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Corporate Law Update 18 Mar 2022

In this week’s update: Legislation is enacted for the disclosure of beneficial owners of non-UK entities that hold or acquire UK real estate, the Model Articles did not permit the sole director of a company to take decisions alone, the Parker Review Committee publishes its 2022 update report and the European Commission extends its sustainable reporting taxonomy to nuclear and natural gas.

Legislation enacted to require overseas landowners to identify their beneficial owners

In our Corporate Law Update two weeks ago, we reported that Government had introduced draft legislation, in the form of the Economic Crime (Transparency and Enforcement) Bill, into Parliament.

The purpose of the original draft legislation was twofold:

  • To introduce a new regime requiring overseas entities that hold real estate in the UK to file details of their beneficial owners in a public registry at Companies House. This new regime, which we will refer to as the “OEBO” (overseas entities beneficial owners) regime, is modelled on the UK’s existing persons with significant control (or “PSC”) regime.
  • To make certain amendments and extensions to the UK’s framework for making unexplained wealth orders.

The Bill has now received Royal Assent to become the Economic Crime (Transparency and Enforcement) Act 2022.

What has changed?

Several amendments were made to the draft legislation before it became law. The main amendments affecting the OEBO regime are set out below. Otherwise, the specifics of the regime remain as set out in our previous Corporate Law Update.

  • The period within which an overseas entity that already holds a “qualifying estate” (i.e. a freehold property, or a leasehold for more than seven years) when the Act comes into effect has been reduced from 18 months to six months. (This would not apply to real estate acquired by an overseas entity before 1 January 1999.)
  • Where an overseas entity holds a qualifying estate on trust, it will also need to provide Companies House with details of the trust and its beneficiaries, settlor and certain other persons. This is in addition to the beneficial owners of the overseas entity itself. This represents a significant expansion of the scope of the regime since the draft legislation was introduced.
  • Details of trusts, beneficiaries, settlors and other persons will not be available to the general public. (Companies House will provide this information only to HM Revenue & Customs (HMRC) and law enforcement agencies.)
  • Companies within the regime will also have to disclose whether their beneficial owners are subject to UK sanctions.
  • An overseas entity will need to register if it disposed of a qualifying estate on or after 28 February 2022, even if it no longer holds any UK real estate. This appears to be designed to prevent overseas entities from avoiding registration by quickly liquidating their UK land assets before the Bill became law.
  • The level of fines for continued non-compliance with certain provisions of the legislation has been increased.

Separately, the Act contains new provisions allowing the Government to impose urgent sanctions on individuals that are already subject to US, EU, Australian or Canadian sanctions.

How does this affect trustees?

The extension of the OEBO regime to trusts creates some overlap with the existing Trust Registration Service (TRS), operated by HMRC.

Trustees of a trust that holds a qualifying estate may be required to register under both regimes, depending on when the trust acquired the property, creating some duplication of administration. There are, however, some differences:

  • Overseas entities that act as trustees will need to register under the OEBO regime if they acquired the property on or after 1 January 1999. Under the TRS, the duty to register is not triggered by an acquisition of property that took place before 6 October 2020. However, there are other triggers for registration under the TRS and a non-UK trust that acquired property before 6 October 2020 may be, or become, required to register on another ground.
  • Details of trusts and beneficiaries disclosed under the OEBO regime will not be available to the public (although details of a trustee’s own beneficial owners will). By contrast, equivalent details submitted under the TRS will be available to any member of the public who can demonstrate a “legitimate interest” or where the trust holds a controlling interest in a non-EEA legal entity. HMRC has confirmed that a person will usually have a “legitimate interest” only if they are conducting an investigation into suspected money laundering or terrorist financing activity.
  • The deadlines for registration under the two regimes are different. Once the OEBO regime comes into force, trustees that are required to register will have six months to do so. By contrast, trustees of trusts that are required to register under the TRS have (broadly speaking) until 1 September 2022 to do so. Given today’s date, this means the TRS registration deadline will fall first.
  • After 4 June 2022, trustees that acquire a qualifying estate will have 90 days to register under the TRS. However, once the OEBO regime comes into force (whenever that may be), overseas entities that act as trustees will not be able to acquire a qualifying estate unless they have first registered under that regime (or are exempt).

What next?

Although now law, the Act is not yet in effect. The Government will need to make an order to bring its operative provisions into force. We will continue to monitor developments and report when the OEBO regime is due to come into effect.

As we noted in our previous Corporate Law Update, it is not yet clear how soon it will be able to do this. The regime cannot be implemented until Companies House has the new register of beneficial owners up and running. It is possible this could be done fairly rapidly, but any changes to the registers at Companies House may need to tie in with the Government’s broader agenda of register reform.

In the meantime, overseas entities that hold UK real estate should examine whether they are required to register under the new regime and, if they are, prepare to do so.

Model Articles did not permit company to operate with a sole director

The High Court has held that a company which adopted the Model Articles with slight modifications was unable to operate when the number of its directors fell to one.

What happened?

Re Fore Fitness Investments Holdings Ltd [2022] EWHC 191 (Ch) concerned an unfair prejudice petition by a shareholder of a company under section 994 of the Companies Act 2006.

As part of the proceedings, a question arose over whether the company had validly served notice of a counterclaim against the shareholder. At the time the counterclaim was served, the company had only one director.

As is common, the company’s constitution was based on the model articles for private companies limited by shares (the “Model Articles”) with certain modifications. To understand the decision, it is important to recite four key provisions of the Model Articles, which we have paraphrased below.

  • Model Article 7(1). Directors are to take decisions either in board meeting (which are governed by subsequent articles in the Model Articles) or a “unanimous decision of the eligible directors” (which are governed by Model Article 8). This is called the general rule.
  • Model Article 7(2). While a company has only one director and its articles do not require it to have more than one, the general rule does not apply. Instead, the sole director can take decisions “without regard to any of the provisions of the articles relating to directors’ decision-making”.
  • Model Article 11(2). The quorum for directors’ meetings can be fixed from time to time, but it cannot be less than two, and the default quorum is two. In this case, the company modified Model Article 11(2) to require specific directors to be present to form a quorum.
  • Model Article 11(3). If at any time the total number of directors is less than the quorum, the directors must not take any decision other than: (i) to appoint further directors; or (ii) to convene a general meeting to enable the shareholders to appoint further directors.

At first glance, Model Articles 11(2) and 11(3) appear to contradict Model Article 7(2). However, the concept that the Model Articles could be internally inconsistent in this way (particularly where they are adopted in unmodified form) is unattractive.

The approach generally taken to date, therefore, has been that Model Article 11(2) and 11(3) form part of the “general rule” and so, while a company has a single director, they do not apply. Instead, Model Article 7(2) allows the sole director to take all decisions.

Another way of phrasing this is that Model Article 11(2) applies only where the company has multiple directors and needs to hold a board meeting, and Model Article 11(3) applies only if the company does not have enough directors to form a quorum for that meeting. Model Article 11(2) therefore sets the quorum for a board meeting, but it does not set a minimum number of directors of the company.

The shareholder argued that this approach was wrong and that the quorum provisions in the articles (in this case, a modified form of Model Article 11(2)) did in fact require the company to have at least two directors at all times. When the counterclaim was served, however, the company had only one director. That director was therefore acting outside his authority and the counterclaim was invalid.

What did the court say?

Perhaps surprisingly, the court agreed with the shareholder.

The judge said that “a provision in the articles requiring there to be at least two directors to constitute a quorum logically is a requirement that the company in question have two directors in order to manage its affairs”.

As noted above, in this case, the company had adopted a bespoke article requiring two specific individuals to be present for a meeting to be quorate. However, the judge’s comments were quite clearly also directed at Model Article 11(2) in unmodified form.

The company had argued that the Model Articles must permit a company to operate with only one director, because the Companies Act 2006 specific permits single-director companies.

However, the judge found that, although the Act contemplates companies with only one director, the Model Articles cannot be used in unmodified form in these circumstances. The Act specifically permits a company to modify the Model Articles, and this is precisely what a company must do to operate with a single director.

As a result, the counterclaim that the company had purportedly launched was invalid and the court struck it out.

What does this mean for me?

Although the judgment is based principally on the wording of the Model Articles, it is equally relevant to bespoke articles that deploy similar wording.

For persons looking to establish a new company, the key point is to ensure the company’s articles are drafted properly. If the intention is that the company should be able to operate with only one director, the articles should make this crystal clear.

The judge suggested that one way to address this would be simply to “delete” Model Article 11(2). Although this may be one solution, it may raise different difficulties. In particular, it would remove the power for the directors to fix a quorum from time to time and leave uncertainty over what the quorum is.

An alternative approach may be to state that any stipulations as to quorum do not apply while the company has a sole director.

For established companies, the judgment raises a few action points.

  • Companies should review their articles of association to identify whether they have adopted Model Articles 7 and 11 without modification or, alternatively, have adopted bespoke articles that broadly replicate those Model Articles.
  • Where this is the case, the company should decide whether it needs to be able to operate with a sole director. If it does need that flexibility, the company should consider putting forward amendments to its articles to make it clear that this will be the case.
  • If the company has historically operated with only one director, it should consider obtaining advice on whether any historic decisions taken by the sole director are or may be void.

Parker Review publishes update on progress towards board ethnic diversity

The Parker Review Committee, led by Sir John Parker, has published an update report on progress towards improving the ethnic diversity of UK company boards.

The Committee was established in 2015 to conduct an official review into levels of ethnic diversity on UK company boards. It published its first report, setting out its findings, in October 2017. The report found that the boardrooms of the UK’s leading public companies did not reflect the ethnic diversity of the UK. The Committee made various recommendations, which included the following:

  • There should be at least one director of colour on each FTSE 100 board by 2021 and on each FTSE 250 board by 2024.
  • FTSE 100 and 250 nomination committees should ensure qualified people of colour are considered for board appointment when vacancies occur.
  • Companies should develop mechanisms to identify, develop and promote people of colour within their organisations to ensure there is a pipeline of board-capable candidates.
  • Companies should set objectives for pipeline development, track progress against those objectives and report to the board on a regular basis.
  • The annual report should include a description of the board’s policy on diversity.
  • Companies that do not meet board composition recommendations by the relevant date should disclose the reasons why in their annual report.

The latest report provides an update and sets out the progress made in 2021 against the Review’s original recommendations. It is based on a voluntary census of FTSE 100 and FTSE 250 boards, carried out jointly with the Department of Business, Energy & Industrial Strategy (BEIS).

The update report notes the following key points. (This year, the report refers to directors from an ethnic minority, rather than directors of colour, but the measure is intended to be the same.)

  • 89% of FTSE 100 companies met the target of one director from an ethnic minority by December 2021. This is a significant improvement on the 63% of FTSE 100 companies that had met the target by the end of 2020, but obviously falls short of the target.
  • However and in addition, at the time the update report was published five FTSE 100 companies had announced the appointment of a director from an ethnic minority in 2022, bringing the percentage to 94%, and three further companies were actively engaged in recruitment.
  • The figures above represent companies that have met the target. Out of the 1,056 FTSE 100 directors, 164 (16%) came from an ethnic minority. Although the Review is not targeting a replication of the proportion of the general population made up by ethnic minorities, it notes that, according to the 2011 Census, ethnic minority groups accounted for 14% of the UK’s population.
  • The majority of these directors held non-executive roles. Only six FTSE 100 CEOs (6%) and three FTSE 100 chairs (3%) came from an ethnic minority. The Review recommends continued focus on this issue.
  • Of FTSE 100 board positions held by directors from an ethnic minority, 49% were held by women, suggesting a nearly even gender balance between ethnic minority directors. (This is similar to 2020, in which 43% of FTSE 350 ethnic minority directors were women.)
  • FTSE 250 companies still have until December 2024 to hit the target. At the end of 2021, 55% of companies had done so. This is, again, a significant improvement on the 31% of FTSE 250 companies that had met the target by the end of 2020.
  • When excluding investment trusts (which tend to have smaller boards and, therefore, less opportunity to make diverse appointments), this percentage rises to 61%.
  • Almost 10% of FTSE 250 directorships were held by persons from an ethnic minority, and 44% of FTSE 250 ethnic minority directors were women. Only 13 FTSE 250 CEOs (5%) and five FTSE 250 chairs (2%) were held by a director from an ethnic minority.

The report encourages FTSE boards not to think of the Parker Review targets as “one and done”. Many FTSE 350 Boards now have directors from minority ethnic groups for the first time, who the Committee believes can providing role models for employees at all levels, in turn improving motivation levels in organisations.

The Committee encourages companies to expand the scale and depth of initiatives fostering inclusion and diversity “from bottom to top”, in terms of both recruitment and talent management, to create sustainable pipelines of ethnically diverse talent.

Finally, the report notes that, although the Parker Review was established to focus on ethnic diversity on boards, the way to achieve this in the long term is to create happy and fair working conditions in which everyone has a chance to achieve their potential, irrespective of their ethnic background.

Other items

  • EU extends climate taxonomy to nuclear and natural gas activities. The European Commission has adopted new legislation to allow nuclear and natural gas energy activities to be included within environmentally sustainable activities under the EU Taxonomy Regulation. To qualify, the activity in question must satisfy certain conditions, including that it contributes towards the transition to climate neutrality. The new regulation does not apply in the UK, but it will be relevant to UK companies whose securities are admitted to trading in the European Union.