What Does an Effective Audit Committee Actually Do?

Part 1 – Role of the Audit Committee

The audit committee makes up one of the three pillars of the Board committee system and forms a critical part of the overall framework of corporate governance for medium to large companies, housing associations, charities, academy trusts and public sector bodies. Experience shows that the role is not an intuitive one and there is often confusion about the purpose of an audit committee.

For example, in a recent Education Funding Agency webinar, a leading accountancy practitioner was asked what is the role of the audit committee in an academy trust? He replied that its job was ‘to manage risk in the organisation’. That may be his perception, but in practice how can this group of usually 3-5 non-executive members possibly have eyes and ears in every corner of the organisation? Do they really have the time and resources to achieve that result? Or is it more a case of providing oversight and ‘reasonable assurances’ to the Board and external stakeholders that appropriate systems and controls are in place? In this piece, I look at the role and functions of the audit committee and share some lessons on what makes it effective.

Why have an audit committee?

In the education sector, all academy trusts with an annual income over £50 million are required by the Financial Handbook to appoint a dedicated audit committee (smaller ones may combine this function with other committee business), under the NHS Codes of Conduct and Accountability and the Monitor Governance Code health trusts are required to establish one, local authorities are required by accounting standards to establish one, the National Housing Federation Governance Code requires that ‘All but small non-developing organisations must have a committee primarily responsible for audit, and arrangements for an effective internal audit function’. Similarly, HM Treasury requires that all government departments, executive agencies and arm’s length bodies should establish an ‘audit and risk assurance committee’. UK listed companies are required by law to have an audit committee.

The UK Corporate Governance Code (widely regarded as the gold standard of best practice) requires that boards should establish formal and transparent arrangements for:

  • Consideration of how they should apply reporting and risk management and principles of internal control; and
  • Maintaining an appropriate relationship with the organisation’s external auditors

These functions are discharged by establishing a formal audit committee with clear terms of reference.

The Board must put in place governance structures and processes to ensure that the organisation operates effectively, meets its strategic objectives and provides the Board with assurance that this is the case. However, even the best structures and processes can let down an organisation if they, and the assurances they provide, are not operated with sufficient rigour. Boards are ultimately responsible for assessing risk, signing off financial statements and the accuracy of public announcements. There can be significant personal liabilities for getting it wrong. Board members need to be reassured that they can rely on the information being presented to them.  Boards look to their audit committee to review and report on the relevance and rigour of the governance structures in place and the assurances the Board receives. The Audit Committee supports the Board in this area by obtaining assurances that controls are working as designed and by challenging poor sources of assurance.

What are the functions of an audit committee?

The UK Code lists the role and responsibilities of an audit committee:

  • To monitor the integrity of the organisation’s financial statements and any formal announcements relating to financial performance
  • To review the organisation’s internal financial controls, internal control and risk management systems
  • To monitor and review the effectiveness of the organisation’s internal audit function (if it has one, and if there is not, annually consider whether there ought to be one in the light of current risks and trends in the market)
  • To make recommendations to the board in relation to the appointment, reappointment or removal of the organisation’s external auditors
  • To approve the remuneration and terms of engagement of the external auditors
  • To review and monitor the independence of the external auditors, as well as the objectivity and effectiveness of the audit process
  • To develop and implement a policy on using external auditors to provide any non-audit services
  • To report to the board on how it has discharged its responsibilities.

The Code recommends that part of the organisation’s annual report should describe the work of the audit committee.

The Financial Reporting Council has published extensive guidance on the role of the audit committee. Of particular note are the following points:

  • The organisation’s management is under an obligation to make sure that the audit committee is kept properly informed and should take the initiative in providing the committee with information instead of waiting to be asked – this is crucial since the audit committee can only work properly if it is kept informed.
  • Whilst the core duties of the audit committee are oversight, assessment and review of systems and functions in the organisation, it is not the duty of the committee itself to carry out those functions or to make or endorse substantive decisions. Executive management prepares financial statements, auditors prepare audit plans. Executive management is responsible for actually managing risk (within the risk appetite and tolerances set by the Board as whole). The audit committee’s role is to provide reasonable assurance to the board and external stakeholders that the functions are being carried out properly. They must flag up issues indentified. FRC guidance recognises that, faced with unsatisfactory explanations by management, the committee may ‘have no alternative but to grapple with the detail and perhaps seek independent advice’. They might also from time to time carry out thematic reviews of known areas of high risk on their own initiative.

In the public sector, HM Treasury sees the role of the audit committee ‘is also to act as the conscience of the organisation’ and to provide insight and constructive challenge where required, for example, on risks arising from increasing constraints on resources, new service delivery models, information flows on risk and control and the general agility of the organisation to respond to new risks.

Oversight of risk management and controls

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. In an earlier post we looked at how boards can develop an effective approach to risk management. Risk appetite is the level of risk that the organisation is willing to take in pursuit of its objectives (it can have ‘upside’ as well as ‘downside’). It is concerned with the amount and types of risk the Board would like the organisation to take without a serious threat to its financial stability – it can be quantified so that prudent limits can be set. Setting that level of risk appetite is a key role for the Board as a whole.

The UK Corporate Governance Code requires that ‘the Board should satisfy itself that appropriate systems are in place to identify, evaluate and manage the significant risks faced by the organisation’. The Board should carry out a review of the effectiveness of risk management systems in the organisation. The work of the audit committee helps to inform this, but it must always be remembered that ‘the buck stops’ with the Board.

An internal control system must be effective in preventing losses arising from risk events, identifying risk events and taking corrective action when they occur. An internal control system is concerned with managing business risks which are largely internal to the organisation. Controls will include the policies, processes, procedures, methods, measures, tasks and behaviours to ensure that operational activities progress effectively. It is designed to provide assurance on the achievement of objectives as follows:

  • Effectiveness and efficiency of operations
  • Reliability of financial reporting
  • Compliance with applicable laws and regulations

Internal controls can be classified into 3 main types:

Preventive controls – intended to prevent an adverse risk event from occurring, e.g. fraud by employees

Detective controls – for detecting risk events when they occur, so that an appropriate person is alerted and corrective action can be taken

Corrective controls – measures for dealing with the consequences of risk events that have occurred.

The various sources of assurance make up what is known as the ‘three lines of defence’:

First line: management assurance from frontline or operational areas;

Second line: oversight of management activity, separate from those responsible for delivery (but still part of management chain);

Third line: independent and objective assurances from internal audit and external bodies.

Together these assurances make up the Assurance Framework.

“The Assurance Framework is the ‘lens’ through which the Board examines the assurances it requires to discharge its duties. The key question Board members need to ask is ‘How do we know what we know?’ The Assurance Framework should provide the answer.” (NHS Audit Committee Handbook 2011).

The role of ‘internal audit’ in assisting the committee

‘Internal audit’s role is to enhance and protect organisational value by providing risk-based and objective assurance, advice and insight’–  Institute of Internal Auditors.

The role of internal audit is to provide independent assurance that an organisation’s risk management, governance and internal control processes are operating effectively. Unlike external auditors, they look beyond financial risks and statements to consider wider issues, such as operational effectiveness, the organisation’s reputation, growth prospects, impact on the environment, dealings with employees and compliance with regulations. The internal audit function can be performed by directly employed staff (with appropriate reporting lines), or alternatively the function can be outsourced to a specialist firm. The scale and frequency of activities really depends on the complexity of the organisation. A properly resourced internal audit function can provide management with valuable objective assurance and advice on risk management and controls. The data and reports produced by internal audit will be valuable data to feed into the audit committee meetings, particularly where they highlight trends or recurring problems which the committee may need to probe more deeply.

In part 2, we will consider the composition of the Audit Committee, how it can manage its business effectively and the qualities to look for in effective members.


Mark Johnson is an experienced solicitor & chartered company secretary supporting businesses, charities, social enterprises & academy trusts on governance, compliance & legal affairs. He also serves as an audit committee member for a leading multi-academy trust. Please get in touch info@elderflowerlegal.co.uk or 01625 260577.

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Top Ten Legal Risks for Enterprise and How to Manage Them

As 2016 dawns, now is a good time to reflect on your business plans for the year ahead. Make some time to consider these legal risks and how you would manage them. A modest investment now could pay handsome dividends later.

  1. Get your company structure in order

Are you using the optimum legal format for your enterprise? Have circumstances changed so that you need to revisit this? For example, if you are a sole trader or partnership taking on more liabilities and risk, is now a good time to incorporate and benefit from limited liability status? If you plan to raise external funding, will funders require you to adopt a specific legal structure, such as a company limited by shares or a community interest company with an ‘asset lock’? Are you making the most of any tax reliefs available, for example by adopting charitable status? Is your company’s constitution in order – is it clear who is responsible for what, who can spend the organisation’s money and up to what limit, who is authorised to enter into contracts or employ staff? If you are working with new partners or external investors, have you got a shareholders’ or partnership agreement in place which protects your position properly, sets out clearly what is expected of each party, how the risks and rewards will be shared and how any falling out would be dealt with? Download our free guide to legal structures here for more tips.

  1. Understand the implications of taking on business premises

If you are planning to take on business premises this year, make sure you understand the risks involved. Taking on a long term inflexible lease can be a real millstone around your neck. Are there more flexible arrangements you could use instead, such as an informal licence, sharing space with others or the increasingly popular shared business centres for start-ups? If you do decide to take the plunge on a lease, understand the implications. Is the rent realistic and affordable, how will it increase during the term of the lease? Insurance and repairs: landlords like to get tenants to sign up to ‘full repairing and insuring’ leases – which means you will be responsible for the costs of insuring the building as well as the rent; you will also be responsible for carrying out works to put the property into a good state of repair at the end (known as ‘dilapidations’) and paying a service charge to cover external repairs, cleaning and building services.  These can be very significant costs to budget for. Consider limiting your liability at the outset by having a schedule of condition prepared. Get proper professional advice before you sign anything!

  1. Get your contract terms in order

Effective and enforceable contracts are the lifeblood of any successful enterprise. Contracts with customers, service users, suppliers, employees, landlords, business partners and insurers all make up the payment flows, risk allocation and risk management tools which allow an enterprise to manage its cash flow, generate surpluses and remain solvent. Properly drafted contracts which are clear and unambiguous are a vital protection for your organisation and can really help to avoid costly disputes if things go wrong. Consider getting your contracts reviewed and put into shape by a professional. Find out more.

  1. Are you up to date with regulations that apply to your business?

The scope and burden of regulations affecting business and non-profits just seems to grow exponentially, especially in highly regulated sectors like health and social care, education, financial and professional services. The default knee-jerk response of politicians to any problem or scandal, however isolated, seems to be to pass new laws, putting more responsibilities and penalties on managers for non-compliance. For example, last year saw the introduction of new laws affecting consumer contracts, a new minimum living wage starting in April 2016, new rules affecting zero hours contracts and tough new approach to data protection violations. It can be difficult for small and medium sized enterprises to keep up with all the developments and stay compliant. One solution is to sign up to a subscription service like ours, designed to provide peace of mind. We can help you to stay focused on running your business while we take care of the paperwork, updating policies, contracts and providing on-call support with cost certainty.

  1. Protect your business ideas and confirm ownership

Have you taken all the necessary steps to protect the names, logos and goodwill associated with your enterprise? These can be a real source of competitive advantage and enhance the value of your business. Patents (which protect mechanical devices, industrial processes and chemical compounds), trademarks (which protect distinctive slogans, logos, domain names and sounds) and designs, can all be registered with the UK Intellectual Property Office. The protection gives you the right to stop others from using them without permission. Other unregistered rights can arise automatically, such as copyright (which protects literary, dramatic, musical and artistic works, sound recordings, films and broadcasts), unregistered trademarks and confidential information (such as method statements or processes). If you are discussing confidential plans with a potential business partner, do you routinely get them to sign a non-disclosure agreement to stop them poaching your ideas? Is it clear in your contracts with staff and suppliers who will own the rights to any inventions or creations?

  1. Control your debts

Good cash flow management is essential to any business. It is important to know the precise identity of the customer with whom you are dealing and ideally perform a credit reference check on them. Mistakes in the name or address of a customer may prevent you from recovering a debt from them later. Get proper written terms of business in place and consider setting credit limits for individual customers. If the customer’s credit looks doubtful, consider taking additional security, such as payment in advance or a guarantee from a third party. 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 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 really help your business. Find out more.

  1. Understand your duties as an employer

It is vital to understand your responsibilities when taking on employees. Most problems in the workplace stem from poor communication, lack of clarity about roles or expectations of new recruits, or failing to tackle performance issues when they arise. With payroll costs typically averaging 60%-75% of total costs for most enterprises, this is a high risk area worthy of intensive attention. Time spent getting your documentation, contracts, policies and procedures in order will pay dividends in the long-run. Although the introduction of employment tribunal fees has deterred some legal claims, an employment dispute can be damaging for morale, costly in terms of time and resources and can have a very negative impact on an organisation’s reputation, including implications when bidding for external contracts. Time spent getting your paperwork in order could be a wise investment to avoid problems and expense further down the line. Don’t put off that appraisal meeting or employee paperwork any longer! See more on this.

  1. Manage disputes effectively

Disputes are almost inevitable at some point in a business relationship. Various techniques can be used to resolve them. The cost of taking a case to court has risen dramatically, not least because of the increase in court fees brought in during 2015. For disputes worth over £10,000 the court fee can be 5% of the value of the claim just to issue the claim form (for example a claim for a debt of £15,000 would incur a fee of £750, plus an additional fee of up to £1,000 payable for the hearing).  Not surprisingly this is prompting a strong interest in alternative forms of resolving disputes, such as ombudsmen, adjudication, expert determination and mediation. Many trade associations now offer a mediation scheme for their members, and we are seeing the growth of private online dispute resolution forums for resolving disputes, such as resolver.co.uk or modria.com. Consider amending your terms of business to require any disputes to be referred to a less costly swifter process, rather than the courts. Remember also that disputes are often won or lost by the quality of evidence available. Make sure you keep good records of contract documents, letters, emails and notes of phone calls and store them securely for at least six years after the relationship ends. Contemporaneous notes of meetings or calls can hold great weight with a judge.

  1. Be careful with your data

As we move inexorably into a digital world, the amount of data stored and transferred concerning operations, customers, suppliers and employees is increasing exponentially. The complexity of modern business relationships, multiple interfaces between networks, cloud-based applications and storage, social media platforms and electronic devices, as well increasingly sophisticated fraudsters and hackers, means the potential for personal data to be lost or misused is growing all the time. At the same time regulators are adopting a tougher enforcement approach towards data breaches and unauthorised use of data, such as unsolicited marketing calls, texts and emails. For example, the organisers of Parklife Festival in Manchester were last year fined £70,000 for sending unsolicited text messages.

In October 2015 TalkTalk suffered massive adverse publicity when it revealed that the data of up to 4 million customers may have been hacked. The charity British Pregnancy Advisory Service was fined £200,000 when it website was hacked and sensitive details of service users compromised. If you handle personal information, you will most likely need to register as a data controller with the ICO. Registration costs £35 per year and can be completed online. Failure to notify or renew a notification when you are not exempt from notifying is a criminal offence, punishable by a fine of up to £5,000. You also need to comply as a minimum with the eight data protection principles.

Take extra care if you are planning to sell or pass on your customer lists to third parties – Pharmacy2U Limited was fined £130,000 in 2015 for passing on its customer lists without consent from customers. It is important to get the right ‘opt in’ consent from customers and service users at the first point of contact with them, either through website forms, on paper or over the telephone.

10.  Get your policies in order

A full suite of policies may be your first line of defence against potential problems with employees or regulatory action. You cannot possibly have eyes and ears in very corner of your business, but you can set out clearly what is expected of your staff, suppliers and partners. Policies should cover every aspect of your business, such as health and safety, prevention of discrimination and harassment, environmental standards, social media usage, data handling, sickness absence and redundancy. If there is an accident or a claim your policies can help to demonstrate that management took all reasonable steps to avoid causing harm. Make sure staff and suppliers are made aware of the policies when first joining and refresh them annually.

Start 2016 on the right footing by giving some thought as to how to best protect your business against legal risks. Contact us now for a ‘no obligation’ discussion on how we could help. We wish you a happy and prosperous New Year.


Mark Johnson is an experienced solicitor & chartered company secretary. As Principal of Elderflower Legal, he provides a range of friendly fixed price legal and compliance services for SMEs, charities, social enterprises, academy trusts and local authority trading companies, helping them to flourish. Please get in touch info@elderflowerlegal.co.uk or 01625 260577.

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Employing Staff for First Time? Know Your Legal Duties!

Are you employing staff for the first time? It is vital to understand your legal duties.

Starting a new enterprise is an exciting time. In due course you may think about employing staff to help you. It is vital to understand your responsibilities when taking on employees. Time spent getting your paperwork in order could be a wise investment to avoid problems and expense further down the line. Here, I offer a few simple tips to ensure compliance.

1  Run a fair recruitment process

Draft a job description and person specification for the role you are looking to recruit. Set out the requirements in an objective way and avoid using problematic phrases like “young and dynamic candidate” which could be construed as discriminatory. Remember that recruits have the right not to be discriminated against on grounds of sex, race, disability, sexual orientation, religion and belief, age, gender reassignment, marriage and civil partnership, pregnancy or maternity. Design a fair recruitment and selection process so all candidates can, as far as possible, be treated equally. Objective competency tests help to demonstrate this better than interviews alone. Remember that if there is a problem, a disgruntled candidate may request copies of all information you hold about them under the Data Protection Act, so make sure your paperwork is in order.

2  Always use a written contract

When employing staff, the law requires employers to provide employees with a written statement of the main terms of their employment within two months of starting work. The statement must cover the following as a minimum in one single document:

  • the employing organisation’s name
  • the employee’s name, job title or a description of work and start date
  • if a previous job counts towards a period of continuous employment, the date the period started
  • how much and how often an employee will get paid
  • hours of work (and whether the employee will have to work Sundays, nights or overtime)
  • holiday entitlement (and whether that includes public holidays or not)
  • where an employee will be working and whether they might have to travel or relocate
  • if an employee works in different places, where these will be and what the employer’s address is

Failure to provide the written statement may entitle the employee to raise a grievance and bring a claim before the employment tribunal for compensation equivalent to 2-4 weeks’ pay.

As well as these main terms, the following further information must also be given in writing, although this can be in a staff handbook or other documents:

  • how long a temporary job is expected to last
  • the end date of a fixed-term contract
  • notice periods
  • any collective agreements that are in place between the employer and trade unions
  • pension entitlement
  • who to go to with a grievance
  • how to complain about how a grievance is handled
  • how to complain about a disciplinary or dismissal decision

As soon as someone accepts a job offer, they have a contract with their employer. An employment contract doesn’t have to be written down, but the use of a written contract helps both parties to know where they stand and can avoid misunderstandings and costly disputes. It also the employer’s opportunity to make sure the employee is aware of certain obligations necessary to protect the employer’s business, such as not poaching customers or staff when they leave, protecting trade secrets, or handing over inventions, documents, passwords and keys when they leave.

The contract of employment can be varied only with the agreement of both parties. If you are proposing to change an employee’s contract of employment, you should consult with that employee and explain and discuss the reasons for the change. Employees are more likely to accept changes if they can understand the reasons behind them and have an opportunity to express their views.

If you impose a change to the contract unilaterally you may be in breach of contract and your employees could bring a legal claim against you for constructive dismissal if the breach is fundamental and significant, claim damages for breach of contract in the courts or bring a claim at an employment tribunal for unlawful deduction from wages, if the change affects their pay.

3  Pay the correct amounts

Do some research to find out what the going rate is for employees in your sector. When employing staff, think about whether to offer a bonus or incentive scheme to encourage good performance and loyalty, but make sure the criteria and rules are clear. Think about what the organisation can afford. Additional benefits, such as pension contributions and childcare vouchers can be attractive for candidates and they may also save tax.

All employees have a right to be paid at least the National Minimum Wage or if they are over 25, from 6 April 2016 the National Living Wage applies, which is £7.20 per hour. Below the age of 25 the following hourly rates apply: 21 or over £6.70, 18 to 20 £5.30, under 18 £3.87, an apprentice aged 16 to 18 or over 19 in their first year £3.30. The National Living Wage for over 25’s, represents a £910 per annum increase in earnings for a full-time worker on the previous minimum wage and it is set to increase year on year. By 2020 the Government predicts a full-time minimum wage worker will earn over £4,800 more in cash terms. The increase is going to have a big impact on the cost base of labour-intensive sectors like health and social care. Organisations will need to budget for these increases in business plans and consider whether and how these costs can be passed onto customers, (or consider recruiting more under 25’s!)

Remember it is unlawful to deduct amounts from an employee’s wages unless you are legally required to do so (e.g. to service student loans), you have a contractual right to do so, or you have a separate written agreement signed by the employee (for example, a right to set off outstanding balance of a training loan or season ticket loan if the employee leaves).

4  Provide induction and ongoing training

At the start of a new job many employees feel highly motivated and excited about their future prospects. Unfortunately this idealism doesn’t always last and some staff members may find themselves becoming disenchanted. Often, this can be attributed to a lack of support, a failure by the business to communicate key responsibilities, an overwhelming amount of new information or because the recruit fails to build a social network within the organisation. A good induction programme is the way to help a new employee settle into the organisation and become effective quickly. Focus on the new employee and provide them with information and training that is needed for them to be competent with their job responsibilities. There should be continuous support: it is a good idea to appoint a mentor to support a new joiner when they first arrive.

Ongoing training for employees has clear business benefits, including

  • Better job satisfaction and morale among employees
  • Increased employee motivation
  • Efficiencies in processes, resulting in financial gain for the enterprise
  • Enhanced capacity to adopt new technologies and methods
  • More innovation in strategies and products
  • Reduced employee turnover
  • Enhanced company image, e.g. through customer service training
  • Better risk management, e.g., training about data protection and equality laws.

Remember that losing staff always has a cost and risk to the organisation in lost productivity, additional recruitment fees and management time in finding a replacement. Research by Oxford Economics in 2014 found that the average cost to replace an employee was a startling £30,000 once you take into account direct recruitment costs and the time taken to reach optimum working efficiency (typically 24-28 weeks for an SME).

5  Make sure employees know the rules

As well as the contract of employment, when employing staff, it is essential to have a set of policies which staff are made aware of during their induction. These will cover issues like sickness absence, , confidentiality and data protection, expenses and subsistence, use of company facilities, home-working, use of social media. Employees should be made aware that failure to follow the rules can result in disciplinary action. You should have in place a clear written disciplinary procedure. ACAS publishes good guidance on best practice.

If employees have a problem with managers or co-workers, they must have an opportunity to raise these through a grievance procedure. If you hold a grievance or disciplinary meeting, the employee has the right to be accompanied by a colleague or trade union official.

You must have a health and safety policy and put in place Employers Liability Insurance which will help you pay compensation if an employee is injured or becomes ill because of the work they do for you. The policy must cover you for at least £5 million and come from an authorised insurer. You can be fined £2,500 every day you are not properly insured. You can also be fined £1,000 if you do not display your insurance certificate or refuse to make it available to inspectors when they ask.

6  Manage attendance

Research by PWC found that the annual cost of sickness absence to UK employers was almost £29 billion in 2013. British workers apparently take more than four times as many sick days off work than other countries, the average unplanned days of absence being around 9 days!

Clearly, there is a significant cost to the employer of this loss of productivity. The costs could be even greater if you are forced to hire additional temporary cover for a key role.  It is important to address this cost by looking for ways to improve employees’ health, morale and motivation. For example, allowing greater workplace flexibility could help to helping break the cycle, e.g. allowing home-working or flexi-time, initiatives to promote exercise or healthy eating may also help. Some employers pay a bonus for a good attendance record.

There should be clear procedures for notifying and recording absences, a requirement to produce medical certificates for prolonged absences of more than 7 days and in the case of long-term absence the employer may want a right to require an employee to undergo an independent medical examination. Specify carefully in the contract how much time an employee can take off on full pay before their salary is reduced. As a minimum, an employee who is off sick for 4 days or more should qualify for statutory sick pay (‘SSP’) (currently £88.45 p.w.) and payable for up to 28 weeks. Until 2014, employers could usually reclaim SSP from the Government, but that is no longer the case – which means the wording of the contract can be crucial to manage your costs. Remember also that annual leave is still accrued while an employee is off sick.

7  Don’t dismiss unfairly

You can only dismiss someone if you have a good reason. Dismissal is normally only fair if an employer can show that it is for one of the following reasons:

  • a reason related to an employee’s conduct (e.g. failure to comply with policies, serious errors or customer complaints).
  • a reason related to an employee’s capability or qualifications for the job (including long term sickness, although extreme care is required if the employee has a disability).
  • because of a redundancy situation (there is insufficient work or roles are being restructured)
  • because a statutory duty or restriction prohibits the employment being continued (e.g. an employee is convicted of an offence or becomes bankrupt where this prevents them holding that role).
  • some other substantial reason of a kind which justifies the dismissal (for example, the employee is sent to prison).

But you must also show that you have acted fairly and reasonably in handling the process. In practice, this means you must:

  • inform the employee of any problem that you with their conduct or performance
  • carry out a proper investigation
  • if it’s a redundancy situation a fair and transparent selection process must be used
  • hold a meeting to discuss the problem
  • allow the employee to be accompanied
  • decide what the appropriate action is (perhaps a verbal or written warning before dismissing)
  • provide the employee with an opportunity to appeal (ideally to someone unconnected with the initial investigation or problem).

In order to make an ‘unfair dismissal’ claim an employee must normally have been employed for at least 2 years, however, there are exceptions if the dismissal relates to an ‘automatically unfair’ reason (see below), where no qualifying period applies.

Some types of dismissal are regarded as ‘automatically unfair’, regardless of the reasonableness, if an employee is exercising specific rights to do with:

  • pregnancy: including all reasons relating to maternity
  • family reasons: including parental leave, paternity leave (birth and adoption), adoption leave or time off for dependants
  • trade union membership grounds and union recognition acting as an employee representative
  • pay and working hours: including the Working Time Regulations, annual leave and the National Minimum Wage.

Employees are normally entitled to at least one week’s notice if you intend to dismiss them, unless a longer period applies. This minimum period rises to two weeks after two full years service and then by one week per year up to a maximum of 12 weeks. It may be possible to pay an employee in lieu of notice if you include this right in the contract. This may be appropriate in certain sensitive roles where it is preferable if the employee leaves immediately.

Sometimes you may dismiss someone without notice on the grounds of gross misconduct. This occurs when an employee has committed a serious act such as theft, violence, physical abuse, serious breach in health and safety or gross negligence. But it is still important to follow a fair procedure as for any other disciplinary offence.

Employees have the right to ask for a written statement of the reasons for their dismissal within 14 days. Having exhausted the internal appeals procedure, an employee may consider bringing an employment tribunal claim. They must normally bring the claim within 3 months of the dismissal. The introduction of fees for tribunal claims since 2013 has been a significant deterrent: the number of claims fell by 60% in the first six months after the fees were introduced. The fee for issuing a claim is £160 for simple claims relating to unpaid wages or time off, or £250 for unfair dismissal or discrimination cases. In addition, the claimant has to pay a hearing fee of £230 or £950 respectively. Before the claim can proceed there is a mandatory process of involving ACAS as an independent conciliator to resolve the dispute.

If an employee is successful at tribunal, the tribunal can order the employer to pay compensation, pay tribunal fees and witness expenses, alter the employee’s working conditions, or to give the employee their old job back, if appropriate. Compensation can be made up of the following elements:

  • a fixed sum for the unfair dismissal – this is known as a ‘basic award’ – this is based on the claimant’s age and length of service multiplied by their weekly pay (up to maximum of £475 per week).
  • compensation for the financial loss the employee has suffered if they have been unfairly dismissed. This is called a ‘compensatory award’.
  • a fixed amount to represent the money owed by the employer for unpaid wages, holiday pay, notice pay or redundancy pay, or for an unlawful deduction from wages
  • compensation for discrimination – this can be money to pay for financial losses the employee has suffered because they have been discriminated against, injury to feelings, personal injury, aggravated damages and interest. There is no statutory limit to this amount.

According to the Ministry of Justice, the average awards of compensation for different types of claims in 2013/14 were: unfair dismissal £11,813, sex discrimination £14,336, disability discrimination £14,502, age discrimination £18,801. Legal costs would be payable on top of these amounts. It may be possible to obtain insurance for these costs.

Don’t underestimate the costs, distraction and management time required to defend a tribunal claim. Sometimes employers will take a pragmatic view and enter into a confidential ‘without prejudice’ settlement.

8  Understand holiday entitlement and working time rules

Almost all workers are legally entitled to 5.6 weeks’ paid holiday per year (known as statutory leave entitlement). You can choose to include bank holidays as part of statutory annual leave, but they do not have to be given as paid leave. So most workers who work a 5-day week must receive 28 days’ paid annual leave per year. This is calculated by multiplying a normal week (5 days) by the annual entitlement of 5.6 weeks. For part time workers it will be pro-rated, so for someone who works 3 days per week leave is calculated by multiplying 3 by 5.6 = 16.8 days of annual paid leave.

The law says that employees can’t be required to work more than 48 hours a week on average – normally measured as an average over 17 weeks. Under 18’s cannot be required to work more than 8 hours a day or 40 hours a week. There are some exceptions to this. Employees can be required to work more than 48 hours a week on average if they work in a job:

  • where 24-hour staffing is required
  • in the armed forces, emergency services or police
  • in security and surveillance
  • as a domestic servant in a private household
  • as a seafarer, sea-fisherman or worker on vessels on inland waterways
  • where working time is not measured and the employee is in control, eg a managing executive with control over their own decisions

Over 18’s can choose to ‘opt out’. You can ask employees to ‘opt out’, but you can’t force them, dismiss them or treat them unfairly for refusing to do so.

The ‘opt out’ can be for a certain period or indefinitely. It must be voluntary and in writing. Workers in certain sectors cannot opt out- e.g. airline staff or road transport workers.

9  Communicate for success

Communication plays a vital role in giving employees a sense of control over their work and increasing their levels of commitment to your organisation. Time spent on a proper induction process, updates from management and regular feedback reviews will pay dividends in the long-run. A structured appraisal or review process provides a vital opportunity to take the temperature of the relationship, review progress, identify any problems or training needs. Experience shows that problems with performance can be more difficult and expensive to manage if they are left to fester for years unchallenged and then later surface as a grievance or dispute. In judging the reasonableness of dismissal of a long-serving employee for poor performance, the tribunal will be looking to see whether the employee was given any previous warnings or an opportunity to improve.

10 Maternity, Paternity and Flexible Working

Female employees have the right to 52 weeks’ maternity leave, regardless of how long they have worked for you. Employees don’t have to take the full 52 weeks, but must take at least 2 weeks after the baby is born. They also have the right to 39 weeks’ statutory maternity pay (SMP). This will be 90% of average weekly earnings (before tax) for the first 6 weeks and then £139.58 or 90% of their average weekly earnings (whichever is lower) for the next 33 weeks. SMP is paid in the same way as wages (e.g. monthly or weekly). Tax and National Insurance will be deducted.

As an employer, you can usually reclaim from the Government 92% of employees’ SMP, Paternity, Adoption and Shared Parental Pay. You may be able to reclaim 103% if your business qualifies for ‘Small Employers’ Relief’. You get this if you paid £45,000 or less in Class 1 National Insurance in the last complete tax year.

Remember also that employment rights are protected while on Statutory Maternity Leave. This includes rights to:

  • pay rises
  • build up holiday
  • return to work

Employers must give pregnant employees time off for antenatal care and pay their normal rate for this time off. A father-to-be or pregnant woman’s partner also has the right to unpaid time off work to attend 2 antenatal appointments.

Employees whose partners are having a baby or adopting are entitled to

  • 1 or 2 weeks’ paid Paternity Leave
  • up to 26 weeks’ paid Additional Paternity Leave, if the mother does not take her full allowance.
  • Shared Parental Leave – i.e. the right to take up maternity leave or maternity pay unused by the mother

Employees can only get Additional Paternity Leave or Shared Parental Leave if their partner returns to work. The shared leave can be taken in blocks separated by periods of work, instead of taking it all in one go.

All employees now have the legal right to request flexible working – not just parents and carers – by ‘making a statutory application’. Employees must have worked for the same employer for at least 26 weeks to be eligible. The employers must deal with the request in a ‘reasonable manner’. This would include:

  • assessing the advantages and disadvantages of the application
  • holding a meeting to discuss the request with the employee
  • offering an appeal process

If an employer doesn’t handle a request in a reasonable manner, the employee can take them to an employment tribunal. An employer can refuse an application if they have a good business reason for doing so.

Examples of flexible working patterns could include:

  • Job sharing – two people do one job and split the hours.
  • Working from home – it might be possible to do some or all of the work from home or anywhere else other than the normal place of work.
  • Part time – working less than full-time hours (usually by working fewer days).
  • Compressed hours – working full-time hours but over fewer days.
  • Flexitime – the employee chooses when to start and end work (within agreed limits) but works certain ‘core hours’, e.g. 10am to 4pm every day.
  • Annualised hours – the employee has to work a certain number of hours over the year but they have some flexibility about when they work. There are sometimes ‘core hours’ which the employee regularly works each week, and they work the rest of their hours flexibly or when there’s extra demand at work.
  • Staggered hours – the employee has different start, finish and break times from other workers.
  • Phased retirement – the compulsory default retirement age has been phased out and older workers can choose when they want to retire. This means they can reduce their hours and work part time.

Final thoughts

In my experience, most problems in the workplace stem from poor communication, lack of clarity about roles or expectations of new recruits, or failing to tackle performance issues when they arise. With payroll costs typically averaging 60%-75% of total costs for most enterprises, this is a high risk area worthy of intensive attention. Time spent getting your documentation, contracts, policies and procedures in order will pay dividends in the long run. Although the introduction of employment tribunal fees has deterred some legal claims, an employment dispute can be damaging for morale, costly in terms of time and resources and can have a very negative impact on an organisation’s reputation, including ramifications when bidding for external contracts. Time spent getting your house in order could be time well-spent.

 


Mark Johnson is an experienced solicitor and chartered company secretary supporting SMEs, charities and social enterprises with legal and governance issues. He offers a range of fixed price packages to help your organisation flourish, whilst staying compliant. Find out more elderflowerlegal.co.uk.

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Implementing a Winning Strategy – Practical Tips for Success

One of the key tasks of any Board in the private, not-for-profit or public sector is to create a strategy for their organisation. Crafting and implementing strategy is inextricably linked to good governance and effective risk management.

Strategy can be defined as ‘the direction and scope of an organisation over the long-term which achieves advantage in a changing environment, through its configuration of resources and competencies with the aim of fulfilling stakeholder expectations.’ (Johnson, Scholes). In an earlier post, we looked at how an organisation crafts a winning strategy by examining its core strengths and weaknesses, analysing market forces and conditions and then deciding how to differentiate its products and services. In this piece, we examine how to put the strategy into practice. And this is a critical area: research by McKinsey found that 7/10 of strategies are unsuccessful. According to Kiechel, successful implementation is even harder, with 9/10 failing at this fence! Given this large failure rate, the ability to successfully implement your carefully crafted winning strategy could easily be a real source of advantage.

Leadership is crucial

The strategic plan will be followed by a business plan which contains business objectives, functional plans dealing with the contribution of, and implications for, operations, finance, marketing, HR and technology. From this work stem targets, budgets, activities and detailed measurement tools.

Many implementations fail because leaders underestimate the scale of the challenge, take their eye off what needs to be done or simply run out of steam. Implementation marks the shift from thinking and planning into live action, managing resources and providing leadership. Do you understand and can your articulate clearly and concisely what you want your people to do differently, and why, as a result of a new strategy? If you can’t do this, don’t expect other layers of the organisation to follow! Leaders need to free up quality time and resources for the Herculean task of communicating a new direction and motivating their people.

Leadership is crucial to create the right conditions for implementation. The organisation must ensure it has the right people on the bus and in the right seats; leaders must clearly communicate the strategic objectives, create appropriate key performance indicators (KPIs) to measure the right things, align the organisation’s culture and behaviours to the strategy, if necessary re-designing internal and external processes and changing the way staff members are incentivised and rewarded to encourage the right behaviours. Progress must be reviewed regularly and the plan tweaked in real time in the light of feedback.

Develop a coherent plan

Successful implementation will require a comprehensive plan to guide action. The plan will contain an analysis of the organisation’s readiness, identify funding and resources and provide discipline and structure. There are various frameworks available to devise the plan. One of these is McKinsey’s 7S model which considers the alignment of the organisation across 7 areas Strategy, Structure, Systems, Shared Values, Style, Staff and Skills.

However, my favourite, which provides a very practical basis for planning and action is Robin Speculand’s Implementation Compass™. The compass examines 8 key areas across the organisation:

  1. People – Do you have the right calibre and type of people in the organisation to deliver the changes required? Do they have the skills and knowledge to execute the plan? Are they motivated? Speculand tells us that we should focus our efforts not on the people that resist change, but primarily on the 20% ‘mavericks’ who embrace it and become advocates and ambassadors for change and improvement.
  2. Business Case – Has the emotional and numerical rationale for change been captured? Has it been explained to staff and do they know why it is important? The use of visual images, branding, slogans and stories to capture and communicate the essence of the message can be very powerful.
  3. Communication – members of the organisation can only adopt a strategy if they know and understand it. Can it be explained in a simple, concrete and compelling way that creates emotional engagement? There are a multitude of channels that can be used nowadays to communicate the message and share success stories and best practice. Traditional media such as advertising, newsletters, as well as social media, videos, podcasts, webinars. Success should be celebrated through awards and bonus incentives.
  4. Measure – The Board will need to adopt the right measurement tools to drive the right behaviours and actions. Remember the maxim ‘what gets measured, gets done’ (some attribute this to the mathematician Rheticus, pupil of Copernicus as far back as the mid-1500’s!). It is likely that a bespoke set of KPIs  will need to be developed to give the Board visibility on progress. These might be quite different from those traditionally used to date. For example, they may track customer or service user satisfaction, staff satisfaction, learning and development, recruitment and retention, teamwork and motivation. Ideally, some form of dashboard report will be generated for the Board.
  5. Culture – This has been defined as ‘the way we do things around here’ (Handy). It is made up of the collection of traditions, values, policies, beliefs, and attitudes in an organisation. Culture is reinforced through rites and rituals, patterns of communication and expected behaviours across the organisation. Will your culture support and foster change? The key questions to ask would be, does your culture encourages teamwork, does it reward innovation, does it stifle initiative? Leaders will need to exhibit visible proof of the expected behaviours – it is no good expecting others to change if the leaders do not lead by shining example! The implementation plan may need to take into account the nature of the organisation’s culture in deciding the pace and style of activities.
  6. Processes – Do the organisation’s processes support the new strategy or do they need to redesigned? e.g. to focus more on the customer and adding value for them? A key consideration is the scope of freedom given to different parts of the organisation to take decisions. If unnecessary roadblocks exist, try calculating the financial benefit as a powerful case for removing them.
  7. Reinforce – Leaders need to continually reinforce the expected actions and behaviours – training and development initiatives may be required; recognition and reward systems may need to change radically to encourage and motivate progress.
  8. Review – The Board must continually review progress and draw upon the lessons learned so far. If necessary, the plan can be adjusted and recalibrated as you go.  Board meetings need to spend an appropriate amount of time on strategic matters, rather than operational items. In carrying out a review the Chair could usefully begin with a critique of his or her own performance to encourage self-reflection by others. One of the most powerful and simplest ingredients can be to start every meeting by checking that all actions from previous meetings have been implemented.

Good implementation of strategy requires the orientation of a series of decisions taken by different people at different times in different places across the organisation towards a common goal. The board needs to provide the leadership to ensure the organisation remains focused on that common goal.  A compelling vision, mission, values and the personal qualities of individual board members are vital to this process. Research shows that Boards are less effective in the field of implementation than they are in creating strategies. If the Board can extend and develop its competence in execution, the rewards can be substantial.

Mark Johnson is a solicitor and chartered company secretary with Elderflower Legal. He is a trusted advisor to SMEs, charities and social enterprises on strategy, governance managing risk and assuring legal compliance. elderflowerlegal.co.uk

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How to Choose the Right Legal Structure for Your Enterprise

Choosing the right legal format for your project is a very important decision.

From my work with inspiring entrepreneurs, community activists and visionary leaders over the past 21 years, I find there is always a thirst for knowledge about different legal structures and formats that can be used for entrepreneurial activity and community action. Whether you want to start a new business, set up a community or social enterprise or run a project in your neighbourhood, choosing the right legal form for your activity is a very important decision. It can have a real impact on your tax status, your exposure to liability, the public perception of your project, your ability to raise funds and borrow money, as well as your personal income and assets. Unfortunately, sources of information about this topic can be bewilderingly complex, inaccessible, sometimes biased and often out of date. Our mission at Elderflower Legal is to demystify and explain, helping you to flourish in your endeavours. We have produced a new concise guide to help you navigate through the many choices open to you and understand the key features of each one. The guide explains in clear language the main legal formats available for profit-distributing, as well as non-profit-distributing enterprises, including companies, associations, trusts, limited liability partnerships, charitable incorporated organisations, cooperatives and community benefit societies. The key constitutional features and governance implications of each format are summarised, along with the tax aspects, the main regulatory obligations, as well as sources of further information to find out more. We examine the benefits and disadvantages of having charitable status, as well as the ability of different formats to raise finance.

This will be a useful addition to any aspiring or seasoned entrepreneur’s bookshelf.

We hope you find it useful and please get in touch with us if you have any questions. We’ll be delighted to help.

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Download your free copy here.

Mark Johnson is an experienced solicitor and chartered company secretary working with charities, not-for profits, SMEs and social enterprises to help them set up new legal structures and governance arrangements, manage risk, secure new contracts and partnerships.  For more information visit our website elderflowerlegal.co.uk

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Why Managing Conflicts of Interest is Vital to Good Governance – Pt 2

How can conflicts of interest be managed?

In the first part of this article, we looked at typical scenarios where conflicts of interest can occur and their possible consequences. In this post, we examine practical strategies for managing them.

There are three steps to ensure conflicts are properly managed and undesirable consequences avoided.

Identify the conflict

Individual board members must be aware of what type of conflicts could occur and they must declare them. The organisation should have a Conflicts of Interest Policy and should arrange training or induction for board members. Declaration can be done verbally at the start of meetings through a standard agenda item, by notice in writing to other board members, or more generally by the board secretary keeping a register of outside interests. If a board member is unsure, it is better to err on the side of caution and openness and discuss the matter with the Chair.

Prevent the conflict from affecting the decision

Remember the Board has an overriding fiduciary duty to act in the best interests of the organisation. They must consider how they can prevent the conflict from affecting proper decision-making. Their approach is likely to depend on how serious the issue is. In very serious cases, the Board may take the view that the conflicted board member must resign. If a substantial number of board members are conflicted, it may necessary to appoint more neutral board members to allow valid decisions to be taken. Alternatives would be not to pursue the course of action or to proceed in a different way.

If the conflict is not completely removed in this way and it is not a fundamental one, the Board will have to follow any specific procedure for managing a conflict set out in the organisation’s constitution. The Articles or governing document typically require that conflicted board members must declare their interest, retire from the meeting and not participate in the voting or form part of the quorum for the meeting to be valid.

If the constitution allows it, the remaining non-conflicted board members may proceed to debate the issues and specifically authorise the proposed action in spite of the conflict. However, even if the constitution of the organisation contains machinery to authorise a conflict, it may be that the matter is so serious that the Board could still not in good conscience proceed to authorise because it would never be in the best interests of the organisation and they would not be discharging their overriding fiduciary duty by doing so.

For companies, Section 175 (3) of the Act states “This duty does not apply to a conflict of interest arising in relation to a transaction or arrangement with the company if, or to the extent that, the company’s articles allow that duty to be so disapplied, which they may do only in relation to the descriptions of transaction or arrangement specified in the company’s articles.”

So for example, Article 14 of the Model Articles for private companies says that a director who is interested in an actual or proposed transaction or arrangement with the company can be still be counted in the quorum and voting if:

  • the members pass an ordinary resolution to disapply the ban (calling a members meeting may not always be practical, of course. But certain transactions always need the shareholder/ members’ approval, such as large loans to a director, directors buying or selling significant assets to/ from the company, service contracts for directors with a notice period exceeding 2 years and ex gratia severance payments); or
  • the director’s interest cannot reasonably be regarded as likely to give rise to a conflict (a common sense test, which can be difficult to apply in practice, of course); or
  • the matter concerns a guarantee to be given by or to a director in relation to the company, the subscription for shares by the director, or which concerns employee benefits for current or former staff.

Where there is doubt about the eligibility of a director to participate, the Chairman’s ruling is final.

On the other hand in the Charity Commission’s model articles for a charitable company, there is a comprehensive and very strict scheme in Articles 7 to 9 regulating conflict situations. In summary, Article 7 permits limited benefits for directors (and their ‘connected persons’) if: they are themselves beneficiaries of the charity; if they are receiving rent for premises let to the charity, or interest on money lent (provided the level is reasonable); participation in normal fundraising and trading activities; or if they are supplying services or goods to the charity and specific conditions are satisfied (namely, there is a written agreement, the remuneration is reasonable, the directors are satisfied it would be in the charity’s best interests to use that particular supplier, persons receiving remuneration are always in a minority and there is no specific prohibition of the payment elsewhere in the constitution).  Also to supply goods, the director affected must not take part in the meeting, voting or quorum, and the reason for the decision are clearly minuted. The exemptions apply also to the same type of dealings with a charity’s trading subsidiary.

Similarly, under Article 9, the unconflicted directors of a charitable company may specifically authorise a conflict of loyalties, provided the conflicted director absents himself from that part of the meeting, does not vote or form part of the quorum and the remaining directors consider it is in the best interests of the charity to authorise, and the person does not derive any personal benefit from their involvement with the outside body.

If the constitution does not contain a procedure to authorise low level conflicts, it would be prudent to considering amending it to include one. In cases of doubt, the Board should take external advice on how to proceed. A court or regulator would be less likely to criticise a board which had acted on professional advice.

In extreme cases, the board may consider making an application to the court for authorisation to proceed, however this could be an expensive solution. In the case of charities, the trustees can seek guidance and authorisation from the Charity Commission under special procedures.

Keep proper records

The minutes of meetings should formally record any conflicts of interest and how they were handled. If a transaction or decision is later challenged in litigation or regulatory proceedings, the minutes form an important record to demonstrate that the Board gave the matter appropriate attention and reached a decision within their margin of discretion. The Board would be in a much better position to defend itself than if there were no paperwork or audit trail.

Remember also that certain types of organisation may be required to disclose ‘related party transactions’ or benefits paid to Board members in their accounts. Consider how it would look to external stakeholders when these details enter the public domain?

Conclusions

The proper identification and management of conflicts of interest is essential to maintain stakeholder confidence and protect the organisation’s reputation. Government and regulators have become very vigilant towards abuses, particularly where public money is involved. For example, in academy schools, the Education Select Committee recently investigated relationships between some academy sponsors and their commercial arms, who may supply paid for back office and curriculum support services into their schools. Similarly in the health sector, Parliament has legislated to regulate conflicts of interest between Clinical Commissioning Groups and their member GP practices who may supply services to them. With the right constitution and procedures in place and appropriate training and support for the Board it is possible to avoid the pitfalls.

Mark Johnson is an experienced solicitor and company secretary working with charities, social enterprises, SMEs and public sector spin-outs to manage risk and ensure sound governance arrangements. More at elderflowerlegal.co.uk

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Why Managing Conflicts of Interest is Vital to Good Governance

In this post we explore how to identify and manage conflicts of interest

An effective system of corporate governance for any organisation must be underpinned by the three pillars of transparency, accountability and integrity. The public’s faith in corporate institutions has been repeatedly shaken by wrongdoing, impaired judgements and undue influence. Perceptions can be just as damaging as events actually occurring in practice. At the heart of these questions of trust often lies a failure properly to identify and manage conflicts of interest.

What is a conflict of interest?

A conflict of interest occurs where an individual’s ability to exercise independent judgement, or to perform a role objectively, is, could be, or could be seen to be impaired or otherwise influenced by their involvement in another role or relationship. The individual does not actually need to exploit his or her position or obtain an actual benefit, financial or otherwise, for a conflict of interest to occur. There are two types of conflicts of interest:

  • Personal benefit conflict – the person could enjoy a potential financial or measurable benefit directly, or through a connected person (for example, a close relative, or a business in which they have a material stake). They may stand to gain personally from decisions made, or may exploit the knowledge gained from their role for personal gain;
  • Conflicts of loyalty – the person’s duty to the organisation may compete with a duty or loyalty they owe to another organisation or person (for example, where a director has been appointed to a board of a joint venture company by one of the joint venture partners by whom she is employed, or where she sits on the board of other organisations or serves as an elected member or officer of a public body). This may prevent her from acting properly or independently, in the best interests of the organisation.

Common examples of conflicts of interest situations include:

  • a board member sits on the board of another organisation which may be awarded a contract by this organisation, or which is in dispute with this organisation
  • a board member may wish to sell to, or purchase assets or property from the organisation
  • a decision is to be made on a contract or payment to a board member for their services
  • a proposal to employ a board member’s spouse or child in the organisation
  • paying a person or business closely connected with a board member for delivering services to the organisation
  • making a payment or awarding benefits to a person who is a close relative of the board member

Why are conflicts of interest so important?

The law takes a dim view of persons who place themselves in a situation where their interests conflict with those whom they are appointed to represent. The duty to avoid a conflict of interest derives from the duty of undivided loyalty which applies to someone acting in a fiduciary capacity. A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a special relationship of trust and confidence. Company directors act in a fiduciary capacity when they take decisions and act on behalf of their company, charity trustees are fiduciaries, as are executors and trustees of a will, as well as investment managers, pension fund trustees, and solicitors and accountants in their dealings with clients.

The Courts have laid down clear rules for fiduciaries. ‘A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal’. (Bristol & West v Mothew 1998, Lord Justice Millett). These principles are supplemented by specific legislation which applies to particular types or organisations, backed up by a range of sanctions for behaviour which contravenes them.

Special Rules for Company Directors

Directors of any company (whether it be limited by shares, limited by guarantee, an academy trust or a community interest company) have specific statutory duties under the Companies Act 2006. These include a duty to promote the success of the company (s 172), a duty to exercise independent judgment (s 173), a duty not to accept benefits from third parties (s 176) and at section 175 we find: “A director of a company must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company”. The section goes on to state that this includes a situation where a director exploits property or information belonging to the company after he has left, even if the company itself could not make use of the material itself.

A breach of any fiduciary duty could have the following consequences:

  • The company, fellow directors or an aggrieved shareholder or member may begin court action for a breach of statutory duty and seek damages for any loss caused by events or actions which breach the duty.
  • Transactions entered into in breach of the duty may be set aside as void (for example, the transfer of property may have to be unwound or a contract may become unenforceable).
  • A director who benefits from the transaction may be ordered to repay the company its loss, or account for any profits he has made.
  • The other directors who authorised a transaction in breach of the duty, when they did not have the power to do so, can also be held liable.
  • A director’s failure to declare an interest in an existing contract or arrangement is a criminal offence making the director liable to prosecution and a fine.
  • The incident or transaction could attract the attention and intervention of regulators.
  • The breach could seriously damage the reputation of the organisation and erode the confidence of key stakeholders, including employees, customers and funders.
  • Serious breaches of duties can lead to a director being disqualified from holding office for up to 15 years.

Special Rules for Charity trustees

Charity trustees have a strict legal duty to act only in the best interests of their charity. They must not put themselves in a position where their duties as trustee may conflict with any personal interest they may have. In addition, charity trustees can only receive a personal benefit from their charity if there is explicit authority, obtained in advance. This authority can only come from one of four sources: a provision in the charity’s governing document, a power in the Charities Act, permission from the Charity Commission or an order of the High Court. ‘Benefit’ has a wide meaning here, including any payments, property, loans, goods or services received from the charity, but does not include genuine reasonable ‘out of pocket expenses’, which are excluded.

Special Rules for Charitable Incorporated Organisations

Specific rules have been developed for trustees of CIOs. Section 222 of the Charities Act 2011 says: “A Charity trustee of a CIO may not benefit personally from an arrangement or transaction entered into by the CIO if, before the arrangement or transaction was entered into, the charity trustee did not disclose to all the charity trustees of the CIO any material interest (whether direct or indirect) which the trustee had in it or any other person or body party to it.”

Regulation 36 of the CIO Regulations says that a trustee who would benefit from a transaction or arrangement which the CIO is proposing to enter into must not take part in the decision-making and cannot form part of the quorum for that decision.

In the second part of this article, we will examine how to manage conflicts of interest.

Mark Johnson is an experienced solicitor and company secretary working with charities, social enterprises, SMEs and public sector spin-outs to manage risk and ensure sound governance arrangements. More at elderflowerlegal.co.uk.

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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

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

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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