Corporate Law Update

• The Government sets up a taskforce to examine regulatory reform in the UK
• Sir James Wates CBE publishes an article on reporting to date against the Wates Principles
• The High Court examines when a derivative claim can be made, against whom and for what kinds of loss
• The House of Commons Library produces a useful briefing note on registers of beneficial ownership
• The Chartered Governance Institute publishes its views on the FRC’s proposed new principles-based reporting framework
• The City of London Law Society publishes its views on the proposed new reporting framework
• The Law Society and City of London Law Society (CLLS) respond to the Government’s consultation on the ban on corporate directors
• The Law Society and CLLS respond to the Government’s consultation on the improving the quality of financial information at Companies House
• The Law Society and CLLS respond to the Government’s consultation on reforming the powers of Companies House
• The Investment Association responds to the European Commission’s consultation on the AIFM regime

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.

Government sets up taskforce to examine regulatory reform

The Government has announced that it is setting up a new taskforce to explore and propose options for regulatory reform to stimulate business dynamism and innovation, and to ensure that the UK’s markets are open and competitive and that businesses can scale up efficiently.

According to its terms of reference, the new Taskforce on Innovation, Growth and Regulatory Reform (TIGRR) will focus on the following themes in particular:

• Opportunities to drive innovation and accelerate the commercialisation and safe adoption of new technologies, cementing the UK’s position as a global science and technology superpower.
• Opportunities to reduce barriers to entry in specific markets and make markets more dynamic and contestable across the economy.
• Opportunities to reduce administrative barriers to scaling up productive businesses, and to tailor any necessary processes to the needs of UK start-ups and SMEs while maintaining the Government’s commitment to high environmental standards and worker protections.
• Opportunities to improve small business’ experience of necessary regulatory requirements.
• Sectors of the economy or regulatory frameworks which should be prioritised for further regulatory deep dives.

The Taskforce will not consider the Government’s broader approach to better regulation (i.e. the targets for deregulation and the metrics used to measure progress towards them) or departmental responsibilities in respect of regulation.

The scope of the Taskforce’s work naturally entails a potential legal impact in certain areas and could have a significant effect on corporate reporting, start-up investment and the UK’s capital markets. We will be monitoring the recommendations of the Taskforce in due course.

The Taskforce is being asked to report back to the Prime Minister in April 2021. The Government states that the Taskforce can be contacted at tigrr@cabinetoffice.gov.uk and welcomes submissions on opportunities to drive growth and innovation through regulatory reform.

Update published on reporting against the Wates Principles

Sir James Wates CBE, Chairman of the Coalition group that introduced the Wates Principles, has published an article on how companies have been reporting against the Principles to date.

For financial years beginning on or after 1 January 2019, companies that satisfy two or more of three conditions (balance sheet total above £2 billion, turnover above £250 million and more than 2,000 employees) have been required to publish a corporate governance statement, stating which corporate governance code they have adopted or explaining what other arrangements they have put in place.

The Wates Principles – formally, the Wates Corporate Governance Principles for Large Private Companies – were introduced in December 2018 as a set of guidelines for companies to use to satisfy this reporting requirement. The Principles operate on an “apply and explain” basis: rather than simply stating which Principles they have and have not complied with, companies are encouraged to explain in detail how they have applied them. For more information, see our previous Corporate Law Update.

The key points arising out of Sir James’ article are as follows:

• The article singles out a handful of very large companies and subsidiaries as good examples of companies that have reported against the Wates Principles.
• The article praises one company which provided not only a 20+ page corporate governance statement, but also a helpful one-page overview with cross-references to the main statement.
• Another company used graphs and charts effectively to add helpful detail to its narrative.
• Several companies were praised for using their statement to address issues their boards are grappling with, including one company whose application of the Wates Principles led to it reassessing its remuneration committee’s terms of reference.
• However, one particular weakness the articles identifies is the statement of purpose. Although companies generally stated what their purpose is, reporting “lacked a sense of authenticity”, sounding more like marketing material than an account of company governance.
• In addition, few companies made their corporate governance statement easily accessible on their website. The article encourages companies not simply to embed their statement in the annual report, where it may be more difficult for a broad range of stakeholders to find.

Nonetheless, Sir James expresses optimism that companies will become more comfortable with the process of applying the Principles and so will improve the quality of their reporting. The article notes that the Financial Reporting Council and the Coalition Group will work together to monitor reporting to date and to highlight and promote good practice.

Court examines the scope of derivative claims against directors

The High Court has clarified the scope of actions that can be brought against a director of a company under a so-called derivative claim.

What happened here?

Hughes v Burley and others [2021] EWHC 104 (Ch) concerned a property development company (Nida) set up by two individuals – Mr Hughes and Mr Burley – who became directors and equal shareholders in the company.

Mr Hughes agreed to provide the technical expertise required to carry on Nida’s property development activities. Mr Burley agreed to provide finance to Nida, which he did by way of a loan, secured over three properties that Nida had acquired.

In due course, the relationship between the two individuals broke down. On becoming concerned that Nida would fail to generate a profit, Mr Burley decided to call in his loan. He appointed an independent receiver over the properties to sell them to realise proceeds to pay off the loan.

In the event, ten days after his appointment, the receiver sold two of the properties to a company owned by Mr Burley (Burprop) and entered into a development agreement with Burprop in relation to the third property. In each case, the receiver did not obtain a formal valuation of the property.

Mr Hughes began legal proceedings. In broad outline, the thrust of his complaint was that Mr Burley and the receiver had not explored ways to continue the business, that the properties had been sold below market value (disadvantaging Nida), and that Mr Burley and the receiver had acted improperly by selling the properties to a company connected with Mr Burley without obtaining a formal valuation.

As part of this, Mr Hughes asked the court for permission to pursue several derivative claims on behalf of Nida. These were complex and Mr Hughes’ allegations can be broken down into three categories, which we have set out below.

• Claims under a joint venture agreement. Mr Hughes argued that he and Mr Birley had entered into a joint venture agreement (JVA), under which Mr Burley assumed fiduciary duties and an implied duty of good faith in favour of Mr Hughes. He also alleged that, by virtue of the Contracts (Rights of Third Parties) Act 1999 (the 1999 Act), Nida could rely on these contractual terms and enforce them directly against Mr Burley, in turn enabling Mr Hughes to bring a derivative claim.
• Claims against Mr Burley as a director. In addition to duties under the JVA, Mr Hughes also owed Nida fiduciary and statutory duties by virtue of being a director of Nida. For the same reasons, he had breached those duties.
• Claims against the receiver. The receiver was under a duty to act equitably when marketing and selling the properties. By failing to obtain a valuation for the properties, and by selling them so quickly to a person connected with a director, the receiver had breached that duty.

In essence, the court had to answer three questions:

• Was it at least arguable that Mr Hughes’ claims on behalf of Nida might succeed?
• Was it required to refuse permission for the derivative claim?
• If it was not required to refuse permission, should it exercise its discretion to do so?

What did the court say?

The case is complex. Mr Hughes sought permission to bring a number of claims against various different parties. Much of the decision is quite particular to the facts of the case, and the court’s role was merely to decide whether Mr Hughes had an arguable case, rather than the decide the claim definitively one way or the other

Nevertheless, the judge made some interesting observations that are worth noting in the context of a derivative claim:

• A derivative claim is available where a director commits a breach of contract. Although the Companies Act 2006 refers to “negligence, default, breach of duty or breach of trust”, breach of contract is a type of breach of duty (namely a breach of contractual duty).
• A derivative claim may be available in relation to acts which a director commits outside of their office (for example, as a “co-venturer”). The Companies Act 2006 contemplates a derivative claim against a director “or another person” where the claim arises out of acts “by a director”. This does not preclude a claim against a director acting in some other capacity.
• Following recent similar cases, such as Al Nehayan v Kent [2018] EWHC 333 (Comm), it was at least arguable that the JVA (if it existed) contained an implied duty on Mr Burley to act in good faith. But it was less likely that it imposed fiduciary duties on him in favour of Mr Hughes.
• Given that any benefit of the development projects depended on Nida’s success, it was arguable that Nida had the benefit of any obligations owed by Mr Burley under the JVA (if it existed) by virtue of the 1999 Act, and that Mr Hughes could enforce them through a derivative claim.
• Although the receiver was independent of Mr Burley and Burprop, he had given only a “relatively sparse explanation” for his actions. A derivative claim against him was not so hopeless that a director promoting Nida’s success would reject it out of hand.
• If successful, the economic benefit of the claims at least “could” outweigh any reputational damage to Nida. The court was not, therefore, required to reject the claim automatically. Instead, the judge would need to consider whether to use his discretion to dismiss it.

The court therefore had to assess various factors to decide whether to exercise its discretion to refuse permission for the derivative claims. The judge made the following comments:

• Mr Hughes was not acting in bad faith. Although he had also brought claims in his own name, the proposed derivative claims were not merely to benefit him personally and were the only available legal remedy, given the rule against reflective loss. (For more information on that rule, see our recent Corporate Law Update.)
• Mr Hughes’ claims were “speculative”. The court was being asked to make findings that “lie at the outer edges of the current thinking on the nature of the duties of joint venturers”. His causes of action were not unarguable, litigation would be drawn out and expensive.
• Given that Nida would in due course be wound up, there was no real reputational risk to it arising from entering into litigation. Indeed, Nida might be taken from insolvency into a solvent position if it were wholly successful in its claim.
• However, Nida was insolvent and unable to meet the full extent of its liability to its major creditor. Even if it were successful in some (but not all) of its claims, its resulting assets would still be less than its debt to Mr Burley and it would remain insolvent. A person looking to promote Nida’s success would undoubtedly pause long and hard before deciding to proceed with the litigation.
• Although Mr Hughes proposed to fund the litigation, there was no evidence of his ability to do so. Nida was already insolvent and a hypothetical director would be concerned that an unsuccessful claim would further reduce the available assets to pay its creditors.
• If Mr Hughes had showed he had the means to fund the litigation, the judge may have been persuaded to let the claims continue. However, because he had not, the judge felt compelled to dismiss them.

What does this mean for me?

Derivative claims can be fraught with difficulty. A court will tread with caution before allowing a member of a company to commit the company to potentially expensive and unmeritorious litigation, particularly if the member may, in reality, be trying merely to advance their own interests.

This case shows how close it is possible to come to persuading the court to allow a derivative claim to begin, only to fall at a single hurdle. On the one hand, the judge was persuaded that each of Mr Hughes’ claims had enough weight to proceed to trial. However, the potential financial damage to Nida, exacerbated by the fact that Mr Hughes had not shown how he would fund the litigation, proved fatal.

The prospect of bringing a derivative claim can often seem enticing to a member of a company. However, if contemplating bringing a derivative claim, a member should bear certain things in mind:

• Does the member have a personal right of claim? A court is much less likely to allow a member to bring a claim in the company’s name if they could do so in their own name instead (and so personally bear the risk of an unsuccessful claim).
• Does the member have any other remedies available? For example, does the member hold sufficient voting rights in the company to remove the board and appoint new directors who will initiate proceedings against any wayward directors? If so, the court may be reluctant to grant permission. For this reason, it may be difficult for a majority shareholder to bring a derivative claim.
• Does the derivative claim have any merit? The court is highly unlikely to allow a claim to proceed which the company has little to no chance of winning. Indeed, the court must refuse the claim if no director looking to promote the company’s success would continue with it.
• How will the claim be funded? A court will be inclined to refuse permission if the claim could cause the company to incur significant costs if it loses. It may be more persuaded to allow a claim if the claimant can provide substantial resources and indemnify the company for any losses.
• What is member sentiment towards the claim? If the company’s members are indifferent to the directors’ alleged transgressions, it is quite possible the court might conclude that they would ratify any breach of duty or trust. This will likely form a bar to the claim.
• What is the member trying to achieve? It is all very well bringing a derivative claim, but any damages awarded if the claim is successful will belong to the company, not the member. That may swell the value of the member’s interest in the company, but it will not put money directly into the member’s hands. Indeed, if the company is insolvent, it may have no commercial benefit to members at all. In this case, a derivative claim may serve little or no purpose.

At the time the statutory procedure for bringing a derivative claim was introduced in the Companies Act 2006, there was concern that it could generate a large number of claims for breach of directors’ duties, including many vexatious claims. In fact, there have been few reported derivative claims. This case perhaps illustration why that is and how difficult it can be to bring a derivative claim.

House of Commons Library publishes briefing on registers of beneficial ownership

The House of Commons Library has published a briefing on registers of beneficial ownership. The paper covers regimes within the UK, including the persons with significant control (PSC) regime, as well as comparable regimes around the world.

Under the UK’s PSC regime, certain types of UK entity, including companies, limited liability partnerships (LLPs) and certain Scottish partnerships, must investigate the identity of persons who control or hold a significant economic interest in them. Although commonly described as a regime for disclosing “beneficial ownership”, the regime also extends to non-economic control.

The briefing paper contains the following:

• An explanation of the concept of “beneficial ownership” and a high-level summary of the UK’s PSC regime.
• A summary of recent calls for improvements to the UK’s PSC regime, including new powers for Companies House to verify the identity of PSCs. To this end, the Government published a consultation in December 2020 to give Companies House more power to verify a range of filings it receives, including in relation to PSCs. For more information, see our previous Corporate Law Update.
• A summary of the Government’s plans to introduce a new “Overseas Entity Beneficial Ownership” (OEBO) regime, which would require non-UK entities to file information on their beneficial owners if they intend to hold UK real estate or participate in a public tender in the UK. To this end, in July 2018 the Government published a draft Bill for consultation. For more information, see our previous Corporate Law Update. We await the Government’s next steps on this proposal.
• A very high-level summary of the UK’s Trust Registration Service (TRS), under which taxable trusts and certain types of non-taxable express trust are required to provide HM Revenue & Customs with certain information, including details of their beneficiaries. For more information, see our previous Corporate Law Update.
• Details of the availability of beneficial ownership information in the UK’s overseas territories (such as Bermuda, the British Virgin Islands and the Cayman Islands) and the Crown Dependencies (Jersey, Guernsey (including Alderney, Herm and Sark) and the Isle of Man).
• Finally, an overview of European Union legislation requiring the publication of beneficial ownership and selected statistics on implementation in EU Member States.

Also this week…

• ICSA responds to FRC proposals to reform corporate reporting. The Chartered Governance Institute has published its views on the recent proposal by the Financial Reporting Council (FRC) for a new “principles-based framework” for corporate reporting. (For more on that proposal, see our previous Corporate Law Update.) Whilst the Institute agrees that the proposal is attractive, it expresses concerns about moving from a model in which all information is accessible in a single place to one under which information is divided up and discrete elements could be overlooked.
• CLLS response to FRC proposals to reform corporate reporting. The City of London Law Society has also published its views on the FRC’s recent proposals (see above). The Society supports the FRC’s goal of seeking improvements in the quality and effectiveness of corporate reporting. However, it also raises concerns that the proposed new framework could extend the potential liability of directors towards stakeholders other than shareholders, and that having multiple reports could make information more difficult to locate. In summary, it favours retaining the existing regime.
• CLLS and Law Society respond to consultation on corporate director ban. The Company Law Committees of the Law Society and the City London Law Society have published a joint response to Government’s recent consultation on exceptions to the forthcoming ban on corporate directors of UK companies. (For more on that consultation, see our previous Corporate Law Update.) The Committees believe that the Government’s proposals strike a broadly pragmatic and workable balance, but note potential difficulties in applying the ban to corporate directors that are incorporated overseas and oppose the extension of the ban to corporate members of limited liability partnerships (LLPs) and limited partnerships (LPs).
• CLLS and Law Society respond to consultation on quality of financial information. The Company Law Committees of the Law Society and the City London Law Society have published a joint response to Government’s recent consultation on improving the quality of company financial information filed at Companies House. (For more on that consultation, see our previous Corporate Law Update.) The Committees support proposals to digitise the submission of company accounts and to introduce iXBRL tagging, but note that any proposals should be accessible to companies of all sizes, should not extend the liability of directors beyond the existing reporting regime and should not impose a significant administrative burden or cost on companies. The Committees also note that any shortening of deadlines for filing company accounts needs to be considered in light of companies’ relative resources and any potential resulting decrease in the quality of corporate reporting.
• CLLS and Law Society respond to consultation on the powers of the companies registrar. The Company Law Committees of the Law Society and the City London Law Society have published a joint response to the Government’s recent consultation on reforming the powers of the UK’s Registrar of Companies. (For more on that consultation, see our previous Corporate Law Update.) The Committees support proposals to increase the Registrar’s powers to combat fraud. However, they believe that the procedure for querying filings and responding to queries must be clear, any powers should be exercised on a risk-based approach after a filing has been registered so as not to delay filings, and that filings that have legal effect should not be removed or amended except with the court’s sanction.
• Investment Association responds to consultation on AIFM regime. The Investment Association (IA) 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 response takes the form of both responses to the Commission’s questionnaire and a separate response sheet. Broadly, the IA is very satisfied with the way the current AIFM regime functions.