ML Covered - November 2024

Welcome to the November edition of ML Covered, our monthly round-up of key events that are relevant for those dealing with Management Liability Policies covering D&O, EPL and PTL-type risks.

High Court considers the interplay between a director's removal from office and their subsequent unfair prejudice claim

In Willoughby v Cole and another [2024], the Court was required to determine an application for strike out and summary judgment of parts of the Defence to an unfair prejudice petition, brought pursuant to s994 of the Companies Act 2006 (the Act).

Background

The petition relates to the affairs of Simply Naturals Limited (Simply Naturals), which was founded by Mr Willoughby in 2001. In 2011, Eric Cole and David Evans (the Respondents), who were long term friends of Mr Willoughby, were invited to join him in developing Simply Naturals.

Mr Willoughby's case was that since early 2022, the Respondents sought to exclude him from the management of Simply Naturals, following which they removed him as a director without providing an offer in respect of his shares.

Mr Willoughby's unfair prejudice petition

Following Mr Willoughby's removal and exclusion as a director, he brought an unfair prejudice petition pursuant to s994(1) of the Act.

The Respondents denied any unfairly prejudicial conduct and contended that there had been misconduct on the part of Mr Willoughby as a director of Simply Naturals, which justified his removal as a director, and therefore that, if such removal was prejudicial, it was not unfair.

There were two sets of allegations relied on by the Respondents in the Defence. The Respondents claimed that they were induced to enter into an agreement by false representations made by Mr Willoughby, which included assertions regarding the financial success of a US company that he owned, which sold the same product being offered by Simply Naturals (the Old Allegations).

The second set of allegations related to more recent alleged misconduct – examples of which included being late for work, failing to get work done in time due to dealing with excessive amounts of personal affairs during working hours and also removing a CCTV camera (the New Allegations).

In response, Mr Willoughby argued that the Old Allegations were historic and irrelevant and that the New Allegations, even if true, did not justify his removal as a director.

The Judge concluded that the Respondents removed Mr Willoughby as a director due to the New Allegations only, and so struck out the Old Allegations.

As to the New Allegations, the judge concluded that there was no real prospect of the Respondents establishing that these matters alone, even if proven at trial, constitute such serious misconduct that they would objectively justify the removal of Mr Willoughby as a director, without a first offer being made for his shares. The Judge therefore granted summary judgment in favour of Mr Willoughby.

The Judge noted that as a matter of law there is no causal connection required between a Petitioner’s conduct and his or her removal as a director. However, the Judge noted that if it is not pleaded as part of the Respondent’s case that the relevant allegations given by the Respondent to the Petitioner were a reason for removing him or her as a director this is a factor that the Court is entitled to consider.

Key takeaways

The Respondents' case largely relied on the Old Allegations, which were seemingly never acknowledged or addressed at the time. As such, the Respondents were unable to demonstrate that the historic conduct was material to their decision to remove and exclude Mr Willoughby as a director.

This case demonstrates the importance of ensuring that conduct relied upon when removing and excluding a director must be material, and weight will likely be given by the Court as to the recency of that conduct. It also demonstrates the importance of acting upon poor conduct as and when such conduct takes place.

To read the judgment, please click here.

The Audit Reform and Corporate Governance Bill – what do the proposals mean for management liability?

The Audit Reform and Corporate Governance Bill (the Bill) is poised to become landmark legislation that will overhaul the regulation of audit and corporate reporting.

The think tank, Audit Reform Lab, recently revealed that 75% of audit reports failed to indicate that companies, which subsequently failed within the following year, were at risk of bankruptcy by providing a 'material uncertainty related to going concern' finding. Coupled with the review of the Financial Reporting Council (the FRC) in 2018 which highlighted its constraints, this provided a clear basis for the establishment of a new regulator – the Audit, Reporting and Governance Authority (ARGA).

The recommendations set out within the previous government's White Paper have now been incorporated into the outline of the Bill currently in draft form, which proposes the transformation of the regulatory landscape, including the scrutiny and accountability of company directors.

In summary, the draft Bill involves replacing the FRC with ARGA as the regulatory body, which would differ from the FRC as follows:

• Wider Remit – The definition of Public Interest Entities (PIEs) will be extended to include the largest private companies thus subjecting them to the same reporting standards as large, listed companies, with a view to ensuring audits of these companies give early warning signs of financial issues.
• Streamlined Regulations – Unnecessary rules would be disapplied to smaller PIEs to ensure that reporting requirements are not disproportionately onerous on smaller businesses.
• Greater investigatory and enforcement powers – Currently, directors can only be held accountable for making incorrect financial statements if they are members of an accountancy body. This limits the efficacy of the existing enforcement regime. The Bill would give ARGA statutory powers to investigate concerns over the accuracy of financial reporting and sanction directors for neglect or breaches of their duties.

FRC updates the UK Corporate Governance Code

The backdrop to the Bill has seen the FRC publish a revised UK Corporate Governance Code (the Code), which will apply to companies listed in the commercial companies category or the closed-ended investment funds category for the financial years commencing on or after 1 January 2025. The purpose of the Code is to "set high standards of corporate governance, reporting and audit by holding to account those responsible for delivering them"

This has given rise to questions as to whether this will see the introduction of a US style of regulation, which requires directors to assume personal liability for the financial information they provide. Whilst the FRC has acknowledged concerns raised by stakeholders, it remains to be seen how the Bill will take shape in this respect.

What might this mean for management liability?

The background to the Bill has involved consistent calls for a new regulator with broader enforcement powers, including the ability to investigate and sanction directors for neglect or breaches of duty. It is therefore clear that the Bill intends to enhance the accountability of directors for incorrect financial reporting.

The outline of the Bill suggests that obligations on directors may increase vis-à-vis the provision of accurate financial information. If the landscape is to develop as indicated, directors and their D&O insurers will need to be alive to any increased risk of claims and ensure that internal controls meet any such higher standards.

To read RPC's blog on this matter, please click here.

The Employment Rights Bill: The key proposals

On 10 October, the Employment Right Bill (the Bill) and an accompanying Next Steps to Make Work Pay (Next Steps) were introduced to Parliament in what has been described by the government as 'the biggest upgrade in employment rights for a generation'. The Bill amends several employment rights — such as the right not to be unfairly dismissed or the right to work flexibly — but also introduces new protections, including the right to not be terminated and replaced. Although the Bill awaits amendments from the House of Lords, the proposed changes shed a light on the government's ambitious approach to employment law reform. Some of the key changes are discussed below.

Flexible working

Currently, employers must deal with flexible working requests in a 'reasonable manner' and can only refuse the application if one of the statutory grounds apply, including the burden of additional costs, inability to recruit additional staff, a detrimental impact on quality, among others. The Bill introduces an additional reasonableness requirement - an employer can only refuse the flexible working request if one of the statutory reasons apply and it is reasonable to refuse the application on that ground or those grounds. The employer must then state the statutory ground or grounds it relies on and explain why they consider it reasonable to refuse on that ground or those grounds.   

Fire and rehire

In its current form, the Bill states that it will be automatically unfair to dismiss an employee if the reason or principal reason is the employer's attempt to alter the employee's contract without their consent or to re-engage the same individual under a revised contract to perform substantially the same duties as before. Dismissal due to a failure to agree to a contract variation will only be fair if the reason for the variation was to eliminate, prevent or significantly reduce, or significantly mitigate the effect of, any financial difficulties which would affect the employer's ability to carry on the business, and the employer could not reasonably have avoided the need to make this variation.

Simply enhancing business efficiency does not meet this requirement; the Next Steps document specifies that there must be a 'genuine lack of alternatives', setting a high standard for justification.

Unfair dismissal

One of the most significant of the proposed changes is the elimination of the two-year qualifying period for unfair dismissal claims.

However, the Bill introduces the concept of an 'initial period of employment' (IPE), during which the standard of reasonableness for dismissals will be modified provided the reason (or principal reason) for dismissal is related to the employee's conduct, capability, statutory restriction, or some other substantial reason. The modifications are yet to be announced but are expected to enable employers to dismiss employees more easily during the IPE. Notably, redundancy has been omitted from the list which means that employees made redundant during the IPE have the full right to claim unfair dismissal from day one.

The government will consult on the length of IPE, but the Next Steps document states a preference of 9 months. Whilst we may see a reduction in whistleblowing and discrimination claims, the likely uptick in unfair dismissal claims will no doubt put pressure on tribunals.

Sexual harassment

In last month's edition of ML Covered, we covered the duty on employers to take reasonable steps to prevent sexual harassment, which came into force on 26 October. The Bill reintroduces the duty to prevent sexual harassment by third parties and amends the wording of 'reasonable steps' to ‘all reasonable steps’, imposing a significantly more onerous duty on employers. Further regulations will be published to clarify what is required to comply with such steps.

The Bill also introduces a new category of qualifying disclosure for whistleblowing purposes ‘that sexual harassment has occurred, is occurring or is likely to occur’.  While there is already a qualifying disclosure for instances where a criminal offence 'has been committed, is being committed, or is likely to be committed', the deliberate inclusion of 'sexual harassment' makes it clear that sexual harassment is a focus for the government.

Impact of the Bill

The government predicts that more than 5,600 extra tribunal claims are expected to emerge once the Bill becomes law, a 15% increase from current figures. Unfair dismissal claims are predicted to be the biggest contributor, adding 3,350 claims and over 10,000 Acas early conciliation cases. It remains to be seen whether additional funding will be provided to tribunals to help cope with these new claims. This will mean further delays to cases coming to hearing and from a practical point of view, will mean a need to ensure all evidence, including witness evidence, is recorded at the start of cases to avoid memory fade or insureds being unable to properly defend cases as relevant witnesses have left the organisation by the time of the hearing and are no longer willing to assist in providing a statement.

The Bill has now passed its second reading in the House of Commons and has been sent to a Public Bill Committee which will scrutinise the Bill before reporting to the House by 21 January 2025. Watch this space for further updates on the Bill's progress.

DWP consults on extending Collective Defined Contribution

The Department for Work and Pensions (DWP) has launched a consultation on extending Collective Defined Contribution (CDC) schemes following the launch of the UK's first CDC scheme for the Royal Mail on 7 October 2024.

At present, CDC schemes are only available to single employers (such as Royal Mail setting up a scheme for its employees), but the government is consulting on draft legislation that would extend the CDC market so that multiple, unconnected employers can pool their pension schemes in the same CDC schemes. This complements broader measures by the new government to tackle "waste" in the pensions industry.  In a CDC scheme, both the employer and employee contribute to a collective fund. The difference to a Defined Contribution (DC) scheme is that the CDC pays scheme members an income in retirement (like a Defined Benefit (DB) scheme). However, unlike DB schemes, the employer does not guarantee the retirement income. Essentially, CDC schemes provide a target pension but it is not guaranteed.

Another key difference to a DC scheme is a CDC is managed collectively, which is seen as one of the advantages of such schemes. The DWP has noted the following as some of the main advantages of CDC schemes:

• Retirement in a single package – members can accumulate and decumulate in the same scheme.
• Longevity risk sharing – people managing their own pension pot's risk of underspending (dying with unused funds) or overspending (running out of funds) and CDC schemes may reduce the risk by paying savers based on average life expectancy across the scheme's members.
• Investment strategy – CDC schemes can have a longer-term investment strategy because of the mix of members with some still contributing whilst others are receiving income and so unlike individual pots which often adopt life styling investment strategies (with monies moved to less risky assets later in life) which offer increased risk for longer and with that the potential for better overall returns.
• No continuing liability for employers (unlike DB schemes).

DWP also accepts there are potential disadvantages, including:

• Falling incomes / lack of guaranteed income.
• Intergenerational risks – earlier generations could end up propping up the retirement of later generations.
• Similarly, members who die will effectively subsidise the pensions of those who live longer – these members may be better off with a DC pension.

DWP's latest consultation on CDC schemes concerns draft legislation that would remove the exclusion of unconnected multiple employer CDC schemes from operating under the existing CDC provisions. It also sets out what CDC schemes that are whole-life unconnected multiple employer schemes must do to become authorised and operate effectively under regulatory oversight.

It seems likely that more CDC schemes will launch following Royal Mail's earlier this month, and this legislation has the potential to pave the way for large schemes involving multiple employers. Given the differences to DB and DC schemes, there will be new risks for trustees (and employers) and their insurers to contend with as new schemes are launched, particularly if the trustees are expected to guard against the risks outlined above.

TPR reminds trustees they are the "first line of defence" against pension scammers

For Scam Awareness Week (21-25 October) the Pensions Regulator (TPR) has highlighted the case of Pauline Padden to remind trustees and administrators to do more to protect savers as "the first line of defence".

Pauline lost her entire pension savings of £45,000 to scammers who contacted her out of the blue to encourage her to transfer her pension to supposedly "high return" investments (along with 244 other victims scammed out of more than £13.5mn after they were persuaded to transfer into fraudulent schemes), and offered a cash incentive of 10% of the transfer value to do so.

TPR has published a video in association with the Pension Scams Action Group (PSAG) (a multi-agency taskforce of law enforcement, government and industry led by TPR), which it has urged trustees and administrators to share with their members to help them identify pension scammers. For members, Pauline suggests they should ask themselves “is it genuine or is it too good to be true” before making any decision.

TPR's PSAG page notes that its work has helped protect savers through legislative change, public awareness measures such as this, and enforcement (including this case where the two individuals running the scheme were prosecuted by TPR and jailed for over 10 years in total). For legislative change, the PSAG notes that there has been a ban on pensions cold calling since 2019, pension trustees now have powers to prevent transfers if they see signs of a scam under the Pension Schemes Act 2021 (with the introduction of the traffic light system), and members are required to take advice before transferring benefits of £30,000 or more.

Whilst there are increased protections in place and a greater awareness of pension scams now such that scams like this should hopefully become less common, with TPR putting the onus on trustees as the first line of defence there is a greater risk that trustees will be held responsible if members are duped into transferring their pensions into fraudulent investments and their due diligence ahead of the transfer is inadequate.

TPR launches resource to help trustees achieve better ESG compliance

TPR has launched a 'suite of essential resources' to help trustees go beyond minimum compliance with environmental, social and governance (ESG) duties.

TPR has noted that although most trustees meet their ESG duties, a review of Statements of Investment Principles (SIPs) and Implementation Statements (ISs) produced by the trustees of 375 schemes reveals many only achieve minimum competence.

• TPR calls for trustees to go beyond minimum compliance to ensure savers' pots are future-proofed – in particular, the regulator calls for:
• ESG to form part of the scheme's decision-making as opposed to being a box-ticking exercise when it comes to completing the climate disclosures they have to publish.
• Trustees to demonstrate they are taking advantage of the opportunities presented by the UK’s ambition to transition to a net zero economy by 2050.

Trustees to work with advisers to develop their understanding, embrace best practice and maximise the opportunities while mitigating the risks material climate change and ESG factors present. TPR does not expect trustees to be climate change experts, but suggests they should be able to identify, assess and manage climate-related risks and opportunities for their scheme.

On that basis TPR notes trustees should have access to the resources they need to achieve better compliance – TPR's resources are now all in one place (which can be accessed here) which includes codes of practice and guidance on climate reporting and investment guidance for both DB and DC schemes. It is good to see the regulator acknowledging the need to provide support when asking trustees to do more but it is an area where we could see challenges to trustee decisions.

Meghraj case clarifies tests for calculation of contribution notices

TPR has outlined the action it took against two individuals in relation to a large cash payment by a subsidiary of a scheme’s employer to an entity outside the employer group. This Meghraj case was the first of its kind at the Upper Tribunal regarding TPR's anti-avoidance contribution notice (CN) powers.  This is relevant to PTL insurers as cover under PTL usually extends to defence costs of individuals challenging a CN (albeit would not cover payment of the CN itself). 

Background

The case involved the Meghraj group of companies, where Meghraj Financial Services Limited (MFSL) was the employer of the scheme with Anant Shah (AH) the sole director. MFSL owned a company called Meghraj Properties Limited (MPL), which in turn owned shares in a joint venture company in India (the Indian JV). Rohin Shah (Anant's nephew) was a director of MPL and was supposedly entitled to 80% of the profit of the Indian JV pursuant to an oral agreement between Anant and Rohin in 2004.

Between 2007 and 2011, MPL paid a series of dividends to MFSL following a disposal of shares in the Indian JV. MFSL used some of those funds to meet its liability under the scheme but also paid large dividends to its parent company, M.P. Group Limited (MPGL) based in the Isle of Man. MPGL used the dividends to pay funds to a nominee company at the direction of Rohin and made further dividends into the Shah family trust. On disposing of the last of its shares in the Indian JV in January 2014, a payment of around £3,688,108 was paid to a nominee company at the direction of Rohin and this supposedly represented his 80% profit share under the 2004 agreement.

TPR's action

MFSL entered creditors' voluntary liquidation in October 2014 and the largest creditor was the scheme with a deficit on a buy-out basis of £5.85 million. This prompted TPR to look at payments made by MFSL to the detriment of the scheme, which led the regulator to conclude that there was no legally binding contract requiring MPL to make the 2014 payment.

In May 2018, TPR issued a Warning Notice to Rohin and Anant on the basis that the 2014 payment should not have been made, and should have been used by MPL or distributed via dividends (as had been the case on the sale of previous tranches of shares in the Indian JV). TPR maintained this would have resulted in funds being available to support MFSL’s creditors, including the scheme. The targets disputed the case on the basis the 2014 payment resulted from a legally binding contract such that the sale proceeds from the Indian JV were not part of MPL's assets. They also challenged on the basis TPR was out of time by reference to the 2004 contract which was outside of the six year period for acts/failures to act that applies to TPR issuing warning notices.

The Upper Tribunal's findings

The case came before the Upper Tribunal after the targets challenged the Determination Panel's determination that CNs in the sum of £ £3,688,108 (the 2014 payment) should be issued to Anant and Rohin on a joint and several liability basis – i.e. they were personally responsible to pay these sums to the scheme. The Upper Tribunal subsequently determined that TPR should issue a CN to Anant for £1,875,403 (50%) (TPR reached a settlement with Rohin ahead of the hearing).

The case has clarified the tests that TPR apply when determining CNs and these show that TPR will have significant leeway in doing so:

• If material detriment is found, the question of what CN amount would be reasonable is limited only by the cap provided by section 39 of the Pensions Act 2004, i.e. the amount of the section 75 debt. There is no further constraint based on the need to show loss and the extent of that loss, and no need to consider whether, and the extent to which, the act or failure to act has prejudiced the recoverability of all or any part of the section 75 debt.
• A target’s financial circumstances is not the only factor to be taken into account when determining whether it would be reasonable to issue a CN. The Upper Tribunal may decide not to place significant weight on a target’s financial circumstances if they do not make full and frank disclosure of their current finances

The amount that the Upper Tribunal considers reasonable for a target to pay can be uplifted to reflect the passage of time since the acts and/or failures to act occurred. In this case, the uplift was calculated by reference to investment return data for the scheme.  The actions taken by CN need to be seen in the context that its powers to issue CNs has widened since the Pension Schemes Act 2021 and so there is increasing scope for TPR to pursue directors and those associated with directors for debts owed to defined benefit/final salary pension schemes.