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Session 2005 - 06
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Standing Committee Debates
Company Law Reform Bill [Lords]

Company Law Reform Bill [Lords]

The Committee consisted of the following Members:

Chairmen: Mr. Eric Illsley, John Bercow
Baird, Vera (Parliamentary Under-Secretary of State for Constitutional Affairs)
Blunt, Mr. Crispin (Reigate) (Con)
Brokenshire, James (Hornchurch) (Con)
Burt, Lorely (Solihull) (LD)
Davies, Mr. Quentin (Grantham and Stamford) (Con)
Djanogly, Mr. Jonathan (Huntingdon) (Con)
Ellman, Mrs. Louise (Liverpool, Riverside) (Lab/Co-op)
Ennis, Jeff (Barnsley, East and Mexborough) (Lab)
Farrelly, Paul (Newcastle-under-Lyme) (Lab)
Greening, Justine (Putney) (Con)
Hall, Patrick (Bedford) (Lab)
Hodge, Margaret (Minister for Industry and the Regions)
Howarth, David (Cambridge) (LD)
Hunter, Mark (Cheadle) (LD)
Jones, Mr. David (Clwyd, West) (Con)
Joyce, Mr. Eric (Falkirk) (Lab)
McCabe, Steve (Birmingham, Hall Green) (Lab)
O'Brien, Mr. Mike (Solicitor-General)
Palmer, Dr. Nick (Broxtowe) (Lab)
Singh, Mr. Marsha (Bradford, West) (Lab)
Ussher, Kitty (Burnley) (Lab)
Vara, Mr. Shailesh (North-West Cambridgeshire) (Con)
Vaz, Keith (Leicester, East) (Lab)
Alan Sandall, Committee Clerk
† attended the Committee

Standing Committee D

Thursday 13 July 2006


[Mr. Eric Illsley in the Chair]

Company Law Reform Bill [Lords]

9 am
Mr. Jonathan Djanogly (Huntingdon) (Con): On a point of order, Mr. Illsley. A few Government proposals have been tabled this morning, so we are now up to new clause 436. It is worth spending some time talking about that. We should put it on the record that we are delighted that this Bill is being consolidated—the Conservative party argued for that from day one—and we are pleased that the Government have changed their mind and decided to consolidate.
The Chairman: Order. That is not a point of order for the Chair.
Mr. Djanogly: I shall come directly to my point, Mr. Illsley. Although we are happy that these proposals have been tabled, they have been tabled very late, so we will not be able to consider them in Committee. I want to put that on the record and to ask whether you have any views on the matter.
The Minister for Industry and the Regions (Margaret Hodge): Further to that point of order, Mr. Illsley. I hope that I am in order, and no doubt you will stop me if I am not. I had informal discussions outside the Committee about the tabling of these consolidation amendments with Conservative and Liberal Democrat colleagues. We agreed informally that there is clearly not time to give detailed consideration to these new clauses in Committee and said that we would share them with professionals, particularly the Law Society. We have shared them with all members of the Committee.
I am prepared to meet Opposition Members during the recess if necessary to consider whether any amendments are required, which we would then table on Report. If that does not work, we will clearly not be able to proceed with this further consolidation.
Mr. Djanogly: Further to that point of order, Mr. Illsley. That is the reality of where we are. It should be put on record that we are in the closing stages of consideration in Committee, following consideration in the House of Lords, and that this is a late stage to table 430 new clauses.
Margaret Hodge: Further to that point of order, Mr. Illsley. These proposals are being added at the express desire of Members of the House of the Lords, particularly Conservative peers, and some Labour peers too. We are trying to meet their views and, most importantly, to ensure that we provide an Act that serves its purpose. If Opposition Members do not wish to co-operate with a procedure that is forced upon us in this way—
Mr. Djanogly: You forced it upon us.
Margaret Hodge: No. That is not true. The consolidation in the Bill of those proposals from other legislation is at the direct request of Opposition Members in the House of Lords. We are responding to that. Clearly, there needs to be co-operation from all members of the Committee and from all hon. Members if we are to consolidate the Bill. That is why I have offered informal meetings during the summer recess to discuss any issues that Opposition Members may wish to raise and why I have said that if amendments are required we will table them on Report.
If hon. Members do not wish to co-operate in the procedure that is before us as a result of a request from Opposition Members in the House of Lords, we will have no option but to withdraw the 400 new clauses.
The Chairman: The hon. Member for Huntingdon (Mr. Djanogly) has made his point, but it is not in the hands of the Chair to respond to it. The timetabling of the Bill is in the hands of the Government, and we are bound by the programme order, which has been agreed to.

Clause 217

Provision of insurance
Mr. Djanogly: I beg to move amendment No. 460, in clause 217, page 99, line 2, at end add—
‘( ) The cost of any excess under an insurance policy permitted to be purchased under this section may be paid for by a company or associated company, provided that it does not exceed £5,000’.
We are discussing the clauses in chapter 7 of part 10 that deal with provisions protecting directors from liability. Clause 217 permits a company to take out and maintain insurance for a director against any liability referred to in clause 216(2), the scope of which we argued in our previous sitting should be broadened. However, if excess is provided for under an insurance policy, it is logical for a company to be permitted to meet the cost, provided that it does not exceed a reasonable amount, given that the existence of an excess normally reduces the premium payable by a company.
The amendment would enable a company to meet that cost under an insurance policy that it is permitted to take out under clause 217. On a probing basis, we suggest that the provision should encompass an excess sum of less than £5,000.
The Solicitor-General (Mr. Mike O'Brien): This is not an unreasonable amendment and we accept that it states a modest face value. It also picks up a recommendation made in the company law review. However, in the light of the major reforms introduced in the Companies (Audit, Investigations and Community Enterprise) Act 2004, we do not feel able to accept it. It is preferable to keep to the basic principles that underline the chapter.
If a director’s liability is to a third party, the company will in most cases be able to indemnify him. However, if the liability is to the company itself, it would be wrong in principle for the company to indemnify the director, even if the amount involved was relatively modest, as I accept the proposed amount is.
The Companies Act 1985 permits companies to indemnify directors against most liabilities to third parties, including shareholders who bring a class action, or to pay a director’s legal costs up front, providing that the director repays any loans, discharges or other liability to the company if he is convicted in criminal proceedings or judgments are made against him in civil proceedings brought by the company or an associated company. It should be clear that companies are already permitted to indemnify directors in a wide range of circumstances.
It is, however, necessary to draw some lines in the sand. Those lines are drawn in the right places in the 2004 Act and in the Bill. The hon. Gentleman’s point is not unreasonable, but we have taken the view that this is a matter of principle. I hope he accepts that that is probably the best way to proceed.
Mr. Djanogly: I thank the Solicitor-General for his consideration of my points, although I am not entirely sure that I agree with his point of policy. When excesses are involved, insurance costs can generally be reduced, so we thought that the amendment would be attractive. However, I have heard what he has to say, and I beg to ask leave to withdraw the amendment.
Amendment, by leave, withdrawn.
Clause 217 ordered to stand part of the Bill.
Clause 218 ordered to stand part of the Bill.

Clause 219

Qualifying third party indemnity provision to be disclosed in directors’ report
Amendments made: No. 303, in clause 219, page 99, line 43, leave out from ‘disclosure’ to end of line 44 and insert
‘in the directors’ report of—
(a) qualifying third party indemnity provision, and
(b) qualifying pension scheme indemnity provision.
Such provision is referred to in this section as “qualifying indemnity provision”.’.
No. 304, in clause 219, page 100, line 1, leave out ‘third party’.
No. 305, in clause 219, page 100, line 9, leave out ‘third party’.—[Mr. Mike O’Brien.]
Clause 219, as amended, ordered to stand part of the Bill.

Clause 220

Copy of qualifying third party indemnity provision to be available for inspection
Amendments made: No. 306, in clause 220, page 100, line 19, leave out ‘third party’.
No. 307, in clause 220, page 100, line 27, leave out ‘third party’.
No. 308, in clause 220, page 101, line 5, leave out ‘third party’.
No. 309, in clause 220, page 101, line 6, at end insert—
‘( ) In this section “qualifying indemnity provision” means—
(a) qualifying third party indemnity provision, and
(b) qualifying pension scheme indemnity provision.’.—[Mr. Mike O'Brien.]
Clause 220, as amended, ordered to stand part of the Bill.
Clause 221 ordered to stand part of the Bill.

Clause 222

Ratification of acts of directors
Mr. Djanogly: I beg to move amendment No. 423, in clause 222, page 101, line 34, leave out subsections (3) and (4).
The Chairman: With this it will be convenient to discuss amendment No. 424, in clause 222, page 101, line 35, leave out
‘nor any member connected with him’.
Mr. Djanogly: We move on to clause 222 dealing with the changes to the law on ratification, and one of our main concerns about chapter 7 and directors’ liabilities. The clause preserves mostly the current law on ratification of acts of directors, but with one significant change. Under the Bill, any decision by a company to ratify
“conduct by a director amounting to negligence, default, breach of duty or breach of trust in relation to the company...must be taken by the members”
without reliance on the votes in favour by the director or any connected person.
We accept what many lawyers are saying: the changes to the law on ratification advance the existing common law position which allows the ratification of the director’s breach of duty by ordinary resolution and which does not disregard the votes of any one person interested in the ratification. The advance on the common law position will place a significant restriction on the actions of directors, make it more difficult to achieve the majority required for ratification, and might lead to an increase in the number of derivative actions taken against company directors.
For instance, what if the majority of shares in a company are held by directors, which is the norm for smaller family-type companies? In such a situation, their votes will be disregarded for ratification purposes, giving much more power to small shareholders, who will then have leverage over the owners, which will not necessarily serve the best interests of the company. What if the minority shareholder owns say only 1 per cent. of the company? Should they still have that veto over ratification?
We have tabled amendment No. 423 to delete subsection (4) and the provisions barring interested parties from voting. However, if the provision remains, would the Minister consider a threshold so that a small minority of shareholders cannot hold the majority to ransom?
Furthermore, I note that subsection (3) stops connected members voting as well. We find that provision worrying also. Surely, connected members still have rights as individual shareholders and should be treated as such, rather than as relatives. If they see it as in the interests of the company to ratify actions, why should the fact that they are a relative of a director mean that they cannot vote? We have tabled amendment No. 424 to deal with that important issue.
I wish to put on the record a letter from Stephen Hancock of Herbert Smith to the Attorney-General on 8 June 2006—it was copied to me and to Lord Sharman. It reads:
“Dear Attorney General
I should like to raise with you concerns I have with provisions contained in the Company Law Reform Bill addressing derivative actions and, in particular, with the new clause 222, dealing with ratification.
On any view the proposal to overturn the rule in Pavlides v Jensen is a major step and potentially undermines two cardinal principles of company law - that companies are run in the interests of shareholders as a whole, and majority rule. In my younger days I acted for many arbitrageurs and hedge funds. It is my view that the existence of this rule is one of the principal reasons why we do not have greenmail problem in this country. If the bill in its current form becomes law we may well start to experience the sort of secretly-settled derivative actions which have plagued other jurisdictions, especially in light of the company court's indulgent attitude to costs awards in company cases. Of course, that risk would be reduced if the court's consent were to be required for the settlement or discontinuance of any derivative action which it has permitted.
Derivative actions should benefit all shareholders and as I have said majority rule is a cardinal principle in our company law. It is important that the objective business judgement of majority shareholders, expressed by means of a ratification resolution, should be allowed to prevail to bar derivative proceedings brought alleging neglect or default on the part of directors. In this regard, it seemed to me that the provision in the earlier draft of the bill (clause 217) rendering ineligible the votes of members with a personal interest (perhaps because of an interest in the counterparty to a transaction complained of) was enough to ensure that ratification was done objectively by disinterested shareholders. However, the new clause 222, which would disregard the votes given by any shareholder connected with a director, does something different.
To begin with, I should like to make two comments on what you said when introducing the new provision. First, although the concept of connected persons will be familiar to directors in the context of disclosure of shareholder interests (usually but a minor irritation) it is quite a different matter to use it in the context of disenfranchisement. Secondly, it was unfortunate that you should seek to justify stripping such a connected person of his property (that is, his voting rights) by suggesting that he is likely to be biased or in some way under the influence of wrongdoers.
There are many companies whose shares are publicly traded and who have controlling investors. Naturally, in such cases among the directors of the publicly traded company will frequently be individuals connected with the controllers, for example a director who is also a trustee of an ultimately controlling family or charitable trust. If the new wording were to become law such controlling shareholders would be disenfranchised on a ratification vote to approve a business decision (perhaps an investment or disinvestment) which is challenged as negligent and reduced to having their views taken into account by the court when considering, in its discretion, whether to permit the derivative action. Surely bringing business judgement to bear on such questions is precisely what shareholding control should be about. Why should such a shareholder have less of a say on such a matter than an arbitrageur or hedge fund investor?
I would respectfully suggest that it would be sufficient in such a case to ensure that all shareholders whose votes in favour of ratification are to be counted have no special personal interest in the matter. This should meet the point debated between you and Colin Sharman. Clause 222 goes much further than, as you yourself put it, capturing ‘...those members who are motivated or influenced by personal advantage or gain arising from a vote in favour of ratification.’”
9.15 am
That very balanced, insightful letter deserves consideration. It did not arrive in time for us to table amendments to reflect Mr. Hancock’s suggestion that only those who have the advantage of a personal interest should be barred from voting rather than what is proposed in the clause, which takes an indiscriminate, blunt approach. The Minister may wish to comment on Mr. Hancock’s suggestion.
We need to get the clause right. If we do not, it could further hamper the aim of making the UK a more business friendly environment. By widening the scope for derivative actions on one hand and reducing the possibility of the directors ratifying their actions on the other, the Government will make it less likely that many talented and able people will come forward to act as company directors. We hope that the Solicitor-General will think again about the matter.
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Prepared 14 July 2006