Big Changes Proposed As Company Law Review Enters Final Phase

The Company Law Review, launched by the DTI in March 1998 under the banner Modern Company Law for a Competitive Economy, is moving towards its scheduled final report in May 2001 (leading, it is expected, to a White Paper in 2001). The Steering Group has produced a number of consultation papers over the period, including three long "strategic" documents addressing a wide range of issues. The last of these, Completing the Structure, was published in November 2000 and signals the final stage of the Review.

As well as refining proposals put forward in earlier documents, Completing the Structure (which is nearly 400 pages long) takes up a number of issues for the first time. Some major changes are proposed. We touch briefly on the salient areas for change below, but this is not a comprehensive overview of the document. We have not, for example, touched on areas where the Steering Group has dropped earlier proposals or, having consulted, has decided that no change is needed.

The Companies Commission

A new institutional structure to underpin a new Companies Act is proposed. The devolution of areas to a rule-making body is intended to make it easier to keep the law up to date through secondary legislative and rule-making powers. The Companies Commission would have continuing oversight of developments in company law. It would prepare an annual report on the state of company law and advise on proposals for new legislation (including secondary legislation) and on other topics referred to it by Ministers. This inherent flexibility would, for example, enable the Companies Commission to monitor the operation of the Combined Code and determine how or whether it should be amended or extended to unlisted companies.

Subsidiary bodies would be responsible for setting detailed rules on both accounting and reporting and other areas delegated to it (such as rules on the conduct of AGMs or corporate governance codes); enforcing reporting and accounting requirements; and ensuring that due account is taken of the needs and concerns of private companies. There are also proposals for a specialist tribunal to hear cases brought by the enforcement body.

Corporate Governance

It is proposed that there should be a statutory statement of directors' duties, requiring directors to promote the success of the company in the interests of its members, but taking account of all relevant considerations. This would include having regard to the long and short term implications of decision-making, and the impact on wider relationships, such as those with employees, suppliers, customers and the wider community. There would be a hierarchy of obligations, with the interests of these wider relationships ranking after promotion of the shareholders' interests. It is also suggested that the statement should include a comprehensive statement of remedies for breach of directors' duties.

Improved transparency would be achieved by requiring the annual accounts of all quoted companies, public companies with a turnover exceeding £5 million and private companies with a turnover exceeding £500 million, to include an "operating and financial review" (OFR), covering all that is (in the directors' view) material for those reading the accounts to make a proper assessment of performance and future plans and prospects. The OFR would be a qualitative, as well as financial, evaluation and would include, where relevant, relationships with employees and others, and community and environment issues (including, for example, details of convictions for breach of environmental requirements). The process followed in preparing the OFR would be audited. The increased level of transparency would feed through to takeovers, leading to disclosure in offer and defence documents of the effect of the offer on OFR matters.

Public companies would be obliged to disclose the training and experience of directors by including this in the biographical details of candidates for election or re-election provided with the notice of meeting. In the case of non-executive directors, there would be an additional requirement to disclose links with the company and individual members of its board.

The idea is floated that companies should be required to disclose significant commercial relationships with investors controlling more than 3% of the voting rights, and to record those investors' votes. Institutional investors would be required to disclose how their votes had been exercised, and fund managers would have to maintain records of their voting and allow inspection by investors, trustees and public authorities. There would be independent audit of voting on shareholder-sponsored resolutions. Reactions are sought as to whether there should be a new criminal offence prohibiting companies or their officers from using commercial pressure to induce a shareholder to change his intentions as to voting or in relation to an offer for his shares.

Directors' interests etc

Relationships of influence or control between a director and another person or body (for example, a shareholder whose nomination of the director had secured his appointment) would be required to be disclosed.

The obligation on directors to disclose their interests in contracts or arrangements with the company would be confined to material interests and would not include matters already known to the other directors (such as self-evident interests under a director's service agreement).

It is proposed that, subject to an initial term of three years, a director's contract of employment should be for no more than one year unless approved by shareholders.

Loans to directors which would be prohibited under the present law would be permissible with shareholder approval.

The DTI and Companies House are encouraged to explore the scope for enabling directors to put a service address on the public record, with their residential address being available only to certain regulatory and enforcement agencies, or on the order of the court.

Shareholders' rights

In recognition of the increasing trend for holding shares through nominees, it is proposed that companies should be allowed (although not obliged) to let registered holders give notice that certain membership rights (such as voting, appointment of proxies, receipt of communications and distributions, attendance at meetings and the proposal of resolutions) are to be exercised by another person. Members would also be allowed to appoint proxies for each underlying beneficial holding. As already permitted for companies whose shares are in CREST, all companies would be permitted to set a "record date" in order to determine who is entitled to receive notice of meetings or to attend and vote.

It is proposed to allow public companies in their annual returns to omit details of members who do not have a notifiable interest (broadly, at least 3%).

It is proposed that a public company should be allowed to dispense with AGMs by unanimous shareholder resolution, and that there should be a uniform 14-day notice period for all shareholder meetings (regardless of whether the meeting is an AGM or concerns special resolutions) of public and private companies (although the 20 working days period for the AGM of a listed company, as required by the Combined Code, should remain). Proxies would be permitted to speak at meetings of public as well as private companies, and to vote on a show of hands at either. Companies would be required to bear the costs of circulating shareholder-proposed resolutions received in time for the mailing of the annual report.

There are also proposals on the ways in which minority shareholders are to be allowed to enforce their constitutional rights. Under these:

• except to the extent that the constitution provided otherwise, all shareholders would have a personal right to enforce any obligation under the constitution;
• the unfair prejudice remedy would remain, subject to the focus laid down in recent case law that, unless the shareholder is relying on breach of the articles or some other breach of duty, he must show breach of some sort of agreement which makes it inequitable to confine him to his strict rights under the constitution;
• derivative actions (taken by a shareholder in the company's name, because the wrong complained of is a wrong to the company - such as breach of duty by the directors - rather than infringement of the shareholder's personal rights) would be put on a statutory basis, extending only to breach of duty by a director. Any action would be capable of being blocked by shareholder ratification by an untainted majority.

Subject to the above, the powers of the majority would be constrained only by the requirement that decisions should be taken bona fide in the best interest of the members as a whole, in cases of alteration of the constitution or of class rights; and in all cases, by the disqualification of those seeking to ratify or otherwise prevent the pursuit of their own wrong or a wrong done by a person to whose influence they are subject.

Proposals applicable to small and private companies only

The main focus is on simplifying the law for private companies. Proposals include:

• a new model constitution to replace the memorandum and standard Table A articles, but disallowing the present practice of incorporating Table A (in whole or in part) by reference; instead, each company's constitution would have to be self-contained. Also, the "elective regime" (under which companies can presently dispense with holding AGMs and a number of related and other matters) would automatically apply from incorporation unless the company resolved otherwise. There would be no need, unless the company had more than one class of share, for shareholder authorisation of the directors' power to allot unissued share capital.
• removing the need to appoint a company secretary.
• allowing written resolutions to be passed by the same majority as would be required at a meeting (75% for special resolutions and over 50% for ordinary resolutions), with no requirement to notify the auditors.
• abolishing abbreviated accounts for small companies, and requiring all private companies to file accounts within seven months of the end of the accounting period. For those small companies which do not already qualify for the audit exemption (broadly, those whose turnover is between £1m and £4.8m), instead of audit an Independent Professional Review (IPR) would be required. Basically, this would involve an auditor examining the company's financial data but without the breadth of information-gathering of an audit.
• extending the exemptions to the prohibition on offers of shares or debentures to the public. Confusingly, the definition of "offer to the public" for private companies is different to the definition contained in the Public Offers of Securities Regulations 1995, which means a double-hurdle for private companies. It is felt that some of the exemptions in the 1995 Regulations (for example, that which exempts offers to 50 or fewer offerees) are inappropriate for private companies. Nevertheless, some alignment of the definitions is recommended. As a corollary, it is proposed to prohibit the listing of private company securities on investment exchanges which (unlike the London Stock Exchange) might otherwise permit this.
• allowing companies in their annual returns to omit details of members whose holdings are less than 5%

Share capital

It is proposed that the prohibition on a company's providing financial assistance for the acquisition of its own shares should apply to public companies only (although possibly no longer as a criminal offence). In addition, the prohibition on post-acquisition assistance would be extended to include assistance by any person in pursuance of an agreement or understanding to acquire the company's shares, whether or not the company is a party to the agreement or understanding.

A new reduction of capital procedure which does not involve applying for court approval is proposed. Instead, the reduction would require a special resolution, backed by a solvency statement by the directors. The solvency statement would not need to be supported by an auditor's report. As a result of these simplifications, there would be no need for the convoluted provisions under which private companies can purchase their own shares out of capital, and these would therefore be repealed.

Having a stated authorised share capital (in effect, a ceiling on the directors' powers to allot) would no longer be mandatory. The terms and manner of redemption of redeemable shares would be required to be set out in the return of allotments, but would no longer have to be contained in the articles of association.

It would no longer be possible to deduct from share premium certain expenses and other amounts presently permitted.

There are also proposals to allay concerns raised by the Aveling Barford case that an intra-group sale of an asset at book rather than market value may constitute a distribution.

Reporting, accounting and audit

It is proposed that quoted companies (which includes unlisted companies whose securities are traded on markets such as AIM, OFEX and overseas markets) should publish their full annual report on their website as soon as it is available and, at the latest, within 90 days of the year end. At least 15 days must then elapse before the AGM notice is circulated to shareholders, to facilitate the tabling of shareholder resolutions. The accounts would be laid before the AGM and filed within 150 days.

Preliminary announcements, although not required to be circulated to all shareholders, would have to be published on the company's website.

For other public companies, the full annual report and accounts would be required to be laid and filed within 150 days, and distributed to shareholders within 120 days.

In relation to audit and auditors' liability; it is proposed that, if the range of the duty of care of auditors is to be extended to potential investors and creditors, the duty of the company and its directors should be similarly extended, but that claimants should be required to prove that they have taken all reasonable steps to protect themselves from loss.

Groups

Views are invited on a proposal for an optional regime which would provide less onerous reporting and auditing requirements for subsidiary companies where the parent guarantees their liabilities; and on whether the prohibition on a subsidiary holding shares in its parent should be extended to apply to entities other than bodies corporate (e.g. certain kinds of partnership) over which the parent has control.

Reconstructions, mergers and jurisdictional migration

There are proposals for streamlining the ways in which companies can restructure, and for a simpler statutory merger procedure within wholly-owned groups of companies.

Annex B (on p. 377 of the document) contains a detailed analysis, with suggested improvements, of Part XIIIA of the Companies Act, which governs the compulsory purchase of the last 10% of shares for which a takeover offer is made if the offeror obtains at least 90% acceptances. The position of overseas shareholders is discussed, and how offers might be deemed to be communicated to them without contravening overseas securities laws. Also, there is a full examination of the formalities for irrevocable undertakings to accept an offer.

"Jurisdictional migration", to enable companies to change their place of incorporation (i.e. to migrate into or out of Great Britain or to move between England and Wales and Scotland) without winding up and re-incorporation is proposed.

Sanctions

Criteria for a coherent framework of criminal and civil sanctions are set out (with "second tiers" applying where dishonesty is involved) are considered, and other ways to encourage compliance, such as warning letters and reminders, and extra-legal remedies such as "naming and shaming".

Responses

Copies of Completing the Structure can be obtained from the DTI (by calling 0870 1502 5000) or off the internet at http://www.dti.gov.uk/cld/reviews/condocs.htm

To understand Completing the Structure it is necessary to refer to earlier documents (particularly the strategic document, Developing the Framework, published in March 2000), but please note that these are no longer on the website.

Responses are requested by 28th February 2001.

For further information, please contact Martin Mendelssohn at martin.mendelssohn@cms-cmck.com or on +44 (0)20 7367 2872; e-mail; or Simon Howley at simon.howley@cms-cmck.com or on +44 (0)20 7367 3566.