obtained in managing related risks.
The board therefore faces two key issues. These are:
To ensure all employees have some responsibility for internal control; and
The system of internal control is such that it forms part of the operation and
culture of the company.
Once these controls are in place, it is then the responsibility of the board to
review the effectiveness of the internal control system. In reporting on this
issue by way of the annual assessment, the board should avoid paying scant
regard to this duty by merely adapting statements used by other companies.
List checking is not sufficient. Although the guidance may not always be
mandatory for a board to observe, nevertheless it does serve a function in a legal
context. The guidance, while not as such having legal status, will normally be
Chapter 6 â€“ Risk and corporate organisational areas: an overview 107
considered as evidence of what is considered to be best practice. Whether a
board of directors fulfil their collective and individual responsibilities will be
determined by a standard of care set by a judge, who will in turn take into
account best industry practice, which will include the type and quality of guid-
ance that is available. As a result, directors cannot and should not ignore the
guidance that is widely accessible. Moreover listed companies are now facing
more and more mandatory requirements, supported by guidance, as is men-
tioned in other chapters.
Evolving board responsibilities
As the above section demonstrates the business world in which we live does
not remain static. In addition to the debate over financial transparency some
other earlier examples relevant to due diligence and corporate governance also
demonstrate how the complex regulatory framework has developed. For
instance, in England the Victorians adjusted to the rapid developments that
occurred in business structures during the nineteenth century by providing for
the incorporation of companies. This meant that the company became a sep-
arate legal entity, and the concept of limited liability developed (mentioned in
Chapter 4). These early developments were adjusted over time by Parliament,
as politicians reacted to the scandals and criminal acts perpetrated by various
individuals within companies periodically, as well as the perceived deficien-
cies in the protection of investors or attempting to prevent fraudulent activities
occurring. Major Acts of Parliament and piecemeal amendments relating to
companies have been adopted from time to time over the past 150 years.
It is important to bear in mind that, whatever the legal environment that
boards have to work within, directors are required to provide leadership and
guidance to the company. In this capacity, as has been seen in other chapters in
this book, it is always incumbent upon directors to be aware and to take stock
of the operating risks to ensure the company is prepared for the future.
Role of regulation and best practice
In terms of managing a business, it has been seen that the sticks and car-
rots operate on a continuum: politicians provide for legal structures on the
one hand, which companies either ignore or are ignorant of, while best
practice operates at the other end of the continuum. Best practice is
encouraged through guidance from various bodies, and is used by some
boards when discharging the majority of their responsibilities.
The English legal framework
In March 1998, the British government set out, in the paper â€˜Modern Company
Law for a Competitive Economyâ€™, its intentions of taking a broad approach to
Part A â€“ Overview of Risk Management
review the framework of company law. A consultation document was
subsequently issued in March 2000, entitled â€˜Modern Company Law for a
Competitive Economy: Developing the Frameworkâ€™ by the Company Law
Review Steering Group (which was available from www.dti.gov.uk/cld/modco-
law.htm). The trial draft statutory statement of directorsâ€™ duties comprised the
Compliance and loyalty;
Independence of judgement;
Conflict of interest;
Care, skill and diligence.
This section is particularly concerned with the last item on the list, and the
consultation document went on, at page 31, to propose that:
A director must exercise the care, skill and diligence which would be exercised by a rea-
sonably diligent person with both the knowledge, skill and experience which may be rea-
sonably expected of a director in his position and any additional knowledge, skill and
experience which he has.
While this consultation document was open to discussion, the Home Secretary
decided to take separate action with the introduction of new legislation relating
to involuntary manslaughter. While this aspect of the law need not worry the
majority of directors, nevertheless, for those directors with responsibilities that
are inherently dangerous (shipping: Herald of Free Enterprise 187 deaths;
Marchioness-Bowbelle 51 deaths; railways: Kingâ€™s Cross 31 deaths, Clapham 35
deaths, Southall 7 deaths, as well as Paddington and Hatfield; oil fields: Piper
Alpha 167 deaths), it is a factor to keep in the forefront of thinking when direct-
ing the affairs of the company.
Bearing in mind the bookâ€™s discussion of sustainable risk management the
debate over responsibility and corporate manslaughter provides a useful case
study for the present chapter.
Corporate manslaughter: a case study in risk
The area of corporate manslaughter has been very controversial as regards the
future of risk management. The paper, published in May 2000, and entitled
â€˜Reforming the Law on Involuntary Manslaughter: The Governmentâ€™s Proposalsâ€™
(available from www.homeoffice.gov.uk/index.htm) set out the governmentâ€™s
intention to clarify the law on corporate manslaughter. The proposed legislation
was based on the Law Commissionâ€™s Report No. 237, Involuntary Manslaughter,
published in 1996. The Law Commission recommended the:
Abolition of the offence of involuntary manslaughter;
Replacement by two new offences of â€˜reckless killingâ€™ and â€˜killing by gross
Creation of a special offence of â€˜corporate killingâ€™, broadly similar to the indi-
vidual offence of killing by gross carelessness.
Chapter 6 â€“ Risk and corporate organisational areas: an overview 109
In introducing the offence of corporate killing, the government intended to
cover a wide range of circumstances in which deaths occur, including those on
building sites and in factories. Examples of the few companies that have been
prosecuted for manslaughter under English law are: OLL Limited, Jackson
Transport (Ossett) Limited and Roy Bowles Transport Limited. All of these were
small companies, and in the Dorset canoe tragedy, the company comprised a
single director. The governmentâ€™s aim was to provide a legal basis for ensuring
that prosecutions were more successful than they have been in the past. It is
therefore incumbent on directors to ensure they take appropriate action to man-
age the risks their company face in order to avoid possible culpability in the
future. They should be aware that the responsibility is both personal and collect-
ive. The legislative area is clearly an issue that directly concerns corporate gov-
ernance and requiring proper monitoring.
The business vehicle
It is easier to set up a business organisation in Britain than in most industrial
nations. Whether or not the business prospers is another matter, but it is
unusual for bureaucracy to be the cause of failure. Getting the structure in place
can be remarkably simple. In this section we consider briefly which business
structure is most appropriate for the contemplated or existing business, with
particular emphasis on how to limit or reduce personal liability for business
mistakes or business insolvency.
At the outset we should consider the sort of circumstances that might lead
to personal liability on the part of the trader and place his or her personal assets
at risk. It probably goes without saying that dishonest or reckless conduct by
the trader in the course of his business, whether or not as a sole trader, partner
in a firm or company director, may well lead to a personal liability for losses
suffered by others as a result. Being honest and conscientious, however, is no
guarantee that personal liability will not arise. As is well known, experienced,
skilled and careful drivers are likely at some time to make an error of judgement
or suffer a temporary suspension of concentration. The consequences can be
fatal and expensive. An otherwise unblemished driving record might persuade
the magistrates to be lenient, but it is unlikely to reduce civil liability for death,
injury and physical damage resulting from driver error. It is no different in busi-
ness. The one-man financial advisor who unwittingly gives what turns out to be
bad advice, the restaurateur whose suppliers supply sound looking but contam-
inated food that is served to a customer and the international auditing practice
who failed to uncover a fraud buried deep in the accounts may all be at risk.
As regards listed companies, the primary exercise by shareholders of their
right to participate in the governance of their corporation or organisation is in
connection with election of the board of directors. Specific information is
required in connection with the election of directors. This includes, for each
person nominated for election by the shareholders:
Business experience over the last five years;
Part A â€“ Overview of Risk Management
Directorships of other listed companies;
Any position they have had with the company;
Any understandings with others related to their selection as a nominee;
Legal proceedings where the directorâ€™s interests are adverse to the
Any bankruptcies of companies they were executives or partners of;
Various types of legal proceedings they have been involved in; and
Indebtedness, financial transactions or other relationships with the company.
Bearing in mind the Higgs Review in the UK regarding the role of non-executive
directors (NEDs) the appointment of NEDs is becoming more sensitive as the
level of responsibility and integrity is raised. Moreover, whereas the review
was aimed at large businesses, advisors have noted that, as with other regula-
tions and standards relevant to ongoing due diligence and good corporate gov-
ernance, there are impacts also on small business. The increased risks and the
growing vigilance of shareholders, as well as other stakeholders, means that a
proactive approach can assist business performance, whatever the size of the
organisation. Being careful is advisable, but it is not enough. How risk can be
reduced will depend to some extent on how the business entity is organised.
The more common alternatives are considered briefly below.
The limited liability company
Unlike setting up as a sole practitioner or as a partner in a firm, establishing a
limited liability company requires a certain formality. It has become a common
business vehicle in the UK. In essence the nature of a limited liability company
It is a legal â€˜personâ€™ and is regarded in law as existing entirely separately to
its shareholders and directors. It is the company that carries on the business
not its directors, officers or owners;
It is owned by its shareholders. The business of the company is under the
control of its directors, who may or may not be its shareholders, and who are
appointed by the shareholders;
The personal liability of the owners of the company (the shareholders) to
those with whom the company comes into contact is (with few exceptions)
limited to what is owed by the shareholders for shares in the company which
they have taken up but for which they have not yet paid; and
Although the shareholders appoint the directors, they have very limited control
over the day-to-day running of the company (subject to the comments above).
If the company incurs liabilities which it cannot meet from its own resources,
the circumstances in which the shareholders or directors will be called upon to
make up any shortfall are very limited provided the loss has not been brought
about through the dishonest activity of the shareholders or directors. There are
exceptions to this rule. For example, directors may be personally liable for unpaid
income tax and National Insurance contributions which have been collected
Chapter 6 â€“ Risk and corporate organisational areas: an overview 111
from employees but not paid over to the authorities. The tendency over the
years has been to increase the circumstances in which directorsâ€™ personal liabil-
ities may be involved by increasing legislation intended to ensure good corpo-
rate management (see also Chapter 21). Compared to partners in traditional
partnerships, company directors and shareholders are much less exposed.
Directorsâ€™ liability insurance is generally available.
A limited company is a vehicle born of statute. It owes its existence to the
due observation of procedures required by the Companies Acts. Its formation
and constitution is a matter of public record. Companies are required to keep
and file up-to-date information concerning the shareholders, directors, location
of registered office, etc. Companies are also required to file accounts each year
showing turnover, profit and loss, etc. All this information becomes a matter of
public record and can be obtained by any member of the public making a search
at Companies House or via the internet where information can be downloaded
or faxed to the applicant on payment of the appropriate fee.
The structure and operation of the company will be determined by its
Memorandum and Articles of Association (its charter), by the Companies Acts
and by the great body of law that has come into being over the years since the
concept arose of a business organisation existing independently of its members.
Despite the due solemnity which necessarily accompanies the formation of
a company, a new company can be purchased for something like the cost of a
colour printer for a PC. Company formation â€˜agentsâ€™ will sell you a â€˜ready madeâ€™
company â€˜off the shelfâ€™ that is a company which has already been incorporated
with temporary shareholders and directors and is available for instant transfer
to its new owners. They will arrange for the temporary directors and sharehold-
ers to withdraw so that the new directors and shareholders can take over. You
can walk in, buy the company over the counter and start trading immediately.
You can also arrange to change the companyâ€™s name to something more to your
liking which will usually take a few days. Alternatively, if you are not in a des-
perate hurry, the formation agent will make a â€˜bespokeâ€™ company according to
your requirements and with the name of your choice if that name is available.
Solicitors and accountants also use the services of company formation agents.
You can of course buy a company elsewhere that has already traded and may
already have an ongoing business.
Private companies (identified by the word â€˜Limitedâ€™ or abbreviation â€˜Ltdâ€™ or
its Welsh equivalent â€˜Cyfyngedigâ€™ or abbreviation â€˜Cyfâ€™ at the end of its name) are
not allowed to offer their shares to the public. If the business of the company
succeeds and outside capital is required, it may be appropriate to transfer the
business of the company to a public limited company (whose name will end in
â€˜Public Limited Companyâ€™ or â€˜PLCâ€™) but that is beyond the scope of this chapter.
Limited companies also have their less obvious uses. Leaseholders in a
block of flats who decide to exercise their collective right to acquire the free-
hold may arrange for the freehold to be held by a limited company in which
each leaseholder becomes a shareholder. Ownership of the freehold by a
limited liability company provides a democratic structure with all the protection
that is provided by company law. Charities or clubs may also be incorporated
Part A â€“ Overview of Risk Management
into a company although a variant form is usually used â€“ the company limited
by guarantee. Such a company has no share capital and therefore no sharehold-
ers. It has a board of directors (or trustees) who operate the company and whose
personal liability is limited to a predetermined (and perhaps nominal) sum,
which is the extent of contribution that can be called up in the event of the