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Corporate Governance: Change is on the way for regulation of company directors' liabilities

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United Kingdom

In February 2021, the UK Government announced that it would be launching a major overhaul of the UK corporate governance regime in order to improve financial reporting and controls. These proposals came in the wake of high-profile accounting scandals over the past few years.

The Government's initial proposals included making directors of large companies more accountable for serious failings in financial reporting, such as significant errors in the company accounts, as well as requiring large companies to publish an annual resilience statement showing how the business would be mitigating both short and long-term risks (for more on this see our previous article: How will UK corporate governance reforms affect company directors?).

A consultation on the Government's proposals ran between 18 March 2021 and 8 July 2021. Following the feedback received, the Government has fine-tuned its proposals and published its response to the consultation on 31 May 2022.

Where are we now?

A key thing to note is that there will be no immediate impact for directors. The UK Government plans to publish draft legislation containing its corporate governance reforms in the next 12 months, meaning that these reforms are only likely become law within the next 2 years.

And critically, following pushback during the consultation, most of the Government's reforms will only apply to businesses with more than 750 employees and an annual turnover of £750m or more ("750:750 Businesses"). It is estimated that this will only cover an additional 600 businesses. The Government has also dropped its proposal to make directors personally liable for internal controls over financial reporting.

For those 750:750 Businesses however, the Government will be proceeding with the following four amended proposals:

  • Directors will need to make a statement about the legality of proposed dividends and any dividends paid in a year and assurances that the dividend will not threaten the solvency of the company. The distributable reserves figure at the balance sheet date will also be subject to audit.
  • Companies will have to publish an annual Resilience Statement, which will include:
    • Notification of matters that they consider to be a material challenge to resilience over the short and medium term and an explanation of how they arrived at this judgment; and
    • Identification of any material uncertainties to the business which the directors consider are necessary for shareholders to be aware of to understand the current position of the business.
  • Directors would be liable to the company for untrue or misleading information in the Resilience Statement if they knew the information was untrue or misleading (or were reckless as to whether it was so) or if they dishonestly concealed a material fact.
  • Directors will have to report on what steps have been taken to prevent and detect material fraud
A beefed up regulator

There is change for the regulator too, with the Financial Reporting Council being replaced with a more powerful regulator called the Audit, Reporting and Governance Authority ("ARGA"), which will also now regulate 750:750 businesses. ARGA will be given the power to penalise directors who breach their legal duties and will be able to investigate the nature of directors’ decisions and take action in cases where the directors have complied with the letter of the law but are nevertheless engaged in dishonest or improper conduct.

A more heavyweight approach?

Although the Government's proposed reforms will now apply to fewer companies than anticipated, it is still essential for companies to ensure that they have first-class corporate governance and financial management systems in place. The Government is keen to put an end to the reporting scandals of the past few years and it's likely that ARGA may well want to flex its muscles and show it means business when it gets up and running over the next few years.

No-one wants the dubious accolade of being the first scalp taken by ARGA and now more than ever, director reviews of company accounts need to be water tight. Companies should stay one step ahead by keeping their policies under regular review to ensure they are complying with the latest rules and best practice.

Fieldfisher is continuing to monitor the Government's proposed corporate governance reforms and will provide a further update once draft legislation has been published.
 

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