Corporate directors: a stop-start reform

On 26 October, the Government's Economic Crime and Corporate Transparency Bill completed its passage into law. The new Economic Crime and Corporate Transparency Act 2023 (“ECCT Act”) is intended to tackle the abuse of UK corporate structures and combat economic crime, although many of the new measures will only take effect once the Government decides to bring them into force.

One of the issues which the Government intends to tackle is the misuse of corporate directors. Although reforms to the corporate director regime do not form part of the ECCT Act, the Government has issued a factsheet confirming that it will utilise its existing powers to restrict the use of corporate directors “in parallel” with the ECCT Act.

This article will outline the current law on corporate directors and explain the reforms, which are expected to be brought into force soon.

The policy background

A corporate director is a director of a company, which is itself a company or another legal entity such as an LLP. Under the current legal framework, the Companies Act 2006 requires that a company must have at least one director who is a natural person (that is, a human being). Otherwise, it is lawful to have any number of corporate directors, including overseas corporate directors. In this regard, UK company law is liberal: many countries, such as the US and Germany, prohibit the appointment of corporate directors.

The Government began to consider tightening the corporate director regime over a decade ago. Corporate opacity was recognised as a problem by global leaders at the 2013 G8 summit in Northern Ireland. Corporate directors were regarded as part of this problem.

Following the G8 summit, a Government impact assessment in 2013 outlined how corporate directors could be abused by bad actors, created mistrust in the legal framework and featured heavily in financial crime: despite only 2.1% of companies having a corporate director, such companies were involved in around 25% of cases handled by the Serious Fraud Office.

On the other hand, corporate directors do have legitimate uses: they are widely used by charitable companies and pension funds, can be useful for the governance of subsidiaries and joint ventures, and generally offer flexibility to companies.

The Small Business, Enterprise and Employment Act

Reforms to the legal framework arrived in the form of the Small Business, Enterprise and Employment Act 2015 ("SBEE Act"). The cornerstone of the SBEE Act reforms was the insertion of a new provision in the Companies Act to the effect that a person may not be appointed as a director of a company unless that person is a natural person. The SBEE Act also enabled the Government to pass regulations creating exceptions to the general prohibition on corporate directors.

After the prohibition comes into force, there will be a one-year transition period, after which a corporate director not within the scope of an exception will cease to be a director (if not already removed). An appointment made in contravention of the SBEE Act regime would be void and a breach of the regime would constitute an offence.

The prohibition on the appointment of corporate directors was originally scheduled to come into force in October 2015, but implementation was delayed. At the same time, it was proposed that the Secretary of State might provide, by regulations, for exceptions to the ban on corporate directors. The reforms were then kicked into the long grass for a time.

Reform revived

In December 2020, the Government published a consultation paper on implementing the prohibition on the appointment of corporate directors, while bringing forward regulations to provide for a principles-based exception to this general rule.

This formed part of its wider corporate transparency and companies register reform programme, which led to the new ECCT Act.

Under the principles-based exception outlined in the consultation paper, company B might be appointed as a director of company A if:

1. the directors of the company B are all natural persons; and
2. those directors have all been subject to a Companies House identity verification process (the ECCT Act will introduce new mandatory identity verification measures through secondary legislation and system developments at Companies House).

The rationale for this exception is to balance the competing interests of improving corporate transparency and tackling financial crime on the one hand and the legitimate uses of corporate directors on the other.

The consultation paper also outlined the Government's intention to put in place regulations to support and safeguard the exception to the ban on corporate directors. Two of these are particularly noteworthy.

First, if company A appoints company B as director, any attempt by B to itself appoint a corporate director would be unlawful and, therefore, ineffective. This also applies in reverse: company A could not validly be appointed as another company's director while company B remains on its board.

Secondly, the offences in the Companies Act around failing to notify Companies House of changes to a company's directorship would apply. This means that to avoid a company and its officers potentially committing an offence, Companies House must be notified in respect of any corporate director which ceases to be a director at the end of the transitional period because it does not meet the conditions for remaining as a corporate director.

The white paper

In February 2022, in its Corporate Transparency and Register Reform White Paper, the Government noted broad support for the proposals in its 2020 consultation paper, stating that the proposals “will promote transparency by lifting the shield of anonymity much earlier in the process”. The white paper also made some clarifications to the proposals.

First, corporate directorships will be restricted to UK-registered entities with legal personality, meaning overseas-incorporated corporate directors will not be permitted.

Secondly, the white paper confirmed that despite mooting the idea in the 2020 consultation paper, the Government does not intend to implement parallel corporate officer reforms for limited liability partnerships ("LLPs") and limited partnerships ("LPs"). This is welcome, given that the roles of LLP members and LP general partners vary depending on the LLP or LP, meaning a one-size-fits-all approach is unsuitable. On the other hand, the role of company director is more fixed.

Members of LLPs and corporate general partners of LPs will nevertheless be required to have their identifies verified under the new identity verification regime. Applications to appoint a body corporate as an LLP member or LP general partner will be rejected unless the body corporate has a verified person in a management position.

In summary

The proposed new regime for corporate directors is actually an old reform, contained in the SBEE Act, which the Government looks set to implement alongside other (new) reforms under the ECCT Act. The Government's position is that the current liberal approach to corporate directors creates opacity and is exploited by bad actors. On the other hand, corporate directors are widely used in some sectors and have many legitimate purposes.

To balance these competing interests, the Government intends to introduce a new provision in the Companies Act banning the use of corporate directors while introducing regulations to implement a principles-based exception to the ban. The core of the proposed reforms is that only a UK company whose directors are all natural persons will be able to act as a corporate director. That corporate director will then be unable to appoint a corporate director to its own board.

We will, of course, await the text of the regulations implementing these exceptions, together with details of when they might be brought into force.