Corporate Law Update

This week:

• The Financial Reporting Council publishes the new-look UK Corporate Governance Code
• The Court of Appeal confirms that a parent company is not automatically liable for the acts of its overseas subsidiaries
• A company was entitled to claim authority to issue certificates for seed enterprise investment scheme (SEIS) relief, even though the qualifying investment was very small

New UK Corporate Governance Code published

The Financial Reporting Council (FRC) has announced the publication of the new shorter and snappier UK Corporate Governance Code. The new Code follows the FRC’s consultation in December 2017. (See our Corporate Law Update for the week ending 8 December 2017 for more information.)

The new Code applies to premium-listed companies (whether UK or overseas companies) for accounting periods beginning on or after 1 January 2019. Under Listing Rule 9.8.6R, a company with a premium listing must comply with the Code and explain any divergence from it.

The Code been formulated as a shorter document based on 18 “principles”, divided into five sections:

• Board leadership and company purpose
• Division of responsibilities
• Composition, succession and evaluation
• Audit, risk and internal control
• Remuneration

Each section contains between three and five principles, which are supported by between seven and ten provisions.

The new Code covers much of the ground that the current UK Corporate Governance Code touches on. However, the FRC has made the following significant changes:

• Workforce engagement. Companies are now asked to choose one or more of three models for engaging with their workforce – appointing a director from the workforce; establishing a formal workforce advisory panel; and / or appointing a designated non-executive director. If a company does not adopt one or a combination of these three models, it must explain what alternative arrangements it has put in place and why they are effective.
• Remuneration committees. In order to serve as the chair of a company’s remuneration committee, a person must first have served for at least 12 months on a remuneration committee (although not necessarily that same company’s remuneration committee).
  
  The new Code also requires companies to submit their general workforce pay and related policies to their remuneration committee for “review”. This is softer than the FRC’s original proposal that remuneration committees “oversee” workforce remuneration. The new Code reserves ultimate responsibility for workforce pay specifically to the company’s board.
  
  
• Diversity. The new Code incorporates the concept of gender, social and ethnic diversity in various places, including in relation to annual reporting and board appointments and evaluation.
• Performance awards. Awards under long-term incentive plans (LTIPs) should be subject to a minimum five-year holding and vesting period, although the new Code does envisage shares being released for sale “on a phased basis”.
• Votes against resolutions. Where a company receives more than 20% of shareholder votes against a resolution, it will need to explain what actions it intends to take to consult with shareholders to understand the reasons behind the result.
• Smaller companies. Companies below the FTSE 350 will now need to ensure at least half of their board is independent. The new Code also prohibits a smaller company’s chair from sitting on its audit committee.

Notably, the FRC has decided not to adopt some of the original proposals in its consultation. These include the following:

• Chair independence. A company’s chair will not be required to remain independent throughout their tenure. Instead, they will merely need to be independent on appointment (as is the case under the current Code). However, the new Code does state that a chair should not serve for more than nine years.
• Director independence. The current Code contains certain factors a board should consider when deciding whether a director is independent. The FRC had proposed to convert these from considerations into “hard conditions”, but ultimately it has decided not to take this path.
• Smaller companies. The FRC had proposed to remove all relaxed requirements for smaller companies from the Code. In some cases, it has done this (see above). However, the FRC has decided to continue to allow smaller companies’ audit and remuneration committees to consist of at least two independent non-executive directors (rather than three, as for larger companies), and not to require smaller companies to conduct a board evaluation at least every three years.

The FRC has also updated its Guidance on Board Effectiveness.

Court confirms parent not liable for overseas subsidiary’s acts

The Court of Appeal has confirmed a decision of the High Court that an English holding company was not liable for the acts of its overseas subsidiary.

The decision happens to be the culmination of a line of judgments relating to the operations of subsidiaries in Africa. You can read more about how this affects the African market more broadly in our recent African Insights article and our subsequent update.

What happened?
AAA and others v Unilever plc and another  concerned Unilever plc, an English-registered joint holding company of the Unilever group, and Unilever Tea Kenya Limited (“UTKL”), a Kenyan subsidiary of Unilever plc that operated a tea plantation.

Around the time of the 2007 Kenyan presidential election, there was an upsurge in inter-tribal violence. Mobs entered the tea plantation run by UTKL and targeted workers and residents on the site, ultimately resulting in deaths.

Those workers and residents (or their personal representatives) subsequently claimed against both UTKL and Unilever plc, claiming that both companies owed them a duty of care to protect them from the violence and that, by failing to comply with that duty of care, they were liable in negligence.

In order to impose a duty of care on a person, a court must be satisfied that three tests are satisfied. Those tests are set out in the seminal case of Caparo v Dickman. They are:

• It must be reasonably foreseeable that the person’s conduct would lead to the loss in question.
• There must have been sufficient proximity between that person and the injured person.
• It must be fair, just and reasonable to impose a duty of care.

The question of interest in this case was whether UTKL’s parent company – Unilever plc – could be liable for matters that were essentially local issues in Kenya and arguably more properly attributable (if attributable at all) to its subsidiary, UTKL. In other words, could Unilever plc be liable for its Kenyan subsidiary’s acts?

The High Court initially found (albeit reluctantly) that the second test above was satisfied. The judge felt that Unilever plc’s activities, or omission to act, was sufficiently connected with the damage suffered by the tea plantation workers and residents.

However, she said that neither Unilever plc nor UTKL could have foreseen the inter-tribal unrest, and it was not fair to impose a duty on them when they were both entitled to rely on the Kenyan authorities to maintain law and order. On that basis, she found that there was no claim against either company.

The individuals appealed against the High Court’s decision that there was no duty of care. Unilever plc and UTKL appealed against its finding that there was sufficient proximity.

Where does this leave us?
The court agreed with Unilever. It said there was clear evidence that UTKL managed its own local risks independently, without help from Unilever plc. Indeed, it found that the managing director of UTKL’s operations was effectively the only person within the Unilever group who was able to assess and appraise effectively the risks arising in the context of the business in Kenya.

In the words of the leading judge, the individuals were “nowhere near being able to show that they have a good arguable claim against Unilever”. The court therefore dismissed the claim.

Practical implications
The decision is not ground-breaking but underscores comments in recent cases, including the High Court’s original decision in this case and the recent judgments in Lungowe v Vedanta Resources plc and Okpabi v Royal Dutch Shell plc.

The combined upshot of these cases is that a parent company is not automatically liable for its subsidiary’s acts, and that a company does not assume a duty of care to third parties merely by virtue of being a parent company. In the court’s words in this judgment:

There is no special doctrine in the law of tort of legal responsibility on the part of a parent company in relation to the activities of its subsidiary, vis-à-vis persons affected by those activities. Parent and subsidiary are separate legal persons, each with responsibility for their own separate activities.

In reality, if a person wants to bring an action in negligence against a parent company on account of its subsidiary’s actions, that person must prove that the parent company had assumed a “stand-alone” duty of care. Again, as the court said:

A parent company will only be found to be subject to a duty of care in relation to an activity of its subsidiary if ordinary, general principles of the law of tort regarding the imposition of a duty of care on the part of the parent in favour of a claimant are satisfied in the particular case. The legal principles are the same as would apply in relation to the question whether any third party (such as a consultant giving advice to the subsidiary) was subject to a duty of care in tort owed to a claimant dealing with the subsidiary.

What this means is that, although a court may attach liability to a parent company in select cases, this will happen only if the parent company has become so involved in its subsidiary’s affairs that it has assumed its own, separate duty of care to third parties. The group relationship between the parent company and the subsidiary may be important evidentially, but legally it is essentially irrelevant.

The court repeated two instances where a parent company might become so involved in its subsidiary’s affairs that it assumes its own duty of care to third parties:

• Where the parent takes over the management of its subsidiary’s activities
• Where the parent gives advice to its subsidiary about how to manage a particular risk

In this case, the court said it was clear that UTKL had managed its own affairs completely independently and had taken no advice from Unilever plc on how to manage its risks locally.

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

• It is acceptable (and, indeed, advisable) to apply risk policies, including safety and compliance policies, “globally” across an entire group. However, parent companies should be careful they do not effectively administer those policies on behalf of their subsidiaries.
• It is sensible to vest decisions regarding the ultimate strategy and direction of a group in the board of the holding company. However, when considering matters that revolve around a particular subsidiary, it is important to demonstrate that decisions are taken independently by the subsidiary’s board.
• Parent companies should think carefully about advising a subsidiary on risk matters. In some cases, this will be natural and unavoidable, especially if the parent possesses experience that the subsidiary lacks. However, groups should give careful consideration to obtaining external advice from third-party risk consultants as a way to mitigate potential parent company liability.

No minimum investment size for claiming SEIS relief

The First-Tier Tribunal has confirmed that shareholders in a company do not need to invest a minimum level of funds in order to qualify for seed enterprise investment scheme (SEIS) relief.

What happened?
Oxbotica Limited v HMRC involved a start-up company – Oxbotica – founded to spin out software produced by the University of Oxford for the design of autonomous vehicles.

Oxbotica was incorporated in late September 2014, issuing 100,000 shares of £0.01 each to four individuals and the University, so raising a total of £1,000 of capital. In addition, the company secured a loan of £110,000 from the University.

In July 2015, Oxbotica applied to Her Majesty’s Revenue and Customs (HMRC) for authority to issue SEIS compliance certificates to three of the four individuals in relation to 31,600 of the original 100,000 shares, which represented a total equity investment of £316.

What is SEIS relief?
SEIS was introduced in 2012 to encourage investment in start-up companies. Similar to its “big sister”, enterprise investment scheme (EIS) relief, SEIS provides certain tax advantages to individuals:

• An individual subscribing for shares in a company can set 50% of the share subscription price off against his or her income tax bill (up to an annual limit of £100,000)
• A sale of those subscription shares is exempt from capital gains tax (CGT)

To qualify for SEIS, the individual must hold the shares for a minimum period of three years. The shares must be issued to raise money for the purpose of a “qualifying activity”.

The shares must also be issued for “genuine commercial reasons”. Relief is not available if the main purpose, or one of the main purposes, of issuing the shares is to avoid tax (such as CGT).

Unlike under the EIS relief regime, there is no statutory minimum amount that an individual must invest to qualify for SEIS relief.

HMRC's response
HMRC refused to give authority. It said that, although there is no minimum investment figure to trigger SEIS relief, it “would expect it to be more than the cost of the share issue, otherwise the funds cannot be said to have been raised for the purposes of … business activity”. HMRC went on to say that it was not prepared to grant relief because the mere £316 raised was not “of meaningful use” to Oxbotica.

There was then a series of correspondence, through which Oxbotica’s lawyers provided considerable information to HMRC in response to its enquiries, and in which they noted to HMRC that there is no statutory minimum investment to qualify for SEIS relief.

However, ultimately HMRC confirmed its refusal to give authority, stating that the amount raised was too small and, given that Oxbotica had already secured funding from the University, the purpose of the share issue had been to secure relief from CGT, rather than to raise money for Oxbotica’s business.

Oxbotica appealed to the Tribunal. In essence, it argued that the size of an investment is not relevant to its purpose. As the SEIS regime does not set out a statutory minimum investment, an investment cannot be denied relief merely because it is small.

What did the Tribunal say?
The Tribunal agreed with Oxbotica. It noted that the SEIS relief legislation was “highly prescriptive” and imposed no minimum investment threshold. It also noted that the legislation contained a specific anti-avoidance provision (see box above). The judge was not therefore prepared to interpret the statute to introduce HMRC’s proposed requirement for a “meaningful level of investment”.

The judge also said that there was no need for the company applying under the SEIS regime to show that a share issue is its only means of funding. It was therefore perfectly acceptable for Oxbotica to apply for relief, even though it had secured substantial funding from the University.

HMRC was therefore not prevented from granting authority to Oxbotica to issue SEIS certificates.

Practical implications
Although still a relatively new relief, SEIS can be extremely useful for budding, start-up businesses and is becoming increasingly significant in today’s tech society in connection with seed financing by entrepreneurs and founder investors.

The Tribunal’s decision in this case confirms that, whilst notably prescriptive, SEIS nonetheless remains a flexible relief which caters for minimal capital investments as well as more substantial ones.

It is important to remember the core issue in this decision: the size of an investment will not of itself dictate its purpose, including whether the share issue has a tax-avoidance purpose.

However, the situation in other cases may be different. Where shares are plainly issued for a purpose other than to fund a qualifying business, relief is unlikely to be available. Likewise, if a company issues shares for the purpose of avoiding tax (whether the sole purpose or one of several), there will be no relief. This will always depend on the specific circumstances in each case.