Changes to English Company Law

October 16, 2007

Companies law in England and Wales is undergoing reform and modernisation by way of the phased implementation of the new Companies Act 2006. Various parts of the 2006 Act became effective on 1 October 2007.  This alert summarises the main changes in force from that date, drawing on separate alerts on individual topics.

The main provisions effective 1 October 2007 include:

This alert also deals with a number of more technical measures that will be of interest to those responsible for administration and compliance matters for English companies.

Codified directors’ duties

The 2006 Act introduces a statutory statement of duties that replaces several common law and equitable rules.  The codified duties will be owed to the company and only the company will be able to enforce them (however, the 2006 Act makes changes to the law governing derivative actions by shareholders and these may now be easier for shareholders to bring). 

The following general duties of directors are now in force:

  • Duty to act within powers (section 171). A director must act in accordance with the company’s constitution and must only exercise his powers for their proper purpose.
  • Duty to promote the success of the company (section 172). A director must act in the way he considers would be most likely to promote the success of the company for the benefit of its members as a whole. In complying with this duty, a director must have regard to:
    • the likely consequences of any decision in the long term;
    • the interests of the company’s employees;
    • the need to foster the company’s business relationships with suppliers, customers and others;
    • the impact of the company’s operations on the community and the environment;
    • the desirability of the company maintaining a reputation for high standards of business conduct; and
    • the need to act fairly as between the members of the company.

The above comprise the so-called principle of "enlightened shareholder value". The list of factors which directors are required to have regard to is not exhaustive.

  • Duty to exercise independent judgement (section 173). A director must exercise independent judgement. This duty will not generally be infringed by a director acting in accordance with an agreement entered into by the company that restricts the exercise of a director’s discretion.
  • Duty to exercise reasonable care, skill and diligence (section 174). A director must exercise the care, skill and diligence which would be exercised by a reasonably diligent person with both (i) the general knowledge, skill and experience that may be reasonably expected of a person carrying out the functions carried out by the director in relation to the company and (ii) the general knowledge, skill and experience that the director actually has.  In other words, directors bringing particular knowledge, skill or experience to the table–for example in relation to finance or actuarial matter–will be held to a higher standard in that regard. In applying the test regard must be had to the functions of the particular director, including his specific responsibilities and the circumstances of the company.

Impact of the 2006 Act

There has been criticism of the codification of directors’ duties and several bodies, including the General Counsel 100 Group (GC100), believe the provisions in the 2006 Act risk having the effect of increasing bureaucracy in companies, making the decision-making process more cumbersome, and increasing the potential liability to which directors are exposed.

In particular, concern has been expressed in relation to section 172 and the principle of enlightened shareholder value.  It has been suggested that board minutes will have to be more detailed to show that the directors have contemplated the non-exhaustive list of factors set out in that section. A GC100 working group has published an influential paper setting out the view that the changes do not mean that directors will have to evidence in board minutes their thought processes, with regard to the stated factors or any other matter influencing their thinking. This view is consistent with the view of Government Ministers expressed during Parliamentary debate on the measures.

The GC100 nevertheless considers it best practice for directors to be made aware of the requirement to consider the factors (to the extent relevant) and for those members of the management team responsible for preparing board papers to ensure that each of the factors that may be relevant is properly considered whilst board papers are being prepared and that appropriate discussion of the same is included in board papers and/or board presentations.

Directors’ Report: business review

For financial years beginning on or after 1 October 2007 all private companies must produce a business review section of the Directors’ report, except those under the small companies accounting regime (section 417). The purpose of these reviews is "to inform members of the company and help them assess how the directors have performed their duty under section 172", the duty to promote the success of the company.

The business review must contain:

  • a fair view of the company’s business;
  • a description of the principal risks and uncertainties facing the company; and
  • a balanced and comprehensive analysis of the development and performance of the company’s business during the financial year, consistent with the size and complexity of the business.

All quoted companies, including those on the Main Market of the London Stock Exchange but not those on the Alternative Investment Market (AIM), must also include in their business review:

  • a description of the main trends and factors likely to affect the future development, performance and position of the company’s business; and
  • information about environmental matters, employees, social and community issues and persons with whom the company has contractual or other arrangements essential to the business, or a negative statement confirming that no such matter(s) exist.

In relation to business reviews, there is a carve out for all companies so that disclosure is not required if it would be seriously prejudicial to:

  • a person with whom the company has contractual or other arrangements essential to the business and it would be contrary to the public interest; or
  • the interests of the company (as regards impending developments or matters in negotiation).

This provision is aimed at reporting significant relationships, critical to the business. In assessing what to report directors will need to exercise their judgment and may need to seek advice.

Political donations

The 2006 Act extends the regulation of political donations and expenditure to cover independent election candidates (unlike the 1985 Act). A company wishing to make a donation to or incur political expenditure relating to an independent election candidate from 1 October 2008 onwards will need to pass a new members’ resolution prior to that date, as companies have had to for party candidates in the past. Even if the company has no intention of including independent election candidates in the scope of any future shareholder resolutions, it may be advisable to pass a new form resolution at the next general meeting. The new provisions will not invalidate existing resolutions.

Approval is now only required from the ultimate UK holding company and not from intermediate holding companies and one resolution can cover multiple subsidiaries. The provisions expressly covering overseas subsidiaries have not been replicated in the 2006 Act. Therefore, an English parent company does not need to seek authorisation in relation to political donations or political expenditure by an overseas subsidiary.

A new section dealing specifically with trade unions has been added and states that:

  • a donation to a trade union is not a political donation unless made to the union’s political fund; and
  • a trade union is not a political organisation for the purposes of political expenditure.

This should remove any remaining concerns regarding issues such as giving employees paid time off for trade union matters and allowing them to use company facilities for trade union purposes (for example meeting rooms).

The de minimis for political donations is still £5,000. Up to that amount no approval is required.

The 2006 Act’s reporting provisions covering political donations and expenditure take effect in directors’ reports relating to financial years beginning on or after 6 April 2008.

Miscellaneous changes

A number of other provisions came into force on 1 October. Summary details of the changes are available by clicking on the relevant links below:

Articles of association

The regulations making amendments to Table A articles also came into force on 1 October, but only apply to new companies formed after that date. Older companies may choose to adopt them.

Company administration: reform of the written resolution procedure

The basic position under the regime in force from 1 October 2007 is that the members of a private company must vote on resolutions either (i) at a meeting of members or, (ii) by way of a written resolution (each in accordance with the provisions set out in the Act). There is no written resolution procedure for members of a public company, who must vote on resolutions at a meeting held in accordance with the Act.

In contrast to the old regime, private companies wishing to take advantage of the written resolution procedure must do so in accordance with the statute. Consequently, private companies are no longer able to pass a written resolution in accordance with a power contained in their articles of association. This rule does not however displace the common law rule that provides for ‘unanimous consent’ of shareholders to be effective in certain cases.

Written Resolutions

The written resolution becomes the default position for private companies. Further, as a result of the blanket application to private companies of the 1985 Act "elective regime", no private company will be required to hold annual general meetings. With the exception of the removal of directors and auditors from office, it will be possible for members of private companies to vote on all decisions requiring their consent by way of written resolution.

A written resolution can be initiated by the directors of the company or by the members, provided those members satisfy certain conditions. The members will only be able to request circulation of a written resolution if (i) they hold 5% or more of the total voting rights (or a lower percentage if set out in the articles), and (ii) the resolution would be effective if passed and is not defamatory, frivolous or vexatious.

Company administration: shareholder meetings

Meetings of shareholders can be convened by the directors or at the request of members holding 10% of the company’s paid up capital who are entitled to vote (this can be reduced to 5% for private companies whose members have not requisitioned a meeting in the previous 12 months). Shareholder meetings can also be convened by the company’s auditors or by the court.

Where a meeting is requested by the members, the directors must call a meeting within 21 days. The meeting must then be held within 28 days of the notice. If the directors default, the members can convene a meeting at the directors’ expense.

A key change for shareholder meetings is that the notice period for all meetings is reduced to 14 days. This stands in contrast to the 1985 Act, where 21 days’ notice was required in respect of "special resolutions". The main exception to this new rule is for public company annual general meetings, which still require 21 days’ notice (although note that 28 days’ notice is required for the removal of a director, or the company’s auditors, from office).

The notice for a general meeting of shareholders can now take the form of hard copy, electronic copy or a notice published on the company’s website.

There are a number of new rules relating to the appointment of proxies and the procedures for shareholder meetings. There are additional changes in the law relating to meetings of public companies and quoted companies.

Directors: Minimum Number

Private companies may have one director and private unlimited companies are permitted to have only one member (section 154). A public company limited by shares must have two directors (section 154). The minimum number of directors required has not changed from those in the 1985 Act.

Directors: Removal

Members still have a statutory right to remove a director by ordinary resolution (sections 168-169).  Special notice is still required and a director removed by a resolution under section 168 retains the right to compensation or damages. A director has the right to be heard at the meeting considering his removal and to make written representations. Directors may be removed by other means (for example under a procedure set out in the company’s articles).

Exercise of Members’ Rights

Companies may have provisions in their articles allowing registered members to nominate another person to enjoy all or any specified rights, including the right to receive notice of general meetings, to receive the annual report and accounts and to appoint a proxy (section 145).

It is mandatory for traded companies, whose shares are admitted to a regulated market in the European Economic Area (which includes the Main Market of the London Stock Exchange, but not AIM), to allow members to nominate another person to enjoy information rights. Members may nominate beneficial holders to have information rights. Persons nominated must be nominated to enjoy information rights in their entirety. The company may enquire once a year whether these rights are to continue.

Proxies and polls

The key changes in relation to proxies include that:

  • they can vote on a show of hands (section 324);
  • the chairman can be the proxy (section 328); and
  • they can be counted in the quorum (section 318).

Articles of a company cannot require the appointment of a proxy to be lodged more than 48 hours before the meeting (excluding non-working days).

In relation to polls there is generally no change in that a poll can be demanded by five members entitled to vote or members representing 10% of total voting rights of all members entitled to vote (or 10% of the total sum paid-up). There are additional requirements for quoted companies to keep the results of polls on their website for two years (sections 351 and 353). There are additional requirements in relation to the request of an independent report by members and the appointment of an independent assessor, whose report must also be published on the website for two years (sections 342, 344, 351 and 353).

Transactions with directors requiring the approval of members

The 2006 Act contains new rules relating to the following four categories of transactions with directors:

  • Service contracts (sections 188 and 189).Companies must keep copies of directors service contracts (or a note of their terms) which were entered into on or after 1 October 2007 at their registered office (or another authorised place) together with any variations until at least 12 months have elapsed from the termination or expiry of the contract. Shareholders also have a right to request a copy of a director’s service contract on payment of a fee. These requirements now apply to all companies (both private and public) and apply irrespective of the length of the service contract. The 2006 Act also extends the existing law so that shareholder approval is required for service contracts in excess of two, as opposed to five, years.
  • Substantial property transactions (sections 190 to 196).  The 2006 Act re-enacts with some amendments the rules governing agreements by companies to acquire non-cash assets from directors. The most significant changes relate to the ability to make an agreement conditional on shareholder approval being given for the substantial property transaction and the raising of the de minimis threshold to £5,000 from £2,000.
  • Loans, quasi-loans and credit transactions (sections 197-214).  The general prohibition on making loans to directors (subject to various exceptions) has been replaced with a general requirement to seek shareholder consent.  A broader range of exceptions has also been introduced.  A more onerous regime continues to apply to public companies and their subsidiaries. 
  • Payments for loss of office (sections 215 to 222).  The rules on payments for "loss of office" have been widened to catch also payments on termination of employment and on retirement. A welcome development has been clarification that it is lawful to make a payment without shareholder consent if the payment is made in good faith in discharge of a legal obligation or by way of compensation for claims arising on termination of office or  employment.

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further details please contact the Gibson Dunn attorney with whom you work or James Barabas (+44 (0)20 7071 4253, [email protected]) in the firm’s London office. 

© 2007 Gibson, Dunn & Crutcher LLP

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.