Companies (Audit, Investigations and Community Enterprise) Bill [Lords]

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Mr. Mitchell: As the Minister said, the Bill is about trying to ensure that corporate governance is effective. We shall come in due course to the social enterprise provisions to which the Minister referred, the principle

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of which we all support. She mentioned that the new clauses deal with the 1.8 million companies on which the wealth of our country is built, and that they arise from the consultative paper issued by the Department of Trade and Industry in December.

The Minister said a few words about the responses that she and her Department received. May I remind her that she kindly said on Second Reading that she would make available an analysis of the responses to that consultation paper in respect of both directors' and auditors' liability? We look forward to seeing that analysis.

The Minister also referred, rather unwisely, to the company law review. One of the Opposition's principal objections to the Bill is that it is a veritable mouse: not the full-blooded reform of company law that we have been promised for so long, but a very small part of what should be a major Bill. We do, however, agree with the Minister when she says that it is essential that we maintain a good pool of non-executive directors. As she rightly said, negligent directors should be held to account. She set out the problems lucidly, but our reservations about the new clauses stem from the Government's response. Our reply to her comments today and to the Government's new clauses is that we give them one cheer. They are, so far as they go, a move in the right direction, but a limited and inadequate one.

The Minister gave some detail on the new clauses, for which I am most grateful, as they are exceedingly complex. New clause 1 deals with the law in section 310 covering a director, which will now be dealt with in new section 309A. These changes mark a relaxation in the prohibition of provisions protecting directors from liability, subject to three conditions in new section 309B that are clearly right. The first is that there can be no company indemnity against a director's liability. Secondly, there can be no indemnity against fines, whether criminal or regulatory; without that condition the law would be nonsense. Thirdly, there can be no indemnity against costs if a director is convicted.

I have two questions for the Minister about new clause 1. As she said, under new section 309C the details of an indemnity would have to be in the company's report and accounts. As I understand it, such an agreement does not require sanction or agreement by shareholders. The Minister was quick to say that shareholders could of course examine the agreement, but she did not say whether their sanctioning of, or agreement to, such a deal between the company and its directors would be required.

If shareholder agreement is not required, do the Association of British Insurers and the National Association of Pension Funds agree with the Minister's decision? Will she confirm that even if the Companies Act does not require shareholder sanction, the law and the relevant regulations leave it open to the Financial Services Authority—or, indeed, to Hermes—to ask for shareholder approval on those points?

New clause 2 deals with cases in which companies pay a director's costs. That enables a director to

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receive what is effectively a loan from the company until he or she wins the case. If the case is lost, the money has to be paid back. That is clearly necessary because, under section 330 of the Companies Act 1985 there is a general prohibition on loans. The new clause makes it clear that such provisions apply only to a loan for a director's defence if the director loses, and that they apply to civil and criminal proceedings.

I have several questions about new clause 2. First, if a director faces regulatory proceedings, will they be covered by the Bill's definition of civil proceedings? Will new clause 2 apply when someone comes before the regulator because the process is being treated as a civil proceeding? Secondly, what does subsection (3) of new section 337A mean? I have reread it several times and perhaps it is my inadequacy but I cannot understand the meaning of the following:

    ''Nor does section 330 prohibit a company from doing anything to enable a director to avoid incurring such expenditure.''

My third question may also arise from my misunderstanding or from inelegant drafting, although that is hard to believe, given the skill of the Minister's officials. As I understand it, a director who is convicted is given no time to pay back the money that he has been lent by the company for his defence. I take that to mean that as he was sent down, he would, from the dock, have to hand a cheque to the company to reimburse it for the costs. Perhaps the bailiffs could be sent round within minutes of a conviction if no cheque has been produced. Would the Bill not be better and more elegant if it stated that someone so convicted, and who has to make a repayment, should have a month or 30 days in which to do so?

We give a cautious welcome to the new clauses and associated amendments. What we are discussing today is a cash-flow matter—an easing of the law. The company law review made it clear that companies should be able to do as we have been describing without infracting section 310, as long as they had a relevant legal opinion. In Sir Derek Higgs' report to the Government, he made it clear that he did not think that a legal opinion was required, and the Government have accepted that advice.

The new clauses are a modest improvement but they say little about the more general liabilities of directors. However, the Minister made a point of saying said that she was concerned about those liabilities. Clause 9 has been rewritten; previously, it placed an onerous and unacceptable burden on directors in general. As a result of the rewriting, which was done largely at the behest of Lord Hodgson of Astley Abbotts, directors now have some defence, but there remains no distinction between executive and non-executive directors.

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As I said on Second Reading, under present company law all directors are considered equally responsible for the company and therefore equally liable. The new clause 9 does not undermine that. However, a non-executive director does not play the same role as the executive director, nor is he as well informed about the operations of the company. He

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must rely on his co-directors, yet the new clause fails to recognise that.

Any person thinking of taking on a non-executive role will ask what risks are involved and what are the possible costs. If we want to encourage good-quality people to take on those positions—a point made by the Minister in her opening remarks—we must ensure that the degree of risk involved does not outweigh any potential reward. As the Bill stands, the role of the non-executive director will become increasingly undesirable.

The potential personal liability of a director of a public company is now out of all proportion to any reward that he or she may receive. As a result, good people will not come forward to serve on major public boards. We are moving towards a situation in which experienced, independent non-executive directors will not be willing or available to come forward. That is happening at a time when, as the Minister said earlier—and we agree with her—company boards should have more independent non-executives, in order to promote good corporate governance.

I said on Second Reading that, as Lord Hodgson pointed out in the other place,

    ''we are nearing the point when the only qualification for being a non-executive director is to know nothing about it.''—[Official Report, 7 September 2004; Vol. 424, c. 648.]

I shall talk about auditors later this morning, but our argument about capping the potential liability of directors remains compelling. Now that the consultation process is complete, the Government should do more to address it.

The Minister referred to the Equitable Life case. That case raises important questions for corporate governance. If non-executive directors are to remain personally liable for their decisions—decisions that are based on the best possible professional advice, or what they have every reason to believe is the best professional advice—what possible incentive is there to be a director of a large public company? For a successful business man, the fees are most unlikely to be adequate justification. The downside, with the loss of professional reputation and now the real risk of financial ruin, is too great.

I understand that head-hunters found clear evidence that certain people who should be non-executive directors of public companies—the Minister and I would entirely agree on what characteristics such people should have—are no longer willing to take on those risks. There may be no shortage of candidates, but good corporate governance depends on such people being the right type of candidate. I know of many well respected senior business men and women who have no intention of serving again on a public company board; the risks go way beyond any possible reward.

Faced with that much rehearsed and well understood problem, the DTI, with all its expertise and understanding, has given birth to this modest Bill. Thank goodness that the extent of any such liability has not yet been tested in the British courts. However, with a not dissimilar legal code, the Australian courts

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have found that the duty of care of a non-executive director is less than that of an executive director.

In passing, I should mention that the only case in which such an issue has been before the courts in the UK took place in the 19th century. At the age of six months, the Marquis of Bute was made a director of the Cardiff savings bank. He attended only one board meeting during his 30 years on the board—and as the court record showed, that was only because he happened to be in the area at the time. The Cardiff savings bank went bust, and in the ensuing legal proceedings the court determined that his culpability was less than that of an executive director.

If the Equitable Life case comes to court, it will undoubtedly have a significant effect on the future of corporate governance in Britain. Faced with such important issues, and with the Government's response in the new clauses, a high-flying executive will have little or no incentive to sit as a non-executive on a major public board. That is at the heart of our concerns about the Government's new clauses.

We welcome the proposals in so far as they make some difference to the cash-flow position of exposed directors. However, the wider issues that I have set out and to which the Minister referred have not been addressed, and they will have to be, in the interests of corporate governance. It is a pity that the Government have not taken the opportunity, if not to table new clauses to give effect to that requirement, at least to make clearer their determination to address a matter that is at the heart of good corporate governance in Britain.

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Prepared 14 September 2004