Company Law Reform Bill [HL]

My Lords, all noble Lords who know the noble Baroness, Lady Bottomley of Nettlestone, expected a fine maiden speech and, of course, we were not disappointed. She is the daughter of John Garnett, who was a behavioural scientist for many years, and she was a very distinguished Secretary of State for Health and for National Heritage. She brings much experience, as well as charm and intelligence, to the House, and I know that in future greatly benefit from it. Many interesting and important points have been raised today, from a number of different perspectives. The Bill has been the subject of extensive consultation with business, the legal and accountancy professions and other interested parties and today’s debate has shown that it will continue to attract a high level of detailed and expert scrutiny during its passage. This is obviously a complex Bill. Before dealing with the key points raised in today’s debate, I would like to comment on two issues, both raised by the noble Lord, Lord Hodgson, which are relevant to how we handle the Bill in Committee,. The first issue is regulations and how we plan to use the powers in the Bill. Much company law is still set out in primary legislation, but the Bill contains roughly 130 substantive individual provisions for delegated legislation, of which about half are new powers to make regulations, and the rest amend, re-enact or restate existing powers. We have used subordinate legislation for a number of reasons; for example, to avoid putting detailed technical provisions on the face of the Bill; to ensure flexibility in responding to changing circumstances, especially technological advance and greater international mobility; and to allow the registrar of companies to make the detailed rules associated with delivering and filing documents. In a number of areas we have already published detail on the regulations which are planned. For example, we published draft model articles for private companies for consultation in March last year, and will publish drafts for public companies during the passage of the Bill. The Takeover Panel similarly published, in November 2005, full details of its proposals for the use of the rule-making power to be extended to it in relation to takeovers and other regulatory matters. It must also be stressed that there are a number of powers contained in the Bill where the Government have no current plans to make regulations. They are included to maintain flexibilities and to anticipate future developments, or to act as a back-stop in case market developments do not in themselves deliver the changes which we want to see made. The Government would expect to consult should it become necessary to use these powers in future. I will come later to the proposed company law reform power. The second issue is the change of words from the 1985 Act and where a change of wording is a matter of substance, and where it is merely cosmetic.  This was also raised by the noble Lord, Lord Hodgson. Our underlying approach in this Bill has been to simplify. Sometimes this has been a question of making substantive changes of policy, and sometimes it has been more an issue of simplifying the drafting of the law to make the language more accessible or consistent, or to reorder the provisions in a more logical way. This approach has been widely welcomed, and I am very pleased that the reactions we have had from stakeholders to the new Bill suggest that the draftsman has been remarkably successful in setting out the law in a way which is as clear and accessible as possible. But I recognise that there can sometimes be questions as to whether a particular change in the language represents a change of substance, with real legal effect, or is a change in language. My department has produced a table of destinations and derivations, showing for each clause in the Bill where it derives from an existing section of the 1985 Act or elsewhere and, if so, whether it introduces a change of substance or is more by way of a simple restatement of the existing provision. That document has been placed in the House Library and is available on the DTI website. I hope it will be of some assistance. Of course, we will come at later stages in the House to discuss individual clauses in more detail. If and when it would be helpful to remove doubt, I will, of course, be very happy to set out the position in respect of specific provisions in more detail. I would now like to comment on some of the key issues raised during the debate. The Bill has more than 800 clauses and the debate involved 21 speakers who raised more than 100 questions, so I cannot answer all of them. I shall try to cover the fundamental issues in the Bill and we will have plenty of time in Committee to cover the detailed points. I shall start with directors’ duties, which are at the heart of the Bill. The noble Lords, Lord Clinton-Davis and Lord Freeman, raised the accessibility of law on directors’ duties. Codification will help to make the law clearer, but we also need to make the law more accessible to the thousands of directors who, quite understandably, will not read companies legislation, however elegantly or clearly drafted. That is why we are also committed to producing plain language guidance which will be made available to all directors. Clause 156 addresses the key issue of in whose interests a company should be run. The clause enshrines in statute a concept which the Company Law Review called ““enlightened shareholder value””. This has two main elements: it gives directors the clarity they need by setting as their objective the success of the company for the benefit of shareholders collectively and, at the same time, the clause recognises that a focus on the short-term financial bottom line cannot deliver long-term prosperity. Directors, in fulfilling the duty, are therefore required to have regard to factors such as the long-term consequences of their decisions, the interests of employees and the impact on the community and the environment ““so far as reasonably practicable””. I am aware that some noble Lords would prefer an approach which the Company Law Review called ““pluralism””, and I believe that that is the direction in which the noble Baroness, Lady Tonge, and the noble Lord, Lord Judd, were heading. Under it, directors would be required to serve a wide range of interests. Both the Company Law Review and the Government have considered the case for a ““pluralist”” approach very carefully. There are three main reasons why we do not believe it would be the best way forward: a pluralist approach would muddy the waters unhelpfully; directors would lack clarity about what they were meant to be doing; and it would, in practice, be more difficult for anyone to hold directors to account. Secondly, company law reform is not a suitable vehicle for our wider agenda on corporate social responsibility. Issues such as environmental protection and health and safety are very important, but they should not be addressed through company law reform. The best way to promote responsible business behaviour is to show how such behaviour leads to business success. The noble Lords, Lord Sharman and Lord Clinton-Davis, and the noble Baroness, Lady Bottomley, raised the issue, and the noble Lord, Lord Lea of Crondall, noted the significance, of the words ““so far as reasonably practicable”” in Clause 156. They have a dual purpose. First, we recognise that business decision-making will sometimes be constrained by time constraints and other practical limits. That does not, of course, mean that directors can simply ignore factors such as the interests of employees, and it is hard to conceive of any situation, even the most urgent, where it will not be reasonably practicable to give any regard to the factors at all. The words also make clear that directors must consider the factors to the greatest extent that it is reasonably practicable to do so. It is, of course, in the company’s interests that they should do so. The duty of directors is not to consider the factors in a superficial manner as part of a box-ticking exercise, but to think through the long-term implications of their decisions and address potential risks. I believe that our approach in this clause responds to wider expectations of responsible business behaviour in a pragmatic and commonsense way. The clause does not impose new duties on directors, and the duty to promote the success of the company will continue to be governed by the good faith judgment of the directors. The courts should not be any more likely to second guess business decisions taken in good faith by directors. The Bill will codify the common law duty of care, skill and diligence without substantive amendment. Recent developments in the law in this area have been influenced by Section 214 of the Insolvency Act 1986, and Clause 158, which introduces a statutory duty to exercise reasonable care, skill and diligence, closely follows this section of the Insolvency Act. The Bill does not make this duty more onerous. On the point from the noble Lord, Lord Borrie, we do not think it will affect director recruitment or behaviour. My noble friend Lord Haskel asked for an assurance that the deregulatory measures in the Bill will in no way diminish the duty of care owed to the company by directors of small companies. I am happy to give that assurance. The noble Lord, Lord Patten, asked what the success of the company means and who are its members. Success for a commercial company means, normally, long-term increase in value. For certain companies such as charities and community-interest companies it means achievement of their objectives. Members is a company law term to cover shareholders and guarantors of companies limited by guarantee. It does not include employees. The position of auditors is another major issue in the Bill. The noble Baroness, Lady Goudie, argued that the threat of criminal prosecution will cause all auditors to carry out more checks and be less willing to exercise judgment. There is no reason why they should. If an auditor is not acting recklessly at present there is no reason why they should change their behaviour because we are introducing this offence. The noble Baroness asked for an assurance that honest mistakes would not result in prosecution. I can give that assurance, not because dishonesty is required for committing the offence—it is not—but because to show that an auditor has acted knowingly or recklessly requires more than a mistake. It requires a conscious decision by the auditor: at least a decision to turn a blind eye. It is possible that some auditors may misunderstand the risk of prosecution, and that this could have adverse consequences. We will be happy during our further consideration of the Bill in committee to explain fully what will be the effect of the phrase ““knowingly or recklessly””, and of the provision as a whole, so as to help avoid such misunderstandings. Our proposal on auditor liability addresses the perceived unfairness that can arise when the negligent auditor is the only solvent defendant after a corporate collapse. It could prevent the loss of one of the big four accountancy firms. On the other hand, it gives the company and its shareholders the option whether to agree to a limitation. If they have agreed, the proposal still ensures that the company has a right to a fair and reasonable compensation from the auditors. The noble Baroness suggests that the Bill as drafted requires a liability limitation agreement to define the limitation as a monetary amount. It does not. The Bill leaves company and auditor free to contract in whatever terms they want. If they were to agree to limit liability to a specific financial limit, it would not be effective if it was not at least fair and reasonable, and the limit would instead be what was fair and reasonable. Having been a finance director for many years, any prediction that audit fees will come down in any circumstances strikes me as incredible. We believe that the clause as drafted will enable the court, if necessary, to determine an amount that is proportionate. It will be able to strike a fair balance between the company and the auditor, taking into account the auditor’s responsibility to the company. The Operating and Financial Review was raised by many noble Lords. Our reason for removing the requirement was that the costs associated with it were, we believed, disproportionate. It was about £33 million, of which £31 million was extra audit requirements. I agree with my noble friend Lord Gordon of Strathblane that we have got to the right place but not necessarily by the most elegant route. Companies will still need to include a business review as part of the directors’ report, in compliance with the EU Accounts Modernisation Directive requirements. We are committed to improving strategic, forward-looking narrative reporting by companies, and to enhanced dialogue with shareholders based on such reporting. It is important for companies to report on non-financial issues relevant to the development and performance of the business, including, for example, environmental and employee matters. Companies will be required to do this as part of the business review. As I explained in my opening statement, we have invited views by 15 February on whether the business review requirements should be clarified to achieve their objectives more effectively. We will take full account of these views on deciding how to frame the amendments we will be bringing forward to the Bill relating to these provisions. Depending on the timing of the Committee stage, we may bring forward amendments either at Committee or Report. In response to the question of the noble Lord, Lord Hodgson, it is our intention to bring forward amendments to the Bill to remove Clauses 393 to 395 as they currently stand. The noble Lord, Lord Hodgson, and the noble Baroness, Lady Murphy, raised the issue of shareholders’ rights. The Government are committed to encouraging the greater enfranchisement of shareholders and the responsible exercise of share ownership rights. That is why the Bill includes new provisions under Clauses 136 and 137 to ensure that companies can enable indirect investors—such as those investing through nominees—to exercise and enjoy varying levels of shareholder rights as suits their needs. The Government believe that a voluntary approach is the better way to achieve greater enfranchisement of indirect investors. However, if the market does not develop appropriate solutions the Secretary of State may exercise the power under Clause 137 to compel companies to provide information to indirect investors. The power is intended as an additional tool towards encouraging and achieving greater enfranchisement benefits. Better-informed investors should be better equipped to demand voting and other governance rights from nominees and the companies in which their investments are made. My noble friend Lord Haskel suggests that companies taking advantage of the electronic communications provisions should automatically be required to enfranchise nominee shareholders. The extension of governance rights to indirect investors and the provisions enabling companies to default to e-communications are entirely separate measures. E-communications present great opportunities not only to reduce costs, but also to enhance the immediacy of dialogue between companies and their shareholders and indirect investors. However, to make enfranchisement of nominee shareholders mandatory would require a definition of exactly which indirect holders should be enfranchised—which would be difficult. We would therefore prefer market solutions to develop but, if they do not, the power will be available. The noble Baroness, Lady Murphy, asked what would be an improper use of the register of shareholders. A current issue here is the use of the register of shareholders by animal rights extremists to harass shareholders. That has been a major problem. We have dealt with it as a one-off, but there are other areas where similar activity could occur and we want also to be able to deal with that. The noble Lord, Lord Sharman, and my noble friend Lord Borrie raised the question of the rules on dividends. My noble friend Lady Goudie also argued that we should expand the Bill to include provisions relaxing the law controlling the payment of dividends by private companies. We understand the concern about current law that links payment of dividends to the concept of realised profits, but the rules on dividends and other distributions are of central importance in protecting creditors and other third parties involved with companies, including lenders, employees, pensioners and trading partners. We see no obvious or simple answer to that complex and important issue. We need to consider it carefully and we intend to do so in full consultation with interested parties.