Ashurst and Practical Law Company Q2 2022

The articles below were written by Ashurst LLP and Practical Law Corporate in Q2 2022 and first published in the company law section of PLC Magazine, the leading monthly magazine for business lawyers advising companies active in the UK.

1. Interpretation of articles: model articles and sole directors
2. Narrative reporting: FRC report on modern slavery reporting
3. Investment Association: shareholder priorities for 2022
4. Parker review update on ethnic diversity on boards
5. Corporate reporting: IFRS sustainability disclosure standards
6. Fifth Anti-Money Laundering Directive: guidance on trusts

1.  Interpretation of articles: model articles and sole directors, 28/4/22

Summary. The High Court has considered the provisions in a company’s articles dealing with directors’ decision making and the quorum for board meetings, and held that the company did not validly serve notice of a counterclaim against a shareholder that had brought an unfair prejudice petition against it.

Background. Schedule 1 to the Companies (Model Articles) Regulations 2008 (SI 2008/3229) sets out model articles for a private company limited by shares incorporated under the Companies Act 2006 (2006 Act) (the model articles.

Article 7 of the model articles (Article 7) provides that any decision of the directors must be either a majority decision at a meeting or a decision taken in accordance with Article 8 of the model articles. If the company has only one director, and no provision of the articles requires it to have more than one director, that director may take decisions without regard to any of the provisions of the articles relating to directors’ decision making (Article 7(2)).

The quorum for directors’ meetings may be fixed from time to time by a decision of the directors, but it must never be less than two and, unless otherwise fixed, it is two (Article 11(2), the model articles) (Article 11(2)). If the total number of directors for the time being is less than the quorum required, the directors must not take any decision other than a decision to appoint further directors, or to call a general meeting so as to enable the shareholders to appoint further directors (Article 11(3)).

A private company must have at least one director (section 154, 2006 Act) (section 154). However, the model articles do not expressly specify a minimum number of directors.

Facts. F was incorporated by L, at which time L was its sole director. H later became a shareholder in F and was also appointed as a director, together with a third director, D.

F’s articles comprised of the model articles, modified by a requirement for two specific directors to be present for a board meeting to be quorate (the quorum provision) and a provision clarifying that any model articles were disapplied to the extent that they conflicted with the modified articles (the conflict provision).

H was removed as a director and D ceased to be a director, after which L acted as F’s sole director. H presented an unfair prejudice petition seeking an order that L buy his shares in F. F served a defence and counterclaim against H.

H applied for an order that F’s counterclaim be struck out, arguing that the quorum provision required there to be two directors for a board meeting to be quorate for any purpose other than taking steps to appoint new directors. H argued that as L was the only remaining director, he had no power to direct F to file the counterclaim.

L and F argued that when L became the sole director, Article 7(2) prevailed over other provisions in F’s articles relating to directors’ decision making, including the quorum provision.

Decision. The court granted H’s application to strike out F’s counterclaim. It held that the quorum provision required at least two directors to participate in any decision to commence a counterclaim. At all relevant times, L was acting as F’s sole director and so had no power to commence the counterclaim; he had acted ultra vires in purporting to do so.

Article 7(2) permits a sole director to manage a company only where no provision in the company’s articles requires it to have more than one director. The quorum provision clearly required at least two directors for a quorum, which logically required F to have two directors in order to manage its affairs. 

To the extent that there was a conflict between Article 7(2) and the quorum provision, it was resolved by the conflict provision, which meant that Article 7(2) was, by its own terms, disapplied. This interpretation was reinforced by Article 11(3), which dealt with the position where F had insufficient directors to represent a quorum and empowered the remaining director or directors to take certain limited steps to resolve the ensuing impasse.

Reading Article 11(2) as requiring a company to have two directors does not create a clash with section 154. Although section 20 of the 2006 Act provides for the model articles to apply if no other articles are registered, there is no requirement for a company to adopt them, whether in whole or in part. 

If a company wishes to operate as a single director company, section 154 permits this, and section 20 permits the model articles to be amended to achieve that end. The model articles need to be amended to permit a single director to run a company and this amendment would include the deletion of Article 11(2); although, in F’s articles, the parties had actually reinforced Article 11(2) in the form of the quorum provision.

Comment. The court’s comments that a company that intends to operate with a sole director must amend the model articles, and remove Article 11(2), are surprising. Before this decision, the industry consensus was that Article 7(2) meant that the general rule set out in Article 7 did not apply to a company with a sole director, who could take decisions without regard to any of the provisions of the articles relating to directors’ decision making, including Article 11(2), which simply sets the quorum for a board meeting and does not require a minimum number of directors. The decision has cast some doubt over this view and it is hoped that the government amends the model articles in due course to clarify the interaction between Articles 7 and 11.

The decision highlights the importance of amending a new or existing company’s articles in situations where the company has articles in the form of, or based on, the model articles and is intending to operate with a sole director. 

The validity of acts taken by sole directors in companies with articles based on the model articles is now likely to be called into question. The issue is therefore likely to come before the court again, which may take a different view. However, companies that have, or have had, a single director may also wish to consider whether, where appropriate, they should ratify some or all of the past decisions of those directors.

Case: Hashmi v Lorimer-Wing (also known as Re Fore Fitness Investments Holdings Ltd) [2022] EWHC 191 (Ch).

2.  Narrative reporting: FRC report on modern slavery reporting, 26/5/22

Summary. The Financial Reporting Council (FRC) has issued a report (the report) on how companies listed on the London Stock Exchange’s Main Market should report on modern slavery in accordance with section 54 of the Modern Slavery Act 2015 (2015 Act) (section 54).

Background. The 2015 Act consolidates offences relating to trafficking and slavery. Section 54 requires certain companies to produce an annual modern slavery statement specifying the steps that they have taken to ensure that their business and supply chains are slavery free, or a statement that they have taken no steps to do this. A company, wherever incorporated, must publish an annual modern slavery statement if it carries on a business, or part of a business, in the UK that supplies goods or services and has an annual turnover of £36 million or more.

Facts. The report is based on research carried out by Lancaster University as an extension to the preliminary research carried out as part of the FRC’s annual review on the extent to which companies are including modern slavery in their disclosures as part of their responsibility to consider the interests of their stakeholders in their annual reports. The research also included a review of reporting on modern slavery governance, policies, and due diligence in modern slavery statements.

The findings in the report include that:

• Reporting on modern slavery in both modern slavery statements and annual reports lacked the information needed by shareholders and wider stakeholders to make informed decisions.
• Around one in ten companies in the sample did not provide a modern slavery statement, therefore failing to comply with section 54. Where companies complied, most statements were fragmented, lacking a clear focus and narrative, or unduly complicated. Only a quarter of companies disclosed results against key performance indicators (KPIs) and just 12% confirmed that they had made informed decisions based on those KPIs.
• Fewer than half of the modern slavery statements in the sample provided a clear and comprehensive discussion of concerns in the context of organisational structure, operating and supply chains. Disclosure often lacked detail, failing to provide information on how policies operated in practice, or how their effectiveness was measured.
• The vast majority of statements were wholly backward-looking, with only a minority clearly identifying emerging issues or a long-term strategy. Although the majority of companies reported that they had assessed modern slavery risk in their own business and supply chain, fewer than a third disclosed an action plan based on the risks identified.
• In annual reports, reporting was minimal. This suggested that many companies did not view human rights issues in their workforce and supply chain as a principal source of risk for their business. The lack of disclosure might raise questions over whether sufficient attention is being paid to these issues.
• Only 14% of annual reports provided a direct link to the corresponding modern slavery statement.
• The findings from annual reports were consistent with evidence of patchy reporting on risk assessment and effectiveness in modern slavery statements, with very few referring to performance indicators. Relatively few reported on internal controls linked to the oversight of human rights and slavery in their annual report. Fewer provided any information about when, and how frequently, their modern slavery policies and governance arrangements are reviewed.

Source: FRC: Modern Slavery Reporting Practices in the UK: Evidence from Modern Slavery Statements and Annual Reports, 25 April 2022, www.frc.org.uk/getattachment/77c053d9-fe30-42c6-8236-d9821c8a1e2b/FRC-Modern-Slavery-Reporting-Practices-in-the-UK-2022.pdf.

3.  Investment Association: shareholder priorities for 2022, 28/4/22

Summary. The Investment Association (IA) has published its shareholder priorities and Institutional Voting Information Service (IVIS) approach for 2022 (the priorities).

Background. In October 2017, the Parker Review Committee recommended that, among other things, there should be at least one director from a minority ethnic group on each FTSE 100 board by 2021 and on each FTSE 250 board by 2024.

In June 2017, the Task Force on Climate-related Financial Disclosure published its final report containing the four pillars against which businesses voluntarily and consistently provide climate-related financial disclosures in their annual financial reports to interested parties such as investors and lenders (the four pillars).

In January 2021, the IA published its shareholder priorities for 2021 (2021 priorities). It updates the priorities annually.

IVIS is the IA’s corporate governance research service. It issues colour-coded reports when analysing listed companies for investors. An amber top raises awareness of particular areas and a red top indicates the strongest level of concern.

Facts. IVIS will monitor companies with financial years ending on or after 31 December 2021 against the approach set out in the priorities. As regards responding to climate change, the IA supports the guidance on transition plans that is incorporated in the FCA’s Listing Rules and encourages companies to publish transition plans before this becomes mandatory. 

Investors also expect to see progress on setting robust and, ideally, science-based targets to achieve net-zero carbon emissions. IVIS will amber top all commercial companies (previously those in a high-risk sector) that do not make disclosures against all four pillars.

In relation to accounting for climate change, investors continue to expect directors to affirm that the financial impact of climate-related matters has been incorporated into the company’s accounts, and to state in the annual report that they have considered the risks of climate change and transition risks associated with achieving the goals of the Paris Agreement when preparing and signing off the accounts. Auditors should consider the risks of climate change when assessing the accounts. IVIS will monitor whether auditors have highlighted climate change-related risks in their key audit matters.

As regards audit quality, companies should continue to meet the 2021 priorities and demonstrate how they have judged the quality of the audit that they have received. IVIS will continue to monitor whether the audit committee has demonstrated how it has assessed the quality of the audit and how it has challenged management’s judgments.

In relation to diversity, IVIS will now give a red top to FTSE 100 companies that have not met the Parker review target of one director from a minority ethnic group, and continue to give an amber top to FTSE 250 companies that do not disclose either the ethnic diversity of their board or a credible action plan to achieve the Parker review’s targets by 2024. It will give a red top to FTSE 350 companies where woman represent 33% (previously 30%) or less of the board or 28% (previously 25%) or less of the executive committee and their direct reports. It will now give a red top to FTSE Small Cap companies where woman represent 25% or less of the board or 25% or less of the executive committee.

With regard to stakeholder engagement, investors expect companies to:

• Continue to identify and disclose their material stakeholders.
• Decide on the most appropriate mechanism to engage with their material stakeholders.
• Clearly articulate how the views of material stakeholders have affected decision making.
• Report to stakeholders on the engagement of material stakeholders.

It continues to be critical to take into account the wider stakeholder experience, including the effects of the COVID-19 pandemic, both generally and when determining executive remuneration. Investors also expect disclosures to include the effect of increases to the cost of living and inflationary pressures on consumers and suppliers.

Source: IA: Shareholder Priorities and IVIS approach for 2022, 1 March 2022, www.ivis.co.uk/media/13898/ia-shareholder-priorities-and-ivis-approach-for-2022.pdf.

4.  Parker review update on ethnic diversity on boards, 28/4/22

Summary. The Parker Review Committee (the Committee) has issued an update report on the ethnic diversity of FTSE 100 and FTSE 250 companies’ boards (2022 report).

Background. The Committee was commissioned by the Department for Business, Energy & Industrial Strategy in 2015 to consult on the ethnic diversity of UK boards. 

In its final report published in October 2017 (the final report), the Committee recommended that, among other things, there should be at least one director from a minority ethnic group on each FTSE 100 board by 2021 and on each FTSE 250 board by 2024. 

The Committee published its first update report in February 2020 (the 2020 report) It published a second update report in March 2021 (the 2021 report).

Facts. The 2022 report reveals that there has been good progress towards meeting the Committee’s targets for FTSE 100 and FTSE 250 companies as set out in the final report.

• 89 FTSE 100 companies reported that they have at least one director from a minority ethnic group on their board. This is an increase from 74 in the 2021 report and 52 in the 2020 report. A further five have since announced new ethnic director appointments and another three are actively engaged in recruitment. The number of board appointees from minority ethnic groups splits evenly between genders, with women comprising 49% of the total.
• 128 FTSE 250 companies (of the 233 FTSE 250 companies that responded) reported that they had ethnic diversity on their boards. Of all board positions held by minority ethnic directors across the FTSE 250, 73 (44%) are held by women.

As the vast majority of director positions remain non-executive roles, the 2022 report recommends that continued attention is focused on this issue.

The 2022 report also summarises some of the preliminary findings of research undertaken for the Financial Reporting Council by the Gender, Leadership and Inclusion Research Centre at Cranfield University into the barriers that prevent individuals from minority ethnic groups achieving senior representation in FTSE 350 companies.

The findings include that:

• As a first step, companies are implementing initiatives to meet the objective of increasing ethnic diversity in senior leadership positions, such as data collection, introducing governance structures for diversity and inclusion, and setting targets. Companies should aim to prioritise reporting the outcomes alongside the actions.
• Evidence-based, targeted programmes can demonstrate active, direct initiatives to increase the diversity of senior leadership. These programmes and the related reporting could be improved by detailing their design and content in order to enable the evaluation of the features that make them effective.
• At board level, intentional recruitment, based on both merit and diversity, is being used by some companies as an effective way to increase the representation of minority ethnic groups.

Source: The Committee: Improving the Ethnic Diversity of UK Boards, 16 March 2022, https://assets.ey.com/content/dam/ey-sites/ey-com/en_uk/topics/diversity/ey-what-the-parker-review-tells-us-about-boardroom-diversity.pdf.

5.  Corporate reporting: IFRS sustainability disclosure standards, 26/5/22

Summary. The International Sustainability Standards Board (ISSB) is consulting on two new proposed draft International Financial Reporting Standards (IFRS) Sustainability Disclosure Standards (together, the proposed new standards).

Background. In June 2017, the Task Force on Climate-related Financial Disclosures published its final report containing recommendations that businesses voluntarily and consistently provide climate-related financial disclosures in their annual financial reports to interested parties such as investors and lenders (the recommendations).

In November 2021, the IFRS Foundation announced the establishment of the ISSB, a standard-setting board created because of the demand for high-quality, transparent, reliable and comparable reporting by companies on climate and other environmental, social and governance matters. 

The ISSB aims to create a global baseline of sustainability-related disclosure standards that provide investors and other capital market participants with details about companies’ sustainability-related information. The ISSB and the International Accounting Standards Board (IASB) co-operate to ensure compatibility between IFRS accounting standards and the ISSB standards.

Facts. The proposed new standards comprise:

• IFRS S1 "General Requirements for Disclosure of Sustainability-related Financial Information", which would require a company to disclose material information about all significant sustainability-related risks and opportunities to which it is exposed. The disclosure would be as a part of the company’s general purpose financial reporting, meaning that the sustainability-related financial disclosures would be published at the same time as the financial statements.
• IFRS S2 "Climate-related Disclosures", which would require a company to provide material information about its significant climate-related risks and opportunities. It incorporates and adds to the recommendations.

The proposed new standards would require a company to centre its disclosures on the consideration of the governance, strategy and risk management of its business, and the metrics and targets that it uses to measure, monitor and manage its significant sustainability or climate-related risks and opportunities. Individual jurisdictions will decide whether companies will be required to comply with the final version of the proposed new standards. The ISSB aims to review and issue the proposed new standards by the end of 2022.

Source: ISSB: IFRS S1: General Requirements for Disclosure of Sustainability-related Financial Information: exposure draft (ED/2022/S1), 31 March 2022, www.ifrs.org/content/dam/ifrs/project/general-sustainability-related-disclosures/exposure-draft-ifrs-s1-general-requirements-for-disclosure-of-sustainability-related-financial-information.pdf; ISSB: IFRS S2: Climate-related Disclosures: exposure draft (ED/2022/S2), 31 March 2022, www.ifrs.org/content/dam/ifrs/project/climate-related-disclosures/issb-exposure-draft-2022-2-climate-related-disclosures.pdf. Comments are requested by 29 July 2022.

6.  Fifth Anti-Money Laundering Directive: guidance on trusts, 26/5/22

Summary. The Law Society has issued guidance on whether various trust arrangements occurring in a transactional context require registration with HM Revenue & Customs’ (HMRC) Trust Registration Service (TRS) (the guidance).

Background. The Money Laundering and Terrorist Financing (Amendment) Regulations 2019 (SI 2019/1511) came into force on 10 January 2020, implementing the Fifth Anti-Money Laundering Directive (2018/843/EU) (MLD5).

This brought all non-taxable UK express trusts within the scope of the TRS regime, unless they are subject to one of the specific exclusions listed in Schedule 3A (Excluded trusts) of the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (SI 2017/692) (2017 Regulations) (Schedule 3A).

Facts. The guidance aims to assist corporate lawyers in determining whether various trust arrangements occurring in a transactional context fall within the scope of the extended trust registration and disclosure requirements arising from the implementation of MLD5.

The guidance identifies trusts that commonly arise in a variety of corporate or commercial transactions and sets out the Law Society’s generic analysis of whether they are express trusts, and if they are likely to benefit from an exclusion from the TRS regime. 

The type of trust arrangements considered include:

• Shares held on trust by a seller pending registration of the transfer, or by a nominee on an ongoing basis.
• Sums held in an escrow account or retention amounts held by a buyer under a share purchase agreement.
• Various trust arrangements arising on a business sale, including in respect of the benefit of assigned contracts and those arising under wrong pocket provisions.
• Trusts arising on a rights issue or open offer, or on an initial public offering or listing pending the shares being dematerialised.
• Consideration paid on the squeeze out of minorities and held on trust under section 981(9) of the Companies Act 2006.
• Holding security granted in connection with secured loan notes.
• Trusts created within a partnership or limited partnership arrangement.

The guidance also highlights that where a trust is within the scope of one of the Schedule 3A exclusions, this disapplies the registration requirement only and its trustees will remain subject to the record-keeping obligations under regulation 44 of the 2017 Regulations, under which they must maintain accurate and up-to-date written records of all beneficial owners of the trust and provide those records on request to any law enforcement body.

Source: Law Society press release, 11 April 2022, www.lawsociety.org.uk/topics/anti-money-laundering/trust-registration-service-trs-and-aml-compliance.