy proves to be defective and a third party suffers loss, the parent may well be exposed.
  • Although it may be sensible to vest decisions on a group’s ultimate strategy and direction in the parent’s board or a group-wide executive committee, it is safer for matters concerning a particular subsidiary to be dealt with independently by the subsidiary’s board.
  • A parent should make it clear that it is not supervising or managing its subsidiaries’ affairs. Generally, correspondence relating to the subsidiary’s operations should be sent on the subsidiary’s letterhead, and emails should originate from an account in the subsidiary’s name.
  • A parent should think carefully about advising a subsidiary on risk matters. In some cases, this will be unavoidable, especially if the parent possesses experience which the subsidiary lacks. But groups should give careful consideration to obtaining external advice from third-party risk consultants as a way to mitigate potential parent company liability.

New guidelines on diversity in private equity and venture capital published

The British Private Equity and Venture Capital Association (BVCA) has announced the publication of a new set of best practice guidelines to help increase investment in under-represented founders and drive diversity and returns across the investment sector.

The guidelines were put together by a number of venture capital and private equity investors following the Rose Review into Female Entrepreneurship in the UK. The Review was tasked with identifying disparities between male and female entrepreneurs when starting and scaling businesses and barriers to women in the PE/VC industry. The result of the Review was published in March 2019 and has resulted in various publications and initiatives.

The new Guidance and Best Practice Examples are aimed at venture capitalists, private equity investors and institutional investors. They take the form of a checklist of best practice processes and are split into separate sections covering:

  • talent acquisition, retention and development;
  • internal education, culture and policy;
  • outreach, access to deal-flow, and unconscious investment bias; and
  • influence, external guidance and portfolio management.

The Guidelines also recommend that investors undertake a portfolio assessment and obtain certification under “The Standard” developed by Diversity VC, Diversio and OneTech, and that financial organisations become signatories to the Investing in Women Code.

Director did not need to declare interest in contract at every board meeting

The Court of Appeal has held that, where a director was interested in a proposed contract with the company of which he was a director, he had to disclose his interest to the other directors at the first board meeting at which that contract was considered. He did not, however, have to disclose his interest again at each subsequent meeting held to consider that contract.

What happened?

Fairford Water Ski Club Ltd v Cohoon [2021] EWCA Civ 143 concerned a private company that owned a lake and surrounding land in Gloucestershire and operated a water-skiing club there.

In addition, the site was the location of a water-skiing school, run by an unincorporated partnership, which we will refer to as the “school”. One of the company’s directors – Mr Cohoon – was also a partner in that partnership. Importantly, the school had been operating at the site for several years, and the company’s other directors had been well aware of Mr Cohoon’s interest in the school.

From April 2006, the company began examining the company’s relationship with the school following comments by a shareholder at the company’s most recent annual general meeting (AGM).

A board meeting was held in January 2007 to discuss formalising the company’s arrangements with the school in a contract and the role that Mr Cohoon was playing at that time. Discussions continued, culminating in a further board meeting in May 2007 to finalise a new management agreement between the company and the school.

At the time of the meetings, section 317 of the Companies Act 1985 required director of a company who was in any way interested in a contract or proposed contract with the company to declare the nature of their interest at a board meeting. Section 317 has now been superseded by section 177 of the Companies Act 2006, which is similar, although there are some important differences.

Where a director fails to declare their interest in a proposed contract or arrangement, they will be in breach of their duties to the company and liable to compensate the company for any loss it suffers or account for any gain they have made. In addition, depending on the circumstances, the company may be able to set the contract aside, effectively nullifying it.

At the January 2007 board meeting, Mr Cohoon declared that he had an interest in the proposed new contractual arrangements with the school by virtue of being a partner in the school. However, he did not declare his interest in the final management agreement at the May 2007 board meeting.

The company and the school entered into the management agreement. Subsequent disputes arose over payments under the agreement. Among other things, the company claimed that Mr Cohoon had breached section 317 by failing to declare his interest in the management agreement at the May 2007 board meeting.

The judge at the initial High Court hearing agreed with the company. He reached two broad conclusions:

  • At the time of the January 2007 board meeting, the final terms of the proposed agreement had not been settled. As a result, Mr Cohoon’s declaration of interest at that meeting was not sufficient. Mr Cohoon had been required separately to declare his interest in the final terms of the contract at the May 2007 board meeting.
  • It was not enough for Mr Cohoon to inform the company’s board that he was interested in the proposed contract. To declare the “nature” of his interest, he had been required to provide the other directors with an independent valuation to enable them to decide whether the fees payable under it were justified.

What did the court say?

The Court of Appeal disagreed on both counts.

The extent of a director’s declaration depends on the nature of the relevant interest and the context in which that interest arises. If the nature of the interest is clear and obvious (for example, where there is an “uncomplicated contract” between the company and the director), very little may need to be said. If the interest is more “indirect”, a fuller explanation may be necessary. The key point is to ensure that the board is "fully informed of the real state of things".

Furthermore, section 317(2)(a) of the Companies Act 1985 required the declaration to be made at the board meeting “at which the question of entering into the contract is first taken into consideration”. This suggested that a contract could be considered over a ”series of board meetings” and that the declaration did not have to be made at every subsequent meeting.

In this case, the Court was satisfied that Mr Cohoon had made his declaration at the first meeting, namely the January 2007 board meeting. The declaration had made the other directors fully aware of the real state of things (if, indeed, they had not already been aware). There was no need for him to make any further declarations.

The Court also disagreed that Mr Cohoon’s notice needed to contain an independent valuation. The other directors had been well aware no valuation had been obtained but nevertheless decided to proceed. Failing to obtain a valuation might have been relevant to other duties owed by Mr Cohoon and the other directors, but it was not relevant to his declaration.

What does this mean for me?

This is a useful and pragmatic decision. Clearly there is little practical utility in forcing a director to declare their interest repeatedly to a board on a matter of ongoing deliberation. Once a declaration has been made, there is an onus on the other directors to take that interest into account and evaluate it when deciding whether the contract or arrangement in question is in the company’s best interests.

However, it does serve as a reminder of the importance of including enough information in a declaration so as sufficiently to disclose the nature of the interest and how that bears on the proposed contract or arrangement.

Interestingly, were the board meeting to take place today, the points might never come before a court. The relevant requirement at the time – section 317 of the Companies Act 1985 – required a director to declare an interest even if the company’s other directors were aware of it at the time.

By contrast, the current requirement – section 177 of the Companies Act 2006 – specifically states that a director does not need to declare an interest “if, or to the extent that, the other directors are already aware of it”. This includes where the other directors ought reasonably to be aware of the interest. Given that the company’s board had known for some time that Mr Cohoon was a partner in the school, it seems unlikely that he would have been required to make a declaration under section 177.

The judgment needs to be understood in context. In this case, Mr Cohoon’s interest in the school had been known for some time to the other directors and remained unchanged throughout the discussions.

However, in many cases, a director’s interest may not be so readily apparent from the outset, and the nature of an interest in a proposed arrangement can change over the course of negotiations and discussions. Section 177(3) specifically states that, if a declaration of interest becomes inaccurate or incomplete, the director must make a further declaration. A director who is interested in a proposed arrangement should therefore continue to review their declaration and, if circumstances change materially, consider making another declaration.

When deciding whether to declare an interest and how much detail to include in that declaration, a director should ask themselves the following:

  • Is the board already aware of the interest? If so, there may technically be no need to declare it to the board. However, in many cases it will be sensible to do so anyway, both to put the matter beyond doubt and to ensure the company has a proper record of the director’s interest.
  • What does the board need to know? Ultimately, the board needs enough information to understand how the director’s interest bears on the proposed contract or arrangement being considered. A director pondering a declaration should include enough information to ensure that the other directors are left in no doubt about what is going on.
  • Would a “general declaration” be better? Section 185 of the Companies Act 2006 allows a director to give a “general notice” of an interest. This is a notice that the director has an interest in a company or firm, or is connected to someone else, and that the director is to be regarded as having an interest in any arrangements with that company, firm or person. If the director knows that the matter will be considered over a series of meetings, making a general declaration at the first board meeting may be easier and, indeed, may cover future contracts as well.

Legislation paves way for enhanced pension scheme notifications

The Pension Schemes Act 2021 has received Royal Assent. The Act follows a consultation published by the Government in 2018 on how to protect defined benefit (DB) pension schemes and create a stronger Pensions Regulator.

Although technically now law, many provisions of the Act will not come into effect until a later date when further regulations are made. You can read more in this blog by our colleague, Rhiannon Barnsley.

For now, the key point to note in the context of corporate acquisitions and disposals is that the Act expands the obligation to notify the Pensions Regulator if a “notifiable event” occurs. The expectation is that additional notifiable events will be introduced. At this point, we do not know what they will be, although previously the Government had suggested that they would include the disposal of an employer under a DB scheme with funding responsibility for at least 20% of the scheme’s liabilities, or a sale of a “material proportion” of such an employer’s business and assets.

The notification would need to be sent along with an “accompanying statement”. Again, the precise contents of the accompanying statement will be set out in due course in regulations. However, the statement will need to contain a description of:

  • the notifiable event;
  • any adverse effects on the scheme;
  • any steps taken to mitigate those effects; and
  • any communication with the trustees or managers of the scheme.

A copy of the statement would also need to be sent to the scheme trustees.

We will continue to monitor regulations made under the Act and provide further updates in due course.

Also this week…

  • BVCA responds to consultation on AIFM regime. The British Private Equity and Venture Capital Association (BVCA) has published its views on the European Commission’s recent consultation on the scope of the European Union Alternative Investment Fund Managers (AIFM) regime. (For more on that consultation, see our previous Corporate Law Update.) The BVCA does not believe there is any need for a “radical overhaul” of the AIFM regime. It also notes that there is currently no parallel consultation on the UKs domestic AIFM regime (which has been inherited from the EU regime following Brexit), but that it is monitoring this in liaison with the Financial Conduct Authority and HM Treasury.
  • FCA announces launch date for new major shareholdings notification portal. The Financial Conduct Authority (FCA) has announced that its new portal for notifying major shareholdings under DTR 5 will go live on 22 March 2021. The FCA first announced the new portal in November 2020. Currently, investors must send a completed copy of Form TR-1 to the FCA by email. Under the new portal, investors will instead be required to complete an electronic Form TR-1 within the FCA’s Electronic Submission System (ESS).
  • FRC publishes draft strategy, plan and budget. The Financial Reporting Council (FRC) has published its draft strategy for 2021/2022. Among other things, the FRC will focus on implementing non-legislative recommendations for improving audit quality, consult on revisions to the UK Corporate Governance Code and respond to its recent discussion paper on reforming the UK’s corporate reporting framework.

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