Corporate law update: 6 - 12 August 2022

In this week’s update: digital security risk reporting by companies, a founder shareholder was unfairly prejudiced when he was excluded from the management of a company, a risk to reputational damage could be taken into account when calculating damages, even though it never materialised, a request for views on a new legal statement on digital securities and the FCA issues a fine for the unlawful disclosure of inside information.

• The UK's new Register of Overseas Entities has now gone live
• The FCA and the FRC publish separate reviews of TCFD reporting by premium-listed companies
• The Law Commission consults on creating a new type of property in English law, called "digital assets"
• The FCA confirms new rules to strengthen the UK's financial promotions regime
• Companies House publishes its corporate plan for 2022/2023

Register of Overseas Entities goes live

The UK's Register of Overseas Entities has now gone live.

Under the regime, an overseas entity that holds certain types of real estate in the UK will need to register with Companies House and provide details of its "beneficial owners" and (in some cases) managing officers and any trusts that sit within its corporate structure.

Overseas entities that already hold a qualifying estate in England and Wales (namely, a freehold estate or a lease granted for a term of more than seven years from the date of grant) now have until 31 January 2023 (inclusive) to register under the regime. Failure to register by that date is an offence.

From 5 September 2022, an overseas entity will not be able to acquire a qualifying estate in England and Wales unless it has first registered under the regime.

Before an overseas entity can apply to register with Companies House, the information it is required to provide must be verified by a regulated person.

For more information on the regime, see this explainer from Companies House or speak to your Macfarlanes contact.

FCA and FRC review TCFD disclosures by listed companies

The Financial Conduct Authority (FCA) and the Financial Reporting Council (FRC) have both published the results of reviews they have undertaken into disclosures by premium-listed companies against the recommendations of Financial Stability Board's Taskforce on Climate-related Financial Disclosures (the TCFD Recommendations).

The TCFD was created in 2015 to develop recommendations for climate-related disclosures. In June 2017, it published its Final Report, setting out four recommendations and eleven supporting recommended disclosures (the TCFD Recommendations). These have quickly become a globally recognised framework for developing consistency in climate change reporting.

Under the FCA's Listing Rules, for financial years beginning on or after 1 January 2021, premium-listed commercial companies must state, in their annual report, whether they have made disclosures consistent with the TCFD Recommendations.

If a company does not disclose against a particular TCFD Recommendation, it must explain why and set out the steps it plans to take to do so in the future.

When deciding whether it has disclosed properly against the TCFD Recommendations, a company must take into account the guidance annexed to the TCFD Recommendations.

What did the FCA find?

The FCA's review involved a preliminary quantitative analysis of disclosures by all 171 premium-listed commercial companies with a December 2021 year-end that had published their annual report by the end of April 2022. The FCA then conducted a more detailed analysis of 31 of those companies, including a comparison with any disclosures they made in the previous reporting period.

The key findings from the FCA's review as set out below.

• Over 90% of companies self-reported that they had made disclosures consistent with the TCFD's Governance and Risk Management pillars, but this dropped to below 90% for the Strategy and Metrics and Targets pillars. 81% of companies indicated that they had made disclosures consistent with all recommended disclosures.
• In some cases, companies indicated that they had made disclosures consistent with the recommended disclosures, but the disclosures themselves were "very limited in content". The FCA is considering these in more detail and may take action as appropriate.
• The number of companies making disclosures that were either partially or mostly consistent with the TCFD framework increased significantly compared with 2020.
• The most common reporting gaps were in respect of the more quantitative elements of the TCFD's recommendations, such as scenario analysis and metrics and targets.
• Details and consistency of disclosures often correlated with sector, size and risk assessment, including the extent to which that company had identified climate change as among principal risks.
• Most companies (76%) sited their disclosures in their strategic report, with a significant minority (18%) referring to disclosures published outside the annual report framework.
• 80% of companies made a "net zero" statement in their report, with target dates for achieving net zero ranging from between 2035 to 2060 (with 2040 and 2050 the most common targets).
• 64% of companies identified climate change as a "principal risk", with a further 19% identifying it as an "emerging risk".

The FCA has said it is "encouraged" by an overall improvement in disclosures against the TCFD framework. However, it has provided guidance to companies of its expectations surrounding disclosures and reminded standard-listed companies that the regime now applies to them too.

What did the FRC find?

The FRC's review was more limited and covered the financial statements of 25 premium-listed companies. It is more narrative and focusses more on the link between TCFD disclosures and a company's financial disclosures.

The key findings from the FRC's review are set out below.

• The FRC encountered some high-level, generic information about climate change that did not adequately explain the potential impact on different businesses, sectors and geographies. It expects the granularity of disclosures to improve as companies embed their processes to manage climate-related risks and opportunities more fully into governance and management structures.
• Some disclosures failed to specify the expected size of climate-related opportunities relative to existing, more carbon-intensive, businesses, or to identify dependencies on new technology. the FRC expects companies to present a balanced view and consider linking the description of climate-related opportunities to any technological dependencies.
• Some TCFD disclosures were not well integrated with other elements of narrative reporting. The FRC expects companies to consider including interlinkages. This might include integrating scenario analysis output with business model and strategy or explaining how climate-related risks have been prioritised compared with other risks.
• Companies did not always explain how they had applied materiality to their TCFD disclosures nor make it clear how, or whether, they had taken TCFD guidance into account. The FRC expects companies to clearly articulate how they have considered materiality when making disclosures and may challenge companies that claim consistency without reference to the TCFD guidance.
• Sometimes discussion of the impact of climate on the financial statements was generic and unhelpful in understanding the relationship between climate risks and amounts in the financial statements. The FRC expects companies to consider whether the emphasis placed on climate risks in their narrative reporting is consistent with how those risks are reflected in judgements and estimates applied in the financial statements.
• The FRC also expects companies to ensure emissions reduction commitments and strategies described in their narrative reporting are appropriately reflected in the financial statements.

Law Commission consults on reform to recognise digital assets

The Law Commission has published a consultation on proposed changes to the law relating to digital assets, such as crypto-tokens.

The consultation runs to over 500 pages, so the Commission has also published a useful summary of its proposals and findings.

The consultation notes that, currently, English law recognises two types of personal property (that is, properly which is not land and buildings):

• Things in possession. These are physical items which can be moved and delivered to other persons. The summary gives the example of a bag of gold, but other examples might include a car, a mobile phone, clothing or food.
• Things in action. These are rights or property that can only be enforced by bringing legal proceedings. The summary cites debts (for example, receivables), contractual rights and shares in a company as examples. Other examples include intellectual property, money in the bank and rent due under a lease.

Among other things, the Law Commission is recommending the creation of a third kind of personal property in law called "data objects", which would cover crypto-tokens, non-fungible tokens (NFTs), but also other forms of digital asset, including digital records, email accounts, in-game digital assets, domain names and carbon emission scheme credits.

The consultation sets out certain conditions an asset would need to meet to fall within this third category, as well as how data objects could be transferred and control over them asserted.

The Commission has asked for responses to the consultation by 4 November 2022.

FCA to strengthen financial promotions regime

The Financial Conduct Authority (FCA) has published a policy statement (PS22/10) confirming that it intends to proceed with proposals for strengthening the UK's financial promotions regime on which it consulted in January (see our previous Corporate Law Update).

The proposed changes affect persons who approve financial promotions (such as financial advisers, sponsors and nominated advisers), rather than the person who communicates a promotion (such as a company offering securities).

Under current FCA rules, an authorised firm that communicates a financial promotion must ensure that the promotion continues to comply with the financial promotion rules for the lifetime of the promotion. However, a firm that approves a communication by an unauthorised person is not required to withdraw their approval unless they become aware that the promotion no longer complies with the rules (a right typically expressly reserved in the relevant engagement letter).

The FCA has confirmed it will strengthen its rules in three respects:

• Ongoing monitoring. A firm that approves a financial promotion will need to take "reasonable steps" to monitor the promotion's continuing compliance for the lifetime of the promotion.
• "No material change" attestations. Every three months during the entire lifetime of the promotion, the firm will need to collect an attestation of "no material change" from the client whose promotion it has approved.
• Competence and experience (C&E). Persons who approve financial promotions will need to self-assess whether they have the necessary C&E in relation to the investment product to which the promotion relates.

The changes take effect from 1 February 2023.

Companies House publishes 2022/2023 corporate plan

Companies House has published its corporate plan for 2022/2023. The plan contains information on the structure of Companies House, as well as initiatives it intends to work on in the forthcoming year.

Matters on which Companies House intends to focus include implementing the Register of Overseas Entities (see item above), preparing for the new Companies House transformation project (including new identity verification and powers to query information submitted to it), and moving away from legacy systems and developing new services.

What did the court say?

The court agreed that there had been unfair prejudice.

A critical question was whether the parties had created a "quasi-partnership" between them. In this case, the court said that IAEP was a quasi-partnership, because all its shareholders were entitled to be directors and take part in its management. This was underscored by the fact that the parties undertook express duties of good faith to each other and agreed not to compete with each other.

This conclusion was not changed by the fact that the shareholders' agreement contained a standard clause stating that the parties had not intended to create a partnership. It was evident that IAEP, as a company, could not be a partnership, but this did not mean there was no quasi-partnership.

This meant that the court was able to consider a wider range of conduct when deciding whether unfair prejudice had taken place. The judge reached the following conclusions.

• By the time of the alleged failure to initiate negotiations between IAEP and SES, the opportunity to acquire the further Lines required to present the entire turnkey solution had disappeared, and so there was no real basis for negotiations for a sale to IAEP or a third party. Mr Dodson could not, therefore, have suffered any prejudice. (The court therefore declined to rule on whether the parties had breached their duties of good faith.)
• Making the library available to CGI and SES at no cost, when the library had considerable value to IAEP, was a clear breach of fiduciary duty and amounted to unfair prejudice to Mr Dodson as a shareholder of IAEP.
• Arranging for the turnkey services to be provided by CGI, rather than IAEP, was a "clear breach" of the business promotion and the non-compete clauses, which again amounted to unfair prejudice to Mr Dodson as a shareholder of IAEP.

What does this mean for me?

Unfair prejudice claims are very fact-specific. However, this is a good illustration of the court applying established principles when deciding whether unfair prejudice has occurred.

The case also shows the dangers of side-lining a founder from a business. Generally, shareholders have no right to take part in a company's business and excluding a shareholder from doing so will not give rise to a claim. But where a business is set up on the basis that all shareholders will be entitled to a say in how it is run, preventing a shareholder from taking part may well give rise to unfair prejudice.

When looking to take a proposed course of action, therefore, companies, directors and significant shareholders should ask certain questions.

• Would the proposed action breach any terms of the company's constitution? If so, there is a greater risk of unfair prejudice. In this respect, it is important to remember that a company's constitution comprises not only its articles of association, but also any special resolutions and, potentially, other agreements between the company and its shareholders, such as a shareholders' agreement, investment agreement or joint venture agreement.
• Would the proposed action amount to a breach of duty by the directors? Directors owe their statutory and fiduciary duties to the company itself, and normally it is the company which must sue for any loss. But if the breaches become part and parcel of the company's conduct, they may well tip over into unfair prejudice and entitle an aggrieved shareholder to petition for relief.
• Was the company set up on a mutual understanding that all shareholders would be allowed to take part in management? If so, acting contrary to that understanding risks exposing the company to an unfair prejudice petition, even if the company and directors are acting in full compliance with the company's constitution and their statutory duties.
• Will the proposed action actually cause any individual shareholders or group of shareholders damage or loss? If not, it will be harder for a shareholder to show that they have suffered any prejudice.

Court of appeal clarifies calculation of breach of warranty damages

The Court of Appeal has clarified the circumstances in which it is possible to take account of a contingency that has not in fact materialised when calculating damages for breach of warranty.

MDW Holdings Ltd v Norvill and others [2022] EWCA Civ 883 concerned the share sale of a waste disposal company.

Following the sale, the buyer discovered that the business had contravened various environmental regulations. This in turn amounted to breaches of warranties in the sale agreement, including that the business had been conducted in accordance with all applicable laws and regulations.

The buyer sued the sellers for breach of warranty and in the tort of deceit. The High Court agreed that there had been a fraudulent breach of warranty and awarded the buyer damages. For more information on the High Court's decision, see this Corporate Law Update (in relation to deceit) and this Corporate Law Update (in relation to breach of warranty).

The sellers appealed the High Court's calculation of those damages, arguing that the judge had been wrong to take into account a contingent risk of reputational damage to the business which the parties now knew had never in fact materialised.

The Court of Appeal dismissed the appeal, noting that the High Court had been "fully justified" in adjusting damages to reflect this risk. At the time of the sale, the existence of a risk to goodwill would have materially impacted the value of the business, even if that risk was contingent at that time and never in fact came to pass. A willing buyer would have factored that risk into any appraisal of the value of the business and "would not have been likely to pay as much for the [business]".

For more information on the case, you can read this in-depth piece by our colleagues.

Views sought for legal statement on digital securities

The UK Jurisdiction Taskforce, an initiative of Lawtech UK, has published a consultation seeking views to inform a new legal statement it intends to publish on digital securities.

The purpose of the legal statement is to support the issue and transfer of equity or debt securities on blockchain and other distributed ledger technology (DLT) systems.

The consultation lists 12 specific questions, which focus on how English law might apply existing securities rules to digital securities and how DLT might legally be used for any necessary registers of securities. It asks for comments on those questions and whether there are any other material issues the questions do not cover.

The Taskforce has asked for responses by 23 September 2022. It will also be hosting a public event on 14 September 2022 to receive feedback in person.

FCA fines on non-executive chair for unlawfully disclosing inside information

The Financial Conduct Authority (FCA) has imposed a financial penalty on the former non-executive chair of a premium-listed company for unlawfully disclosing inside information.

The individual in question was appointed as the non-executive chair of the company, which was premium-listed and admitted to the Exchange's Main Market of the London Stock Exchange (the Exchange), in October 2016.

As chair, the individual was responsible for governance over, and closely involved in the preparation of, the company's issuance of RNS announcements to the Exchange.

In October 2018, he disclosed inside information concerning an expected RNS announcement relating to the revision of the company's financial guidance and the retirement of the company's CEO. The information was disclosed to a senior individual at one of the company's shareholders, then shortly afterwards to a senior individual at another of its shareholders.

Under articles 10 and 14(c) of the European Union Market Abuse Regulation (EU MAR), which applied in the UK at the time of the disclosures, it is unlawful to disclose inside information except to the public as required by MAR or "in the normal exercise of an employment, a profession or duties". Unlawful disclosure of inside information is classified as a form of market abuse.

The FCA concluded that the individual acted negligently in disclosing the information. He had received training on EU MAR and, given his considerable experience and position, should have realised that it may have amounted to inside information. It was not in the normal exercise of his employment, profession or duties to disclose it selectively to shareholders.

It is notable that the FCA decided to impose the penalty, notwithstanding certain mitigating factors in the individual's favour. These included the following.

• At the time of disclosure, the company had not yet classified the information as "inside information", as it had been advised to seek further information so as to make an announcement.
• The company's board and brokers had been informed in advance that the individual was intending to disclose the information to shareholders.
• The company had imposed no-dealing restrictions on one of the shareholders, and the individual had imposed similar restrictions on the senior individuals to whom he disclosed the information.

The FCA imposed a financial penalty of £80,000 but declined to make a public censure.

The decision shows the significant risks involved in selective disclosure to shareholders. Although a director or senior executive may genuinely feel that disclosure is appropriate and may enhance stakeholder relations, this kind of behaviour will almost certainly fall foul of market abuse restrictions in the UK (now embodied in the UK version of the Market Abuse Regulation).

Separately, it could also give rise to allegations that directors have treated some shareholders more preferentially than others, or that they have breached their duty in section 172 of the Companies Act 2006 by failing to consider the need to act fairly as between members of the company.

Before disclosing any confidential information to shareholders or other stakeholders, a director should discuss with the other directors and the company's sponsor or brokers whether the information is likely to amount to inside information.

The views of the company's financial advisers will be key to this question, as they are in a more objective position to advise on whether the information, if made public, would be likely to have a significant effect on the price of the company's shares.