Trustees’ Duties in Academies & Free Schools

Trustees’ Duties in Academies & Free Schools

‘The landscape of schooling in England has been transformed over the last five years. Academy sponsorship has encouraged and facilitated the contribution of individuals not previously involved in education provision and laid down a challenge to maintained schools to improve or face replacement by the insurgent academy model’– Education Select Committee Report, January 2015.

Academy schools are independent semi-autonomous schools funded by the Government. At the time of writing, out of 21,500 schools in England, there are over 4,464 academy schools, made up of 2,385 primary schools and 2,079 secondary schools. The first academies were born out of the City Technology Colleges: schools outside of local authority control, introduced by the Conservative Government in 1988. The policy was continued by New Labour from 2000 under the ‘City Academy’ label. The momentum really began with the passage of the Coalition Government’s Academies Act in 2010, which paved the way for any school to convert to academy status, including secondary schools, primaries and special schools. The momentum continues under the new Conservative administration. Today, many academy schools are part of multi-academy trusts (federations or clusters of schools supported by a common sponsor). This brings economies of scale, can attract more teaching resources and enhanced funding opportunities.

Free schools are usually new schools formed as academy trusts. Whenever a local authority plans to establish a new school to meet demand for more school places, they must now run a competition and promoters of free schools (often parent-led groups) can put in a bid to establish a free school. This will be a completely new school, often in new or converted premises. There are now more than 400 free schools either open or approved. The new Government has said they will approve 500 more by 2020. Some private fee-paying schools have chosen to become free schools to ensure their continuing viability.

Further types of academies have developed over time, such as studio schools, university technology colleges (UTCs), and cooperative schools. Essentially, these are all variations on the same academy trust model, but with different sizes and a specialist curriculum.

An academy trust is a company limited by guarantee with charitable status. As a company, it has an independent legal identity, can enter into contracts, employ staff and be sued in its own name. It enjoys a fair degree of autonomy (within the constraints set by the Department of Education’s Funding Agreement and Financial Handbook), but the trade-off for this is more responsibility on the managers and trustees to run the school’s affairs prudently and professionally. As a company with ‘exempt charity’ status, the trust and its managers must also comply with duties laid down by company law and charity law.

Converting a school to an academy, setting up a new free school and running the new organisation once it is set up, bring a series of opportunities and challenges. Operating under these new arrangements can be quite a daunting experience at first. Following several recent scandals and press coverage there is now an increased focus on good governance and propriety controls in academies, in particular the need to avoid conflicts of interest and to ensure the proper stewardship of public money. It is important that academy promoters, managers, trustee directors and governors understand their responsibilities and duties.

‘Our particular interest is on leadership in relation to financial management and governance...We must respond to increasing calls for greater transparency. This means we must all be open about who is involved in the governance of our public bodies, including academies and free schools, and how they are run‘ – Peter Lauener, CEO, Education Funding Agency, Sept 2015’

Academies often point to the increased freedoms and financial resources that independence from local authority control brings. With those freedoms comes additional responsibility and accountability. Despite the label of being independent state-funded schools, academy trusts are in fact quite heavily regulated by means of the Funding Agreement with the Secretary of State, OFSTED inspection regime, the extensive accounting and reporting requirements, as well as by general company and charity law. These issues are not insurmountable, but they do require a watchful eye on governance and compliance tasks. Elderflower Legal has produced a new concise guide intended to provide an overview of the key points to be aware of, based on our extensive experience of acting as trusted advisor to academies and free schools.

“Academy trusts should be required to appoint a part-time Company Secretary to ensure probity in decisions around the constitution and powers of Boards and governing bodies.” – Education Select Committee Report, September 2014.

As a trusted advisor to academies and free schools, Elderflower Legal can help guide you through the maze of regulation and compliance and help you to put in place effective governance arrangements which ensure the organisation fulfils its mission effectively, as well as providing reassurance to Board members and wider stakeholders that the academy trust is well-managed. Find out more about services for Academy trusts..

Download your free copy of our Concise Guide to Academies & Free Schools. Please feel free to get in touch to discuss any of the issues raised.

 Mark Johnson is an experienced solicitor and company secretary helping academy trusts, charities and social enterprises to manage risk, ensure good governance and protect their legal position. elderflowerlegal.co.uk
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Directors’ Duties Under the Spotlight

Directors’ Duties Under the Spotlight

“Statutory directors are on duty, responsible and liable twenty four hours a day, seven days a week.. Being a director is not just about what happens around the boardroom table. There is serious work to be done..” – Bob Garratt, The Fish Rots from the Head.

Directors of limited companies and other entities with limited liability perform a vital role in the UK economy. The Institute of Directors estimates that there are just over 2 million registered company directors in the UK. They are the stewards of their organisation’s assets and money, provide the leadership and strategy to drive the organisation forward; they must identify and manage risks, as well as being aware of their wider legal and social responsibilities. Whether in the for-profit, charity or not-for-profit sector, directors occupy a crucial space in the governance of the organisation. Corporate governance is the system of direction and control that ensures the organisation fulfils its purpose and creates value over the long term, whilst respecting appropriate legal and ethical boundaries. In recent years, the public’s faith in corporate institutions has been shaken after a series of scandals involving misappropriation of funds, accounting irregularities and unethical behaviour. The past few months alone have seen relentless media attention on the impact of poor governance practices, ranging from the machinations at FIFA, a spectacular accounting scandal at Toshiba and the high profile untimely demise of the charity Kids Company amid bitter recriminations between government, regulators, trustees and management. All of this highlights the need for directors and trustees to focus attention on governance and compliance issues, before regulators do! Good governance, regulation and compliance is likely to remain firmly on the corporate agenda in coming months. Elderflower Legal & Secretarial offers a range of service packages to keep organisations compliant.

With directors’ duties under the spotlight, their role in ensuring that organisations comply with the law and sound ethical practice will assume great importance. In the course of our work with newly appointed directors, we find there are often misunderstandings and misconceptions about what the role entails and exactly what their responsibilities are. In smaller businesses and organisations, there is often informality about the governance arrangements. In a small owner-managed business, the directors and shareholders are often the same people. However, it is important for the participants to understand that they may wear different hats at different times. It is still important to understand the obligations which apply when wearing the director’s hat: the law still applies and ignorance is no defence. Elderflower Legal has produced a concise guide to help demystify and explain the issues in a digestible format. If you have any questions on the content, we would love to hear from you.

Download you free copy here.

Mark Johnson is an experienced solicitor and company secretary helping SME businesses, charities, social enterprises to manage risk, ensure good governance and protect their legal position. elderflowerlegal.co.uk
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Community Interest Company & Community Shares?

Can a Community Interest Company Issue Community Shares?

With growing appetite for socially motivated investment and community share offers, is it time to level the playing field for CICs?

Community and social enterprises are booming. According to government data, there are now 70,000 social enterprises in the UK contributing £18.5bn to the UK economy and employing nearly a million people (BIS/BMG 2013). Social and community enterprises are businesses that aim to generate their income by selling goods and services, rather than through grants and donations; they are set up to specifically make a difference and they reinvest most of the profits they make in their social mission. At a time of dwindling trust in large corporations, they have really found their niche.

To date they have focused on renewable energy, local food production, community shops, pubs and brewing, affordable housing, sports and leisure. Increasingly, they are also running a wider range of public services, including health services, social care and childcare. They have also been very successful in raising capital from their communities and supporters. Since 2009, 286 community share offers have been successfully completed or are underway. According to the Community Shares Unit’s Inside the Market report (June 2015), more than £80m of share capital has been raised from over 60,000 investors since 2009. There is growing appetite from philanthropists, foundations, charities, and crucially members of the public, to invest in these enterprises. The new Social Investment Tax Relief allows individual investors to offset 30% of the cost of the investment against their tax bill, if relevant criteria are satisfied. The involvement of these community based members and investors creates strong engagement between the new enterprise and those it serves. They can enhance the governance of the organisation by holding the board the board to account.

To date, community share offers have mainly used the industrial and provident societies (now called cooperatives or community benefit societies), as their legal format of choice. This legal format has a long and proud history dating back to the self-help movement of the nineteenth century and was recently reinvigorated with the passing of the Cooperatives and Community Benefit Societies Act 2014. There are three main reasons for the use of this format. Firstly, cooperatives and community benefit societies can issue ‘withdrawable shares’ – a type of share capital unique to this legal format, which allows the enterprise to pay a fixed or capped rate of interest (usually at the discretion of the board, as finances allow), but at the same time allows the investor to withdraw their capital, but normally not to sell or transfer their shares. Secondly, share offers made by a community benefit society or cooperative are an exempt category of security for the purposes of the Financial Promotion Order 2005, (by virtue of Schedule 1, paragraph 14(3)(c)), which means there is no obligation to involve an expensive FCA authorised adviser in structuring or marketing the investment. Thirdly, a community benefit society (but not a cooperative) can qualify as a charity (if it has exclusively charitable objectives), with all the attendant tax reliefs and status and still issue shares to the public.

Community interest companies on the rise?
The community interest company (CIC) is the newer kid on the block. This format has just celebrated its tenth anniversary. There are more than 10,600 in existence. This legal form was heralded as the new way to kickstart social investment and philanthropic ventures when it was introduced in 2005. The community interest company has a number of attractive features which should promote investor confidence: an automatic ‘asset lock’ is designed to ensure that the company’s cash and assets are only used for the stated community purpose. A ‘dividend cap’ ensures that a CIC limited by shares can only distribute 35% of distributable profits to shareholders and the other 65% must be reinvested in the community mission. And the CIC is overseen by a community interest regulator who will only register it if it has a genuine community purpose and who expects to see annual reports detailing how its mission has been fulfilled in practice. (Arguably, these present a much more demanding regime than the FCA’s current supervision of cooperatives and community benefit societies). But in raising community investment, this format is lagging behind. Why is this?

We first need to understand the restrictions which apply to the community interest company. A lot of these stem from the fact that legislation creating CICs was grafted onto the back of existing company law for commercial enterprises. There are two main issues.

Firstly, a CIC is caught by the prohibition in section 755 of the Companies Act. Section 755 (1) states:

“A private company limited by shares… must not (a) offer the public any securities of the company, or (b) allot or agree to allot any securities of the company with a view to their being offered to the public”.

If companies wish to offer shares to the public, they are supposed to become public limited companies (PLCs), which are more heavily regulated. This provision also catches a CIC limited by shares by virtue of section 1 of the Companies Act 2006. The phrase ‘offer to the public’ is defined in section 756. An offer is not to be regarded as an ‘offer to the public’ if it can properly be regarded in all the circumstances as-

(a) not being calculated to result, directly or indirectly, in securities of the company becoming available to persons other than those receiving the offer, or
(b) Otherwise being a private concern of the person receiving it and the person making it.

A successful community share offer does depend on heavy promotion and marketing amongst supporters of the project. To rely on the first alternative (a), the promoters would have to take extreme care that the investment was not publicised generally, but only to prequalified supporters.

756 (4) goes on to say that an offer is to be regarded (unless the contrary is proved) as being a private concern if (a) it is made to a person already connected with the company..
756(5) defines ‘a person already connected with the company’ as (a) an existing member or employee of the company or (b) a member of the family of a person who is or was a member or employee of the company

[plus others categories not relevant for our purposes].

So from this we can take that a CIC limited by shares could lawfully issue shares to a defined class of persons provided they were already supporters or members or employees of the company.

So far so good. We then turn to look at the second obstacle. That derives from Financial Services and Markets Act 2000, specifically section 21 and the Financial Promotions Order 2005 made under it. This paternalistic piece of legislation is designed to prevent unscrupulous promoters of investments from taking advantage of unsophisticated investors by making it an offence to promote investments unless, either they have been approved by an FCA regulated advisor, or one of the exemptions applies. As we saw above, the issue of shares in a cooperative or community benefit society benefits from a complete exemption in Schedule 1 paragraph 14(3)(c). However, there is no such explicit exemption for shares in a community interest company. It is difficult to see a justification for this apparent disparity, since both legal formats are regulated and should have an asset lock in place, both formats are equally capable of being used to fulfil the social investment purpose.
So we must then turn to look at other possible exemptions that might be helpful in issuing shares to supporter members. The one which is likely to be most helpful is in Article 52. This applies to an offer of shares or debentures to an identified group of persons who, when the financial promotion is made might reasonably be regarded as having an existing and common interest with each other and the company.

Article 52 states—(1) “Common interest group”, in relation to a company, means an identified group of persons who at the time the communication is made might reasonably be regarded as having an existing and common interest with each other and that company in—

(a) the affairs of the company; and
(b) what is done with the proceeds arising from any investment to which the communication relates.

(2) If the requirements of paragraphs (3) and either (4) or (5) are met, the financial promotion restriction does not apply to any communication which—

(a) is a non-real time communication or a solicited real time communication [a real time communication is defined as a ‘personal visit, telephone conversation or other interactive dialogue’];
(b) is made only to persons who are members of a common interest group of a company, or may reasonably be regarded as directed only at such persons; and
(c) relates to investments falling within paragraph 14 or 15 of Schedule 1 which are issued, or to be issued, by that company [which includes the issue of shares in a corporation].

The relevant conditions in paragraphs (3), (4) and (5) can be summarised as follows:

(3) the communication must be accompanied by an indication—

(a) that the directors of the company (or its promoters named in the communication) have taken all reasonable care to ensure that every statement of fact or opinion included in the communication is true and not misleading given the form and context in which it appears;
(b) that the directors of the company (or its promoters named in the communication) have not limited their liability with respect to the communication; and
(c) that any person who is in any doubt about the investment to which the communication relates should consult an authorised person specialising in advising on investments of the kind in question.

(4) The requirements of this paragraph are that the communication is accompanied by an indication—

(a) that the directors of the company (or its promoters named in the communication) have taken all reasonable care to ensure that any person belonging to the common interest group (and his professional advisers) can have access, at all reasonable times, to all the information that he or they would reasonably require, and reasonably expect to find, for the purpose of making an informed assessment of the assets and liabilities, financial position, profits and losses and prospects of the company and of the rights attaching to the investments in question; and
(b) describing the means by which such information can be accessed [e.g. on a website]

(5) The requirements of this paragraph are that the communication is accompanied by an indication that any person considering subscribing for the investments in question should regard any subscription as made primarily to assist the furtherance of the company’s objectives (other than any purely financial objectives) and only secondarily, if at all, as an investment. [emphasis added].

Furthermore the communication must satisfy additional criteria:

The communication must accompanied by an indication that:

– it is directed at persons who are members of the common interest group and that any investment or activity to which it relates is available only to such persons;
– that it must not be acted upon by persons who are not members of the common interest group;
– proper systems and procedures are in place to prevent recipients other than members of the common interest group engaging in the investment activity to which the communication relates with the person directing the communication, a close relative of his or a member of the same group

Paragraph 8 further restricts the definition of a common interest group for the avoidance of doubt: Persons are not to be regarded as being in a common interest group just because
(a) they will have such an interest if they become members or creditors of the company;
(b) they all carry on a particular trade or profession; or
(c) they are persons with whom the company has an existing business relationship, whether by being its clients, customers, contractors, suppliers or otherwise.

From this we can take it that, subject to complying the various formalities outlined above, the CIC could proceed to issue shares to a group of people who already have some form of engagement or commitment to a common cause. There is of course quite an onerous responsibility on the board of directors to comply with the specific requirements. We return to this point below.

The third obstacle is then how could the attractiveness of the ‘withdrawable share capital’, which is unique to cooperatives and community benefit societies, be replicated? This allows investors to ask for their original stake back. Controls normally exist in the governing document to stop all investors withdrawing at once and for the board to set limits and timetable for withdrawals. Company law does not have an exact equivalent to this concept, however, its nearest equivalent would be ‘redeemable shares’. Section 684 of the Companies Act allows a private limited company to issue redeemable shares, unless its Articles of Association provide otherwise. The shares can be redeemed by the company at their nominal value (i.e. the amount paid for them, rather than the market value) at some stated future date. It would be possible for the Articles to set out the mechanism for determining this date at the board’s discretion. Model Article 22 for private limited companies contains helpful wording: “The company may issue shares which are to be redeemed, or are liable to be redeemed at the option of the company or the holder, and the directors may determine the terms, conditions and manner of redemption of any such shares.” There are two conditions which must be satisfied (a) there must normally be sufficient distributable profits to make the redemption. (This is calculated by net realisable profits less net realisable losses – usually found in the retained profit line in the balance sheet); (b) there must be at least one share in issue which is not redeemable to ensure the entire capital is not redeemed leaving no shareholders. In theory, a payment out of capital would also be possible under section 709 and 713 of the Companies Act 2006, however in practice the need to have a directors’ statement of solvency, obtain an auditor’s report, and pass a resolution of the members and advertise the proposal would make this a complicated and expensive process.

Once redeemed the shares are cancelled and cease to exist. Article 33 of the Model Articles for a CIC limited by shares (with power to pay dividends) states:

“Purchase of Own Shares: Subject to the articles, the Company may purchase its own shares (including any redeemable shares) and may make a payment in respect of the redemption or purchase of its own shares otherwise than out of the distributable profits of the Company or the proceeds of a fresh issue of shares. Any share so purchased shall be purchased at its nominal value.”

So CICs are able to issue redeemable shares, provided that the amount of redemption does not exceed the amount paid for them at the outset (Regulation 24 of the CIC Regulations 2005). This is to stop capital and profits being siphoned off in contravention of the statutory asset lock provisions.

How does this compare with the position for cooperatives and community benefit societies? Coops and community benefit societies do not have the same formal statutory restriction on repaying shareholders only from distributable profits, however in practice the same constraint is likely to apply, since a prudent board could only sanction repayment if there was sufficient accumulated reserves and working capital to make the payment. A second difference is that cooperatives and community benefit societies are allowed to pay interest on share capital at whatever rate which is reasonable to attract investment (which is a more subjective judgment), whereas CICs have an absolute cap of 35% of distributable profits.

Thirdly, cooperatives and societies can treat interest paid on their share capital as a deductible expense against any corporation tax liability, whereas dividends paid by a CIC will have to come out of post corporation tax surpluses.

A further wrinkle – the requirement for a prospectus?

Section 85 of the Financial Services and Markets Act 2000 states:

“It is unlawful for transferable securities to which this subsection applies to be offered to the public in the United Kingdom unless an approved prospectus has been made available to the public before the offer is made.”

Contravention is punishable by a prison sentence or fine and can give rise to claims for damages by persons who suffer loss. If the Articles of the CIC or the Rules of a CIC permit the shares to be transferred from one person to another (which may not actually be necessary), this prohibition could apply. Most withdrawable shares in societies are expressed in their rules to be non-transferable so the problem does not arise. However, Section 85 (5) goes on to say that the prohibition does not apply to securities listed in Schedule 11A. In Schedule 11A we find exemptions for a charity, registered housing association, a community benefit society (but not a cooperative) registered under the 2014 Act, a pre-existing old style industrial and provident society and “(e) a non-profit making association or body recognised by an EEA State with objectives similar to those of a body falling within [any of the other categories]”. Perhaps unhelpfully, there is no specific reference to a community interest company, but it would be reasonable to describe a community interest company as a non-profit making body falling within (e) since its core purpose is not to maximise profit, but to serve a community purpose. Alternatively, Section 86 (1)(b) may help: it states that the prohibition does not apply if the offer is made to or directed at fewer than 150 persons or is for an amount less than 100,000 euros (currently £70,688).

A possible route for CICs to issue community shares?

Some commentators have suggested extreme measures, such as winding up the CIC and transferring assets into a community benefit society, or setting up a community benefit society alongside the CIC as a subsidiary or holding company in order to facilitate a community share offer using a CIC. All these artificial routes entail additional costs and complexity which most community groups could do without, frankly.

Taking into account all of the above, I would like to suggest a scenario which could be used for a CIC to issue community shares (though this comes with a health warning that it is untested and unproven). A group intending to raise funds from the community using a CIC format could proceed as follows:

– Set up an unlimited company – this is a body corporate, but does not benefit from limited liability status. It could be used to assemble and organise a body of supporters who will later become investors.
– Recruit supporter members to this unlimited company
– Once the membership drive is complete, re-register the unlimited company as a private company limited by shares and community interest company
– Proceed to offer and issue shares to the existing membership who are then within the common interest exemption, being careful to comply with the requirements about the communications with investors and making suitable background documents available to enable investors to reach an informed view.

Creating legal certainty
Looking to the longer term, it would be immensely helpful if the Cabinet Office and legislators introduced specific exemptions to create legal certainty in this area: (a) An ‘offer of shares to the public’ in section 755 of the Companies Act could specifically exclude share offers by any community interest company for community benefit; (b) the Financial Promotions Order 2005, Schedule 1 paragraph 14(3) could include an additional exemption for ‘Offer of securities by a community interest company for community benefit’; and (c) the Financial Services and Market Act Schedule 11A, paragraph 7 could usefully include an explicit exemption for prospectuses for a ‘community interest company’.

I am happy to be shot down in flames on these proposals, but I offer them up to advance debate in this area!

Mark Johnson is an experienced solicitor and company secretary helping social enterprises, charities and SMEs to flourish. His company Elderflower Legal advises on the development of successful community and social enterprises. This article is intended for general guidance and to stimulate debate on the topic. We are not responsible for action taken in reliance on this post unless you have a professional retainer with us.

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Community Share Offers

A new way to raise capital from local citizens to kick start funding for public services and infrastructure?

With continuing austerity measures in local authority and NHS budgets, local communities are seeking innovative ways to protect local services and infrastructure as the state decommissions services or withdraws grant funding. Politicians are increasingly having to shift their mindset and seek the holy grail of financially self-sustaining services, income generation and co-production of local services, involving the community more in designing and delivering services, as well as harnessing the power of volunteering. The Localism Act 2011 introduced new rights for communities to bid to run local services and to acquire local infrastructure, such as buildings, shops or pubs before they are sold off for development. These ‘community rights’ recently received a funding boost from Government to kickstart more activity. In tandem with this, an exciting programme to build capacity and awareness of community share offers has been undertaken by Locality and Cooperatives UK. With funding from the Department for Communities, this saw the launch in October 2012 of the Community Shares Unit devoted to developing the market. On 30 June 2015 the new Community Shares Standard Mark was unveiled– a quality assurance scheme designed to give social investors confidence that community share offers have been properly designed.

A virtuous circle of community engagement

Community share offers are a neat way to raise capital from local citizens to support local projects and community enterprises. Fledgling enterprises often struggle to raise the seed capital required to launch the business from traditional sources. Community shares offer a solution. With bank deposit interest rates still running at low levels, retail investors with some spare cash to invest may obtain a rate equal or better to the deposit account, whilst also supporting a worthwhile venture with positive social benefits. Set up correctly, the medium of share offers creates a really positive alignment and increased engagement between the new community enterprise and the wider public. Shareholders become natural ambassadors for the products and services offered by the new enterprise, creating a virtuous circle where it is in their interests as members and investors also to be active as customers, supporters and volunteers.

Community Benefit Societies

The term ‘community shares’ refers to ‘withdrawable shares’ in community benefit societies set up under the new Cooperative and Community Benefit Societies Act 2014. This Act overhauled old legislation around industrial and provident societies. The community benefit society is a limited liability entity with a constitution based on a set of rules and a two-tier governance structure comprising the board and general membership. Unlike shares in a limited company, these shares are usually non-transferable and carry a right to capped or fixed interest only. There is no right to participate in profits or a slice of the underlying assets – so no scope for capital gain, so the enterprise is preserved for the common wealth. The decision to pay interest on the shares is usually at the discretion of the board and will only occur if there are sufficient trading surpluses to justify this, without compromising the organisation’s core mission. If a shareholder wishes to cash in, the society simply returns the original cash stake. Controls exist to stop all shareholders cashing in at the same time. Most societies are also subject to an asset lock, which prevents the society being sold and the proceeds of the sale being distributed amongst shareholders.

Tax reliefs and lower costs

There are three other important advantages of this legal format. First, the shares may qualify for Social Investment Tax Relief, which allows the investor to claim 30% of the amount invested as relief against their tax bill in that year or the previous year, either through their tax return or PAYE – thereby adding to the return on investment. Second, if the rules and objects are drafted correctly, they may qualify for charitable status, which may bring tax benefits for the enterprise in corporation tax, stamp duty land tax, relief from business rates and some VAT privileges. Third, the issue of such shares is exempt from the heavy regulation which otherwise applies to promotion of shares to the general public by companies, meaning that a community share offer can be put together much more cost-effectively, often using low-cost crowd-funding platforms.

A growing market

Since 2009, over 400 new societies have been registered, and 286 community share offers have been successfully completed or are underway. According to the CSU’s Inside the Market report (June 2015), more than £80m of share capital has been raised from over 60,000 investors since 2009. Amazingly, this now represents a 10% share of the total social investment market and is the second largest form of crowd-funding in the UK. This seed capital been used to attract matched funding from grants or commercial loans. These new enterprises have so far focused on renewable energy, local food production, community shops pubs and brewing, affordable housing, sports clubs and faith groups. There is no reason why they could not be used to support and kick start activity in a wider range of public services. We are working with groups now running former statutory services who intend to raise funds through this route. An obvious area for further development would be health and social care services, particularly for high growth areas such as services for older people or patients coping with long-term health conditions in the community. The initiative already has the backing of DCLG and DEFRA and it is understood HM Treasury is increasingly taking an interest in the potential for further development.

Launching a successful share offer

The process for achieving a community share offer requires careful forward planning. There needs to be a competent development team in place to develop the idea and get the organisation investment ready; then a business plan demonstrating the viability of the enterprise and its ability to generate a profit to pay a (modest) return to shareholders. The target community needs to be fully engaged in the development process to persuade them to invest in shares. Marketing and promotion plays a key role here. Finally, experienced professional support is needed to launch the share offer.

Community share offers can be a great tool to support local services and infrastructure. The availability of new tax reliefs and lower regulatory burden make this an attractive route for enterprises and investors alike. This year sees several new initiatives and programmes focusing on kick-starting more community enterprises, such as Big Potential, The Power to Change and DCLG’s latest Community Rights programmes: community share offers will dovetail nicely with these.

Mark Johnson is an experienced solicitor and company secretary helping social enterprises, charities and SMEs to flourish. His company Elderflower Legal advises on the development of successful community share offers and he is part of the Community Shares Unit’s licensed practitioner development programme.
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The Rights and Responsibilities of Members

What is the Role of Members in Ensuring Good Governance?

In a limited liability corporation, as well as unincorporated associations, the members can play an important constitutional role, acting as a check and balance on the powers of the board. Unfortunately, the rights and responsibilities of members are often misunderstood.

In our work with companies, social enterprises and charities, we find there is often confusion or a lack of clarity about the precise role of the members. But the relationship and balance of power between the board of directors/ trustees and the wider members of an organisation is really a vital fulcrum at the heart of the system of governance for any enterprise. In this piece, I attempt to explain and demystify the position.

Who are the members?

‘Members’ here are the persons who have a form of relationship with the organisation that enables them to exercise some right or power in relation to it. The nature of that relationship will vary for different organisations, depending on the way they are constituted and, specifically, what the constitution says about membership rights.

In a profit-making company, the position is usually clear-cut. The members are the shareholders who have invested their capital in the enterprise in return for certain rights (e.g. sharing in profits and voting on key decisions). However, in non-profit distributing organisations, the position can be more complex. In a company limited by guarantee, there will be no shareholders, but instead there are members who pledge to contribute a nominal sum (usually £1 or £10) if the company is wound up and unable to pay its debts. In the case of charities or unincorporated associations, there may be various types of member who expect to have some say or involvement in the way the organisation is run – these might include beneficiaries and service users, supporters who pay subscriptions or volunteer their time. The constitution may talk about full members, associate members, and supporter members, for example.

The power of members depends on the precise structure and wording of the governing document. At one end of the spectrum is the ‘oligarchical model’ where the members are the same people as the directors/ trustees. These people have absolute discretion to control the organisation. (Many academy trusts have historically been set up using this model, but the Department for Education has recently encouraged schools to appoint a wider group of members who can ultimately hold the board to account). At the other end of the spectrum is a wide membership model, where the members can exercise oversight and control over the board. The members may act as custodians of a particular ethos or values and may take action, if they feel the board is not acting in the best interests of the organisation. There are also hybrid models in between, where members enjoy certain limited rights, such as the right to attend the AGM, receive information or have privileged rights of access to facilities, but no legal right to control any aspect of the organisation’s governance.

Rights of members

The typical rights that members enjoy, either in the constitution or under relevant statute law, include the following:

  • to appoint and dismiss the whole board or individual board members
  • to change the organisation’s constitution
  • to wind up the organisation and distribute the remaining surplus after settling the liabilities (unless there is an ‘asset lock’ in place to prevent this, as with a community interest company or charity).
  • in a private enterprise, the shareholders expect a financial return on their investment, usually in the form of a dividend and/or a capital gain. However, shareholders cannot force the company to declare a dividend. Capital gain is achieved by allowing membership rights (shares) to be transferable (which is usually not allowed in not-for-profit corporations).

The members exercise these rights by calling a general meeting. The organisation’s constitution will lay down the conditions for calling a valid meeting and passing valid decisions (such as the minimum notice, quorum and required majority to pass resolutions). For example, a resolution to change the constitution usually requires a special resolution, which may require a 75% majority. Remember though, that may be 75% of those present at the meeting, rather than the whole membership. So in an organisation with say 500 members, the constitution might state that a valid quorum for a general meeting to proceed is 10% of the membership (i.e. 50 members). To pass a special resolution would require only 38 of those present to vote in favour. For that reason, some organisations choose to set the bar higher for fundamental changes. Sometimes the constitution may permit a decision of members to be made by circulating a written resolution for signature by a minimum percentage of members, rather than calling a meeting.

The constitution forms the basis of a contract between the organisation and its members, and between the members themselves: as such, it can be enforced by the courts. Proper running of general meetings is important: if the organisation is prospering, the members may leave the board alone to run the organisation. However, once problems and disagreements arise, then members may start to flex their muscles. If notice and quorum requirements are ignored, there is a risk that resolutions and decisions reached can be struck down as invalid, which could entail significant costs and embarrassment to unwind the situation.

If the organisation is a company (limited by shares, guarantee, or a community interest company) the Companies Acts also provide certain minimum statutory rights. These include the following rights:

  • to receive notice of, attend, ask questions of the board and vote at general meetings; to inspect minutes of the same and request copies.
  • to appoint a proxy to attend, speak and vote at general meetings if the appointor cannot attend.
  • to requisition a general meeting and to require that a resolution be put to the meeting (if the support of 5% of the members can be achieved). The members can also require the company to circulate a statement of up to 1000 words to other members. If the directors fail or refuse to call the meeting within 28 days, the members can proceed to call the meeting themselves and the costs of doing so are deducted from the directors’ remuneration! (Sections 303-305, 292-295 Companies Act)
  • to propose a resolution (with special notice) to dismiss a director
  • to be provided with a copy of the Articles of Association
  • to receive a copy of the annual accounts
  • to inspect the company’s register of members and other statutory books
  • to inspect copies of directors’ service contracts
  • to appoint and remove auditors or require the company to obtain an audit of its accounts, if it would otherwise be exempt
  • to bring a ‘derivative claim’ in the name of the company against directors or a third party for default or breach of duty
  • to bring an ‘unfair prejudice’ petition to request the court to intervene in the company’s affairs.

Under company law, the definitive test of whether someone is a member is whether their name has been entered into the register of members. Many companies, especially companies limited by guarantee, can be quite lax in keeping this up to date – which can cause problems later. By contrast, the new Charitable Incorporated Organisation set up under the Charities Act 2011 is obliged to keep a register of members and to keep it up to date.

Duties of members

Members also have certain duties, again depending on what the constitution says. Typically, they will be required to:

  • Contribute the agreed sum for their shares if not already paid, or for a guarantee company the nominal contribution of £1 or £10.
  • Sometimes members are required to pay a recurring annual subscription towards the running costs of an organisation, in addition to their upfront capital contribution.
  • Interestingly, the Charitable Incorporated Organisation specifically requires that members are obliged ‘to exercise their powers in good faith in a way which would be most likely to further the purposes of the CIO’. No such explicit rule applies to other types of legal format, however.

Stakeholder members

Sometimes organisations have corporate members such as local authorities, public bodies or other charities who have some interest in what the organisation does. The stakeholder member may often appoint an individual to act as its authorised representative. Sometimes they may have right to nominate, or even directly appoint, a board member. Problems can often arise where this representative (who may be an employee or officer of the authority) wishes to give priority to his appointor’s interests over those of the organisation. If the representative sits on the board, they will usually be obliged to put the interests of that organisation first and exercise independent judgment, rather than being fettered by their appointor. They are allowed to consult with their appointing organisation, however. A possible solution might be to limit the role of the authorised representative to that of observer – with a right to attend and speak at board meetings, but no voting rights.

Problems for not-for-profits

The Charity Commission looked in detail at membership issues after analysis showed that more casework was opened for internal disputes in membership charities than any other type. Their report found that there were clear benefits from membership structures, including enhancing the board’s transparency and accountability, providing better understanding of the needs of beneficiaries, improving the charity’s advocacy role, providing better fundraising opportunities and access to a source of new trustees. However, the most common reasons for problems were:

  • Trustees are often not clear about their role and their responsibility to the members
  • Members were not clear about their rights and responsibilities
  • There were insufficient or inadequate governance structures in place to manage the relationship with members
  • The board puts up barriers to member involvement either deliberately or inadvertently
  • The membership lacks diversity, so the board is change resistant and self-perpetuating group
  • The board deliberately or carelessly disregards proper procedures for calling valid meetings and passing resolutions, leading to disputes.
  • Weak administrative arrangements lead to problems such as invalid elections held on the basis of inaccurate membership lists or inquorate meetings.

How to manage the relationship with members

The following best practice tips could help your organisation to avoid problems:

  • Keep membership registers and contact details up to date – get specific written approval from members to communicate with them via email to keep costs down.
  • Include a provision in the constitution that if the member fails to keep the organisation informed of their current contact details, they forfeit their rights. A practical illustration of this problem is recent attempts by football clubs to move to a community membership model, only to be hampered by the need to trace and obtain approval from numerous shareholder members whose whereabouts are unknown.
  • The constitution should clearly set out the mechanics for a person to become a member, to leave or to be expelled (subject to a right of appeal). The board may usefully have an explicit power to determine conclusively whether a person is a member, if the position is uncertain.
  • Ideally, the detailed mechanics about categories of members and relevant criteria could be set out in a set of standing orders, regulations or a handbook, which can be amended from time to time without the need to pass a resolution to change the whole constitution.
  • New board members should receive an explanation about the various categories of member and their rights, as part of their induction.
  • The organisation should communicate regularly with its members to inform then about developments and keep them engaged.
  • Consider including specific mechanics to resolve disputes involving members without recourse to the courts, such as mediation or expert determination. Judges are reluctant to interfere in the internal workings of membership organisations and have been scathing about the dissipation of funds to pursue litigation relating to internal disputes.

Members can be a vital, but often a missing piece of the jigsaw, in a system of sound governance. Ignore them at your peril. Organisations as diverse as NHS Foundation Trusts, Network Rail and cooperative schools and academies have all sought the benefits of giving wider stakeholders a say in the running of their organisation. The move to create more mutuals for public service delivery, employee-owned organisations and growing interest in community share issues (where member investors contribute start-up capital) will increasingly throw the spotlight on an organisation’s relationship with its members.  The board should have a clear understanding of the role and rights of these members and the constitution should be kept up to date so that it is fit for purpose. Both the Chair and the company secretary can play an important role in ensuring harmonious relations with members and keeping them informed and engaged.

Mark Johnson is an experienced solicitor and company secretary helping SME businesses, charities, social enterprises to manage risk, ensure good governance and protect their legal position. elderflowerlegal.co.uk
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How Can the Board Develop an Effective Approach to Risk Management?

Does Your Board Have an Effective Approach to Risk Management?

Risk management is a key component of sound corporate governance. There has been a popular view in the past that risk management was a brake on progress: a discipline inhabited by clip-board clutching box tickers intent on stifling entrepreneurial innovation. Not any more – for enlightened organisations have embedded an effective approach to managing risk into their culture and everyday processes. Risk management should be as much about spotting opportunities, as avoiding hazards.

‘The effective development and delivery of an organisation’s strategic objectives, its ability to seize new opportunities and to ensure its own long-term survival depend on its identification, understanding of, and response to, the risks it faces,’ says the Financial Reporting Council.

High profile scandals in private, public and third sectors, corporate failures, the banking crisis of 2008-2009, as well as increased globalisation, interconnectedness and the fast pace of change in the business environment, have all focused more attention on the way boards handle risk management. There has been a step change in the need for boards to focus on risk in the last few years. Regulators have toughened their approach – all but the smallest companies in the UK must now prepare a ‘strategic report’ which includes a ‘fair review of the company’s business and a description of the principal risks and uncertainties facing the company.’  For charities, the SORP 2015 requires in the annual report from trustees ‘a description of the principal risks and uncertainties facing the charity and its subsidiary undertakings, as identified by the charity trustees, together with a summary of their plans and strategies for managing those risks’. Sector specific regulators from the Care Quality Commission, to the Health & Safety Executive expect to see a proper risk management strategy.

Corporate Governance codes all stress the need for an effective approach. The UK Code states in Section C, ‘The board is responsible for determining the nature and the extent of the principal risks it is willing to take in achieving its strategic objectives. The board should maintain sound risk management and internal control systems.’ In the 2014 edition this was strengthened to include a new provision that ‘a robust assessment’ is carried out annually of the ‘principal risks facing the company, including those that would threaten its business model, future performance, solvency or liquidity.’ Similarly, the Governance Code for the Voluntary Sector requires that the board must ensure ‘..it regularly identifies and reviews the major risks to which the organisation is exposed and has systems to manage those risks.’ But also, there are increasing expectations from all stakeholders that the Board is aware of risks and has an effective plan to manage them. It is no longer acceptable in the public’s mind for organisations to find themselves in a position where unexpected events cause financial loss, operational disruption, damage to reputation and loss of market position. Witness the outcry every time a bank’s cashpoint network goes offline.

What is risk?

A useful working definition is ‘an event with the ability to impact (inhibit, enhance or cause doubt about) an organisation’s mission, strategy, projects, routine operations, objectives, core processes, key dependencies and/or the delivery of stakeholder expectations.’

By taking a proactive approach to risk management, organisations should achieve positive benefits:

  • Operations should be more efficient because events that can cause disruption are identified in advance and actions taken to reduce the likelihood and containing the costs if they do occur.
  • Processes should be more effective because of the thought that is given to selecting processes and thinking about the risks involved in different alternatives.
  • Strategy should be more effective, because risks associated with different options will have been carefully analysed and better decisions reached, leading to better outcomes.

Types of risk

Risks break down into different types. Risk management practitioners classify risks into hazard risks, control risks and opportunity risks. In general terms, organisations seek to mitigate hazard risks, manage control risks and embrace opportunity risks.

Risks break down into categories:

  • Financial risks – (e.g. accuracy and timeliness of financial information, accurate accounting records, adequacy of cashflow, interest rates, exchange rates, investment returns).
  • Operational risks (machine failure, human errors, service quality, incorrect contract pricing, employment issues, health and safety, IT failures, data breaches, fraud and theft).
  • Environmental and external risks (reputation and adverse publicity, cyber attacks, demographic trends, government policy, terrorism, extreme weather events, pandemics).
  • Compliance with laws and regulation – risk of legal claims, regulatory action, prosecution and fines for failure to comply with obligations.

Risk assessment

Having identified the risks faced by your organisation, they should be categorised in terms of their likelihood of occurrence and potential severity of impact (including financial loss or impact on reputation). Sometimes a risk score of 1-5 may be awarded (with 1 being very low and 5 being very high). The impact score may be multiplied by the likelihood score to identify the areas where most board attention and scrutiny is required.  This will build up into a risk register similar to the one shown in Figure 1 below.

Figure 1 Example Risk Register

Risk Table

Once each risk has been evaluated, the board will need to consider any action that needs to be taken to mitigate the risk, either by reducing the likelihood of it occurring, or lessening the impact if it does. The technique of ‘4Ts’ is sometimes used:

  • Tolerate – accept the risk because it is not considered a significant threat.
  • Trim – take measures to control or reduce the risk, so that the residual risk after control measures have been applied is acceptable (e.g. create policies and processes, train staff on how to reduce likelihood).
  • Transfer – shift the financial consequences to third parties (e.g. through taking out insurance or outsourcing to the supply chain, or using indemnity clauses in contracts).
  • Terminate the risk – by getting out completely – e.g. closing down an excessively risky operation or facility.

The risk register should be used for recording risks that have been identified, actions taken to investigate the risk, identifying the person with management responsibility for the risk, recording measures taken to deal with risks, and recording regular reviews of the risks. The risk register should be a living document that is reviewed at scheduled intervals by the board – not a one-off exercise that then sits in a filing cabinet

How does the Board discharge its responsibility?

The approach taken by any Board obviously depends on the size of the organisation and the complexity of its operations, but any organisation can benefit from a structured approach. In an organisation with full time professional managers, it would be usual for the managers to take the lead in assembling the risk register and bringing it to the board for review. However, in a smaller organisation the board members themselves may have to take the lead in compiling a risk register, perhaps with the assistance of an external facilitator, such as Elderflower Legal.

The processes  which boards use to consider risks were examined in some detail by the FRC in 2011 and the Sharman Inquiry in 2012. The key areas of best practice recommended were:

  • The board must first decide on its appetite and willingness to take on risk – this feeds into the organisation’s culture, behaviour and values. Are the risks commensurate with the expected returns? An environment of excessive or ill-informed risk-taking could be fatal to the organisation’s long-term future. The Walker report into the banking crisis found that boards simply did not understand the risks that their traders were taking on mortgage backed-securities. At its simplest level, the board may set financial downside limits on transactions and these feed through into specific limitations on the authority of managers in any scheme of delegation. There are also inevitable linkages to personal reward systems and motivations and HR policies and how these influence staff attitudes to risk.
  • Risk management and internal control should be incorporated within the organisation’s normal management and governance processes – not treated as a separate or one-off compliance exercise.
  • The board must make a robust assessment of the main risks to the organisation’s business model, including ability to deliver its strategy, solvency, liquidity and long-term viability.
  • Once the risks have been identified, the board should agree how they will be managed and mitigated. It should satisfy itself that the management and control systems are adequate and, in larger organisations, receive adequate formal assurances from managers, the audit committee and external auditors. Regular reports should be coming to the board to provide this. Risk data should be captured from across the organisation: often front-line staff are the first to be aware of problems.
  • Risks and associated control systems should be reviewed on a regular ongoing basis.
  • The organisation should report publicly and transparently to its stakeholders on the principal risks it faces, any material uncertainties and their review of the risk management and internal controls. Stakeholders should feel that the board has a visible role in governance and stewardship and that the board is held accountable.

Five key questions for the Board

What are the top 5 actions the board can take to ensure success?

  • Focus on the culture – is there an embedded commitment to risk management and control in your organisation? Does the board lead by example? There should be openness and creativity around risk issues. (Don’t be like HBOS, which sacked its group head of risk when he tried to warn the Board they were taking excessive risk).
  • The risk register and associated controls must be documented, understood, reviewed and disseminated regularly – not locked in a filing cabinet and dusted off once a year, or even less frequently.
  • There must be a process for monitoring and reviewing risk – adequate time must be scheduled at board meetings to consider risk issues and review whether the organisation has the skills and capacity and tools to manage risks effectively. The board should focus its attention on the top ten areas identified with highest risk score.
  • The board must be alert to new and emerging risks (such as cyber attacks, sovereign debt crises, Grexit/ Brexit, global political instability/ terrorism, climate change, social media, pandemics, demographic changes).
  • Report on the board’s activities in examining and reviewing risks so that stakeholders can gain assurance that the board is discharging its duties and form a balanced, clear and informed view of the organisation’s prospects.

As with all aspects of good governance, the effectiveness of risk management and internal control ultimately depends on the skills, knowledge and behaviour of those responsible for operating the system. The board must set the desired values, ensure they are communicated, incentivise the desired behaviours, and sanction inappropriate behaviour.

Mark Johnson is an experienced solicitor and company secretary helping SME businesses, charities, social enterprises to manage risk, ensure good governance and protect their legal position. elderflowerlegal.co.uk
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Late Payment of Invoices – Are You Claiming Your Full Entitlement?

Good cash flow management is essential to any business. Used wisely, Late Payment legislation can help you with cash flow management.

Late Payment legislation was introduced in 1998 to encourage a culture of prompt payment. Evidence suggests that late payments are a major continuing problem. A survey by the Federation of Small Business in March 2015 found that 43 per cent of firms have waited over 90 days beyond the agreed payment date before they got the money they were owed.

New rules were brought in during 2013, but the level of awareness about how to use the rules still appears to be low. Businesses may fear upsetting their customers and jeopardising future business, but used wisely the rules can help your business.

What can you claim for?

Claim interest

If you are in business (no matter what your legal structure) and have supplied goods or services for business purposes (i.e. B2B and not to an individual consumer) you can claim interest on late payments at 8% plus the Bank of England current base rate (0.5%), so 8.5% in total.

You can claim interest for the period starting from the date on which the invoice should have been paid, and ending on the date it was actually paid.

For example, if your business were owed £1,000:

Annual interest would be £1000 x 8.5% = £85
Divide that by 365 days, daily rate = £0.23
So a payment which is 60 days after the due date, 60 x £0.23 = £13.80

You can still claim the interest, even if the payment has since been made outside the permitted period. You have up to 6 years to make your claim (So you could go back 6 years from now and claim on payments that were made late – something to think about perhaps if you have no ongoing relationship with the customer).

When do payments become overdue?

Public authorities must always pay within 30 days of either (a) the date of receipt of invoice or (b) the date of delivery of goods or service (if later). ‘Public authority’ for these purposes includes schools, academy trusts, NHS trusts, housing associations, clinical commissioning groups and council-owned companies. Public authorities are not allowed to set a longer period. They may specify a process for verification of invoices, but this must be made explicit in tender documents or contracts and cannot exceed 30 days, unless expressly agreed. New public procurement legislation has recently included a legal requirement for all new public contracts to include 30-day payment terms for all the sub-contracts in the supply chain.

Commercial customers – if the contract doesn’t specify a period, a default period of 30 days from delivery or receipt of invoice applies (and interest runs thereafter).However, if the contract does allow a longer time for payment, 60 days is the maximum and statutory interest starts to run from 60 days after delivery, unless the customer can argue that an extended period is reasonable and fair in all the circumstances and in accordance with normal commercial practice (a high hurdle to overcome in practice).

If the contract says payment will be by instalments, you can claim statutory interest on each instalment that is paid late. If a payment is made upfront before delivery, the interest will run as from the date on which all the goods or service have been delivered.

You can also claim compensation for recovery costs.

As well as the interest, the law allows you to claim a fixed sum for each invoice paid late, depending on the amount.

Below £1,000            £ 40 per invoice
£1,000 – £9,999.99   £ 70 per invoice
Over £10,000           £100 per invoice

If you take the debtor to court, you may also recover additional costs of recovery above these sums.

How do you claim?

You could send a new invoice, but in fact all you are required to do is write to the customer and tell them what is due:

  • Amount of interest, compensation and costs
  • What it relates to – state the invoice number(s)
  • How they can make payment

You don’t need to send a prior warning letter. You charge interest on the gross amount of the debt (including any element of VAT, but you do not pay VAT on the interest).

Are there any exclusions?

  • If the amounts are disputed, the customer is still expected to pay any amount that is undisputed, while the issues are resolved.
  • If there is real doubt about the amount due, you may not be entitled to claim until the position has been clarified.
  • Consumer Credit Agreements and mortgages are not covered.

How can you take steps to protect your position?

  • Check your terms and conditions – what do they say about due date for payment?
  • What do they say about interest on late payment – don’t set a lower interest rate than the 8.5% you are entitled to by law.
  • Include a clause entitling you to charge ‘indemnity costs’ for recovering any sums not paid by the due date. This will increase your chances of getting more of your costs back if the dispute goes to court.
  • Circulate updated terms of business to all those affected.
  • Watch out for purchase orders which seek to impose the customer’s terms and conditions over yours – e.g. if they attempt to deprive you of a remedy by setting a low rate of interest – they may be struck down as void.
  • Tell your customers on your quotations, orders and reminder letters that it is your policy to make full use of the Late Payments legislation: “Please note we will exercise our statutory right to claim interest and compensation for debt recovery costs if we are not paid according to agreed credit terms.”
  • Remember the best way to secure timely payment is to agree clear terms in advance of the transaction and to invoice promptly and accurately.
  • Send your invoices electronically with confirmation of receipt or post them with a proof of posting certificate (free) or recorded delivery, so that you can prove the date of despatch.

Late payments continue to be a hot political issue. The amount tied up in late payments runs into billions and acts as a drag on the economy.  Further legislation is expected which will oblige public authorities and larger businesses to publish regular statistics on their payment records, thereby allowing persistent late payers to be named and shamed.

Mark Johnson is an experienced solicitor and company secretary with Elderflower Legal. He helps SMEs, charities and social enterprises to flourish by managing risk, assuring compliance and protecting their legal position. See more at elderflowerlegal.co.uk.
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The Pivotal Role of the Chair in Ensuring Good Governance

How can the Chair perform the role effectively to maintain accountability and high performance from the Board?

Last time we considered the conditions for a high performance board. A critical player in making the Board effective is the Chair. He or she has a crucial role to play both inside and outside the boardroom. The Chair should be a team-builder: ensuring the Board understands the strategy and common objectives; promoting open and two-way communications, facilitating participative decision-making and providing visible leadership.

Managing meetings is critical

The Chair’s role is to create a safe space in which constructive inputs from all board members can occur. The Chair runs the Board and set its agenda. Meetings should be held in conducive locations and should start and finish on time. Agendas should focus on strategic matters, value creation and performance, rather than operational details, which are better delegated to executive managers.

The Chair should ensure that all members of the Board receive accurate, timely and clear information. This should cover both financial and non-financial indicators. This will enable the Board to make decisions based on evidence and properly to discharge their duty to promote the success of the organisation. Information should generally be circulated in advance of meetings to allow reading time.

For each item, the Chair should invite the person leading on it, often an executive manager, to introduce the subject and report, then open up the subject for discussion and debate. Vociferous members of the Board should not be allowed to dominate, particularly if this discourages quieter members from contributing. The Chair’s primary role should be to elicit the views of others and not to manipulate the discussion so that it goes their own way. The sense of the meeting must be ascertained and the outcome documented in the minutes. The Chair must ensure that actions are followed through.

The Chair should manage the Board to ensure that sufficient time is allowed for discussing complex or contentious issues. Board members should not be faced with unrealistic deadlines for decisions. All Board members should be encouraged to participate and offer constructive challenge. One Chair I know always sets homework for individual board members in advance of the next board meeting!

A skilful Chair should encourage feelings to be openly expressed and create a climate of trust and candour. Conflict should be surfaced and handled, with constructive negotiation, rather than personal attacks. Contrary views should not be glossed over. One technique to avoid ‘group think’ and ensure proper debate is to assign the role of devil’s advocate for unpopular alternatives, to stronger members of the group. Or occasionally the Chair could divide the board into two groups to evaluate options.

If consensus cannot be reached on a particular decision, the Chair should consider adjourning the discussion and returning to it at the next meeting. In the meantime, the Chair should attempt to identify the concerns of dissenting directors and reduce differences of opinion. Resisting contrary views may only serve to entrench the dissenter in his views, or even polarise the Board. If agreement cannot be reached, it may be appropriate to go to a vote: this should draw a line under the debate and allow the Board to move on.

The Chair should make certain that the board decides the nature and extent of the risks that it is willing to tolerate in implementing strategy. Sufficient attention should also be given to the composition, skills mix and succession planning for Board roles.

Chair’s role outside of the Board room

A newly appointed Chair should make a special effort to get to know the other board members through one-to-one phone calls or meetings. Valuable insights can be gleaned by drawing out fellow directors’ perceptions of the strengths, weaknesses, opportunities and threats facing the organisation. The Chair may help to facilitate social time in advance or after meetings to enhance teamwork within the group, by encouraging Board members to get to know and understand each other’s background, skills and perspective.

The Chair should take the lead in providing a proper induction programme for all new appointees to the Board (assisted by the Secretary, where appropriate). The Chair should also lead on evaluating the performance of the Board as whole, as well as individual directors, preferably on an annual or biennial basis. The Chair’s performance should be subject review by fellow directors too.  Following the review, the Chair should follow through on any training and development needs which have been identified.

The Chair has a crucial role to play in managing communications with the organisation’s stakeholders and ensuring that board members develop an understanding of the needs and desires of customers and employees, investors, funders, as well as regulators. There is a key role to play in dealing with the media, particularly during a crisis, to protect the organisation’s reputation.

What makes an effective Chair?

An effective chair needs self-confidence, usually acquired through experience, good listening skills and charisma, which arises from being simultaneously in control, yet still open to contributions. To lead the board effectively, the Chair must know the directors, their strengths and weaknesses, so that they can be drawn out on relevant matters, or reined in when they are becoming too long-winded. A visible presence, walking the floor, motivating and talking to staff, as well as meeting and presenting to external stakeholders, is important.

The Higgs Review of 2003 found that an effective Chair:

  • Upholds the highest standards of integrity, probity and good governance, leading by example
  • Sets the agenda, tone and style of board discussions to promote debate and discussion and sound decision-making
  • Ensures a clear structure for running board meetings, including starting and finishing on time and spending proportionate amounts of time on thorny and complex issues
  • Promotes effective communications, inside and outside the boardroom
  • Builds an effective board by initiating change and succession planning for board vacancies
  • Ensures that Board decisions are implemented effectively
  • Establishes a close relationship of trust with the senior executives, providing wise counsel, advice and support, but at the same time being careful not to interfere with operational management decisions
  • Provides coherent leadership of the organisation, including representing the organisation to the outside world and understanding the views of all the organisation’s key stakeholders.

Chairmanship is a challenging role. A good Chair will have a clear vision and focus on strategy, bringing together the disparate skills, qualities and experience of other board members. The Chair should foster a positive culture of corporate governance which then permeates down through the organisation and delivers positive results.

I hope you enjoyed reading about The Pivotal role of the Chair in Ensuring Good Governance.   Next time we look at The Board’s role in identifying and managing risk.

Mark Johnson is an experienced solicitor and company secretary helping charities, social enterprises and SME businesses to flourish. His company Elderflower Legal offers a range of support packages to help organisations with legal compliance, managing risk and good governance. For more resources check out elderflowerlegal.co.uk.
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How to Create a High Performance Board

How can you put in place the right systems, structures and processes to ensure that your Board drives success?

Any organisation, whether in the private, third sector or public sector is only as good as the people who lead it. Board members have a vital responsibility to define the vision and mission of the organisation, to decide its strategy and objectives, to manage the risks and to fashion the ethos and culture of the organisation.

The Board is the epicentre of any system of corporate governance, by which the organisation is directed, controlled and held accountable to achieve its purpose and create value over the long-term; it must balance the needs and interests of different stakeholders, whilst at the same time providing the entrepreneurial drive and leadership to succeed. Sound governance should be seen as a source of competitive advantage, not a brake on progress.

Four key tasks of the Board

An effective Board has four main strands to its work:

  • To establish and maintain the vision, mission and values of the organisation (the vision should be an inspiring picture of the organisation’s potential, the mission is a statement of how to achieve the desired state, whilst values are the principles and deeply held beliefs and standards of conduct embedded in the organisation’s way of doing things).
  • To decide the strategy and structure – the Board should continually review and evaluate the strengths, weaknesses, opportunities and threats and consider how best to play to the organisation’s strengths, or bolster the required competencies. (More on strategy here).
  • Delegate authority to managers and then monitor and evaluate the performance of the strategy and business plan, whilst maintaining appropriate monitoring and controls over risks; determine the appropriate KPIs to be used for effective monitoring.
  • Communicate with all the stakeholders in the organisation (such as customers, employees, funders, and members): maintain a continuous dialogue to understand their needs, promote their goodwill and support.

In carrying out these tasks, there needs to be a dynamic dialogue within the Board. As the Walker report into the behaviour of bank boards during the financial crisis found, many boards ‘lacked a disciplined process of constructive challenge’. They had descended into ‘group think’ and had focused on conformance with rules, rather than thinking laterally and strategically. The Financial Reporting Council in its 2010 Guidance on Board Effectiveness tells us, ‘An effective Board should not necessarily be a comfortable place. Challenge, as well as teamwork, is an essential feature’.

The role of the Board

One of the Board’s first tasks is to decide how it will function and identify the key issues and decisions which it must tackle collectively and which cannot be delegated – a schedule of reserved matters. Following that, there will be a scheme of delegation of powers to executive managers, committees and subsidiaries. Typical matters reserved for decision-making by the Board, include:

  • Approval of the annual report and accounts
  • Approval of dividends (in a profit-distributing organisation)
  • Approval of communications with members and the public
  • Appointment or removal of auditors
  • Developing, approving and reviewing the strategy
  • Approval of operating plan and budgets, review of progress against budgets
  • Approval of expenditure and contracts in excess of delegated limits
  • Approving the prosecution, defence or settlement of any litigation
  • Approval and ongoing monitoring of risks – the board should set appropriate risk management policies and seek regular assurance that the system is working effectively
  • Appointment and removal of Board members and senior executives
  • Succession planning for key roles
  • Ownership of health and safety policies
  • Approval and ownership of ethics codes and CSR policies
  • Setting terms of reference for delegation of powers to executives and committees

Practical steps for success

There are several practical organisational steps which will contribute to success of any Board:

  • The Board must be properly constituted with the right skills and have the resources to undertake its duties, such as a good company secretary. Board members must dedicate sufficient time to their role.
  • The number of meetings should be sufficient to deal with the business effectively.
  • Agendas should be properly planned and sent out in advance, together with supporting papers to allow for prior reading and preparation.
  • There should be enough time to devote to the items on the agenda, with the right focus on the most important topics – especially strategic issues, rather than mundane operational detail.
  • Minutes should be accurate and available promptly to aid follow-up actions. (Minutes also form a legal record of decision-making that must be kept for up to 10 years).

The organisation’s governance framework should be implemented in a way that is proportionate and realistic. However, as the Financial Reporting Council commented in 2009, the quality of corporate governance depends ultimately on the behaviour of individuals, not on procedures and rules. That leads us to consider what are the desired qualities and skills of valuable Board members?

Desired attributes of Board members

The late Neville Bain, former Chairman of the IoD boiled it down to ten attributes:

  1. Ability to understand issues and identify central points for decision
  2. Sound judgment – probes facts and assumptions, weighs evidence to arrive at decisions
  3. The ability to provide and accept challenge in a constructive way
  4. Ability to influence through clear communication and persuasion
  5. Good interpersonal skills and ability to manage conflict
  6. Forward thinking – anticipating new trends and events, alert to the need for change
  7. Ability to think strategically, to understand the role of risk analysis and control
  8. Financial and commercial skills to understand how well the organisation is progressing against its goals.
  9. Integrity and high ethical standards – which they live by in practice.
  10. Good self-awareness – a thirst to improve personal knowledge and performance.

Boards must strive for continuous improvement

An effective Board should aim to be a learning organisation. They should continually review their collective performance as well as the performance of individual members. A useful way to approach this is through a structured external board effectiveness review, such as BoardCHECK360™ offered by Elderflower Legal. The review will examine various aspects of the Board’s operating procedures, composition and succession planning, induction, meetings management, internal controls and risk management, delegation and will highlight good practice, as well as areas for improvement.

As Bob Garratt tells us: ‘Directors are there to ensure that at the cybernetic centre of the enterprise, there is a heart and brain. This heart..creates an emotional temperature appropriate to that specific organisation. This is the essence of that organisation’s climate or culture”.

Next time: the pivotal role that the Chair plays in developing a successful Board.

Mark Johnson is an experienced solicitor and company secretary helping charities, social enterprises and SME businesses to flourish. His company Elderflower Legal offers a range of support packages to help organisations with legal compliance, managing risk and good governance. For more resources check out elderflowerlegal.co.uk.
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What Makes a Successful Joint Venture?

Joint ventures can be a useful route to combine resources and skills, to secure greater market power or better access to markets for SMEs, charities and social enterprises.

A new corporate entity can be used to ring-fence more risky trading activities or to develop a distinct brand or business culture outside the strictures of the host participants (such as borrowing controls, pay scales or corporate overheads).

Partnering with an outside organisation may bring access to new technology, lean business processes and technical know-how. A joint venture arrangement in which partners each hold a shareholding provides an opportunity for ‘value capture’: as the business takes off their shareholding should increase in value. A shareholding and directors on the board provide a ‘seat at the table’, visibility and transparency on the money flows and activities of the business: areas of obscurity, which have been frequently criticised in more arm’s length outsourcing and licensing arrangements.

A joint venture is ‘an arrangement between two or more parties who pool their resources and collaborate in carrying on a business activity with a shared vision and a view to mutual profit’.

Analysing the elements of this, we find several main ingredients:

  1. There is a contribution of resources, assets and skills from both parties. Participants need to consider carefully the terms on which they make their staff and assets (land, equipment, brand, intellectual property rights etc) available to the new venture. Do the partners have the necessary powers and approvals to set up the arrangements?
  2. A joint venture is usually about starting a new business. There must be clarity about the business plan and risks, whether there is a demand for services or products supplied by that new business. Is there a wider market beyond the hosts’ areas that can be exploited to generate more revenue?In many cases, the joint venture will involve establishing a new limited company in which the partners each take a stake. The terms of the joint venture agreement are very important. Important areas to consider will be the agreed strategy and business plan for the venture, relative shareholdings and capital contributions, policies on reinvestment of profits vs. distributing them as dividends, decisions for which unanimity is required vs. decisions taken by majority and, crucially, what are the exit provisions if things don’t go according to plan or if one party wants to leave and sell its stake? Some enterprises with long-standing joint ventures have recently found it difficult to extricate themselves from arrangements which are no longer fit for purpose or perceived as too expensive. For example, Liverpool City Council had a long-standing JV with BT plc. It to come to an end after it was reported that BT would not agree to cutting the cost of the £70m-a-year deal any further than the £5m a year over three years they had negotiated so far.
  3. There must be genuine joint working around a shared vision. A lot of joint ventures have come unstuck because the partners have not invested enough time at the outset in considering explicitly what both parties’ objectives are from the arrangement. For one partner, the objective may be to achieve a step change in products or service levels by levering in new investment, technology and improved business processes; for another, the objective may be to achieve a defined level of profit and to use the contract as a springboard to capture more market share and new distribution channels. Open conversations about how each partner can help the other achieve these goals are important.
  4. A good joint venture has an appropriate balance of shared risks and rewards. The parties should ensure that they negotiate an appropriate share of future rewards, but equally it must expect to shoulder its share of the risks of making the business successful

Joint Ventures with the Public Sector?

Joint Ventures are increasingly of interest to public bodies too. They are experiencing a paradigm shift as they move to become smaller enablers and commissioners of services, rather than direct providers. They are looking for new ways to work with private and third sector organisations to ‘do more for less’. Over time this is leading to a diverse landscape of provider organisations, such as joint ventures, spin outs, arms length trading companies. Participants need to think carefully about the governance and accountability arrangements over these more exotic arrangements. All participants need to have appropriate mechanisms to monitor the performance and risks of joint ventures. Are they provided with timely financial information, performance reports against defined KPIs and, the figures for staff turnover, (always an interesting barometer of internal culture)?

So What Makes a Successful Joint Venture?

Here are my top tips for success.

  • Establish the commercial rationale for the arrangements – capture it succinctly in writing and then share and obtain buy-in from all your stakeholders.
  • Set clear objectives for the joint venture – what are the expected benefits and what contribution needs to be made by each partner? Set out the assumptions clearly.
  • Identify the possible partner(s) and select the most appropriate using clear selection criteria – remember cultural and behavioural factors can be just as important as infrastructure and know-how.
  • Carry out a due diligence process – each partner should share key information (under a confidentiality agreement) and introduce their team members.
  • Establish an appropriate legal format for the joint venture – this could range from a contractual arrangement, through to a full-blown new limited company in which each partner takes a stake.
  • Negotiate an agreement that reflects the goals of all partners, but at the same time includes a clear exit strategy (which describes the consequences of leaving), and clear agreed strategies for resolving disputes.
  • Create an appropriate structure for the management and ownership of the JV. Ideally, the principals shouldn’t get involved in the day-to-day issues and decisions, but leave it to a dedicated management with the capability and freedom to get on with the job. The JV management team should have clear control parameters and reporting lines.
  • Put in place proper project management arrangements and get the back-office infrastructure, systems and processes working well.
  • Make time to manage cultural issues – make sure that key personnel get to know each other on a social and professional level – teams that play together, stay together!
  • Be aware of the likely tension points– these include a perceived loss of control by one partner, a change of regime in one partner brings in new personalities, or the external environment changes and the reasons for the joint venture become less compelling.

Joint ventures can be a powerful medium to achieve growth, enter new markets, share and ring-fence risks. However, they need to be properly tended to bear fruit. Leaders need to make time and resources available to promote and defend the partnership, if it is to succeed. Cultural and behavioural factors can often be the most difficult issues to get right. The documentation needs a clear exit plan in case things don’t work out.

Mark Johnson is an experienced lawyer and company secretary working with SMEs, charities, social enterprises and public bodies to create successful collaborations and partnerships. elderflowerlegal.co.uk
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