In this month’s update we consider:
- how subtleties in the drafting of two non-compete restrictions made one enforceable and one unenforceable;
- examine the interaction between sole director and quorum provisions in articles of association;
- explain how the Government proposes to transform Companies House from a passive administrator of information into an active gatekeeper and custodian of reliable data.”
Non-compete restrictive covenants: The enforcable and the unenforceable
The High Court has held in Law By Design Ltd v Ali  EWHC 426 (QB) that a non-compete restrictive covenant in the service agreement of a senior employment solicitor was valid and enforceable whilst an equivalent covenant in the shareholders' agreement between the solicitor and her employer was unenforceable for being in restraint of trade.
The solicitor had been employed by a boutique employment law firm for some time before she became a shareholder and entered in the shareholders' agreement. Some years later, she was promoted again and entered into a new service agreement. But just four months later she resigned and announced she was going to work for a large law firm.
Although both the service agreement and the shareholders' agreement contained a non-compete restrictive covenant, there were key differences in the way the two provisions were drafted:
- the restriction in the service agreement prevented the solicitor from working for any business which was (or intended to be) in competition with the parts of her employer's business in which she had been materially involved during the 12 months before she left; and
- the restriction in the shareholders' agreement, however, prevented the solicitor from working for any business which competed, directly or indirectly, with a business of her employer in the same territory in the 12 months before she left.
The High Court accepted that a non-compete restriction was an acceptable way for the employer to protect its confidential information and guard its valuable customer connections. It also accepted that a duration of 12 months was reasonable on the basis that it would take this long to find, successfully recruit, and then train and integrate a lawyer into a niche practice.
In relation to the restrictive covenant in the service agreement, the High Court noted that it was limited to those parts of the employer's business in which the solicitor was involved to a material extent within a relatively close period to her departure. This ensured that the covenant was reasonable in the scope of its operation. If the solicitor was not involved in parts of the business to a material extent, then the covenant did not catch those parts; but if she was involved in parts of the business to a material extent, then the covenant would bite and it was reasonable to restrict her from joining a business which competed with those parts of the employer's business.
The covenant in the shareholders' agreement, however, operated to prevent the solicitor from being involved in any other business that competed with any part of the employer's business, regardless of whether or not she had any role in the conduct of that part of the business or enjoyed customer connections in relation to it. The court found that this was unreasonably broad and extended beyond what was reasonably necessary for the protection of legitimate business interests.
The case is interesting as it is often the covenants in commercial contracts, such as a shareholders' agreement, which are considered more reliable than those in a service agreement. The court acknowledged that in commercial arrangements involving the sale of a business a less stringent approach was taken regarding the enforcement of non-compete restrictions. However, on the basis that no goodwill had been acquired by the employer when the solicitor entered into the shareholders' agreement, it declined to take that approach in this case.
Quorum provision in articles prevented sole director from acting
The High Court has considered the interaction between provisions in a company's articles of association, holding that a requirement for a quorum of two directors prevented a sole director from acting on behalf of the company.
In Re Fore Fitness Investments Holdings Ltd, Hashmi v Lorimer-Wing  EWHC 191 a company had adopted bespoke articles of association which applied as its baseline articles the Model Articles for Private Companies Limited by Shares (the Model Articles). Those Model Articles were then disapplied to the extent they conflicted with the bespoke articles.
The case arose out of a dispute relating to the interpretation of certain provisions of the articles, namely:
- article 7(2) of the Model Articles – which provides that for so long as the company has a single director, the general rule about directors' decision-making by majority decision at a board meeting (or by unanimous written resolution) doesn't apply and the sole director may take decisions without regard to any of the provisions of the articles relating to directors’ decision-making;
- article 11(2) of the Model Articles – which provides that, unless otherwise determined by the directors, the quorum for a directors' meeting was two; and
- bespoke article 16 - which expressly modified article 11(2) above by requiring a quorum for a board meeting to be "two Directors one of whom must be an Investors' Director (if appointed) and one the Executive".
When a shareholder brought a claim for unfair prejudice against the company, the company approved and filed a counterclaim in that action. But, when it did this, the company only had a sole director. The shareholder argued that, by virtue of bespoke article 16, the company's articles required a quorum of two directors to be present at directors' meetings. So, the shareholder said, the sole director did not have the power to direct the company to approve and file the counterclaim.
The judge agreed with the shareholder and held that article 7(2) permits a sole director to manage the company, but only in circumstances where no provision of the articles requires the company to have more than one director. Here, bespoke article 16 did require there to be multiple directors in order for board meetings to be quorate. The judge said that a provision in the articles requiring there to be at least two directors to constitute a quorum logically was a requirement that the company in question have two directors in order to manage its affairs. So bespoke article 16 required there to be two directors and Model Article 7(2) was disapplied.
Although the Model Articles were intended to cater for the situation where a company may have either a sole director or multiple directors, since their introduction the interaction between article 7(2) and article 11(2) (or any bespoke quorum requirement) has been unclear. Many practitioners and commentators take the view that article 7(2) should prevail over article 11(2). But in this case the judge said that article 11(2) would need to be deleted to permit a single director to run a company. Companies that wish sole directors to have full power and authority may wish to include express wording in their articles disapplying the quorum requirement in article 11(2) (or any bespoke provision) for so long as they have a single director.
Corporate transparency and register reform: white paper published
The Government has published a White Paper detailing its final plans for extensive reform of Companies House and increasing the transparency of UK corporates. The proposals are intended to clamp down on economic crime and help safeguard national security. They will be introduced through a second Economic Crime Bill that will sit alongside the recent Economic Crime (Transparency and Enforcement) Act 2022 which received Royal Assent on 15 March 2022. That Act, and the new proposals, have been accelerated in response to the conflict in Ukraine.
Digital identity verification
One of the most significant reforms relates to the introduction of compulsory identity verification procedures for each of the following:
- new and existing company directors (and their equivalents, including general partners in limited partnerships and designated members in limited liability partnerships);
- persons with significant control (PSCs); and
- individuals who file information on behalf of a company.
The new digital method for identity verification will link a person with an authorised identity document for example, a passport. The White Paper conforms that, in most cases, this process should only take about 15 minutes to complete. Once verified, users will have one account that will be able to access all Companies House services, without having to reverify each time. It is intended that all entities registered at Companies House will have at least one fully verified natural person directly associated with them on the public register.
Under the new system, Companies House will not register someone as a director without them having a verified account. A director whose appointment has not been registered by the end of a set period will be committing an offence and may also be liable for a civil penalty. Similarly, a company that has an unverified director will also commit an offence.
The process for PSCs is different from directors as PSCs can be registered at Companies House without prior verification. If the PSC does not then verify their identity within a set period after registration, Companies House will flag the PSC as “not verified”. Continued failure to verify, even after flagging, will amount to a criminal offence and may be liable to a civil penalty.
There will be a transition period for existing companies to comply with the new verification requirements. Failure to comply by the end of that period may result in criminal sanctions and civil penalties.
Improving transparency of company ownership
To improve the usefulness of information held at Companies House on shareholders and PSCs, companies will be required to record full names for their shareholders in their registers. Private companies and traded companies where shareholders hold at least 5% of the issued shares of any class of the company, will also be required to provide a one-off full shareholder list. The list will be updated annually with any changes when the company files its confirmation statement (as is currently the case.)
Companies House will also collect and display:
- more information from companies claiming an exemption from the requirement to provide details of its PSCs; and
- the Relevant Legal Entity (RLE) conditions that have been satisfied to be recorded as a PSC, and if the RLE is listed on a regulated market, the name of that market.
Improving financial information on the register
The White Paper also contains proposals to improve the quality and value of financial information at Companies House. The new measures include the following:
- enhanced validation checks: the Registrar will be able to carry out enhanced validation checks on financial information to ensure that it is coherent, complete for a company of that size and type, and is consistent with accounts submitted to other agencies.
- digital filing: company accounts will be required to be filed in a digital format using Extensible Business Reporting Language (iXBRL) and be fully tagged. The tagging will make the information easier to interrogate, compare and check.
- reduced filing options: the filing options available to small and micro companies will be reduced to just two – micro-entities and small companies. The option to file abridged and ‘filleted’ accounts will be removed. As a result, all small companies will be required to file a full balance sheet and profit and loss, but micro-entities will be able to opt out of filing a directors’ report.
The Government will continue to explore options to enable companies to file their financial information once a year and in one place (a ‘file once’ approach) instead of filing information with different government departments at different times.
The accuracy and transparency of information filed at Companies House has been much criticised over the years and the Government’s reforms will be welcomed if they are successful in rectifying that situation.
Once implemented, the reforms will amount to the biggest change to the role and purpose of the Registrar of Companies since it was created in 1844. The Government's aim is to transform Companies House from a passive administrator of information into an active gatekeeper and custodian of reliable data.
This update was first published on Accountancy Daily.