Corporate governance focus turns to subsidiary companies

Out-Law Analysis | 07 Aug 2019 | 11:28 am | 2 min. read

Companies in the UK are under more corporate governance scrutiny than before.  Subsidiaries in particular may need to change their practices to enhance their decision-making processes and ensure they meet these more stringent regulatory requirements.

The focus of governance – both within groups of companies and for regulators – tends to be on the relevant managing board, usually that of the ultimate parent company.  It is often overlooked that there are other legal entities in a group, each with their own separate legal personality, rights and liabilities and, crucially, their own directors.

The latest version of the UK Corporate Governance Code, released in 2018, acknowledged that it may be relevant to a group of companies. However, such guidelines may not always work for a large wholly-owned subsidiary  with its own staff and customer bases.

What has changed

What has changed in the UK is that companies are now required to disclose more about their internal governance, or lack of it, as a result of the Companies (Miscellaneous) Reporting Regulations 2018.

Any UK company, including a subsidiary, with more than 2,000 employees or a turnover of more than £200 million and a balance sheet total of more than £2 billion must provide a governance statement. This means that the company’s directors’ report must state which corporate governance code, if any, the company has applied during the year, how the code was applied and any departures from the code and the reasons behind them.

If the company did not apply a named code for the year that decision must be explained, along with the governance arrangements that were applied for the year. The obligation is to report on what has happened during the year under review and the governance arrangements in place throughout that year. This means that companies, including subsidiaries, that are required to make the statement should be giving careful thought to which code they will choose to apply: the UK Corporate Governance Code, the Quoted Companies Alliance Code, the Wates Principles or another.

Of these the Wates Principles, drawn up last December by a panel under the leadership of construction magnate James Wates, are the most flexible and arguably the easiest for a subsidiary company to adopt. However, even these six principles suggest that companies should report in areas which are not normally within a subsidiary’s remit, such as remuneration policy.

Webster Martin

Martin Webster

Partner

It is often overlooked that there are other legal entities in a group, each with their own separate legal personality, rights, liabilities and directors.

The new legislation also offers companies the option of explaining why existing codes are not entirely suitable for them, and instead setting out the governance arrangements applied during the year. Groups with existing, well-developed internal governance structures may choose, even if those arrangements have not always been formalised and reduced to something akin to an internal code or manual, to apply and explain the governance arrangements that they have been working with.

Decision making

One of the reasons for subsidiary governance to be overlooked is the frequent mismatch between legal and managerial structures, with organisations often run by division rather than in line with the group’s legal entities. This can create difficulties when it comes to formalising governance practices and reporting on them.

The directors of subsidiaries are often not the decision-makers for the group or division, and it can be difficult to explain board decision-making if in practice the board rarely meets and decisions are made elsewhere. 

Two solutions might be considered. The more straightforward would be to align the two structures by at least ensuring that the individuals on the decision-making committees and the statutory directors are one and the same, and that committee meetings can be treated as board meetings. That may require a greater degree of formality than has previously applied, but it has the virtue of symmetry and clarity.

A second solution is perhaps more cumbersome and bureaucratic. The articles of most companies will allow a board of directors to delegate decision-making, although the detail should be checked to ensure the widest possible delegation is permitted, including to employees and non-employees.

It is important to make sure that this delegation does not give the impression of the board being sidelined or ignored, and the statutory directors should receive regular reports on what has been done in their name.

A version of this analysis first appeared as a chapter by Martin Webster in The International Comparative Legal Guides (ICLG) Corporate Governance Guide