Company Law Bill [HL]

We are very much aware of the concern about the current rules that link the payment of dividends to realised profits. The suggested Part 19A would introduce a new principle for private companies—the solvency test, representing a radical departure from the current law, which is defined by reference to a company’s accounts and current accounting practice, upon which we rely for the interpretation of the concept of realised profits. This test, as it stands in the amendment, would depend on directors satisfying themselves that, at least for the year ahead, they would be able to meet their debts as they fall due. The Company Law Review consulted and reported in great detail on capital maintenance and the scope for possible reform. Among the options discussed was the question of a solvency test as a possible basis for determining a company’s ability to make dividend payments. Respondents were concerned, however, that an assurance of short-term solvency, whether by directors’ declaration or independent audit, was not in itself a sufficient guarantee of its ability to meet its debts, and therefore did not provide adequate protection for creditors. The Company Law Review was also concerned that the position for private companies should keep in line with that for public companies, on which we are constrained by the Second EC Company Law Directive. The British Institute of International and Comparative Law more recently also considered the question of a form of solvency test. In June 2004, it recommended its application to both public and private companies. This would again require agreement at European level. We have indeed been pressing for review of the Second Company Law Directive and the Commission has undertaken to review the issue of distributions in the context of wider capital maintenance issues. The solvency test proposed in the amendment would only require the directors to consider debts falling due in the next year, thus allowing the company to pay a dividend even though it had long-term liabilities—such as for pensions—exceeding its assets. Directors would still, of course, need to consider their general duties under Chapter 2 of Part 10 of the Bill, but there is a real question as to whether this would be sufficient protection for long-term creditors. We understand that these issues are particularly affected by the move towards international accounting standards for UK companies. We are aware that there are concerns that the application of IFRS to companies leads to certain areas of income and expenditure being treated differently from UK accounting practice. The accounting bodies of England, Wales and Scotland issued joint guidance in June 2005 on the potential impact for distributable profits. It is still early for an assessment of the full impact of the new rules. It is one of the many factors that we must consider in a discussion of these issues. There are other important questions of principle we would have to address in considering a change to the existing law, whether the replacement was to be a solvency test or based on some other approach. Those questions could include, for example, whether it is appropriate that a company should be able to pay a dividend without ever having made a profit; or to what extent companies should be paying into their pension schemes rather than paying shareholders. These are hugely important issues which any proposed amendment must also satisfy. There is no simple or obvious answer. We need, and have asked, interested parties to provide us with more information now that we have reached the end of the first full reporting year under the new standards. We accept that the issue is one we need to look at carefully. We intend to gather evidence on the nature of the problem and what might be done, and discuss the matter with appropriate parties. I hope that, in the light of this, the noble Baroness will not press the amendment.