UK Company Law Reform: A Status Report August 2006

Table of contents

Introduction 1

Duty of directors to promote the success of the company 2

Derivative claims 4

Conflicts of interest 5

Indemnification of directors of pension trustee companies 7

Narrative reporting 8

Liability for narrative reporting and Transparency Directive disclosures 9

Auditors’ liability 12

Protecting directors’ and shareholders’ home addresses 13

Enfranchising indirect shareholders 15

Disclosure of institutional voting 16

Company secretary and execution of documents 17

Matters open to comment 19

Contacts 20

Please refer to www.linklaters.com/regulation for important information on the regulatory position of the firm.

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Introduction As Parliament heads for the hills or the beaches on its summer recess, the rest of us have time to reflect on the current status of the Companies Bill - as the Company Law Reform Bill has been renamed.1 A number of recent developments in the Bill have been the subject of little consultation or scrutiny, and the summer period is being offered by the Government as time for consultation and comment on a number of new provisions in the Bill.

The Bill has undergone some significant changes since last January

The Bill, described as “gargantuan” when first debated by the House of Lords in January this year, is now almost 50% larger, and is said to be the longest Bill ever, with over 1,250 clauses. The Bill’s expansion is largely the result of the Government’s welcome decision to consolidate large parts of the existing Companies Act 1985 into the new Bill. This will avoid UK company law being divided between two separate pieces of legislation and has resulted in the introduction of approximately 400 new clauses, which are intended to restate existing law without substantive amendments. The decision to make the Bill a consolidating measure was taken partly in response to general concerns that company law needed to be easily readable in a single statute, and partly because of the deletion of a controversial reform power which could otherwise have been used to achieve further consolidation in due course.

The Bill is now a consolidating measure

Other amendments have affected some of the more contentious provisions of the Bill, such as the codification of directors’ duties, shareholder litigation rights and the enfranchisement of indirect investors, while new provisions include measures to define and limit liability for directors’ annual reports and accounts and other periodic financial reports.

A number of the more contentious provisions have been amended

Given the large number of amendments made at a relatively late stage, both the Government and the Opposition have in a number of instances reserved their positions, and further amendments are likely to be made at the Commons Report stage, after Parliament resumes in the autumn. The expectation remains that the Bill will receive Royal Assent before the current session ends in November. Following Royal Assent, there will be regulations, transitional provisions and commencement orders to be finalised. The expected implementation date for most of the Bill’s provisions is October 2007.

This report is intended to highlight the key outstanding issues and the most significant amendments made to the Bill during its progress through both Houses so far.

This report is intended to give general information only, and should not be relied on as legal advice.

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1 The Bill as amended in the House of Commons Standing Committee as at 20 July 2006 has been reprinted and can be found at: http://www.publications.parliament.uk/pa/pabills/200506/companies.htm References in this report to Clauses are to Clauses of the Bill as reprinted.

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Duty of directors to promote the success of the company One of the key aims of the Bill is to provide a statutory statement of directors’ duties. Among these duties is the duty to promote the success of the company for the benefit of its members as a whole (Clause 173). This duty is one of the most hotly debated of the Bill’s provisions because it includes the obligation to have regard to a list of factors including employees, the environment, the community, relationships with customers and suppliers, and the desirability of maintaining a reputation for high standards of business conduct.

Among the codified duties of directors, the “enlightened shareholder value” duty remains controversial

Opponents of the duty in its current form are divided into two camps:

– those who consider that the provision will overburden directors with a new obligation to follow due process and that directors will need to keep detailed records of how they took the various factors into account, not least in order to defend themselves against litigation by persons seeking to influence or challenge directors’ decisions, and

– those who consider that the duty still does not do enough to ensure that companies behave in a socially responsible manner - not only in the UK but in relation to their operations (and the operations of their subsidiaries) throughout the world.

The Government has attempted to meet the concerns of businessmen and lawyers regarding the regulatory burden that the clause might create by making some changes to the wording of the duty. This new wording:

– omits from the obligation to have regard to the factors the words “so far as reasonably practicable”. This change reduces concerns that the duty would have established an objective standard by which directors should behave, thus opening up their decisions to judicial scrutiny. This would have represented an overturning of the principle that business decisions taken in good faith by directors will not be revisited by the courts,

Amendments have removed the objective element, which could have led courts to second-guess directors’ business decisions

– emphasises that there is a single duty to work for the benefit for shareholders - and not a separate set of duties in relation to the stakeholders represented in the list of factors - by bringing the list of factors into the same sub-clause as the primary duty, and

– explicitly states that the list of factors to which directors must have regard is not exhaustive.

In its amended form, the duty still causes concerns that directors will have to pause to consider the specified factors, and record how they have done so, in order to be able to demonstrate that they have complied with the duty. This could lead to increased paperwork and longer meetings. Against this, it is argued that there should be no need for onerous procedures, just as there have not historically been problems or undue bureaucracy resulting from the existing duty to have regard to the interests of employees under the Companies Act 1985. The difference, perhaps, is that the impact of company decisions on employees will generally be fairly obvious and immediate. The same may not be true, and conflicting considerations may arise, so far as external factors, such as the community, the environment, customers or suppliers, are concerned.

Directors will have to be mindful of the new factors to which they must have regard

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The Government has consistently tried to provide comfort to directors on the impact of the provisions. For example, the Attorney General, Lord Goldsmith, said in the Lords:

“There is nothing in this Bill that says there is a need for a paper trail….. I do not agree that the effect of passing this Bill will be that directors will be subject to a breach if they cannot demonstrate that they have considered every element. It will be for the person who is asserting breach of duty to make that case good…..[Derivative claims] will be struck out if there is no decent basis for them”. 2

The Government-sponsored amendments to the derivative claims procedure, intended to prevent frivolous actions, are discussed below.

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2 Hansard, 9 May 2006: Col 841.

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Derivative claims One of the major concerns that directors have had with the Bill is that they will be more exposed to litigation as a result of the codification of directors’ duties and the new procedure laid down by the Bill to make it easier for shareholders to bring claims on behalf of the company (Clauses 260-9). In particular, there are fears that the new procedure would make it too easy for shareholders to bring unmeritorious claims against directors, with a view to generating publicity, causing embarrassment or obtaining information.

The Government responded to these concerns by introducing a package of amendments in the House of Lords. These amendments were designed to make it easier for the courts to throw out claims at an early stage without involving the company.

The amendments:

The barriers to bringing a derivative claim have been raised - a prima facie case must be shown at the outset

– introduce an additional hurdle in the procedure for bringing a derivative claim. At the outset, the applicant would be required to show a prima facie case against the defendant. The court would consider this on the basis of the claimant’s evidence only, without requiring any evidence from the defendant. If the claimant’s evidence did not show a good case, the court would have to dismiss the claim. This reduces the opportunity to embark on “fishing” litigation,

– make it clear that the court may make costs or civil restraint orders against the applicant,

– give explicit power to the court to adjourn proceedings, for example, to allow a general meeting or consultations with shareholders to take place, and

– require the court, in deciding whether to permit a derivative claim to continue, to have particular regard to any evidence that is available of the views of members of the company who have no interest in the matter.

Directors will be able to call in aid the views of other shareholders

These changes will be welcome to directors, as they should limit the scope for members to bring cases without good cause. The amendments will also allow the views of members who are independent of the directors to be taken into account, so making it more difficult for a shareholder to bring an action against the wishes of shareholders generally. Nevertheless, the new procedure is likely to heighten the likelihood of tactical litigation against directors by activist shareholders, unless and until experience in practice shows that the courts will have no time or sympathy for such tactics.

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Conflicts of interest The duties of directors, as codified by the Bill, include three duties in relation to conflicts, or potential conflicts, of interest or duty (Clauses 176-8). The first is a duty on a director not to allow any conflict or interest to arise in respect of any property, information or opportunity that conflicts or may conflict with the interests of the company - it does not apply to a conflict in respect of transactions with the company. The second is a duty not to accept benefits from third parties. The third is a duty to declare an interest in a proposed transaction or arrangement with the company.

Conflicts falling within the scope of the first duty will not constitute a breach of duty if approved by the directors. Authorisation of conflicts by the other directors is only permitted, in the case of a private company, if the constitution does not prohibit such authorisation and, in the case of a public company, if the constitution expressly permits such authorisation.

In order to preserve the current position that certain types of conflict are expressly permitted in companies’ Articles of Association (i.e. without further authorisation), the Government agreed to calls for an amendment to permit Articles to contain provisions dealing with conflicts. However, the extent to which provisions will be allowed is limited to “such provision as has previously been lawful for dealing with conflicts” (Clause 232).

Articles permitting directors to have conflicts will be allowed, to the extent currently lawful

Apart from failing the test of accessible, easily understandable law, the reference to “previously lawful” provisions leaves considerable uncertainty. There is no current clear definition of what is lawful in this context. Moreover, changes made by the Bill could alter the analysis of what would be lawful.

The common law tends to treat a situation of potential conflict as disabling a director from acting, rather than as amounting to a breach of a fiduciary duty. On this analysis, it is not automatically wrong to be in a position where a potential conflict arises, but in such a case a director must stand aside from consideration of the particular matters. Articles of Association currently commonly provide that directors may have certain conflicts provided they are not counted in the quorum for, and do not vote at, any relevant meeting. The leading case concerning the lawfulness of such Articles reconciled them with the general prohibition on provisions exempting directors from liability for breach of duty (currently section 309A of the Companies Act 1985) by relying on the proposition that conflicts merely create a disability. 3

However, the permitted scope of such Articles is unclear

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3 Movitex Ltd v Bulfield and others [1988] BCLC 104. In the Report stage debate in the House of Lords (Hansard, 9 May 2006: Col 865-6) , the Attorney General explained the position as follows: “I am reluctant to get into detailed consideration of the Movitex case, which lies behind part of the assessment of what the current law is, but essentially that case attempted to reconcile the principle that it was not open, according to Section 309A [of the Companies Act 1985], to exempt directors from certain responsibilities, with the no conflict rule. The court concluded that the general principle forbidding directors from putting themselves in position where their duty to the company might conflict with their own interest was not a duty in the strict sense of the word but was a disability. Thus, it was not caught by Section 309A of the Companies Act 1985. That is where we are. … It is fair to say that because clauses [161 and 162] are characterised as duties, that means that the particular route which was used in the Movitex case … may not be available.”

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Even if one were able to follow the Movitex case and make an assumption that provisions in existing Articles were lawful, there would be no certainty regarding any extensions of these which may be necessary to reflect the duties as codified by the Bill. For example, the 1985 Table A Form of Articles contains provisions allowing directors to have certain interests in relation to transactions to which the company is party or body corporates in which it is interested, but does not deal with other conflicts - i.e. in relation to opportunities etc. where the company is not involved.

Existing Articles typically do not contain provisions broad enough to deal with many conflicts that would be caught by the duty to avoid conflicts. Even if existing provisions are deemed lawful, on the basis that they have been so previously, new carve outs to the duty may well not be. Concerns that this duty is likely to cause difficulties for directors who hold multiple directorships are therefore not fully allayed by the Government’s amendments.

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Indemnification of directors of pension trustee companies The law defining the extent of a company’s ability to indemnify its directors was significantly amended by the Companies (Audit, Investigations and Community Enterprises) Act 2004, and the Bill as originally drafted carried forward the provisions made by that Act without substantive amendment.

The Government has, however, now acted on concerns raised by the CBI and others that the 2004 Act provisions had the effect of precluding indemnities in respect of acting as director of a pension trustee company, where non-corporate trustees would normally be able to be indemnified. The Bill has been amended to allow “qualifying pension scheme indemnity provisions” (echoing the “qualifying third party indemnity provisions” permitted for directors generally). These are provisions indemnifying a director of a company that is a trustee of an occupational pension scheme against liability incurred in connection with the company’s activities as trustee of the scheme (Clause 235). Such provisions must not include any indemnity against any liability incurred in defending criminal proceedings, or in respect of any criminal fine or regulatory penalty.

Directors of pension trustee companies have won a wider right to indemnification

The amendment will allow parent or other associated companies of pension trustee companies, as well as the trustee company itself, to provide the indemnity. This is important, as many pension trustee companies have insignificant assets, making any indemnity given by them alone fairly worthless.

This amendment will be welcomed by directors of pension trustee companies, although pension trustee companies or their associates will in many cases have to rewrite indemnities made void by the 2004 Act to bring them within the scope of the Bill.

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Narrative reporting The Bill’s provisions on business reviews in annual reports have been amended, following the Government’s consultation on what should replace the mandatory operating and financial review (“OFR”).4 The amendments introduce additional contents requirements to the business review for quoted companies as well as making a number of other changes that will apply to the business reviews of both quoted and unquoted companies (Clause 423).

Quoted companies will have to include additional information in their business reviews covering future developments and environmental, employee and social policies

A quoted company will have to disclose, in addition to the other contents of a business review, and to the extent necessary for an understanding of the development, performance or position of the company’s business:

– the main trends and factors likely to affect the future development, performance and position of the company’s business, and

– information about (i) environmental matters (including the impact of the company’s business on the environment), (ii) the company’s employees, and (iii) social and community issues, including information about any policies of the company in relation to those matters and the effectiveness of those policies.

In effect, these provisions reinstate most of the old OFR disclosure requirements and forward-looking focus for quoted companies.

The Bill makes a number of other changes to the business review requirements for both quoted and unquoted companies:

– while auditors must report on the consistency of the directors’ report with the annual accounts, there will be no additional requirement to check for other inconsistencies that auditors may come across in performing their role as auditors (which was one of the most unpopular and potentially costly measures of the OFR),

– the Bill states the purpose of the business review as being to inform members of the company and help them assess how the directors have performed their duty (as stated in the Bill’s codified statement of directors’ duties) to promote the success of the company, having regard to factors such as employees, the community and the environment,

There will be no statutory reporting standard in relation to the contents of the business review

– there will be no statutory reporting standard for the business review for either quoted or unquoted companies, and

– companies will be exempted from disclosing information that is seriously prejudicial to the company’s interests. This exemption was previously only provided for quoted companies in relation to the OFR.

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4 The OFR was introduced by the Companies Act 1985 (Operating and Financial Review and Directors’ Report etc) Regulations 2004 for quoted companies with financial years beginning on or after 1 April 2005, but repealed in December 2005 on the basis that the contents requirements of the OFR, and the responsibilities of directors and auditors in connection with it, represented an example of unnecessary “gold plating” (i.e. imposing requirements upon UK companies that are more onerous than those required by the EU). The Government conducted a consultation on what should replace the OFR in early 2006.

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Liability for narrative reporting and Transparency Directive disclosures The risk of liability to investors for statements about a company’s prospects could potentially be a factor limiting the scope of disclosure made by directors in the OFR or enhanced business review, To encourage better quality narrative reporting, and discourage over-cautious, boilerplate-type disclosures, many respondents to the consultation on replacing the OFR argued for a safe harbour to limit the liability of directors.

The question of potential liability to investors for reports is currently governed by common law

There is currently no statutory regime dealing with the liability of directors for negligent misstatement in reports and accounts. It is generally understood, using the principles laid down by the House of Lords in Caparo Industries plc v Dickman5 (which concerned the liability of auditors), that directors have a duty of care to shareholders as a whole to enable them to exercise their governance rights but not, in the absence of circumstances creating proximity or a special relationship, to individual shareholders in relation to their investment or to potential investors or other third parties.

Under these principles, the liability of directors would be affected by implementation of the Transparency Directive. This Directive, which is due to be implemented by 20 January 2007, requires, amongst other things, issuers to publish periodic financial information, consisting of annual reports, half-yearly reports and interim management statements (reports published approximately mid-way through a half-year). The objective of periodic financial information published under the Directive is to allow investors to make an “informed assessment” of an issuer’s position and to increase investor protection within the EU. Periodic financial information must be made generally available throughout the EU. For annual and half-yearly reports a statement of responsibility must be given by the directors.

The effect of the Transparency Directive could, in the absence of legislative intervention, be to extend the scope of liability under English law for annual accounts and other periodic information to investors and the public in general across the EU. However, while member states must impose liability for information published under the Directive on at least the issuer or its directors, the Directive allows member states to determine the extent of that liability.

Responding to concerns about both the potential extension of liability of UK issuers and directors under the Transparency Directive and the need for protection of directors in relation to forward-looking statements in narrative reporting, the Government put forward two new clauses. Both provisions operate so as to define when liability on published reports will arise, and to exclude liability in other circumstances.

The Bill will provide a clear new regime on liability, with the aim of encouraging high quality narrative reporting

Liability to company for directors’ reports The first provision (Clause 471) relates to the directors’ report and directors’ remuneration report or information in summary financial statements derived from either of these reports, and provides that:

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5 [1990] 2 AC 605

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– a director will be liable to compensate the company for any loss it suffers as a result of any untrue or misleading statement in, or omission from, such a report, but only if he knew or was reckless as to whether the statement was untrue or misleading or knew the omission to be dishonest concealment of a material fact, and

Directors will be liable to their company if reckless or knowing as to misleading information or omissions, but not otherwise – no director, auditor or other person will have any liability to anyone other

than the company resulting from reliance on these reports.

The clause thus limits the liability of directors in relation to directors’ reports (including the business review) to the company only. Directors will not be liable to shareholders or other third parties for such reports unless they take some action beyond publishing their reports in accordance with company law. For example, if a director were to send a copy of the company’s annual report and accounts to a bank in connection with the negotiation of an overdraft facility, he might still, as now, be liable to the bank as a result of an express or implied representation to the bank as to the accuracy of the contents of the report.

Liability for reports published pursuant to Transparency Directive The second provision (Clause 1234) will insert a new Section 90A into the Financial Services and Markets Act 2000 (“FSMA”) and deals with liability in relation to periodic financial information published under the FSA’s rules, or any other provisions made under the Transparency Directive, by issuers with securities traded on a UK regulated market.6 The provision:

Issuers may be liable to investors where misleading reports published, if directors are at fault

– imposes on an issuer of securities liability to pay compensation to any person who relies on, and suffers loss as a result of, an untrue or misleading statement in (or omission from) a report. But the liability only arises if a person exercising managerial responsibilities7 within the issuer knew (or was reckless as to whether) the report was untrue or misleading, or knew the omission to be a dishonest concealment of a material fact, and

– exempts the issuer and any other person from any other liability, subject to: – the existing power under FSMA for a court or the FSA to require

restitution to be paid to investors or others who have suffered loss resulting from a breach of FSA rules. Although never yet used in the context of a breach by an issuer or director of the Listing, Disclosure or Prospectus Rules, this power does at leave open the possibility of personal liability to investors on the part of directors, and

– civil or criminal liabilities such as under the market abuse regime, penalties for Listing Rule breaches or criminal acts under Section 397 FSMA.

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The combined effect of these liability provisions is that investors should not have a direct right of action against directors but they could claim against the

6 This will include issuers admitted to the official list, whether incorporated in the UK or elsewhere, but will not include Alternative Investment Market issuers. 7 “Person exercising management responsibilities” is defined to include a director and any senior executive of the issuer having responsibilities in relation to the publication. This definition would potentially catch a large number of people within the company. Our understanding is that the Governement’s intention is only, in fact, to catch directors or persons occupying an equivalent position, but the drafting needs tightening to reflect this intention.

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company, if they can show that they have suffered loss, and that there was knowledge or recklessness on the part of one or more directors regarding the defect in the report. The company could then claim its own loss (compensation paid to an investor) against an individual director who had the requisite knowledge or was reckless.

It should be noted that these provisions would not protect issuers or directors being sued in other EU jurisdictions under laws implementing the Transparency Directive. During negotiations on the Directive, the Government attempted to introduce a provision that would have required cross-border civil liability disputes to be resolved within the civil liability regime of the issuer’s home member state but this was not accepted.

The new provisions have been generally welcomed as creating certainty and a reasonable balance between responsibility and the ability to report in an open and forward-looking manner without undue fear of litigation.

One concern with the provisions, however, is that there is a somewhat arbitrary division between disclosures which are within the regime and those that are not. Periodic financial reporting, limited to annual and half-yearly reports and interim management statements, will be subject to the new liability regime. The regime will not apply to other disclosures made by quoted companies, including preliminary announcements of results, price-sensitive announcements such as profit warnings, or announcements of significant transactions under the Listing Rules. It is possible that the existence of different liability regimes for different types of announcement could influence corporate behaviour - deterring companies from making prompt announcements, or causing them to arrange matters so that more information is contained in periodic financial reports, with less being disclosed by way of ad hoc announcements.

The new regime applies to periodic reports but not to preliminary results or ad hoc statements

An amendment was tabled by the Opposition in the Commons to extend the new provision to cover preliminary statements of results and other announcements permitted or required under the Disclosure or Transparency Rules, and also to companies with securities quoted on the Alternative Investment Market. The amendment was not passed, but the DTI is expected to seek comments on these provisions over the summer, following a statement8 by the Minister (Margaret Hodge) in the Commons that the Government wished to consider with stakeholders the question of whether it would be appropriate to broaden the scope of the liability regime.

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8 Hansard, 6 July 2006: Col 484

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Auditors’ liability Auditors will benefit from the new liability regime on periodic financial reporting described above, in relation to their reports included in information published by issuers. This will protect auditors from liability to persons other than the company. The Bill will also, for the first time, allow public and private companies, with shareholders’ approval, to agree to limit the liability of their auditors to the company by means of a liability limitation agreement (an “LLA”) (Clause 548).

Following concerns that the Bill, as originally drafted, did not deliver to auditors their goal of proportionate liability, the Government introduced amendments in the Lords. These included provisions that:

Auditors have clarified that their liability can be made proportionate to fault

– it is immaterial how an LLA is framed and the limit on the amount of the auditor’s liability need not be a sum of money or a formula, and

– when the court is considering what is fair and reasonable, it should not take into account matters arising after the loss or damage has been incurred or matters affecting the possibility of recovering compensation from other persons liable in respect of the same loss or damage.

The second item deals with the concern that the auditor may be the only person with any money to meet a judgment by the time of court proceedings, leaving a risk that the court may find it reasonable for the auditor to pay for everything.

A further concern, particularly among mid-tier accountancy firms, has been the risk of LLAs developing in a way that would damage competition in the audit market. The Government has therefore introduced a new power for the Secretary of State to make regulations about how LLAs are expressed, particularly with a view to preventing adverse effects on competition.

There have also been minor changes to measures introduced as part of the package of measures designed to improve audit transparency and accountability:

– Signature of senior auditor: The provision requiring audit reports to be signed by the senior auditor (Clause 517) has been amended to clarify that, although he signs in his own name, he signs on behalf of the audit firm.

– Disclosure of engagement terms: Opposition peers argued for the deletion of the power for the Secretary of State to publish regulations requiring a company to disclose audit engagement terms (Clause 507). They pointed out that the Financial Reporting Council decided against including a provision in the Combined Code to require public disclosure of such documents on a company’s website and argued that it was unlikely that shareholders would be interested in such documents. In the end, the only concession made by the Government was to make the new power subject to the affirmative procedure rather than the negative procedure enabling Parliament to debate the case for exercising the power.

Greater Parliamentary scrutiny will be required if regulations are made on the disclosure of audit engagements

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Protecting directors’ and shareholders’ home addresses Threats to GlaxoSmithKline shareholders from animal rights activists in April 2006 provided the backdrop to debates on the Bill in the Lords. The Government proposed the following initiatives to protect directors and shareholders.

Confidentiality of directors’ home addresses The Bill originally proposed a new simpler procedure to exempt directors from public disclosure of their home addresses. Following amendments in the House of Lords, however, directors will in all cases simply be able to use a service address rather than their home address on the public register (Clauses 162-7). The service address can be “the company’s registered office”. Directors must also provide their usual residential address to the company, and the company must maintain a new register of directors’ usual residential addresses. This will not be open to public inspection. When companies file particulars of directors with the Registrar of Companies they must provide both the service address and the usual residential address, but the latter will not be normally open to public inspection at Companies House. The Bill lays down a procedure under which the Registrar of Companies may put the usual residential address on the public register if there is evidence that the service of documents at the service address is not effective to bring them to the notice of the director. Changes to both service addresses and residential addresses must be notified to the Registrar of Companies.

Directors need only place a service address on the public register

The Government is resisting attempts by the Opposition to impose a general requirement on the Registrar to remove historically filed records from the register. This is because of practical constraints. However, the Bill does contain provisions enabling the Secretary of State to make regulations, requiring the Registrar, if an application is made, to remove specific addresses from the public register.

Right to inspect and require copies of the register of members The Bill, as originally drafted, retained the right of the public to inspect and obtain copies of the register of members and (for companies having more than 50 members) index of members’ names. However, a company would be able to apply to the court for a direction that it need not comply with a request on the grounds that it was not for a “proper purpose”. Requests must be complied with within 5 days unless an application to court is made.

Following the action against GlaxoSmithKline shareholders, the Government tabled amendments to tighten the procedure and deter unmeritorious applications (Clauses 116-9):

– a person seeking to exercise the right to inspect or require copies of the register of members will have to specify, in its request to the company, their name and address, the purpose for which the information to be used and whether the information will be disclosed to any other person and if so to

Persons seeking copies of shareholder registers will have to give reasons

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whom and why. The aim is to make it easier for companies to identify the purpose for which requests are made and decide whether or not to comply. It will also help create a paper trail and assist in enforcing existing aiding and abetting offences under the Serious Organised Crime and Police Act 2005,

– if it appears to the court that the company may be subject to other requests for a similar purpose, it may direct the company not to comply with the request and make such provision as it thinks appropriate. This attempts to deal with the risk of a company being swamped by coordinated campaigns in which activists generate large numbers of similar access requests,

– it will be an offence for a person knowingly or recklessly to make, in a request to inspect or require a copy, a statement that is misleading, false or deceptive in a material particular, and

– it will also be an offence for a person in possession of information obtained by exercise of either of these rights to do anything that results in the information being disclosed to another person or fail to do anything with the result that that the information is disclosed to another person knowing or having reason to suspect that such other person may use the information for an improper purpose. This is to prevent the unscrupulous using a person with a legitimate purpose to get access to the information on its behalf.

It will be an offence to seek shareholder information, or allow it to be used, for an improper purpose.

Similar protections will apply in relation to access to the register of debentures and the register of interests that public companies are required to maintain if they issue a notice requiring information about interests in shares.

There remain some concerns over the lack of clarity of “proper purpose”, but the Government is resisting a definition, arguing that it would be impossible to catch all situations and could restrict the discretion of the courts.

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Enfranchising indirect shareholders The Bill, as originally drafted, contained a Clause allowing, but not requiring, companies to include a provision in their Articles to extend voting and information rights to investors who hold shares through nominee accounts. Following representations made by the UK Share Association, the Share Centre and the Association of Private Client Investment Managers and Stockbrokers, Opposition peers won a vote in the House of Lords to replace this with a provision which would have required all companies admitted to trading on a regulated market to recognise as entitled to vote and to receive documents any person nominated by a member. It was widely recognised that this provision would have been unworkable in practice.

An amendment requiring companies to recognise indirect shareholders would have been unworkable

The Government put forward new provisions (Clauses 146-153) in an attempt to reach a compromise. The clauses focus on ensuring that indirect investors will have the ability to receive information directly from listed companies. A registered member of a company whose shares are traded on a regulated market will have the right to nominate another person (a “nominated person”), on whose behalf he holds shares, to enjoy rights to receive communications sent to members. Companies will be allowed to communicate with a nominated person by website, unless the nominated person specifically requests hard copies and provides the address to which such copies are to be sent. The procedures under the Bill allowing companies to communicate electronically with shareholders will also apply to nominated persons. In addition, companies will be allowed to enquire of a nominated person not more than once a year whether he wishes to retain information rights, and the rights will cease if no response is received within 28 days.

It has been replaced by a process for enabling indirect investors to receive information and participate in corporate actions

Where a notice of meeting is sent to nominated persons, the notice must be accompanied by a statement alerting them to the fact that, under an agreement with the member who nominated them, they may have rights to be appointed as a proxy, have someone else appointed as a proxy, or give voting instructions.

The provisions also aim, without giving direct rights to indirect investors, to prevent companies from disadvantaging them in cases where an election has to be made, and to enable nominees to reflect the wishes of underlying investors. Companies will therefore be obliged to allow nominees, or others who hold shares on behalf of more than one person, to split voting and other rights in respect of their holdings, so that they can be exercised in different ways.

The clauses also set out a procedure to allow indirect investors to participate in requisitions relating to: the circulation of a statement relating to a meeting; the circulation of a resolution for an AGM; an independent report on a poll; and website publication of audit concerns. The clauses do not, however, make any provision for indirect investors to receive dividends directly.

A number of technical issues have been identified with the new clauses. In particular, they may give rise to difficulties in relation to compliance with overseas securities laws. There is also no provision requiring a member to terminate a nomination where he ceases to hold shares on behalf of the nominated person. Given the late introduction of these clauses, it is possible that further amendments may be made at the Report stage.

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Disclosure of institutional voting Institutional investors objected strongly to a power contained in the Bill to make regulations requiring them to disclose how they vote listed companies’ shares. Although this was only a reserve power and the detailed regulations would have to be consulted upon, they argued it was not necessary to legislate in this area as sufficient transparency could be obtained by voluntary means, whilst a compulsory regime could impose undue administrative burdens and costs on investors.

A power to require disclosure of voting has been reinstated

In the House of Lords, the Opposition succeeded in removing the offending clause. However, the Trades Union Congress has been pressing for greater disclosure in this area and the Government reinstated the power by an amendment in the House of Commons. The new provision (Clauses 1241-4) is substantially in the same form as the original draft, except that it specifies in greater detail the kind of information that regulations could require to be disclosed. This includes information about the exercise or non-exercise of voting rights and any instructions given or delegation made about the exercise or non-exercise of voting rights.

⏐August 06 16

Company secretary and execution of documents The Government has sought to promote the proposed abolition of the requirement for private companies to have a company secretary as a key “deregulatory” measure. The reality is, as pointed out by the Institute of Chartered Secretaries and Administrators in their briefing paper of January 2006, that the only burden from which private companies are relieved is the obligation to file particulars of the company secretary with the Registrar of Companies; the functions carried out by a company secretary will, of course, remain, and where a company secretary is appointed, he becomes an officer of the company despite the absence of any filing/registration regime. However, despite a protracted debate about the wisdom of this proposed abolition in the context of corporate governance, sound administration, etc, it seems likely that the Government will have its way and the Bill will eliminate the requirement for a private company to have a company secretary.

Abolition of the role of company secretary for private companies left existing powers in limbo

However, the tangential issue that has provoked animated discussions in both Houses has been the change in the regime for the execution of documents by companies. At present, a document signed by a director and the secretary, and expressed to be executed by the company, has the same effect as if executed under the common seal.

Under the Bill, the secretary of a private company will have no statutory authority to execute documents on behalf of the company. Documents will be validly executed (and can therefore take effect as deeds) if signed by two directors, or by one director, signing in the presence of a witness. The secretary may therefore sign as witness to the director’s signature, rather than ex officio as secretary. This will obviously be a source of some confusion, as many private companies will continue to execute documents under the old regime, being unaware of the new provisions - leading to technically invalid documents. Note that the execution regime is without prejudice to the ability of a company to authorise (normally by board resolution) any person to sign a contract on behalf of the company (and authorisation can of course be implied from the signatory’s position in the company).

The Government has responded to some of these uncertainties by proposing the introduction of a new “authorised signatory” regime. This would enable companies to appoint one or more authorised signatories who, by virtue of such appointment, are authorised to sign documents of any description on behalf of the company (Clauses 281-3). Directors would be authorised signatories ex officio. This seems to be an unnecessarily elaborate regime which replicates, to an extent, the existing regime for company secretaries - particularly with regard to the maintenance of a register by the company, and the filing of such appointments with the Registrar of Companies. However, the First EU Company Law Directive requires details of those having authority to bind the company to be on the public record, so the filing requirement is an inevitable element of any such regime.

Secretaries or others can be appointed as authorised signatories to execute company documents

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The Government has indicated that transitional provisions will permit company secretaries already holding office to be regarded as authorised signatories, without the need for formal authorisation by the company.

The authorised signatory regime is not to be confused with the ability of persons authorised by or on the behalf of the board to sign contracts, cheques or other documents on behalf of the company. Such persons will be able to continue to be appointed and act without completing any filing formalities at Companies House. The distinction is that “authorised signatories” under the Bill sign as the company itself, rather than as agents on the company’s behalf.

One minor positive improvement is the clarification of the ability of a company to appoint an attorney to execute, on its behalf, deeds or other documents, whether in the UK or outside the UK. Under existing legislation, express provision is only made for execution outside the UK.

⏐August 06 18

Matters open to comment The Bill now includes some 400 “restatement clauses” which consolidate into it parts of the Companies Act 1985 not originally covered by the Bill. The existing law has been rewritten to reflect other changes made by the Bill and the Bill’s general drafting style. The Government has obtained agreement from the opposition parties that they will not seek to move amendments to alter the substance of the current law - otherwise there would be little chance of the Bill being passed within this Parliamentary session. However, comments are sought by 8 September 2006 on any aspects of the drafting, particularly as to whether any unintended changes to the law would be made by the restatement.

A large bulk of material has recently been published for consultation

The DTI has published model Articles of Association for public companies and is seeking comments on these by 30 August 2006, although it also plans a more formal consultation on all three planned sets of model Articles - for public companies, private companies, and companies limited by guarantee - before making the regulations that will prescribe the model articles. We have a number of concerns with the wording of the model articles in their current, draft form. But if these concerns are dealt with, the model Articles, like the existing Table A forms, should provide a useful template and guidance - particularly on issues which are new, or are significantly affected by the Bill, such as nominated indirect investors, and directors’ conflicts of interest. Nevertheless, many existing companies may prefer to retain their own forms of Articles, making only any amendments necessitated by the Bill itself.

As mentioned above, the DTI is also proposing to discuss with stakeholders, such as listed companies and investors, the scope of the liability regime in relation to communications to the market by issuers.

And there will be more to come before the Bill can come into full effect

In due course, the DTI is expected to consult on transitional provisions. These are expected to deal, for example, with the powers of existing secretaries of private companies (as mentioned above), and with the continuing validity of shareholder authorities to allot shares by reference to current Section 80 of the Companies Act 1985, which will be repealed and replaced by a new Section in the Bill.

There will also be a number of regulations to be made under the Bill which will need to be passed before the Bill can come fully into effect. Those include regulations setting out the content of directors’ reports and directors’ remuneration reports.

The Government has undertaken to publish guidance for directors on their duties. This will not have any statutory basis and will therefore not be capable of providing a definitive statement of how the duties will apply in practice. Nevertheless, as the DTI will be consulting on the guidance, it should provide an opportunity to develop a reasonable consensus of views on the practical implications of the codified directors’ duties.

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Contacts If you would like to discuss any of the issues raised by this report, please contact Lucy Fergusson (Email: lucy.fergusson@linklaters.com or tel: 020 7456 3386) or Steven Turnbull (Email: steven.turnbull@linklaters.com or tel: 020 7456 3534) or your usual contact at Linklaters.

This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts at Linklaters.

© Linklaters. All Rights reserved 2006

Please refer to www.linklaters.com/regulation for important information on the regulatory position of the firm.

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