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How does the Government propose to increase transparency and trust in UK Business?

About The Author

Thomas Horton (Former Writer)

Thomas studied Law at the University of Birmingham, and graduated with a 2:1 in July 2013. In the elapsed time, Thomas has worked for law firm HowardKennedyFsi LLP as a paralegal in the property department. Thomas has also been awarded a Major Scholarship by the Honourable Society of the Inner Temple and will begin the BPTC with City Law School in September 2014.

In July 2013, Secretary of State for business, innovation and skills, Vince Cable MP published a ‘Transparency and Trust’ discussion paper. The aim of the discussion was to receive views on how to improve corporate transparency and accountability in UK companies. In particular the paper focused on establishing a central register detailing beneficial ownership of companies, financial industry-specific directors’ duties, and an enhanced regime for directors who have engaged in misconduct.

The discussion paper and the Government Response (GR) highlight an attempt to bring the financial sector under political management following deregulation under the last Labour government. The wider proposals presented in the GR represent a powerful movement towards greater transparency and trust in UK business.

Central register of beneficial ownership of companies

A lack of transparency and of accountability with respect to those controlling a company erodes trust and damages the business environment. Ultimately this can hold back economic growth. (Executive Summary, GR, paragraph 6)

Whilst company law requires certain information of a company to be made publicly available, such as the identity of its directors (s. 162 Companies Act 2006) and the company’s shareholders (s. 114 Companies Act 2006), this information does not necessarily reveal who the beneficial owner(s) of the company is.

The beneficial ownership of a company is something that has previously discussed in my article Recent Decisions Avail to Clarify Piercing the Corporate Veil. Summarily, in the context of the BIS discussion paper and the GR, the beneficial ownership refers to those companies or trusts that are behind the ownership of shares in a company (i.e. to who the benefit in the shares in the company ultimately reverts to).

One of these benefits is that a company creates a separate legal entity that will be held accountable for its debts and liabilities (Salomon v Salomon [1896] AC 22). However, there are circumstances where litigants argue to “pierce the corporate veil” that a company can create in order to hold its shareholders to account. As the law currently stands following the Supreme Court’s decision in Prest v Petrodel, when a company is willingly utilised to evade a legal obligation or restriction, those utilising the company for that purpose will not receive the liability benefits enjoyed by the separate legal entity of a company.

As noted in my previous article, Lord Mance JSC in Prest stated obiter at paragraph 102:

…[O]ne would wish to hear further argument on this or any other suggested exception [to the Salomon principle], in a case where it is directly relevant.

Being able to easily determine who are the beneficial owners of a company will assist the court in determining whether or not the corporate veil should be lifted to prevent the Salomon principle being relied upon in order to facilitate fraud. A major point that is present from the GR is the intended default prohibition of corporate directors (where a company director is not a natural person (an individual) but a legal person (another company) (GR, paragraph 169). This move will provide significant progress towards greater transparency and accountability of individual directors. This requirement will additionally see the filtering out of current corporate directors after a year of the introduction of the statutory default prohibition (GR, paragraph 174).

The GR proposes that that information on individuals who ultimately own a company (such as other companies, partnerships and trusts), or control more than 25% of a company’s shares or voting rights (a blocking-minority in certain decision-making processes of a company), or who ‘otherwise exercise control’ over the company or its management, will need to be obtained and held by the company and provided to the central registry (to be maintained by Companies House). The use of the language ‘otherwise exercise[s] control’, however, could be problematic if implemented to any statutory provision that should be formulated following the GR. Indeed, creating a codified subjective test may not be of much assistance to the court for their determination of whether the corporate veil should be pierced.

It is understood that the collation of this information will be provided for by an amendment to Part 22 of the Companies Act 2006, which currently provides means for the disclosure of information about interests in a public company’s shares. An amendment to Part 22 will provide for an obligation on the company and the beneficial owner to provide full information (GR, paragraph 80) of the ownership of the company. Companies will be under an active obligation to collate information of its beneficial ownership (GR, paragraph 114). This requirement demonstrates a clear attempt to maintain regulation of companies in order to reduce the possibility of fraud occurring; regular publicly accessible (GR, paragraph 109) updates of a company’s ownership will provide the utmost transparency in UK business.

Interestingly, given the amount of non-UK companies that carry out business in the UK, the requirement to disclose beneficial interests in a company will not be extended to non-UK companies. Nevertheless, the Department for Business, Innovation and Skills (BIS) has pledged to lobby other jurisdictions to follow suit in this requirement.

The proposed way forward for the disclosure of beneficial interests in company ownership are robust, yet clearly signal the aim of the Government to make the UK the leading jurisdiction for a transparent business environment.  Following the implementation of this requirement, the GR demonstrates an intention to make the withholding of ownership information, or the willful provision of incorrect information, to be punishable as a company law criminal offence (GR, paragraph 131). The benefit and purpose of establishing a central register of beneficial ownership of companies would provide clarity when identifying those who participate in the misuse of companies.

Updating the directors’ disqualification regime

The discussion paper issued in July 2013 made a proposal for the mandatory education of directors in order for them to be fully aware of the duties that they incur by way of their position (directors’ duties are applicable under s. 170 and detailed at s. 171-177 of the Companies Act 2006). However, the GR reveals that they will not proceed with implementing this mandatory requirement. Instead, the Registrar of Companies will contact new directors to:

[I]nform them [the new directors], amongst other things, of their responsibilities and legal obligations as a director, and that they might want to consider their position if they are unwilling or feel unable to meet them. Our intention is to support this system with more widespread improvements in the availability and content of information about directors’ duties in the UK. This will promote a fundamental level of awareness of directors’ duties across the UK and increase the likelihood of future compliance. This should help deter those who act as irresponsible front directors, who might currently, and wrongly, believe they can do so without being accountable. (GR, paragraph 93.)

Making directors explicitly aware of the duties they assume when taking the position of a director of a company will ensure greater surety in the adherence to good business. If a director does conduct their affairs contrary to their duties, the previous exposure to their statutory duties will put them in a weaker position of attempting to defend their actions.  A ramification of this procedure will be to oust the use of front directors, which are used as a mere façade for the true controlling members of the company (known as shadow directors). A shadow director is not appointed as a de jure director (s. 250 Companies Act 2006). S. 251(1) Companies Act 2006 defines a shadow director as ‘a person in accordance with whose directions or instructions the directors of the company are accustomed to act’, and whose instructions are not acted upon in a professional capacity. Morrit LJ lucidly described shadow directors as someone ‘pulling the strings’ whilst standing in the shadows of the company (Secretary of State v Deverell [2000] 2 All ER 365). Additionally, the de jure directors must be accustomed to act upon the shadow director’s advice (Ultraframe Ltd v Fielding [2005] EWHC 1638).

The identification of shadow directors can be difficult, and the deterrent of warning front directors of their statutory duties, and the consequences of breaching those duties, will prevent an abuse of a company’s arrangements for criminal activity or control of a company by a previously disqualified director. The Government has called for views on if and how the extension of statutory directors’ duties can be extended to shadow directors (s. 170(5) Companies Act 2006), rather than only assuming a fiduciary duty (GR, paragraph 197). I believe that the duties that a de jure director is subject to should be imposed upon a shadow director upon a finding of there being a shadow director through an amendment to s. 170(5) Companies Act 2006.

The desire to eradicate the involvement of disqualified directors, and those that should be disqualified, from returning to and carrying out business in the UK is present throughout further proposals in the GR. The summary procedure for disqualifying a director is set out at paragraph 204 of the GR:

The Company Directors Disqualification Act 1986 (CDDA) provides for the disqualification of directors, either by court order or by a director offering, and the Insolvency Service (acting on behalf of the Secretary of State) accepting, an undertaking not to act in the management of a company for a period. Disqualification can last for up to 15 years, depending upon the seriousness of the misconduct, while breach of a disqualification order or undertaking is a criminal offence.

Schedule 1 CDDA provides for a set of considerations that the court should take into account when determining whether a director is unfit under grounds for disqualification in s. 6 and 8 CDDA. Nevertheless, these considerations have not been updated since the enactment of the CDDA, which has caused a plethora of case law where the court have exceeded these posited considerations in order to come to a determination of whether a director should be disqualified. For example, in Re Dawson Print Group Ltd [1987] BCLC 601, the court considered whether a director had acted with ‘gross incompetence’ to determine that the case was not suited for a disqualification order to be made (per Hoffman J at 601-604). Moreover, in the House of Lords decision in Ronald Allwyn Baker v The Secretary of State for Trade and Industry [2000] 1 BCLC 523, Morrit LJ, delivering a single judgment of the court details, at paragraph [35], a formula that the court applies when determining the disqualification of a director. This formula refers to the application of a ‘broad approach’ of a director’s actions and that there is no requirement of a breach of duty for a finding of a director’s unfitness.

The GR makes several recommendations of how the Schedule 1 CDDA considerations should be modified to take into account modern standards of business for the determination of a director’s fitness to act as a director and disqualification. The Government has recognised that simply adding to the list of considerations would not be helpful; the creation of an exhaustive list would soon again become outdated as considerations that are not explicitly listed will not be taken into account by the court or the Secretary of State. Instead, the GR details at paragraph 222-223:

We will make new provision for the matters to be taken into account, including the materiality of the conduct, culpability of the individual and the impact of the individual’s behaviour. We will recast a more generic set of factors that the court must take into account…

The new set of factors will cover misfeasance, breaches of duty, legislation or sector regulation by an individual as a director, applying both domestically or overseas.

By providing a generic set of factors, the court and Secretary of State will be offered the flexibility to adequately assess the fitness of a director. Moreover, the allowance for consideration of breaches of sectoral regulations (which can be seen as supra-duties of directors for their specific business sector) will assist the court and the Secretary of State greatly when determining the fitness of a director, or whether they should be issued with a disqualification order under any ground (GR, paragraph 224).

The July 2013 discussion paper posited two methods of enhancing accountability of directors, particularly in the banking sector. Firstly, there was the proposition of sectoral regulators being able to initiate disqualification proceedings, rather than just the Insolvency service. Secondly, there was the proposition of introducing an extra duty upon directors operating in the financial sector by which they would be required and statutorily responsible for the financial stability of their companyover the interests of shareholders.

Surprisingly, but in light of concerns expressed in responses to the discussion paper, neither of the two proposals is being carried through. It is felt that by simply allowing the Insolvency Service to work closer with sectoral regulators, the first of these propositions will be effectively satisfied (GR, paragraph 257). We can expect, therefore, the Insolvency Service and the Financial Conduct Authority to have a close working relationship. It was further determined that the duty of a director to promote the success of the company, which includes the consequences of any decision in the long term (s. 172(1)(a) Companies Act 2002), is sufficient, in light of the integrated-whole of the sectoral regulators and the Insolvency Service, to ensure a financial company’s financial stability. I confess myself disappointed with this reluctance to heighten the responsibility of directors in the financial sector; the reluctance to impose stronger duties to directors in the financial sector appears contrary to the purpose of the discussion paper in the first instance: tackling the previous deregulation of the financial sector.

The emphasis of rooting out the bad-eggs of the director world is to be extended to those that have been convicted of criminal offences overseas, or who have had restrictions imposed in their role with respect to a company overseas. Providing the courts with the ability to consider these overseas sanctions when determining whether to disqualify a director, and providing the Secretary of State with the power to disqualify directors in the UK that have been subject to such overseas sanctions, will be a powerful tool considering the international diversity of businesses in the UK. The Government has further commissioned research into whether regulations can be added to Part 40 of the Companies Act 2006 which would automatically restrict directors that have received sanctions from overseas from taking up director positions in the UK.

If this heightened level of scrutiny was not robust enough, and in order to avoid the situation of a director avoiding disqualification proceedings (i.e. due to the complexity of the misconduct, which, for example, would be seen in complex financial business) the time limitation period for instituting disqualification proceedings is to be extended from two years (s. 6(4) CDDA) to three years from the date of the first insolvency event (GR, paragraph 283).

Lastly, the GR details plans to allow the Secretary of State to be able to apply to the court for a compensation order against a director who has been disqualified where creditors have suffered identifiable losses from their misconduct (GR, paragraph 273). In addition, the Secretary of State is to be awarded the power to accept a compensation undertaking from a director against whom disqualification proceedings have been brought as an alternative to going to court. One would expect, for this latter proposal, strict regulatory mechanisms to be put in place to ensure that directors facing disqualification proceedings are not exploiting their financial means. More clearly, there should be a limitation on how many times a compensation undertaking can be provided in order to prevent repetitive bad directorship.

Conclusion

The proposals from the GR are incredibly detailed, and show a great desire for the regulation of good business in the UK. Whilst it is disappointing to see that there has not been an explicitly robust approach to heightening the duties of directors of financial companies, the increased awareness of the work of sectoral regulators is a welcome development to ensuring financial stability of a sector’s respective companies. The BIS’s ambition of creating a transparent and trustworthy environment of business in the UK is a realistic prospect following the proposed actions detailed in the GR. Following the end of the Great Recession, such legal developments will provide greater stability and growth of the UK’s economy.  

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Tagged: Commercial Law, Company Law

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