Corporate Law Update

• The buyers of shares in a company could not bring a warranty claim because they were aware of the breach before signing
• The Government is consulting on exceptions to the forthcoming ban on corporate directors
• The Government is consulting on widening the powers of Companies House to purge incorrect information
• The Government is consulting on ways to improve the quality of company accounts
• The QCA publishes an updated version of its Remuneration Committee Guide
• The FRC announces its review programme and sector priorities for 2021/22
• The FRC’s Financial Reporting Lab publishes its most recent newsletter
• The London Stock Exchange updates its rulebooks for the end of the UK/EU transition period

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.

Buyers of shares unable to bring warranty claim because they were aware of breach

The High Court has held that, in deciding whether a time bar on claims applied, a matter had been disclosed to a buyer of shares even though it had not been set out in the disclosure letter.

What happened?

Butcher and another v Pike and others [2020] EWHC 3432 (QB) concerned the sale by two individuals of the entire issued share capital of a company to three other individuals.

The company’s main business was enabling private landlords to advertise properties for rent through on-line platforms, including Rightmove and Zoopla.

The share sale agreement (SPA) contained a warranty by the sellers that the company had “not defaulted under any agreement or arrangement to which it is a party”.

The SPA stated that the sellers’ warranties (including the warranty above) were “subject only to … any matter which is fully, fairly and specifically disclosed in the Disclosure Letter” sent by the sellers to the buyers. The effect of this was that, if a matter was disclosed in the disclosure letter, the sellers would not be liable in respect of it. This is a standard mechanism on a share sale, although the level of detail required for a disclosure to be effective is often a matter of negotiation.

The buyers later discovered that both Rightmove’s and Zoopla’s respective terms and conditions (which we will call the “platform terms”) appeared to allow the company to advertise a property through the platform only if the instruction to market the property originated at one of the company’s branches.

The buyers argued that this restriction prevented the company from marketing properties on behalf of landlords and that, by doing so, the company had breached the platform terms. Although the sellers had disclosed the platform terms to the buyers, they had not specifically stated in the disclosure letter that the company was in breach of them. This, the buyers said, put the company in breach of the warranty in the SPA. The sellers disputed this.

The SPA also stated that the buyers could not bring a warranty claim unless they notified the sellers of the claim within six months of completion of the sale. This kind of time limit is customary on a share sale (although the time limit is usually longer than six months). However, the SPA also stated that this time limit did not apply “where there has been fraud or negligent non-disclosure”.

As noted above, the SPA required the sellers to set out any disclosures against the warranties in the disclosure letter. The buyers argued that, because the sellers had not stated in the disclosure letter that the company was in breach of the platform terms, there had been a “non-disclosure”, causing the time limit not to apply.

The sellers responded that, although the SPA required disclosures against the warranties to be set out in the disclosure letter, for the purposes of the time limit, disclosure could occur outside the disclosure letter. They said the buyers were well aware of the company’s business and the platform terms and so could not argue that there had been a “non-disclosure”.

What did the court say?

The court agreed with the sellers.

The judge drew a distinction between disclosure for the purpose of qualifying the warranties and disclosure for the purpose of deciding whether the time limit on claims applied.

He said that the purpose of the disclosure letter was to allow the sellers to show that a warranty was not true and to elicit acknowledgement of that fact from the buyers.

However, in relation to the time limit, what the parties were trying to say is that the buyers would not be prevented from notifying a claim outside the time limit where the reason for the late claim is that the sellers have failed to disclose something which they ought to have disclosed.

If the buyers were actually aware of a matter, they would not be able to notify a warranty claim after the time limit expired, even if the matter was not set out in the disclosure letter.

What does this mean for me?

This was merely a decision on an application for summary judgment, and so the judge was not required to decide whether the sellers had in fact disclosed the matter to the buyers. In any event, he found that the company was not actually in breach of the platform terms, and so the issue was moot.

Nevertheless, this is an interesting decision on disclosure and it highlights some uncertainties.

It has for some time been a matter of debate whether a buyer can claim for breach of warranty where it knows about the breach before it signs the SPA. Case law suggests that a buyer cannot claim in respect of a matter it actually knew about before signing the SPA (Eurocopy v Teesdale [1992] BCLC 1067), but that the parties may be able to modify this position by including suitable wording in the SPA itself (Infiniteland Ltd v Artisan Contracting Ltd [2005] EWCA Civ 758).

It is generally accepted that, if a buyer is to be able to bring a warranty claim despite having actual knowledge, the SPA must explicitly allow it to do so. This is sometimes called a “sandbagging clause” and is unusual on UK transaction, although standard in other jurisdictions, such as the United States.

It is not clear whether the wording in this case – “subject only to” matters disclosed in the disclosure letter would have been explicit enough to amount to a sandbagging clause.

It is true that the issue in this case took a slightly different guise: the question of disclosure arose in the context of a time limit, rather than qualifying a warranty. But this distinction may have little relevance in practice. It is all very well for a buyer to argue successfully that a seller is liable for breach of warranty where a matter is not disclosed in the disclosure letter, but this will be of little use if the buyer cannot then launch the warranty claim due to a time limit.

Parties to a share or business sale should bear the following in mind when drafting their SPA:

• Set out the required standard of disclosure. It is important to specify the level of detail of any disclosures. A common formulation is to require disclosures to be “fair” and to contain “sufficient detail” to allow the buyer to understand the issue. Absent any specific wording, the courts will require any disclosures to be “fair”.
• Specify the buyer’s rights where it knows of issues in advance. If the buyer is to be able to claim despite knowing about a breach of warranty, the SPA must say this explicitly. Wording might state that no actual or constructive knowledge of the buyer will prevent it from bringing any claim for breach of warranty.
• Maintain consistency. The fact that the term “disclosure” is specifically defined in one part of the SPA may not mean it carries the same meaning or effect in another part. A common way to address this is to include a definition of “Disclosed”, which can then be used in various places in the SPA.

Government consults on ban on corporate directors

The UK Government has published a consultation on implementing the ban on corporate directors.

What is the ban?

The legislation setting out the ban was enacted in March 2015 in the Small Business, Enterprise and Employment Act 2015, which makes prospective changes to the Companies Act 2006. However, nearly six years later, the ban has still not been brought into force.

When the ban is brought into force, only natural persons will be able to serve as directors of UK companies. Any attempt to appoint a legal entity (such as another company) as a director will be void, and an offence will be committed by the company that attempts to make the appointment, the legal entity it is attempting to appoint, and each of their respective directors who are in default.

For existing companies with corporate directors, there will be a “grace period” of 12 months once the ban comes into effect. This will give companies a year to remove their corporate directors. Any corporate directors still in office at the end of the grace period will simply cease to hold office.

Crucially to all of this, the legislation gives the Government power to create exceptions to the ban. The Government’s powers in this respect are very broad, although any exceptions must still require at least one director of a company to be a natural person. This is important because the extent of the ban can be understood only once the scope of any exceptions become clear.

What is the Government proposing?

In preparation for bringing the ban into force, the Government is consulting on the exceptions that should apply. Previous administrations have consulted twice – once formally in 2014 and once informally in 2015 – on how these exceptions could be structured, but there has been no movement over the past five years.

The Government is now proposing to introduce an exception based on two principles. Under this approach, a corporate entity could serve as a director of a UK company if:

• all of that corporate entity’s own directors are natural persons; and
• those natural persons verify their identity with Companies House before the corporate director is appointed.

At the moment there is no way to verify a person’s identity at Companies House. However, the Government has previously consulted on the matter and announced measures it intends to take to make it mandatory for UK company directors to verify their identity (see our previous Corporate Law Update).

It would not matter where in the world the corporate director is established. Provided the two conditions above are satisfied, an entity would be eligible to serve as a corporate director of a UK company.

At this point, the Government is proposing to restrict the types of entity that can act as a corporate director to limited companies. However, it is seeking views on whether limited liability partnerships (LLPs) and limited partnerships (LPs) should also be allowed to serve as corporate directors and, if so, how the conditions should apply to them.

As noted above, to serve as a corporate director, an entity’s own directors would all need to be natural persons. The Government is proposing that, where one UK company (X) appoints another UK company (Y) as a corporate director, Y would not be permitted to have any corporate directors of its own. Any attempt to appoint a corporate director would be void.

UK law cannot regulate appointments of directors of overseas entities in the same way. So, the Government is proposing that, where a UK company proposes to appoint an overseas entity as a director, it would be required to assure itself that the overseas entity’s directors are all natural persons and to confirm that each year in its confirmation statement.

The Government has not set out a proposed time frame for implementing the ban. However, as the proposed exception would rely on the proposed new identity verification procedure, we can expect that the ban will not come into effect until that procedure is ready to be implemented.

What does this mean for me?

We have been waiting for some time now to see how and when the Government would implement the prohibition of corporate directors. Although the ban might seem significant, the Government estimates that, of the approximately 33,000 companies with corporate directors, at least 66% would meet the proposed conditions and so could continue with their corporate directors.

Based on those figures, that does leave a good 11,000 companies that will need to consider carefully how to restructure their board arrangements. These companies should start preparing now to replace their own corporate directors or ensure that their corporate directors remove any non-natural persons from their own boards.

Depending on the efficacy of the proposed new Companies House identity verification system, the Government’s proposals for enforcing the ban on UK companies serving as corporate directors would seem plausible.

More difficult will be enforcing the ban where overseas entities are appointed as directors. The new identity verification system will need to be set up to handle a variety of documents in potentially various languages submitted as part of applications to verify individuals in overseas jurisdictions.

The Government has asked for comments on its proposals by 3 February 2021.

Government consults on reforming the UK’s companies registry

The UK Government has published a consultation on proposed reforms to the way company information is held in registers. Titled “Powers of the registrar”, the consultation in fact goes further and sets out proposed changes to the registers that companies must keep.

The public register

At the moment, Companies House has the power to reject documents sent to it for filing if they appear not to comply with requirements for delivery. This might include where they have not been signed properly or there is information missing. However, it has very limited powers to reject information that is irregular, erroneous, fraudulent or obsolete or to remove information from the public register.

The Government is proposing to expand Companies House’s powers as follows.

• Companies House would be able (but not required) to query any “error, inaccuracy or anomaly” that appears “fraudulent” or “suspicious” or that “might impact significantly on the integrity of the register and the UK’s business environment”.
• It would do this using a “risk-based approach”, prioritising the biggest risks to the integrity of the register and the quality of the information it holds. This would include where there is evidence that information submitted to Companies House might pose a risk to the UK’s reputation as a good place to do business.
• Ultimately, Companies House would be able to reject a document that contains errors or inaccuracies, even if it appears on its face to comply with the relevant filing requirements. This could lead to documents not being filed and company formations not taking place.
• It would also be able to query information in a document that has already been registered and, if it does not receive a satisfactory response, remove offending material from the public register. In some cases, this would continue to require a court order.
• The paper gives example scenarios where Companies House might use this new power, including where a company applies to be struck off, then withdraws its application and changes its officers and registered office address (suggesting it may have been “hi-jacked”), or frequently changes its registered office address.
• The paper places particular emphasis on the fraudulent use of company names. It proposes to give Companies House a power to reject a company name if it believes it has been chosen to mask underlying criminal or fraudulent activity. For existing companies, it would have the power to direct a company to change its name or forcibly change an offending name.
• The Government is also proposing to give Companies House a new power to reject a name that uses a sensitive or misleading word in a foreign language. (Currently, Companies House can only challenge sensitive words in English, Welsh or Gaelic.)
• The Government is also proposing to introduce powers to remove information from the register which is not fraudulent or suspicious. (As noted above, Companies House currently has very limited powers to remove information from the register.) These proposals are separate from the proposed new querying power above, but would naturally need to interlace with that power.
• Finally, the consultation proposes certain changes to close loopholes and shorten time periods in certain other circumstances, such as where a company is using a registered office address without authority or appoints someone as a director without their knowledge.

A company’s own registers

By law, a company must keep certain registers. These include registers of its members (usually shareholders), directors, secretaries and persons with significant control (PSCs). These registers are available to members of the public for a small charge, although (in some cases) a person wishing to inspect a register can do so only for a “proper purpose”.

Normally, companies keep these registers in physical or electronic form at their registered office address or another inspection location. A company can alternatively keep its registers centrally at Companies House, although very few companies have chosen to do this.

Information in a company’s register of directors, secretaries and PSCs must be filed publicly at Companies House within 14 days. Information in a company’s register of members needs to be provided to Companies House annually with the company’s confirmation statement.

The Government has previously stated that it intends to change the law so that a person will not be able to be appointed as a director of a UK company until they have verified their identity with Companies House (see our previous Corporate Law Update). In line with this, the Government is proposing to abolish the need for a company to keep a register of directors. Instead, the public record would be definitive proof of a company’s directors.

The consultation also seeks views on the requirement for companies to keep other statutory registers, although the Government has signalled that it is unlikely to make any changes to the existing arrangements for companies’ registers of members.

What does this mean for me?

This consultation is long overdue. The current powers for Companies House to amend the public register are patchy and very narrow. It is often very difficult, if not impossible, to remove erroneous information from the public register which has been filed accidentally or under incorrect assumptions.

For example, if a company’s directors discover that the accounts it has filed are defective, they should revise them and file corrected accounts. But Companies House has no power to remove the old, incorrect accounts from the public record. This can lead to confusion for persons who wish to understand a company’s financial standing.

The position with PSCs is particularly frustrating. It is not uncommon for a company to file details of a PSC, only to find that that person is not, in fact, the PSC. This might arise through a simple mistake, by incorrectly applying the legislation, or because the company believes it can register a foreign entity. It is usually impossible to remove the name of the incorrectly identified from the public register, giving the impression that someone controls a company when, in fact, they do no such thing.

And then, at the extreme, it can even be difficult to remove a director’s name from the register in the face of fraud, such as where there has been identity theft and the person “appointed” has no knowledge of their appointment.

Whilst a wide power for Companies House to remove incorrect information will naturally require more intervention and delicate decisions for the Registrar, it will be of substantial benefit to companies and the general public.

The proposal to remove a company’s register of directors goes hand in hand with the Government’s decision to require director identity verification and may well represent the first stage in the increasing centralisation of company information.

In the UK, the definitive record of a company’s officers and owners is kept by the company itself. Although in theory open to the public, the time and procedure involved in gaining access can put all but the most determined off. Several jurisdictions, such as Singapore, have now moved to a system where the definitive records are stored centrally and available on-line.

There is naturally a balance to be struck here between promoting transparency and accessibility for the public (on the one hand) and respecting the privacy of a company’s affairs (on the other). The Government will need to craft this balance carefully when implementing any reforms.

To the extent that the definitive record of a company’s matters does start to gravitate towards the public register, the Government will need to ensure that the procedure for filing and (where necessary) correcting information remains streamlined and efficient. Experience informs us that, where an authority is given responsibility for safeguarding or guaranteeing the legal significance of a given matter, the process of making any changes can often be burdensome or take time.

The Government has asked for comments on its proposals by 3 February 2021.

Government consults on improving the quality of company accounts

The UK Government has published a consultation on ways to improve the “quality and value” of financial information kept on the companies register at Companies House.

What is the current position?

Currently, UK companies must prepare a set of accounts (comprising a balance sheet (or statement of financial position) and a profit and loss statement) and a series of reports for each of their financial years and file a copy of those accounts and reports at Companies House.

The types of report a company needs to prepare and the contents of those reports depend on various matters, including the size of the company and whether any of its securities are admitted to trading on a securities exchange. Reports required by UK law include (depending on the company) a directors’ report, a strategic report and a directors’ remuneration report.

Private limited companies must file their accounts and reports at Companies House within nine months of their financial year-end (their so-called “accounting reference date”). Public companies have six months, although listed companies must publish their financial statements to the market within four months of financial year-end. These deadlines have been extended during the Covid-19 pandemic. All companies have 12 months from financial year-end to file their accounts with HM Revenue & Customs (HMRC).

Accounts can be filed at Companies House either in paper form or electronically. Once published, they are stored indefinitely and available to the general public free of charge.

Similar obligations apply to limited liability partnerships (LLPs) and some partnerships.

What is the Government proposing?

The Government believes there are opportunities to improve the way in which companies publish and file their accounts and reports. It is therefore seeking views on suggested reforms.

A main driver of the reforms is to harmonise the procedure for filing financial information at a variety of places, including Companies House and HMRC, making the procedure simpler for companies and making it easier for Government agencies and others to extract relevant financial data.

The reforms on which the Government has asked for views include the following.

• Digitisation. The Government is proposing to require all company accounts to be filed digitally. It says that, currently, 15% of companies – mainly larger companies – still file paper accounts at Companies House, meaning their financial information cannot be easily extracted, shared and analysed, even though they file digital accounts with HMRC.
• iXBRL tagging. The consultation proposes to introduce a requirement for company accounts to be fully tagged using iXBRL. (See XBRL’s website for more information on iXBRL.) Full tagging to iXBRL is already mandatory for accounts filed with HMRC and in certain other jurisdictions, and will be mandatory across the European Union from 2021.
• Deadline for filing accounts. The Government believes that advancements in technology have made it quicker to prepare accounts. It is therefore asking for views on shortening the periods for companies to file their accounts and reports with Companies House. One suggestion is to reduce the periods for private limited and public companies to six and three months respectively.
• Company size thresholds. Medium-sized, small and “micro” companies can include less information in their accounts than large companies. Size is determined by the company’s turnover, size of balance sheet and number of employees, but it is not always possible to tell what these are from a company’s accounts. To enable Companies House to validate that companies are filing under the right size category, the Government is proposing to require company accounts to state these metrics and to require its directors to certify that it is eligible to file in the category it is claiming.
• Level of detail. The Government is concerned that accounts prepared by small and micro-companies contain insufficient detail to be useful to the public and, in some cases, are being prepared when the company does not qualify. It also notes that some companies prepare accounts with varying levels of detail for different Government bodies. It is therefore asking for ways in which the small and micro regimes can be simplified and whether a company should be required to file the most detailed version of any accounts it prepares with all relevant bodies.
• Presenting financial information. Finally, the Government has asked for views in which companies’ financial information could be shown at Companies House in a more accessible way.

The Government has asked for comments on its proposals by 3 February 2021.

Also this week…

• QCA publishes updated Remuneration Committee guidance. The Quoted Companies Alliance (QCA) has published an updated version of its Remuneration Committee Guide, which was last updated in 2016. The 2020 guide adopts a new structure but preserves much of its predecessor’s content. New areas of focus include extending the remcom’s remit to senior managers, communication with shareholders, and additional factors to consider when setting remuneration policy. The 2020 guide is available direct from the QCA for a fee.
• FRC announces areas of focus for 2021/22. The Financial Reporting Council (FRC) has announced its corporate reporting and audit quality review programme and its priority sectors for review for 2021/22. Key areas of focus for the FRC in corporate reporting will include going concern and viability, streamlined energy and carbon reporting (SECR), alternative performance measures (APMs) and interim reporting. The FRC intends to focus, in particular, on the travel, hospitality and leisure, retail, property and financial services sectors.
• FRC publishes December Lab Newsletter. The Financial Reporting Council (FRC) Financial Reporting Lab has published issue 4 of its Lab Newsletter. The newsletter contains an update on the Lab's projects and a round-up of its recent reports and guidance.
• London Stock Exchange updates rulebooks for end of Transition Period. The London Stock Exchange has published Market Notice N20/20, announcing that it has updated its rulebooks in readiness for the end of the UK/EU transition period at 11:00 p.m. on 31 December 2020. The changes are all technical and so the Exchange has not consulted on them. The Exchange has published mark-ups of its Admission and Disclosure Standards, AIM Rules for Companies, AIM Rules for Nominated Advisers and International Securities Market (ISM) Rulebook. Separately, the Exchange has published Market Notice N21/20, announcing changes to its secondary market rulebooks. The changes all come into effect on 1 January 2021.