On 16 July, the Government issued the first of its White Papers on the proposed reform of UK Company Law. The White Paper is the first proposed legislation to result from the three year review of the law and the consultation process conducted by the Company Law Review Steering Group, which culminated in its July 2001 final report. The Government's declared purpose is to bring UK company law up to date and to provide a simple, modern and cost-effective infrastructure for carrying out business in the UK. It has indicated that it intends to implement many of the recommendations made in the July 2001 report.

As the scope of the review was broad, many of its recommendations will involve significant change for companies and their advisers. This White Paper, which contains over 200 draft clauses to be incorporated into a new Companies Bill, concentrates mainly on changes which are designed to simplify the administrative burden on smaller private companies. In addition, there are a number of provisions which will affect larger companies and their directors. The proposed changes include:

• requiring public and large private companies to publish in their annual report an audited operating and financial review (OFR), containing an assessment of the company's business, performance and prospects, as well as its community and environmental impact and relationships with staff. See the section below containing further detail about the OFR;

• requiring directors of companies and their subsidiaries to volunteer to the auditors all information which they need in order to carry out their audit (failure to do so will be a criminal offence); and

• changing the definition of a 'small company' for accounting purposes, so that more companies can take advantage of the more relaxed reporting regime;

• shortening the time limit for private companies to file accounts from 10 months to 7, and for public companies from 7 months to 6;

• automatically removing the requirement for private companies to hold AGMs, unless the members want them;

• making 15 days the notice period for all general meetings (unless the members agree to a shorter notice period);

• allowing companies to give notice of a shareholders' meeting by notifying members of its publication on a website;

• allowing proxies to speak at meetings and to vote on a show of hands;

• giving members the right to have a poll at a general meeting scrutinised by an auditor;

• automatically reducing from 95 per cent to 90 per cent the majority required to permit an EGM of a private company to be held on short notice;

• allowing private companies to pass written resolutions with the approval of 75 per cent of the members (for special resolutions) or 50 per cent plus one (for ordinary resolutions) - instead of 100 per cent for both types as at present;

• abolishing the requirement to have a company secretary;

• abolishing corporate directors over a period of, say, three years;

• reducing the problems for third parties where a company acts 'ultra vires', by giving new companies unlimited capacity in their constitution, and giving directors deemed authority to exercise any power of the company;

• creating a new model constitution in a single document, to replace the current 'Table A' articles and the provision for a company's memorandum to contain the objects of a 'general commercial company';

• putting on a statutory footing the current common law duties of directors. The draft Companies Bill envisages directors being judged according to a combination of an objective standard (the knowledge, skill and experience reasonably expected of a director in that position) and a subjective one (the knowledge, skill and experience of that particular director). As this broadly reflects the formulation of directors' duties in existing case law, it is likely that past cases will continue to be relevant. There will also be a formal duty to take into account in good faith the company's relationships with employees, customers and suppliers and its impact on the community and environment in the long and short term, to the extent that it is practicable to do so.

Operating and Financial Review (OFR)

The Government believes that companies should provide more qualitative and forward-looking reporting as well as information that is quantitative (e.g. the balance sheet), historical (e.g. the financial results for the past year) or about internal company matters (e.g. the size of the workforce). The Government believes that information about future plans, opportunities, risks and strategies is just as important to users of financial reports as a historical review of performance.

Under the proposals, the OFR will have to contain at least the three core elements:

• a statement of the company's business in the financial year to which the OFR relates;

• a fair review of performance during that financial year and of the position of the company at the end of that year; and

• a fair projection of the prospects for the company's business and of events which will, or are likely to, substantially affect that business.

In addition, there are a list of areas which the directors of the company must consider when compiling the OFR. These include relationships with employees, customers and suppliers and the company's impact on the wider community. They also include the company's impact on the environment.

Any OFR should be prepared on a consolidated basis if the company is a group holding company. A company would only need to produce an OFR where it meets two out of the three following size criteria:

Public Companies

Turnover more than £50 million
Balance Sheet total more than £25 million
Number of employees more than 500

Private Companies

Turnover more than £500 million
Balance Sheet total more than £250 million
Number of employees more than 5000

According to the White Paper, this will catch approximately 1,000 companies and groups. The Government estimates that together these companies have an aggregate turnover in the region of £1,000 billion and cover a quarter of corporate economic activity in the UK. However, since they represent less than 0.1 per cent of registered companies, the Government considers that the proposed new requirements strike a justifiable balance between the additional burden to companies and the benefits to investors of quality reporting.

The company's auditors will be required to report on the OFR. Their review will essentially concern the adequacy of the process of preparation, focusing on how the report is prepared and not on its detailed content. However, the auditors will be required to report on the company's compliance with applicable rules and whether the OFR is inconsistent with the financial statements or with any other information which the auditors are aware of as a result of the audit.

Contrary to the recommendations made by the Company Law Review Steering Group, the draft clauses for the new Companies Bill do not allow companies to exclude information from the OFR for reasons of confidentiality or commercial sensitivity. The Government has asked companies to identify examples of any issues which they would prefer to exclude on these grounds, and for suggestions on how, if any information were to be excluded, this fact should be drawn to investors' attention, in order to ensure that the OFR is not misleading.

Reductions of share capital - a simplified procedure?

The White Paper also proposes new rules designed to simplify the procedure for private and public companies to reduce their share capital without having to go to Court. Private companies will be allowed to do so if the reduction is approved by a special resolution of shareholders and the directors make a formal statement that the company is and will be solvent for the next 12 months. For public companies, the same requirements will apply, and in addition creditors will have a right to object to the proposed reduction. The Government is specifically consulting further on these proposals, as well as on the recommendations of the Company Law Review Steering Group that the procedure for companies to redeem or purchase their own shares should also be simplified.

Consultation Period and Further Developments

The consultation period on this White Paper, entitled 'Modernising Company Law', runs until 29 November 2002. A copy of the White Paper can be found online at:

www.dti.gov.uk/companiesbill/whitepaper.htm

Further White Papers are expected to be published soon. These are likely to reflect many of the other recommendations made by the July 2001 report, including:

• management and regulation of directors' conflicts of interest - including disclosure of interests to the Board (and shareholders), dealings between a company and its directors, and the sanctions related to these;

• regulation of conflicts of interest between companies and their major shareholders - e.g. by compelling institutional investors to disclose publicly how they voted;

• transparency in the terms of service of executive and non-executive directors, and controls on the length of their contracts;

• simplification of the procedure for public and private companies to reduce their share capital and to redeem or purchase their own shares;

• relaxation of the prohibition on a company giving financial assistance in connection with the acquisition of shares in itself or its holding company; and

• the rights and remedies of minority shareholders.

The Government has also indicated that it intends to devolve responsibility for introducing and monitoring some of the changes relating to companies' accounts to:

• a new 'Standards Board', based on the current Accounting Standards Board, to make and enforce rules on the form and content of financial statements, including the new OFR, and to keep under review the Combined Code on Corporate Governance; and

• a new 'Reporting Review Panel', as successor to the Financial Reporting Review Panel, to enforce the rules on the form and content of the accounts of public and large private companies.

The progress of the Companies Bill onto the statute book will be determined by the amount of available Parliamentary time and the approach which the Government takes. At present it is not known whether the Government intends to bring in the changes piecemeal, or whether it will wait until all of the areas for review have been consulted upon and finalised before taking a single comprehensive Bill through Parliament. In order to reduce the amount of legislation which will require the scrutiny of the full Parliament, the Government has already indicated that it intends to effect many of the less controversial changes by means of secondary legislation.

For further information, please contact:

Martin Mendelssohn
Corporate Partner
martin.mendelssohn@cms-cmck.com
+44 (0)207 367 2872
(contactable after 27 August)

or

Charles Currier
Corporate Solicitor
charles.currier@cms-cmck.com
+44 (0)207 367 2736

or

Peter Bateman
Corporate Solicitor
peter.bateman@cms-cmck.com
+44 (0)207 367 3145