the companies act 2008 - is it fit for purpose?
In 1959 the Jenkins Committee was appointed to review and report on the provisions and workings of the Companies Act 1948 and to consider, in the light of modern conditions and practices, what the duties of directors and rights of shareholders should be going forward.
While the Committee was praised for highlighting the problems existing within company law at the time, their final recommendations could reasonably be described as defeatist…. “we would gladly see a reduction in the unwieldy mass of legislation but have not found it possible to make suggestions contributing to that end to more than a limited extent.” (Report of the Company Law Committee (para 6))
The negativity continued further; “…it would be wrong in principle to disturb in any important respect long standing provisions…unless they have clearly outlived their usefulness or are demonstrably objectionable on other grounds.” (Ibid) thus arguing that even to attempt such a task of reform would be undesirable other than in the most exceptional circumstances.
In paragraph eight of its report the Committee even goes so far as to question its own utility “…some witnesses have been inclined to question the need for….further changes of major importance in a system found by experience to have worked reasonably well.” This phrase appears to me to be pivotal in terms of setting the benchmark for acceptable reform. Surely as home to one of the most respected legal systems in the world we should be aiming for more than “reasonably well”?
The Company Law Review (CLR) Steering Group was set up in 1998 and represented the next major attempt to comprehensively re-examine and modernise company law. This should have presented the perfect opportunity to address both the unwieldiness of the legislation and the inconsistencies between the legislation’s emphasis on public companies compared to the ever increasing number of small owner managed private companies.
There was initial optimism that this time there would be meaningful reform. The CLR adopted a ‘Think Small First” injunction and proposed substantial deregulation for private companies and a plain English style of writing to increase accessibility. However, the Companies Act 2006 (CA06) that ensued, became the largest Act of Parliament ever enacted, comprised of 47 parts with 1,300 sections, 16 schedules and over 70 statutory instruments. The recommendation to draft in plain English was ultimately disregarded and there was little to no special consideration for small companies.
According to government statistics, there are currently 5.9 million private companies registered in England & Wales. (Chris Rhodes and Mathew Ward, (7 July 2020) Business statistics House of Commons Library Briefing Paper no. 06152. (House of Commons Briefing Library) 3.) Of these, 5.8 million are small and 4.5 million of these small businesses hired no employees other than the owner(s). (Ibid 5) This represents a 95% increase in quasi sole trader entities since 2000. Legislation cannot, therefore, be regarded as working “reasonably well” for the majority.
This essay explores the ramifications of the Jenkins report and the further reforms of the CA06 which have in combination contributed significantly to the stagnation of company law over the past sixty years. The ‘reluctance to interfere’ has led to inertia and slow decision making in a rapidly changing arena.
Under the CA06 it is possible to incorporate a company with a single shareholder and director. (S154(1) Companies Act 2006) This has been invaluable for high net worth individuals (HNWIs) who wish to protect their personal assets from potential litigation claims via the limited liability structure. It is note-worthy from the statistics detailed in the abstract that the reduction of tax advantage for small companies are having no discernible impact on the popularity of this type of vehicle. (Chris Rhodes and Mathew Ward, (7 July 2020) Business statistics House of Commons Library Briefing Paper no. 06152. (House of Commons Briefing Library 3.)
It is no longer a legal requirement to have a company secretary pursuant to S270(1) of CA06 which dispenses with unnecessary red tape for small owner manged businesses. In an independent survey of 27 small company directors, only 22% reported that their company had a company secretary. (See question 3 of the survey at appendix 1) One respondent wasn’t sure, which initially suggests a lack of awareness but perhaps this is unfair. The role of the company secretary within a private company is not defined by the CA06 so directors can perhaps be excused for not knowing for what purpose they may, or may not, need one. At a practical level the option to have a company secretary is a legacy of historic legislation geared to public companies which has been incrementally adapted, rather than being subject to a complete overhaul.
More positives exist in S336(1A) CA06 which dictates that only traded private companies are under the obligation to hold an AGM and is a change from the CA85 position. This also means that there is no longer a statutory requirement for private companies to lay their accounts before the members for approval unless the Articles of Association dictate otherwise. In an owner managed business much, if not all, of the management will be conducted informally and continuously throughout the year so there is no logical benefit to be derived from the same individuals reporting in their capacity as directors to themselves in their capacity as shareholders. (See question 9 of the survey at appendix 1) Survey respondents noted that 63% of the companies they directed held no board meetings at all and 25% held only informal/ ad hoc ones. 98% of these directors were also shareholders of the company in which they held directorial responsibilities. Although positive therefore, reforms could justifiably be extended further for small companies to provide an additional exemption to S248(1) and (2) where the directors of the company are also its shareholders. (S248(1) the obligation to keep minutes of all board meetings / S248(2) for 10 years ) It is my view that criminal sanctions for non-compliance of minute keeping and retention are unnecessarily harsh for a small family run company and importantly there is no equivalent under the Limited Liability Partnerships Act 2000.
S678(3) CA06 provides a carve out to the former restriction in CA85 preventing all companies from providing financial assistance for the acquisition of their shares. The restriction now only applies to the acquisition of shares in a public company or a company that is a subsidiary of a public company. Unfortunately, as well as protecting creditors and minority interests the blanket restriction had inadvertently prohibited many genuine commercial transactions and placed unnecessary barriers on small private company succession strategies. The ability of companies to provide finance to assist the introduction of new members into the business has been positive in facilitating an enterprise culture and greater flexibility for succession planning.
CA06 delivered practical administrative reforms such as eliminating the requirement for directors to disclose their personal addresses on the public record and allowing the provision of a service address via S163(1)(b). Information can still be requested from the Register of Members for an appropriate fee but sections 116 and 117 introduce tests to ensure that the request is for a ‘proper purpose’. The aim of this reform was largely to prevent incidents such as that in 2001 when a senior executive was attacked with baseball bats by animal rights activists outside his home. (https://www.theguardian.com/uk/2001/feb/24/paulkelso1)
Directors duties were codified for the first time in CA06 in sections 171-177 with some subtle changes to the previous common law position. Of the company directors surveyed, just under 15% either disagreed or strongly disagreed with the statement that they had a good understanding of the legislation surrounding directors duties and 22% disagreed or strongly disagreed that they had good knowledge of civil and criminal sanctions that could be brought against a director in breach of any of these duties. (See questions 7 and 8 of the survey at appendix 1) This raises the question of whether lack of practical enforceability means that directors can afford to have a less than satisfactory knowledge of the legislation due to the minimal risk to themselves.
S172 of CA06 provides an interesting example of this issue. (Duty to promote the success of the company) The section incorporates a long list of stakeholder groups that directors should give regard to, in addition to the traditional focus of maximising shareholder value. However, as the section is intended to be discretionary and not to be treated as a tick box exercise, the danger is that it becomes irrelevant in practice. In reality many of the categories are not applicable to a typical small company, for example S172(1)(a) can be ignored by the 76% of UK companies which have no employees. (Chris Rhodes and Mathew Ward, (7 July 2020) Business statistics House of Commons Library Briefing Paper no. 06152. (House of Commons Briefing Library) 5) The impact of the company’s decision making on the local community and environment is also likely to be negligible for the majority of small businesses. (S172(1)(d) Companies Act 2006)
In terms of enforceability, the historic problem with breaches of sections 171-177 of CA06 was that, per the old common law rule in Foss v Harbottle ( 2 Hare 461 (Court of Chancery)), it was only the company, as the ‘proper claimant’, who could sue for harm done to itself. This necessitated a majority of the board wishing to litigate. In a single owner director company, or where the decision was made by majority decision, the director(s) would have to sue themselves for not reaching a subjectively reasonable decision or ratify the decision retrospectively. There was a narrow exception to this rule provided by the common law which enabled a member to sue on behalf of the company, provided that both fraud and wrongdoer control could be proven. (Prudential Assurance Co. Ltd. v Newman Industries Ltd. and Others (No. 2)  Ch. 204) Essentially CA06 codifies and extends this exemption via S260 to incorporate a breach of directors’ duties arising from negligence, default and breach of duty or trust.
An alternative to a derivative action is now provided by S994(1) CA06 which enables a member to petition for an order on the grounds that that the company’s affairs have been conducted in a manner which is unfairly prejudicial to one or all of the members. However, once again, the procedure is expensive and time consuming and in order to pursue a petition the shareholder must not have declined a reasonable offer (O’Neill v Phillips  1 W.L.R 1092 1107-8) to purchase their shares at market value which is not always the most desirable outcome for the complainant.
Based on the discussions in the first chapter a sensible preliminary reform would be to draft a new definition of a small owner managed business which is distinct from those which are simply “small” under S382. This could be a modified version of the ‘close company’ definition set out in the Corporation Tax Act (S439 Corporation Tax Act 2010) and effectively revitalise the exempt private limited company status which existed up until the Companies Act 1948 (CA48) but was abolished as a result of the Jenkins reforms. For the purpose of this essay I propose to classify this category of company Qualified Small. The creation of this new category of company would enable various carve outs to be added into the legislation in areas in which it would be non sensical for individuals to report to themselves (as shareholders) by themselves (as directors). Sections of the legislation where this would be appropriate include S77(1)(a) - company change of name, S307- notice required of a General Meeting and S197(1) loans to directors.
One third of the directors surveyed said that their company did not maintain a register of members, which I predict would increase significantly if the sample was extended. (Question 5 of the survey at appendix 1) There would be two options of how to approach reform to S113(1) (Every company must maintain a register of its members), either a carve out for the newly defined Qualified Small companies as mentioned above, or by reducing or eliminating the filing fees at Companies House and requiring that every change to members is registered publicly within seven days of the appointment.
Returning to the discussion in chapter one regarding the problems surrounding practical application of S172 CA06 for a small business, a better way to encourage corporate social responsibility (CSR) could be through an extension of the Corporate Governance Code. The Code is currently only applicable to companies with a premium listing but there is no reason that this could not be extended in part to private companies encourage CSR within areas such as the environment, sustainability, ethical working practices or sourcing locally. Potentially small and Qualified Small companies could choose to ‘opt in’ to all or various sections as a marketing tool to highlight their commitment in these areas to like-minded consumers.
The practical enforcement of director’s duties and protection of the minority shareholder remains a problem. Derivative actions are lengthy, expensive and frequently not in the company’s best interests. At its essence such an action is intended to be of benefit to the company at the expense of the shareholder and if the courts do not see sufficient benefit being derived by the company, permission will not be granted. (https://www.morningstar.co.uk/uk/news/AN_1412239614994218500/elektron-technology-says-court-rejects-claims-against-its-directors.aspx
) In addition, the majority rule principal protects shareholder from bringing proceedings if the alleged wrong is a transaction that was made binding by majority agreement.
There are similar problems for members looking to seek redress through S996 for complaints such as excessive directors’ remuneration, exclusion from management, failure to pay dividends and misappropriation of assets. Litigation is costly, time consuming and detrimental to the business. In one example an offer to purchase the claimant’s shares was made after nearly three years of litigation. (O’Neill v Phillips  1 W.L.R)
Given that the most common remedy awarded by the courts is share repurchase at fair value under S996(2)(e) a more effective protection for all shareholders would be to add a minority protection clause in the Model Articles. Should this Article be triggered by to any cause of action which would give rise to a claim under S996 the minority shareholder could elect to appoint an independent valuer to assess the value of his shareholding and trigger a mandatory purchase. The valuer would also be responsible for determining over what period this consideration should be paid to the exiting shareholder based on a thorough review of the company’s financial statements and with the intention of maintaining the business as a going concern throughout the buyout period. Should the remaining shareholders wish to contest the time period for payment they should apply to the courts for an extension on specific grounds.
The law has typically shied away from such a radical concept in order to protect both the democratic principal of majority rule and the best interests of the company as a separate legal entity as distinct from its owners. It is my belief that reform is required to counterbalance the dangers of majority control and give due regard to the true nature of owner managed companies in which such disputes frequently arise. Although there would undoubtedly be concerns regarding abuse, my feeling is that the Article would be approached with extreme caution and only triggered as a last resort. In such ‘last resort’ circumstances the issue would be dealt with much more efficiently and economically than via the courts and in the majority of cases result in the exact same outcome of share re purchase at a fraction of the cost. Ultimately the mechanism would give protection for all parties as well as acting as a strong deterrent against board manipulation.
When surveyed, just under half of the respondent directors stated that they would elect not to file their financial statements on the public record if this option were available. A further 30% were ambivalent. (Question 6 of the survey at appendix 1) Interestingly prior to the Jenkins recommendations that led to CA85 private exempt companies were not required to file any financial information on the public record. This benefit was lost to all companies as the private exempt company was abolished and for the last thirty five years companies of all sizes have been required to file at least a balance sheet on public record.
The Jenkins Committee report made an interesting point regarding its recommendations in this respect “we appreciate the argument that the filing of accounts may cause embarrassment or inconvenience to some exempt private companies through the fears which have been expressed to us on this score are, we believe exaggerated.” Although I can’t comment on the accuracy of this statement made in 1962, in my capacity as a chartered accountant in public practice in 2020, I strongly believe the issue to be more than about embarrassment in today’s world and one which should not be trivialised.
HNWI’s trading via a limited company are regularly subjected to “Trial by Tabloid” in which actual facts bare little relevance to the story. (https://www.mirror.co.uk/3am/celebrity-news/lorraine-kelly-mocked-tax-claims-14167216) It is my view that where there are no shareholders other than the directors, accountability for compliance should lie solely with HM Revenue & Customs (HMRC)- not the general public. This could be via a two stage test, firstly the company must be defined as Qualified Small and secondly satisfy additional tests as set by HMRC to assess the merits of a privacy application. Clearly this would need to be researched in greater depth and a trial process commissioned using volunteer companies.
The involvement of HMRC in the proposed reform above is pivotal to its success. In my view the supporting institutions of company law all need to undergo a level of reform and re-engagement in order to achieve meaningful and comprehensive change. For example, although companies must update the PSC register pursuant to S790M(1) there are virtually no checking procedures in place at Companies House for weeding out incorrect or inconsistent data. There needs to be a mechanism in place within Companies House which flags inconsistencies and issues penalties for careless filing which currently does not exist.
Reforms need to better recognise the close relationship between small owner managed companies and partnerships. At a basic level this may include introducing a new category of company which will enjoy a series of carve outs from the primary ‘large company focussed’ legislation.
The correct regulator for small companies with no shareholders other than the directors is HMRC. Reforms should enable HMRC to take on the enforcement arm by significantly improving Companies House procedures and systems to act as a better control mechanism.
An extensive review process should conduct further research into the qualification criteria required to authorise a private limited company to file its financial statements direct with HMRC as opposed to on the public records.
New procedures should be introduced to enable recourse for a minority shareholder subject to board domination and prevent majority rule being legitimised by the courts.
Whilst there will be inevitable administrative difficulties executing any reforms this should no longer be allowed to be the driver of inertia in company law. Change must be progressive and dynamic and if necessary anti avoidance legislation used to support any teething issues.
The Companies Act 2006
The Companies Act 1985
The Companies Act 1948
The UK Corporate Governance Code 2018
The Limited Liability Partnerships Act 2000
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The UK Corporate Governance Code 2018
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