UK: Corporate Legal Update

Last Updated: 19 March 2003

In early December we announced the conversion of the UK partnership of Mayer, Brown, Rowe & Maw to an English limited liability partnership. Our firm is the largest legal practice in the UK to have taken advantage of the recent legislation which firstpermitted the establishment of LLPs in April 2001. At the time of the combination of Rowe &Maw and Mayer, Brown & Platt in February 2002, the firm set itself the deadline of achieving LLP status in the UK by November 2002. That we were able to meet this ambitious deadline is due in no small measure to the experience the firm has gained over the years through being at the forefront in the developments in this area of the law. We have advised many professional practices on the advantages of incorporation, including Ernst & Young LLP, the first limited liability partnership established under the new legislation. Turning to the field of company law, the past few months have been notable for a number of developments which will have a significant effect upon the legal terrain through which company directors must tread (and, it seems, tread carefully). For the most part, this issue of Corporate Legal Update is devoted to those developments and, in particular, to providing an overview of some of the principal corporate governance changes and proposals over the past few months which affect UK company directors. From this question of "best practice" for directors, we end this issue by examining what might constitute "best practice" in terms of a company’s document management policies, an issue which has also received much attention of late due to certain high profile cases regarding the destruction of documents, both in the UK and overseas.

Turning to the field of company law, the past few months have been notable for a number of developments which will have a significant effect upon the legal terrain through which company directors must tread (and, it seems, tread carefully). For the most part, this issue of Corporate Legal Update is devoted to those developments and, in particular, to providing an overview of some of the principal corporate governance changes and proposals over the past few months which affect UK company directors. From this question of "best practice" for directors, we end this issue by examining what might constitute "best practice" in terms of a company’s document management policies, an issue which has also received much attention of late due to certain high profile cases regarding the destruction of documents, both in the UK and overseas.

Paul Maher
Head of Corporate Group (London)

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COMPANY DIRECTORS- RECENT CORPORATE GOVERNANCE DEVELOPMENTS

Foreword by Stephanie Bates, Corporate Finance partner

In recent months, there have been a number of developments which will have a significant effect upon the legal and regulatory framework applying to UK company directors. In the quartet of articles which follow, we look at some of these developments including the recent Higgs Report recommendations about the composition of listed company boards, new regulations governing the way in which directors’ remuneration is reported and approved and new areas of potential liability for directors, not only under UK legislation but also, since the advent of the Sarbanes-Oxley Act, under US laws. These are certainly interesting times to be a director.

Background

The roll-call of recent legal initiatives affecting UK directors is long. Since July of last year, it includes:

  • the Government’s publication of its White Paper proposals for company law reform, including the proposed codification of directors’ duties (July 2002);
  • in the US, the signing by President Bush of the Sarbanes-Oxley Act of 2002 (July 2002);
  • new regulations in respect of the reporting and approval of directors’ remuneration (August 2002);
  • the Enterprise Act, which contains competition law provisions relevant to directors (November 2002); and
  • the publication of the Higgs Report in relation to non-executive directors and the Smith Report on audit committees (January 2003).

Some of these developments, such as the Higgs report, the directors’ remuneration regulations and the requirements of the Sarbanes-Oxley Act, will principally affect directors of listed companies. Others, however, will be of interest to all directors. In our previous issue of Corporate Legal Update (Winter 2002), we summarised some of the key proposals in the Government’s White Paper on company law reform, including the proposal to codify the duties owed by directors. In this issue we describe some of these other initiatives.

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THE HIGGS & SMITH REPORTS

The face of corporate governance in the UK is set to change over the next few months. January saw a number of Government-initiated reviews coming to fruition. Derek Higgs has published his independent report on the role and effectiveness of non-executive directors. Sir Robert Smith has issued a report on the role, responsibilities and activities of audit committees. Both recommend wholesale amendments to the Combined Code on Corporate Governance which are expected to take effect on 1 July 2003 once the Financial Reporting Council (FRC), a Government-appointed body responsible for keeping the Combined Code updated, has consulted on the precise wording. The Combined Code applies to UK companies with a full listing on the London Stock Exchange but not to overseas companies listed in London.1

The detailed changes are helpfully summarised in the introduction to the Higgs Report. Here, we examine just a few of them:

Board composition

At least half a listed company’s board, excluding the chairman, will have to be independent non-executive directors and, for the first time, there will be a comprehensive definition of independence in the Combined Code. Companies may face practical difficulties in meeting this requirement in the short term unless the pool of suitable candidates is increased. A small group of business leaders and others will be charged with identifying how to bring to greater prominence potential candidates from the non-commercial sector. Also, companies are encouraged to allow executive directors to take up non-executive posts in smaller non-competing companies, in order to gain experience of the role.

Chairman

The roles of chairman and chief executive (or chief operating officer) will have to be separated and the division of responsibilities between the two set out in writing and agreed by the board. This requirement has been broadlywelcomed and indeed about 90% of listed companies already split these roles. The report goes further by saying that chief executives should not go on to become chairmen of their own companies as they may find it difficult to relinquish executive control. This latter proposal has been met with some opposition by listed companies since many feel that the chairman’s role is enhanced by having a deep and thorough understanding of the business obtained through hands-on experience of running it.

Perhaps more contentious are suggestions that no individual should chair the board of more than one major company and that full-time executive directors should not take on more than one non-executive directorship or become chairman of a major company. Again, this means the pool of potential recruits for senior non-executive posts needs to be deeper.

Role of non-executive director

For the first time, the Combined Code is to contain a formal description of a non-executive director’s role and a separate description of the role of the board as a whole. This step was perhaps encouraged by the proposed codification of directors’ duties in the UK company law reform process.

There will be limits on the length of a non-executive director’s tenure; two three-year terms being the expected norm. Some commentators consider this period too short and that companies may as a result be forced to lose (and find replacements for) talented board members when they are at the peak of their effectiveness.

Non-executives will have to make sure they have enough time to perform their roles taking into account other commitments. They will have to inform the chairman before taking on any other non-executive appointments during their period of office. These are issues which it may be sensible to address in engagement letters.

The report has steered clear of capping the number of non-executive appointments held by any individual, recognising that the optimum number varies depending on the person in question. This has sparked debate in the investment community as some investor bodies would have preferred to see a maximum prescribed.

Shareholder consultation

Non-executive directors will have specific duties to consult directly with investors. As well as attending annual general meetings, they will need to attend meetings with major investors from time to time and should certainly do so on request. There will be a particular onus on the senior independent non-executive director to attend sufficient meetings of management with key investors to develop a proper understanding of their concerns. This proposal has been strongly criticised by listed companies who are concerned that rival formal channels of communication between companies and their shareholders could give rise to conflicting and confused messages to the market and possibly the inadvertent premature release of unpublished price-sensitive information.

Training and induction

Companies will have to provide a comprehensive formal induction programme for new non-executive directors as well as on-going training for all directors.

As a corollary to training, companies will have to carry out regular performance reviews of board and board committee members giving details in the annual report, which will also have to detail directors’ attendance records at board and committee meetings. Investor representative bodies have warmly welcomed formal performance reviews seeing them as an important early warning system for potential problems.

Remuneration and appointment

The Combined Code will contain an outright prohibition on non-executive directors holding options over their company’s shares; and any exceptional grant of options to non-executives will have to be approved by shareholders in advance.

The Higgs Report recognises that remuneration generally should be sufficient to attract high quality individuals. This is likely to be a sensitive issue given the increased levels of commitment to be expected of non-executives and also the need to attract fresh recruits to non-executive roles. Investor bodies recognise that non-executive remuneration should reflect these increased demands but, on the other hand, will not be happy with rewards which could impact on the independent status of non-executive directors.

These recommendations need to be seen in the context of the recently implemented regulations on directors’ remuneration (see page 5).

Committees

The Combined Code will contain formal statements of the principal roles of the audit, nomination and remuneration committees. The existing rules on the composition of those committees will also be enhanced. For example, while the chairman may be a member of the nomination committee, it will have to be chaired by an independent non-executive director.

The role of audit committees will be enhanced with a detailed specification of their functions. A key proposal of the Smith Report is that audit committees will need to be comprised wholly of independent non-executive directors at least one of whom must have significant, recent and relevant financial experience.

What should listed companies be doing now?

Listed companies should, in anticipation of 1 July 2003, prepare for a new Combined Code incorporating all the principal features of the Higgs Report, including by:

  • re-examining the composition of the board and board committees;
  • reviewing terms of reference of nomination, audit and remuneration committees;
  • re-examining and enhancing induction and on-going training for non-executive directors;
  • reviewing the terms on which non-executive directors are engaged (e.g. any standard engagement letter) to ensure future appointments are made on appropriate terms;
  • reviewing standing corporate governance procedures such as lists of matters reserved for board approval;
  • checking articles of association for consistency with the amended Combined Code;
  • ensuring annual reports issued on or after 1 July 2003 contain the required disclosures;
  • ensuring annual general meetings held on or after 1 July 2003 meet the necessary requirements.

1 This is an abridged version of our Legal Alert issued in February 2003, entitled "The UK’s answer to Sarbanes-Oxley? UK corporate governance reforms"
(see www.mayerbrownrowe.com/london/groups/corporate/news.asp)

Comment

Andrew Sharples, a partner in our Corporate Group, comments: "The proposed new Combined Code has been broadly welcomed by the investor community who consider that in many companies power is currently too heavily concentrated in the hands of executive directors or non-independent chairmen. However, the chairmen of a number of listed companies have publicly expressed concern that the cumulative effect of the proposals is to undermine the role of public company chairmen (who will no longer be able to chair key committees) and that the strengthened role of the senior non-executive director (and the non-executive directors generally) is likely to create divisions on the board.

Generally, companies are concerned that the enhanced responsibility of the role of non-executives and the increased level of commitment (together with the fact that it has been estimated that at least 1000 more non-executives will be required to meet the Higgs requirement for an independent majority on each board) will make the task of finding candidates of the right quality even more difficult than is presently the case.

However, although the CBI is considering putting pressure on ministers and the Financial Reporting Council to make changes before the Higgs Report recommendations are included in a revised Combined Code, it is unlikely that the Government will succumb in any meaningful way to such demands."

Review of the role and effectiveness of non-executive directors (Jan 2003, Derek Higgs): http://www.dti.gov.uk/cld/non_exec_review/

Audit Committees Combined Code Guidance (Jan 2003, Sir Robert Smith); http://www.frc.org.uk/publications/content/ACReport.pdf

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DIRECTORS’ REMUNERATION

The Directors’ Remuneration Report Regulations came into force on 1 August 2002. The principal objective behind the Regulations is to ensure improved disclosure by listed companies on remuneration policy, and in particular the linking of performance to remuneration, and the requirement that shareholders vote on a revised remuneration report.

The Regulations in brief

The Regulations (which apply to financial years ended on or after 31 December 2002) provide that:

  • the directors must prepare a directors’ remuneration report for each financial year containing certain specified information and in a specified format;
  • copies of the remuneration report must be circulated to members and all other persons entitled to receive notice of general meetings, and a copy delivered to the Registrar; and
  • an ordinary resolution to approve the remuneration report must be put to shareholders annually. This is a vote on the report itself and not the remuneration policy.

If the shareholders’ resolution is not passed, this will not affect any director’s legal entitlement to remuneration but the expectation is that companies and directors will be unlikely to proceed with any remuneration package which has failed to obtain approval.

The Regulations apply to all UK incorporated companies whose shares are listed on the London Stock Exchange (LSE), in another European Economic Area state, on the New York Stock Exchange (NYSE) or on NASDAQ, but do not apply to AIM companies (which will remain subject to the disclosure regime under the Companies Act). Currently, all companies are subject to the disclosure requirements in respect of remuneration under Part I of Schedule 6 to the Companies Act 1985 and, in addition, companies quoted on the LSE are subject to the separate requirements of the Listing Rules and the Combined Code.

How will the Regulations affect listed companies?

The Combined Code currently requires the board to consider inviting the AGM to approve the policy set out in the remuneration report. Indeed, pressure from institutional shareholders has led a number of listed companies to allow shareholders to vote on remuneration in recent years. However, the fact that the Regulations make the vote compulsory and in respect of the whole report, not just the policy aspects, is a significant development.

Let us look at a few of the other ways in which the Regulations have extended the disclosure regime in respect of the remuneration of directors of listed companies. Currently, for instance, the Listing Rules require a statement of policy on directors’ remuneration but do not set out exactly what should be included. The Regulations, on the other hand, require the report to contain a statement of the company’s policy on current and future remuneration of directors, as well as details of policies on performance conditions for share option schemes and long-term incentive plans (LTIPs), including an explanation as to why those performance conditions were chosen, and a statement of policy on performance linked and non-performance linked pay.

The disclosures in respect of service contracts will also need to be broader than currently required, encompassing details of any notice periods (currently only those of more than 12 months need be disclosed) and any provisions which provide compensation for early termination.

Whilst the disclosures required in relation to emoluments and compensation, share options, and pensions will remain broadly similar to the requirements of the Listing Rules and the Companies Act, in a few cases, such as inrelation to LTIPs, the requirements will significantly increase.

Remuneration reports will also have to contain a performance graph, showing a company’s total cumulative shareholder return over a number of years compared with that of a broad equity market index, to show investors how a company has performed against comparative companies. Very few listed companies have to date included such a graph in their remuneration reports.

Comment

These reforms are likely to spur investors on to even greater scrutiny of directors’ remuneration, especially in relation to such issues as the setting of performance conditions and lengthy notice periods. Indeed, as recently as last December, the Association of British Insurers (ABI) and the National Association of Pension Funds (NAPF) issued a joint statement of "Best Practice on Executive Contracts and Severance", which recommended that companies implement merit-based recruitment and remuneration policies and calculate at the outset the potential monetary cost of terminating a director’s contract for failure or under-performance. The statement urges companies to consider the "serious reputational risk of being obliged to make and disclose large payments to executives who have failed to perform".

Companies may wish to review directors’ service agreements and ensure that their remuneration committees open any necessary dialogue with major shareholders well in advance of their next AGMs to iron out any contentious issues before shareholders have the opportunity to vote on, and potentially to vote down, a remuneration report.

Directors’ Remuneration Report Regulations 2002 (SI 2002/1986): www.legislation.hmso.gov.uk/si/si2002/20021986.htm

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ENTERPRISE ACT: COMPETITION ASPECTS

The Enterprise Act 2002 received Royal Assent towards the end of last year. Its competition and consumer provisions are expected to come into force sometime this summer.2

Criminalisation of cartels

The Act includes competition provisions of specific concern to directors, such as the criminalisation of cartels. A new criminal penalty will apply to individuals (generally directors, but in certain circumstances also company employees) who dishonestly engage in "hard core" cartel arrangements in the UK such as price-fixing, limitation of supply or production or market-sharing. Individuals found guilty of the offence can be imprisoned for up to five years and/or be subject to unlimited fines.

The draconian step of imprisoning a director is perhaps less likely in practice than the imposition of a fine, unless the director has knowingly instigated a "hard core" cartel. Those that have played a less central role in any cartel activities in the UK may benefit from leniency in the form of a "no action letter" from the OFT which would prevent a criminal cartel prosecution being brought against them. In order to benefit from leniency, however, the director must admit participation in the cartel and provide full co-operation in the investigation. There is currently no provision for a director to approach the OFT on a no names basis and no guarantee of a no action letter being issued to a director that does come forward. A consequence is that directors may need to seek separate legal advice before approaching the OFT.

Disqualification orders

Once the relevant provisions of the Enterprise Act are in force, the OFT or a sectoral regulator (for example, OFTEL) will be able to apply to the High Court to disqualify directors for up to 15 years for competition offences, not only in relation to the cartel offence above, but for any breaches of UK or EC competition law. Disqualification is effected by the court making a Competition Disqualification Order (CDO) against a person, on the basis that a company of which that person is a director has committed a breach of competition law and the court considers that person’s conduct as a director makes him or her unfit to be concerned in the management of a company.

A director may face a CDO in circumstances where the director ought to have known that the behaviour was unlawful even if he or she did not actually know it. Also, it will not be a defence for a director simply to have absented himself or herself from the board meetings at which the anti-competitive conduct was agreed.

2 This is an abridged version of the Competition Group’s publication "Competition Law: Quick Guide, Directors’ Disqualification" (see www.mayerbrownrowe.com/london/groups/ECLaw/news.asp)

Comment

Kiran Desai, Competition partner, comments: "We recommend that companies ensure that their competition compliance programmes are updated to reflect these changes. If a company can demonstrate ongoing competition compliance training, its directors are more likely to be able to disassociate themselves and the company from any wrongdoing in circumstances where an employee has breached competition law and the company may benefit from mitigation should a fine be imposed. In the meantime, directors and employees should note the importance of being vigilant against any evidence of competition law infringements. With possible imprisonment for 5 years, disqualification for 15 years, and unlimited fines, company directors now face significant potential liabilities in relation to breaches of competition law."

Enterprise Act 2002: http://www.legislation.hmso.gov.uk/acts/acts2002/20020040.htm OFT overview of the Act: http://www.oft.gov.uk/publications.htm

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SARBANES-OXLEY ACT OF 2002

The United States Congress has also shown a keen interest of late with regard to the activities of directors. The Sarbanes-Oxley Act of 2002 was signed by President Bush on 30 July 2002. It represents a significant expansion of US securities laws in respect of corporate governance, disclosure, reporting and accounting requirements in the wake of Enron and the other financial scandals to have hit the US in recent times. The Act is now fully in force, as are a number of detailed rules adopted by the Securities and Exchange Commission (SEC), which set out precisely how the Act’s various provisions will take effect. In this article, Corporate partners Jeff Gordon and Mark Uhrynuk examine how directors of non-US companies which are subject to Sarbanes-Oxley are likely to be affected.

The Sarbanes-Oxley Act applies not only to US companies but also to certain non-US companies, notably those with a secondary listing of shares or American Depositary Receipts (ADRs) on the NYSE or NASDAQ and those filing periodic reports with the SEC. Accordingly, the Act will apply to some of the UK’s largest plcs, including many of our clients. The Act will also affect our clients who are subsidiaries of US public companies.

CEO/CFO certification

Certain provisions of the Act have particular application to directors and executive officers. For example, the Act requires the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) - or their equivalents, whether or not they hold those specific titles - to certify that they have reviewed each "periodic report" (meaning, for non-US companies, each annual report on Form 20-F), that each such report is materially accurate and complete and that the financial statements and other financial information included in each such report fairly present in all material respects the financial condition and results of the company. The required certification goes beyond a representation that the financial information has been prepared in accordance with generally accepted accounting principles. Also, the certification applies to the entire report, not just the financial statements, including risk factors and management’s discussion and analysis of results and financial condition. Criminal penalties may be applied for the filing of incorrect certifications, but only in the case of "knowing" or "wilful" violations.

Whilst UK companies are already required by the Companies Act to have their annual accounts and directors’ reports approved by the board and signed by a director, boards of UK companies subject to the Sarbanes-Oxley certification regime will need, with their auditors’ assistance, to adopt disclosure procedures and controls that are designed to ensure that disclosure in the companies’ periodic reports to the SEC are made in an accurate and timely way.

Code of ethics

Companies are required to disclose in their periodic reports whether or not they have adopted a code of ethics applicable to their CEO and senior financial officers and, if not, why not. The code of ethics must include standards to promote honest and ethical conduct, including the handling of conflicts of interest; full, accurate and timely disclosure in reports filed with the SEC; and compliance with applicable governmental rules.

Any company (including a non-US company) subject to these rules will need to include the new code of ethics disclosure in its annual report filed with the SEC, and will be required to file with the SEC any code of ethics adopted or to make any such code of ethics available either through its website or by undertaking to provide copies upon request.

These requirements will apply to annual reports filed in respect of financial years ending on or after 15 July 2003. UK companies which are subject to these rules will need to consider, among other things, whether to produce a code of ethics that meets the Sarbanes-Oxley requirements and, if so, whether to produce a stand-alone code or to incorporate it within any pre-existing internal code of conduct (noting, however, that it is not a requirement of the Combined Code for UK listed companies to adopt codes of conduct). It will be interesting to see whether UK companies will elect to produce a code of ethics or instead to disclose in their SEC filings that they have not adopted one, perhaps seeking to justify this position on the basis that UK corporate governance requirements are already sufficiently stringent. It is unclear whether the latter approach would be acceptable to the US market.

In addition, UK companies with a secondary listing on the NYSE will need to take into account that the NYSE has recently proposed its own set of corporate governance rules which are currently under review by the SEC. Those proposals incorporate many of the corporate governance provisions of Sarbanes-Oxley, including a requirement that companies disclose whether or not they have adopted a code of business conduct and ethics. The NYSE’s proposed rules provide for independent governance, audit and nominating committees, but these provisions are not mandatory for companies with a primary listing outside the US. Instead, the NYSE proposals would require UK companies to disclose, on their websites or in their annual reports filed with the SEC, the ways in which their corporate governance practices differ from those required under NYSE rules.

Audit committees

Whilst non-US companies with a New York listing will be "exempt" from the governance provisions of the NYSE rules, those non-US companies (whether NYSE listed or otherwise) which are subject to the Sarbanes-Oxley Act will, however, be required to comply with many of the new corporate governance rules imposed by the Act. These include, most importantly, the requirement of an independent audit committee with the power, amongst others, to hire and fire auditors and review and approve auditors’ services. These powers appear in certain respects to be greater than those which the Smith Report recommends are given to audit committees (see page 4); for instance, the Smith Report advocates giving audit committees the power to make a recommendation to the board on the appointment of external auditors, but ultimately leaving it to the board to decide whether to accept the committee’s recommendation. Whilst these proposals would leave greater power in the hands of the main board than the equivalent Sarbanes-Oxley auditor appointment regime, we expect there to be little difference in practice in that UK boards will be unlikely to go against their audit commitees’ recommendation, especially as they would be expected to disclose their reasons for taking a different view when seeking shareholder approval for the appointment.

Having said this, UK companies with a full listing on the London Stock Exchange, which are at the same time subject to Sarbanes-Oxley, will need to be alive to these subtle differences between the US and UK audit committee regimes.

Loans to directors and executive officers

Sarbanes-Oxley also prohibits companies from extending or guaranteeing personal loans to their directors and executive officers. Personal loans already existing on 30 July 2002 may continue in effect, provided there is no subsequent material modification to any term or any renewal of the loan. Loans are widely defined so that certain other emoluments may also be caught. Although common corporate practices, such as cashless options, cash advances for business expenses and tax gross-ups for expatriates, could be caught by the broad wording of the statute, most law firms with US practices (including ours) have taken the view that these types of credit extensions are not personal loans.

Compare the equivalent regime under the UK Companies Act (s330), where the restriction on loans applies only to directors, not non-board executives, and where, unlike under the Sarbanes-Oxley provisions, certain exceptions are allowed including where the loans are regarded as de minimis. Again, boards of UK companies subject to Sarbanes-Oxley will need to understand the differences between the UK and US regimes.

Reimbursement of bonuses

If a company has to prepare an accounting restatement due to material non-compliance, through misconduct, with any financial reporting requirement under US securities laws, the CEO and CFO are required to reimburse the company for any bonus or other incentive or share-based benefit received from the company in the 12-month period following filing of the non-complying document, together with any profits realised by them from the sale of shares of the company during that period. The Act creates a private right of action for the company’s shareholders to recover these bonuses and profits on behalf of the company.

For our dedicated homepage on the Sarbanes-Oxley Act, see http://www.mayerbrownrowe.com/sarbanesoxley which includes the following memoranda produced by Mayer, Brown, Rowe and Maw:

"Highlights of the Sarbanes-Oxley Act of 2002 for Non-US Issuers", an overview of how the Act may affect foreign private issuers;

"SEC Adopts Rules Implementing Sarbanes-Oxley CEO/CFO Certification and Internal Controls Requirements" and "Suggested Disclosure Controls and Procedures", regarding the certification requirements;

"Audit, Nominating & Governance and Compensation Committees of Boards of Directors and their Committee Charters and Corporate Governance Guidelines and Corporate Ethics Policies of Boards of Directors", which includes, at Appendix I, a suggested model code of business conduct and ethics intended to take into account the requirements of both the Sarbanes-Oxley Act and the NYSE’s corporate governance proposals. See also our memorandum "Disclosure of Codes of Ethics for Senior Officers".

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DOCUMENT MANAGEMENT

Over the last year issues of document retention and destruction have achieved high public profile. Arthur Andersen LLP was found guilty of obstructing justice because it destroyed documents that were relevant to an investigation into the affairs of Enron. In McCabe v BAT, an Australian case, it was held initially that BAT should not be allowed to defend a claim because it had destroyed vital documents. And, in the recent case of Douglas & Others v Hello! & Others, the Vice-Chancellor confirmed that, in appropriate circumstances, a claim or defence might be struck out because the other party had destroyed or disposed of relevant documents.

Against this dramatic background, there are also important issues that arise regarding documents when companies and other institutions find themselves involved in legal proceedings. A coherent document retention programme (together with good practices concerning document creation) will pay significant dividends should a dispute or regulatory issue arise. The purpose of this article is to provide some useful guidelines for document management.

Document retention and destruction

The terms of a document retention policy must provide for the retention for specified periods of those types of documents that need to be kept for potential future use (according to regulatory requirements and statutory/legal obligations) and for the destruction on specified dates of documents that are no longer required. A combination of the above, together with commercial and risk management considerations, should dictate the terms of a company’s policy and provide a single point of reference for all personnel. This will help to ensure that there is a coherent and consistent approach. Relevant considerations when deciding whether a document needs to be kept include:

  • statutory obligations;
  • regulatory requirements in the UK and abroad (such as requirements imposed by the Financial Services Authority);
  • disclosure in the event of litigation;
  • data protection (such as the requirement that certain documents must be destroyed after a specified date).

There are additional considerations when litigation is pending or anticipated. Disclosure of documents is a cornerstone of the litigation process and it is likely to be ordered by the court in most commercial disputes. "Standard disclosure" requires disclosure of documents which are relevant to a dispute, whether advantageous or disadvantageous to a party’s case. A "document" for these purposes is anything in which information of any description is recorded, and in addition to the more "conventional" document, includes e-mails, web pages, tape or video recordings and microfilm records.

If documents are not available, a party must state when, how and why they were lost or destroyed. At best, destruction of documents might cause embarrassment and make the court suspicious. At worst, if it was a key document, that could have an adverse effect on the outcome of the litigation. Where litigation was reasonably foreseeable (or possibly in the context of a regulatory investigation) there are potentially severe sanctions (including proceedings for contempt of court or obstructing justice) if relevant documents are destroyed. The fact that a document was destroyed in accordance with an established policy will not provide protection from censure. Companies must have plans in place to deal with such situations quickly.

Retaining every document ever created, just in case litigation arises, is not commercially practicable or necessary. Rules on limitation of actions should assist in formulating a sensible approach because they preclude most actions (such as breach of contract and/or negligence) from being brought more than 6 years from the date on which the relevant cause of action arose. If no dispute arises after 6 years (and litigation is not reasonably foreseeable), it will generally be safe to dispose of documents. It might be sensible, however, to allow a 1 year buffer period. There is, however, a health warning – the 6 year plus 1 rule will never be 100% safe because there is potential for limitation periods to be longer than 6 years, in particular where mistake or fraud is alleged. Furthermore, other more specific factors (legal or otherwise) may apply to a document or class of documents, extending that period.

Features of a document retention policy

Although there is no single document retention policy which can be said to be appropriate for all businesses, key features of every policy will generally include the following: • detailed guidance regarding archiving procedures and the type and extent of information to be recorded in storage records;

  • detailed provisions regarding storage arrangements;
  • minimum retention periods for specified classes of documents, having particular regard to regulatory requirements;
  • bespoke provisions to deal with extension of the minimum retention period in the case of documents such as original agreements and provisions for varying the general policy in respect of a part of the business that may be subject to special rules on document retention;
  • procedures for selecting documents for destruction;
  • provisions for monitoring and reviewing the policy;
  • clear notice that the policy must be suspended as regards certain classes of documents where a threat of litigation arises.

E-mails

Companies should be aware that there is no exclusive "law of e-mail" and that in the event of litigation, e-mails are discloseable. Potentially, one of the biggest dangers is that e-mails are traceable even when deleted. That means that they have a longer life than most documents. In addition, proliferation of e-mails is common, easily done, and can be both damaging and embarrassing. The following are some practical tips (which are applicable in many respects to other types of documents, such as letters and memoranda):

  • do not create e-mails unnecessarily;
  • exercise caution before typing and sending an e-mail;
  • avoid ambiguity and make sure the e-mail is put in context;
  • alert everyone to the fact that e-mails are potentially discloseable in legal proceedings and regulatory investigations.

Legal professional privilege

Legal professional privilege makes it possible to protect certain sensitive communications with in-house legal counsel and/or external lawyers that would otherwise be discloseable. It covers the obtaining of legal advice and some (but by no means all) communications in relation to a potential or existing dispute. In deciding whether privilege attaches to a document, the key question is what was the dominant purpose for its creation. If the answer is that it was created for or in connection with obtaining or providing legal advice or obtaining or giving evidence (where there is a reasonable prospect of litigation at the time of the document’s creation) the document is likely to be privileged.

Note that privilege may be lost or compromised by proliferation of a document. For example, forwarding a copy of legal advice to a colleague with comments and annotations may result in loss of privilege. Privileged documents should be kept separately and they should not be copied or circulated unnecessarily. Privilege is a technical area and prior legal advice should always be taken.

Conclusion

A document retention policy that is adhered to as a matter of course should serve as a risk management tool by limiting the possibility of losing or prematurely destroying documents that are important and/or potentially discloseable. This, in turn, will prevent the chance of a business finding itself in an embarrassing or damaging situation and will serve to protect its most important asset – its reputation. If you have "troublesome" documents, shredding them is not the answer. When in doubt, seek advice.

Comment

Edmund Sautter, a partner in our Litigation and Dispute Resolution group, comments: "The judgment in January this year in the case of Douglas & Others v Hello! and Others shows that parties to litigation and their advisers are more aware of the possibility of attempting to strike-out a claim or defence on the basis that the other party has destroyed or disposed of relevant documents (whether before or after commencement of proceedings). Although declining to do so in that case, the court confirmed that such an application might succeed in appropriate circumstances.

Parties must be particularly alive to the dangers of inappropriate document destruction, including e-mails (which pose particular legal and technological issues). A coherent document retention policy, consistently applied throughout the organisation, limits damaging situations such as this and should minimise the cost and disruption caused by disclosure obligations in legal and regulatory proceedings."

* * * *

Copyright © 2003 Mayer, Brown, Rowe & Maw. This Mayer, Brown, Rowe & Maw publication provides information and comments on legal issues and developments of interest to or clients and friends. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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