Professional firms in the UK, such as law firms and consultancies, are usually organised as Limited Liability Partnerships. These LLPs are run by the partners group, and have no obligations as regards the official Corporate Governance Code. This could change under the reforms being planned in corporate governance by the Government and the Financial Reporting Council. Compliance with the Code would require radical reorganisation on the part of law firms and consultancies. For now, this remains at the proposal stage, however, in the future, professional service firms, organised as LLPs, may have to comply with the UK Corporate Governance Code.
Timeline for UK Corporate Governance Reform
- 2016. Department for Business, Energy & Industrial Strategy (BEIS) Green Paper
- 2017. Consultation on Green Paper BEIS published an agenda for reforms in April
- April 2017. Government’s response to Green Paper
- November 2017. Draft legislation is expected in this term of parliament
- Financial Reporting Council (FRC) to propose reforms to the Corporate Governance Code (for which it is responsible) in the Fall-Winter period of 2017
- March 2018. Legislation to be approved in parliament
Professional Service Firms to Comply with the Code?
Under current UK law, compliance with the Corporate Governance Code is obligatory only for Public Limited Companies (PLCs) which are listed on the stock exchange, and for some private limited companies (in financial services, for example). But private limited companies make up the majority of UK companies, and some very large ones are perceived by regulators as posing system risk (they are arguably ‘too big to fail’).
The Government, along with the FRC, plans to make compliance with the UK Corporate Governance Code mandatory for the largest private companies. It is also considering including Limited Liability Partnerships (LLPs) in this group, as some of the firms with this type of corporate organisation are indeed very large. The Government estimates that allowing for exemptions for large companies already required to report against the Governance Code or subject to corporate governance disclosure under the FCA’s Disclosure Guidance and Transparency Rules, about 1,400 companies could become subject to these new requirements.
Law firms and professional services firms (consultancies) often use the LLP corporate organisation, and so they would, for the first time, be obliged to show compliance (or explain non-compliance).
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It is far from certain that the Government will implement these proposals – it is not even certain for large private businesses. Nonetheless, this move would radically change the conditions under which law firms and consultancies are regulated.
At the moment, these are only proposals, and the Government has asked bodies such as the Financial Reporting Council, the Investment Association and the GC100 to prepare advice and guidance on these points. The Government plans for secondary legislation to be approved by March 2018, with a view to having it come into effect in June 2018 for financial years starting after that date. Further consultation is underway on the contents of that legislation, according to corporate governance experts at the London-based law firm Jones Day.
The FRC has commented: “In private companies ownership and control are often vested in the same individuals or entities. For many such companies, the costs of subjecting them to greater regulation and scrutiny have been generally deemed to outweigh the benefits. However, there are many large private companies which are economically significant and there are strong arguments to suggest that they should be more transparent about their governance.”
“This is, therefore, not so much a question of alignment, but of a tailored code or guidance or regulated disclosure which takes into account the specific circumstances of large private companies, which are not uniform in their ownership arrangements. A ‘large private company’ should be proportionately defined by a suitable significant minimum threshold of turnover and/or number of employees. A code or guidance directly applicable to the governance arrangements of large private companies should be developed. The FRC is prepared to lead this.”
The Government will invite the FRC to develop voluntary corporate governance principles for private companies. It will also implement legislation that requires such companies to publicly disclose their corporate governance arrangements and whether they follow any formal code. The Government is considering whether to extend this principle to limited liability partnerships of an equivalent scale; large professional services firms may therefore be affected.
Nature of Limited Liability Partnerships
It is worth noting that, currently, LLPs are not legally treated as partnerships in the UK. Instead, they are treated in much the same way as are public and private companies. What is different is that some or all of the partners must have limited liabilities, which means that they are only responsible for their own misconduct or negligence, rather than being responsible as a collective (which is the more traditional partnership model).
Another key element of an LLP is that, unlike other corporations, the partners are allowed to directly manage the business. In other company types, the shareholders have to vote to elect a board of directors, and the board employs other people to manage the company.
The latter element is the most important with respect to eventual compliance with the corporate governance code. At a law firm or consultancy, partners make all the decisions as a group. They also split profits, share bonuses, etc. almost entirely according to their lights, and there is no obligation to stakeholders of any kind.
None of this would be possible if the Corporate Governance Code were to be applied to LLPs.
As UK law Shearman & Sterling pointed out in a report, “Many companies will be concerned about the amount of yet more corporate governance reporting that will now be required. This may be particularly the case for those large privately-owned UK companies and LLPs that, even if they voluntarily choose to make some disclosure about their internal governance arrangements, are not currently subject to any mandatory or ‘soft law’ corporate governance regulation.”
Under these reforms, they would have to start disclosing their corporate governance arrangements. Law firms, which are also regulated by professional bodies like the Solicitors Regulatory Authority, and as such are subject to considerable requirements for transparency and disclosure, would no doubt find the additional regulatory burden onerous, although there has been little comment from the profession so far.
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