What to consider if appointing employees to boards in the UK

Out-Law Analysis | 11 Aug 2020 | 9:14 am | 12 min. read

Growing regulatory support for large UK corporations to ensure employee interests are represented to and properly considered by their boards should spur organisations to consider whether 'worker directors' would help provide a fresh perspective on decision making.

Worker directors may help provide a better link between the board and the workforce, but they are under the same legal duties as all other directors. In addition, issues around conflicts of interest and issues of confidentiality may prove more complex in the worker director context. Worker directors are relatively uncommon in the UK currently, but boards considering their appointment can look to examples of UK businesses that have appointed worker directors for inspiration.

Worker directors and corporate governance reform

The idea of workers representing the interests of their peers and communities directly to boards, while in circulation for some time, gained traction with Theresa May's bid for leadership of the UK's Conservative party in 2016 and the party's subsequent, albeit laboured, election victory. Although the suggestion that workers must be appointed to boards would not come to fruition, the resulting corporate governance reforms, and associated consultation papers, considered the implications of workers on boards in the UK in some detail.

In practice, a worker director is likely to be seen, even by the appointing board, as representing the workers alone. The law would not agree. Such a director will have to act in the interests of all shareholders, as any other director would need to do. This level of responsibility, despite the seemingly focussed nature of the role, is one of the most often suggested difficulties of appointing a worker director.

In the UK government's 2016 green paper on corporate governance reform it was acknowledged both that some companies already have well-developed mechanisms for listening to their employees’ views – singling out trade unions among others – and that a small number of companies had voluntarily appointed workers to their boards, with FirstGroup plc being the most well-known. However, it was conceded that the practice was not generally adopted.

The position is approached very differently in Europe. Germany's two-tier board system, for example, includes worker representatives on the supervisory board, but a supervisory board cannot make any executive decisions or give formal orders to the management board. The UK's unitary board system, where all the directors have the same set of duties and are collectively responsible for decisions, creates a more complex framework within which worker directors must operate.

Nevertheless, the idea of employees being on boards remains topical in the UK. Beyond the government's green paper, the issue has been considered in detail in the BEIS Committee report which evaluated and considered the proposals set out in the green paper, as well as in the government's eventual response.

In its green paper, the government, while offering the appointment of employee representatives to boards as an option in efforts to strengthen stakeholder voice in the boardroom, was ambivalent about it, noting only that those in favour of employee representatives on boards argue that it can bring new perspectives to board discussions but there were significant obstacles. In particular, that real decision making would move from the boardroom to less formal channels; that there was a risk of tokenism; that choosing a worker representative would be difficult; and, perhaps most importantly, that the worker representative would be constrained by the common directors’ duty to promote the success of the company and by the confidentiality of board discussions. This raises the fundamental question of whether boards should be cohesive governing bodies rather than forums for representatives of different interests to resolve their varied approaches.

The view of the BEIS Committee was that having a single worker on a board would not fully address the issue of the company’s engagement with the workforce. Nevertheless, employees bring a different perspective and challenge to the board, and are more likely to encourage a long-term perspective. Recruiting directors internally from the workforce is consistent with the public benefit of companies recruiting directors from the widest possible net of suitable candidates.

There is nothing in law, the Committee noted, that prevents workers serving on boards, and the diversity of board members, including workers on boards, is beneficial. In the opinion of the Committee, just as the drive for women directors overcame resistance it should become the norm for workers to serve on boards, although it stopped short of recommending that companies over a certain size be compelled to include a worker on their board.

Importantly, in the Committee's view, it must be acknowledged that employees appointed to boards are directors in their own right. They must have the necessary skills and aptitudes to play a part as a full board member rather than a representative of the workforce. They would not be a delegate, but would provide the same strategic evaluation and challenge that every director should bring.

The government summarised these "pros" and "cons" in its response to the green paper consultation. In favour: a valuable new perspective and contribution of operational knowledge to the board; encouraging a long-term approach; improving board diversity and challenging ‘group-think’. In opposition: the potential for conflicts of interest given that directors have specific legal responsibilities in relation to shareholders; the danger of creating two classes of director, particularly if directors no longer share a common purpose; the risk of delayed decision-making; the possibility of some stakeholders being prioritised over others; and the practicalities of identifying a suitable individual. According to the government, about 40% of those that responded to the consultation supported the idea, while 60% were sceptical.

Although employees still do not have a right to board representation, the 2018 UK Corporate Governance Code – applying to premium listed companies on the London Stock Exchange – introduced new measures which require greater engagement by boards with the workforce. Employee engagement at board level is now expected to be by way of one or more of the: appointment of a director from the workforce; establishment of a formal workforce advisory panel; and/or creation of a designated non-executive director role with focus on the workforce. If a company's directors have not chosen one or more of these methods, directors must explain the 'alternative arrangements' that they have put in place.

The Code, as the "gold standard" for UK corporate governance reporting, is influential. Large, privately-held companies which do not need to comply with the Code but for whom best-practice governance is important may be encouraged to assess their approach to employee engagement, including the possibility of having worker representatives on boards. Such an approach may even be extended to their operating subsidiaries.

What to consider if appointing a worker director

Directors’ duties

Worker directors will owe the same duties to the appointing company as other directors. These include, in addition to common law fiduciary duties, those duties codified under sections 171 to 177 of the Companies Act 2006: to act within powers; to promote the success of the company; to exercise independent judgment; to exercise reasonable care, skill and diligence; to avoid conflicts of interest; not to accept benefits from third parties; and to declare an interest in a proposed transaction or arrangement with the company. Particular attention should be given to the requirement under section 172 that a director of a company acts in a way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, having regard, but no more, to particular stakeholder factors.

These are serious responsibilities which need to be understood both in terms of legal substance and internal policy. Worker directors will need to understand their obligations to the company, not just the workers they represent. They must act in good faith in their decision-making and will be expected to contribute to all board discussions, as reflected in the minutes, in order to demonstrate compliance with these duties.

They will also be expected to perform their duties, whether statutory, fiduciary or common law, diligently and to a standard commensurate with the function of the role and their individual knowledge, skills and experience. Large companies which need to produce a strategic report will need to include a statement explaining how the directors – including any worker director – have promoted the success of the company in performing their duties.

Some comfort for any incoming director may be found in section 1157 of the Companies Act 2006, which gives the court power to excuse a director from all or part of any liability for any breach of duty if they have acted honestly and reasonably, and having regard to all the circumstances of the case they ought fairly to be excused.

It might be the case that a worker director, appointed with the best of intentions to provide better links between the board and employees, who acts honestly and reasonably at all times, incurs the sympathy of the court, finding some relief from errors at board level. Yet this is not to be relied upon as it is the director who would need to demonstrate to the court that such relief was appropriate, that they had acted honestly and reasonably, and that may be very difficult to do if problems have arisen.

Confidentiality

The board will need to think carefully about how it will ensure confidentiality of board matters while still allowing the worker director to report to and engage with their colleagues. Given the dual role of worker and director, there will be tension. The worker on the board would be privy to sensitive information that no other employee would normally be able to access. This is a far from insurmountable issue and employees have played a useful role as pension fund trustees for many years. But how this is communicated and reinforced will be a matter to which the board should give careful thought.

On appointment the worker director, as any other director, should be made aware that they owe a duty of confidentiality to the company and that information acquired as a director should not be disclosed other than with permission or in the interests of the company. They will have undergone a change of position: a director stands in a fiduciary relationship to the company, distinct from an employee who is not a director and does not assume any such fiduciary duties merely by virtue of their role. They should also be reminded of the need to hold and retain information under appropriately secure conditions.

It may be that confidentiality can be satisfactorily dealt with by way of training and through standard provisions of the worker director's contract, which should directly address breaches of confidentiality. It is likely that further safeguards will be needed:

  • It may be that the board decides that it is appropriate for a reminder about the importance of maintaining confidentiality to be a standing agenda item at meetings of the board.
  • It may be that the chair requests the worker director to recuse themselves in relation to discussion of certain information, although this is a request that can be denied as the general rule is that all directors are entitled to attend board meetings. A refusal may be necessary in order for the director to comply with their statutory duty to use all reasonable skill and care in their role – if they are going to share responsibility for a decision, why should they not be allowed to participate in the decision-making? Leaving the meeting is likely only to be appropriate if it is a personal interest under discussion, as would be the case for any other director. This pre-supposes that a worker director feels able to take such a firm position, which may not be the case.
  • If the board has decided that the worker director has a fundamental conflict of interest inherent in the situation, then assuming the non-interested directors have previously authorised the conflict and set parameters to manage the conflict, which may include exclusion from attending board meetings or parts of board meetings and/or withholding of certain information, then this would provide additional flexibility. If appropriate, such an authorisation should be put in place from the moment the worker director is appointed to the board.
  • Clear decisions should be made and recorded about how the worker director will engage with employees, what information is permitted to be shared and when, and how the director will report back to the board. Prevention of a breach of confidentiality is more important than any remedy: although a breach of the duty of fidelity gives rise to the normal remedies available for a breach of contract – damages and possibly an injunction – and breach of fiduciary duties can trigger equitable damages or compensation broader than just the actual loss suffered, this is of little comfort once confidential information has been released. The threat of remedies is likely, of course, to act as a deterrent to all board members.
Training

Both directors' duties and the importance of confidentiality should be communicated to worker directors on appointment. However, for worker directors who may not have any prior experience of board behaviours, governance or company law, a well designed and thorough induction is crucial.

The Financial Reporting Council's guidance on board effectiveness emphasises that, for companies seeking to comply with the UK Corporate Governance Code, the chair should ensure that all directors receive a full, formal and tailored induction on joining the board and that. This is best practice and good sense for any company. It is up to individual companies how best to implement this. Mentoring by an existing NED could be part of the process.

There should also be ongoing training, allowing the worker director to develop and refresh skills and knowledge in areas which are mutually identified as likely to be required, or of benefit to the worker director in carrying out their duties effectively. If the worker director is asked to join a committee, specialist training might be necessary.

For listed companies, the performance of individual directors and the whole board and its committees is evaluated annually. Although the worker director will be assessed like any other director, a nominations committee should think about what contribution is to be expected well in advance of the review and probably on appointment.

Practical matters

After considering the context in which a worker director might be appointed, and having decided that it is the right thing for its company, there are a number of practical matters that the board must decide:

  • Proposed selection and eligibility criteria / number – what qualifications and/or experience for the role, if any, must the candidate have? Will they be appointed or elected, and by whom? How many worker directors will be appointed? In large organisations, how will the board identify candidates that represent all workers, including those overseas, or a sufficiently wide cross-section? If unionised, what role will the union and its representatives play?
  • Preparedness and support – how will a worker, particularly if inexperienced, be prepared for a board role? There should be the offer of training, but boards will need to consider additional assistance – the use of mentors, perhaps, or external support. What role should the company secretary play?
  • Right to time-off for board duties – a board position is a serious and often time-consuming role. How long should worker directors be required to commit to the role? How long should they have to prepare for and attend each board meeting outside of their "day" job?
  • Level of compensation – how much will a worker director be paid? Will it be the same rate as a company's existing NEDs, with associated expenses? If something less, on what basis?
  • Consulting with colleagues – how will this take place? Are there pre-existing forums and bodies that a worker director can engage with? Are terms of reference required? How will the board assure themselves that the worker director remains "of the workers" rather than "of management", such that their input remains valuable?

A worker director may be of particular assistance where a description of a company’s engagement with employees is required in its directors' report, as is the case under the changes introduced by the Companies (Miscellaneous Reporting) Regulations 2018. Such a company must describe the action that has been taken during the financial year to introduce, maintain or develop arrangements aimed at:

  • providing employees systematically with information on matters of concern to them as employees;
  • consulting employees or their representatives on a regular basis so that the views of employees can be taken into account in making decisions which are likely to affect their interests;
  • encouraging the involvement of employees in the company’s performance through an employees’ share scheme or by some other means; and
  • achieving a common awareness on the part of all employees of the financial and economic factors affecting the performance of the company.

In addition, a summary should be given of how the directors have engaged with employees, and how the directors have had regard to employee interests, and the effect of that regard, including on the principal decisions taken by the company during the financial year. This can certainly be done without a worker director, but reporting on how employee matters have reached and been considered by the board is likely to be facilitated by the contributions of such a director.

There are no right answers and the procedures put in place will depend on the needs of the company and its objectives in putting a worker on the board. There will necessarily be a number of practical and pragmatic decisions to be made to ensure a fair process identifies the right candidate to achieve sensible outcomes.