Section 172 statement – further guidance on how to prepare it

Additional guidance has been published by the Financial Reporting Council Lab to assist companies when preparing their section 172 statements. This includes:

• Explain why - the statement should explain the board's reasoning behind why particular stakeholders are identified as key; particular engagement methods were effective; and key decisions were taken in light of engagement and feedback which may have accumulated over time

• Decision making process - start early by highlighting key decisions and engagement activities which could be considered for inclusion in the statement as they happen. Consider tailoring templates for agendas, papers and minutes with reminders to consider relevant stakeholders

• Reflect on board's oversight - investors want information about how the board oversees and challenges management's engagement with stakeholders and the formulation of strategy, how issues are escalated to the board, the board's training on stakeholder issues, and how the effectiveness of complaints/grievance mechanisms is assessed

• Case studies - use examples and case-studies of significant strategic decisions taken during the year

• Be specific and genuine and avoid 'box ticking' - the statement should reflect on how the company met the requirements, explain what is relevant to it and what happened during the year and, where applicable, what the board and management plan to do in future.

What's our view?

The introduction of the section 172 statement was always going to require boards to be more structured and systematic about their approach to directors' duties. And, it was also always going to necessitate making and recording board decisions from the start of the year with an eye on the section 172 statement published after that year but about that year. The recent guidance from the Chartered Governance institute and this guidance represent, we think, a strongly held view within the FRC that section 172 statements should explain how each of the s172 (1) (a) to (f) factors has been taken into account and the 'effectiveness' of the engagement with key stakeholders, and the 'why' not just the 'how'. This view will be particularly pertinent when it comes to describing key decisions this year such as around furlough, working from home/the office and any redundancies. And, we think, it is one part of a broader debate about the corporate purpose of companies, their impact, the value they deliver to stakeholders and the alignment of a company's business with socially responsible and beneficial activities.

What is a section 172 statement?

A separate statement in a company's strategic report describing how the directors have had regard to the matters set out in section 172 (1) (a) to (f), Companies Act 2006 when performing their duty under section 172.

The strategic report is given a statutory purpose: to inform the members of the company and help them assess how the directors have performed their duty under section 172.

Companies must include the statement in annual reports for financial years beginning on or after 1 January 2019 (section 414CZA Companies Act 2006).

What does the section 172 (duty to promote the success of the company) require?

A director of a company must act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (among other matters) to:

(a) the likely consequences of any decision in the long term;

(b) the interests of the company's employees;

(c) the need to foster the company's business relationships with suppliers, customers and others;

(d) the impact of the company's operations on the community and the environment;

(e) the desirability of the company maintaining a reputation for high standards of business conduct; and

(f) the need to act fairly as between members of the company.

Which companies must make a section 172 statement?

All UK incorporated companies other than those that qualify as medium-sized (under sections 465 to 467) or are small companies. Medium-sized companies must have at least two out of three of the following:

• turnover of £36m or less
• balance sheet total of £18m or less; or
• 250 or less employees.

But the tests are technical and need to be checked carefully as certain companies are excluded from being treated as medium-sized because they are ineligible. For example, any public company that is a medium-sized company must still make the statement and a group with a financial services authorised entity in it can result in a company that would otherwise qualify as medium-sized being treated as "large" instead.

Does it apply to groups or individual companies?

The tests apply on an individual company basis, so each qualifying company (whether a parent or subsidiary) will need to report separately. Qualifying subsidiaries must prepare their own statement even if the parent company must prepare a group strategic report.

A parent company needs to report where it does not meet the thresholds but does meet them through consolidation. Where a parent company prepares a group strategic report, it can, where appropriate, give greater emphasis to the matters that are significant to the group, taken as a whole.

How long do you have to publish a section 172 statement?

The section 172 statement is published in the annual accounts, so the timing will tie in with the deadline for publication of annual accounts.

There are variations depending on the year of incorporation and the length of the accounting reference period, but for the usual 12 month accounting reference period, the accounts of a private limited company including a strategic report (and within it the section 172(1) statement) must normally be filed within nine months of the end of accounting reference period. This deadline has been temporarily extended by three months to 12 months because of COVID-19. This applies to any accounts that have to be filed between 27 June 2020 and 5 April 2021. See Extension of rules that temporarily ease company meeting for more information.

Where is a section 172 statement published?

Companies must publish their section 172 statement on a website (maintained by or on behalf of the company, which identifies the company and to which access is free and unrestricted) as soon as reasonably practicable. It must be kept available there until either:

• the section 172 statement for the company's next financial year is made available; or
• if no statement is required to be made available for the next financial year, the end of the next financial year.

Quoted companies must already publish their annual accounts on a website.

Unquoted companies must do so for the first time. They can satisfy this requirement by publishing any of the section 172 statement or the whole strategic report (which includes the statement) or the whole annual report. Where the section 172 statement cross refers to other parts of the strategic report or annual report it will be easier to publish at least the whole strategic report.

What information could be included in a section 172 statement?

The information to include in a section 172 statement depends on each company's individual circumstances, but, as indicated in the FAQs on the regulations which introduced this requirement and the FRC's Guidance on the Strategic Report, companies are publishing information on some or all of the following:

• the issues, factors and stakeholders the directors consider relevant in complying with section 172(1) (a) to (f) and how they have formed that opinion;
• the main methods the directors have used to engage with stakeholders and understand the issues to which they must have regard; and
• information on the effect of that regard on the company's decisions and strategies during the financial year.

The FAQs also state that companies will need to judge what is appropriate, but the statement should be meaningful and informative for shareholders, shed light on matters that are of strategic importance to the company and be consistent with the size and complexity of the business. There does not, however, appear to be any carve out for confidential information.

Where appropriate, companies can cross refer to information in other parts of the strategic report or annual report.

Further guidance on the content is included in the FRC's Guidance and the editorial changes to Appendices II and III of it, issued on 11 May 2020.

The Chartered Governance Institute has also amended its Guidance on directors' general duties to include a new section on the section 172 statement. This provides practical guidance on each of the factors. It also states that whilst the section 172 statement must be included within the strategic report, a statement on the factors relating to employee engagement and business relationships will need to be included in the directors' report or cross-referenced to the s172 statement in the strategic report.

What if there is an overlap between the directors' report and section 172 statement information?

The directors' report must explain how the directors have:

• engaged with employees, suppliers, customers and others; and
• had regard to employee interests, the need to foster the company's business relationship with suppliers, customers and others, and the effect of that regard, including on the principal decisions taken by the company during the financial year.

Where the board considers this information to be of strategic importance, it can be included in the strategic report and cross references to the strategic report included in the directors' report (so there should be no need to duplicate information).

What happens if you don't publish a section 172 statement when you are supposed to?

If a strategic report is approved that does not comply with the Companies Act 2006 (for example, content requirements) every director who:

• knew it did not comply (or was reckless as to whether it complied); and
• failed to take reasonable steps to secure compliance or prevent the report from being approved, commits an offence.

Every officer of the company also commits an offence if the section 172 statement is not published on the website and kept available there for the specified periods, as described above.

Please contact Charles Mayo, Jo Weston or Zoe Cafritz if you would like any advice on which companies within your group must make a section 172(1) statement or on how to structure it.