Second Standing Committee on Delegated Legislation

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Second Standing Committee on Delegated Legislation

The Committee consisted of the following Members:

Chairman:

Mr. Martin Caton

†Bacon, Mr. Richard (South Norfolk) (Con)
†Betts, Mr. Clive (Sheffield, Attercliffe) (Lab)
†Challen, Colin (Morley and Rothwell) (Lab)
†Clifton-Brown, Mr. Geoffrey (Cotswold) (Con)
Cox, Mr. Geoffrey (Torridge and West Devon) (Con)
Davidson, Mr. Ian (Glasgow, South-West) (Lab/Co-op)
†Dhanda, Mr. Parmjit (Gloucester) (Lab)
†Efford, Clive (Eltham) (Lab)
†Harris, Mr. Tom (Glasgow, South) (Lab)
†Hendry, Charles (Wealden) (Con)
†Holloway, Mr. Adam (Gravesham) (Con)
Lamb, Norman (North Norfolk) (LD)
†Laxton, Mr. Bob (Derby, North) (Lab)
†Michael, Alun (Minister for Industry and the Regions)
†Mole, Chris (Ipswich) (Lab)
†Reid, Mr. Alan (Argyll and Bute) (LD)
Ian Cameron, Committee Clerk

† attended the Committee

 
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Tuesday 21 June 2005

[Mr. Martin Caton in the Chair]

Draft Community Interest Company Regulations 2005

4.30 pm

The Minister for Industry and the Regions (Alun Michael): I beg to move,

That the Committee has considered the draft Community Interest Company Regulations 2005.

I start by welcoming the opportunity to sit under what I am sure will be your firm and fair chairmanship, Mr. Caton. I believe this is the first time that I have had that opportunity and I am sure that it will be illuminating to us all, as I hope the debate will be.

The Companies (Audit, Investigations and Community Enterprise) Act 2004 paved the way for community interest companies, The regulations before us are to be made under that Act. It might help hon. Members if I give a brief history before coming to the detail of the regulations.

It is fair to say that social enterprise has been frustratingly undervalued across Whitehall over the years, but that has now changed. The Department for Trade and Industry has contributed through support for the establishment of the Social Enterprise Coalition as an umbrella body for the sector, and by publishing a strategy for social enterprise in 2002. Also in that year, the strategy unit published a report entitled “Private action, public benefit”, which set out amongst other things, a proposal for community interest companies.

Social enterprises are often attracted to the company form because it is familiar, flexible and easy to set up. However, it has disadvantages: it is difficult to lock in assets for the benefit of the community; there is no automatic way to distinguish social enterprise companies from those set up purely to make profits for owners; and because social enterprise is still not widely understood in some quarters, there can be difficulty in raising finances.

That is why we are taking forward the strategy unit’s recommendation to create the community interest company, as well as its recommendations for improvements in the regime for industrial and provident societies, which provide another important vehicle for social enterprise. One should bear in mind that both models are enterprises—businesses that have to be businesslike and have to generate income. That is the heart of our approach.

The key characteristics of the community interest company under the Act are as follows. First, it has to pass the test that a reasonable person might consider that its activities are being conducted for the benefit of the community or a section of the community. Secondly, it is distinguished from other companies by
 
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having a name ending in “cic” or “community interest plc”, or their Welsh equivalents, rather than “Ltd” or “plc”. Thirdly, its memorandum and articles must contain certain provisions that in practice bring about the asset lock set out in the regulations. Fourthly, if it chooses to be a company limited by shares and to issue dividend-bearing shares, the dividend is subject to a cap, set initially in the regulations. Finally, it is subject to a regulator and must publish an annual community interest report.

Since the Act received Royal Assent last October, John Hanlon has been appointed as the regulator of community interest companies. He has a small office at Companies House in Cardiff, and is preparing to consider the first applications to form or to convert to a community interest company. As the regulator, he is also preparing guidance forms and model memorandums and articles, all of which will be published on his website. The DTI has also produced three factsheets on community interest companies, which are available in English and Welsh on the DTI website. Provided that the regulations are approved here today and by another place before 30 June, the legislation will come into force on 1 July, and the regulator expects to be ready to start to process applications from 25 July.

The 2004 Act sets out the basic elements of the community interest company, including the means of formation and the system of regulation, with a regulator and an appeal officer. However, this is a new type of company and experience is likely to develop over time, so it is sensible to put the detailed implementing provisions in secondary legislation. The regulations take account of the valuable comments that interested parties have made on the earlier drafts.

Part 1 of the regulations contains the standard provisions on citation, commencement and definitions. Part 2 deals with the community interest test and excluded companies. To avoid any argument about whether political activities benefit the community—we have in mind the activities of some extreme parties—regulation 6 excludes political parties from being or owning community interest companies. Regulation 3 adds to that exclusion by specifying that political activities are, for the purposes of community interest companies, not to be regarded as benefiting the community.

I stress that that is the case only for the purposes of the community interest company—I am sure that hon. Members agree that their own activities in politics are entirely for the benefit of the wider community. The definition in regulation 3 draws on the Political Parties, Elections and Referendums Act 2000. The purpose is simply to prevent any political organisation from using the community interest company form, because there are other, more suitable vehicles for political activity. The community interest company is intended specifically for social enterprise and we do not wish that purpose to be obscured or confused. Social enterprises can be involved in campaigning or lobbying, just as many charities are, and that is allowed, providing that the campaigning or lobbying is ancillary to their activities to benefit the community.

 
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Regulation 4 excludes a company with activities that benefit only the members of a particular body or the employees of a particular employer, because it does not pass the community interest test. Social enterprises are often described as having a double or triple bottom line. That means that, in addition to producing a financial return from their trading activities, they produce other benefits, for example, by creating jobs for people who would otherwise find it difficult or impossible to get work, or by improving the environment. Fair trade organisations are a good example of social enterprises. They import and sell produce but also provide additional benefits to third world farmers and their communities. Regulation 4 makes it clear that a company owned by its employees can be a community interest company provided that its activities pass the community interest test. It might employ people with disabilities or who are long-term unemployed, or provide socially valuable goods or services at affordable prices for people who would otherwise not have access to them.

I am sure that many hon. Members know of such organisations and see how the community interest company form might suit them in terms of local constituency interest. A sports club for the employees of one employer could become a community interest company by making its facilities available to the whole community, for example. In each case, the members of a particular body or the employees of a particular organisation clearly benefit, but the company’s activities also produce significant benefits for the wider community.

Regulation 5 defines the term “section of the community”. Regulations 7 to 10 in part 3 and schedules 1 to 3 deal with the special provisions that community interest companies must have in their memorandums and articles. To ensure that community interest companies continue to meet the community interest test, regulations 13 to 16 require the regulator’s approval for any change in the community interest company’s objects and for the company to publicise the proposed change before it is made.

Part 6, comprising regulations 17 to 25, deals with the cap on dividend payments, distribution of any residual assets on wind-up, and share redemptions, buy-backs and capital reduction, all of which are part of the asset lock. During consultation widely differing views were expressed on whether community interest companies should be allowed to pay dividends and if so, how those dividends might be capped to preserve the asset lock. Following advice from a group of experts on social enterprise and finance, we have set the cap initially in the regulations, rather than leave it to the regulator, because he has his hands full in preparing guidance and getting ready to start processing applications. He agreed that it would be difficult for him to consult and set a cap to come into effect with the regulations. The legislation allows the regulator to change the cap after consulting.

Following consultation, we have improved the regulations by creating a kind of double cap on dividends. The first cap is a limit expressed as a
 
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maximum percentage of the paid-up value of a share, which can be paid out each year. We set that at Bank of England base rate plus 5 per cent. Since the base rate is currently 4.75 per cent., the maximum dividend for a £1 share is 9.75p in a year. We would not want a community interest company to pay out all or most of its profits in dividends to financial investors, so we have added a second cap, which is that a community interest company may pay out no more than 35 per cent. of its distributable profits as dividends in a given year. We have given some examples of how the two caps will work in the notes on the draft regulations. We believe that that arrangement will allow community interest companies that wish to raise capital by issuing shares to pay a reasonable rate of return to investors and, at the same time, ensure that a substantial proportion of profits is retained in the business, or used for the community benefit. After all, community benefit is the whole point of having this company model.

Part 6 also sets a cap on debt with equity characteristics to prevent a community interest company from using a form of debt to get round the restrictions on share dividends. We have set the initial cap on such debt at base rate plus 4 per cent., reflecting a slightly lower risk on debt compared to equity.

Part 7, comprising regulations 26 to 29, deals with the annual community interest report, which is in addition to the normal accounts and directors’ report. The regulator will look at community interest reports, but the main value will be for employees or members of the community the company is intended to benefit. They will be able to compare the report with their experience of the company’s activities and, if the company is not complying with the law or living up to its own objectives, they will be able to alert the regulator who can investigate complaints. This part provides the information to enable a low-bureaucracy approach to ensuring that the objectives of this form of company are being achieved.

Part 8 sets out the specific powers of the regulator when he appoints a manager to run a community interest company, in what the Act calls the “default condition”, in circumstances where there has been misconduct or mismanagement and there is a need to protect the company’s property, or the company is failing to comply with the community interest test or to carry out its activities in pursuit of its community interest objects. These conditions are set out in section 41(3) of the Act. Regulations 30 to 33 deal with payments of managers, failure and removal, and allow the regulator to require regular reports.

Part 9 contains minor consequential amendments to the functions of the registrar of companies and part 10 and schedule 5 set out the fees for the regulator’s main activities, namely considering applications to form or convert to a community interest company and annual community interest reports. We have set each fee at £15.

 
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Finally, part 11 of the regulations sets out the requirements for bringing an appeal against any decision of the regulator. This is designed to be much simpler, quicker and cheaper for appellants than judicial review.

The regulations provide the necessary detail to get the community interest company system up and running. This will be a welcome addition to the legal forms available for social enterprises, which are already playing a valuable role by providing goods and services to many communities and which have the potential to do a great deal more. The regulations provide one tool in the toolbox of approaches available to those who want to undertake business activities that benefit the community. The asset lock provides assurance for those who form such a company that their intentions cannot be subverted, and the regulations seek to give form to that intention. I hope that the Committee agrees that we have designed the regulations appropriately to fit with the intentions of Parliament when the Act was passed.

4.43 pm

Charles Hendry (Wealden) (Con): Mr. Caton, I join the Minister in welcoming you to the Chair, Mr. Caton. It is a privilege to serve under your chairmanship.

I endorse some of the initial comments made by the Minister. I agree that the progress towards social enterprise has been, in his words, “frustratingly undervalued” and I am pleased that we are now seeing significant progress in that direction.

I should put on the record the fact that I have an interest as a trustee of the Big Issue Foundation, which is the charitable arm, not the trading arm, of The Big Issue. That is clearly the sort of organisation that would benefit from this sort of development.

We should pay tribute to the work of the Social Enterprise Coalition for the hard work that it has continually put in to raise the profile of the organisations involved in community interest work. It must be pleased that that work is approaching fruition.

I also agree with the Minister about the importance of the detailed provisions being made through secondary legislation. Clearly, the nature of such companies will evolve dramatically over time. If the regulations were set out in the Act, they could not be developed as is seen fit. The flexibility thus provided is entirely appropriate.

Although we can all agree on the general principle of community interest companies, the Conservatives have some general questions about how they will work and some concerns about the bureaucracy that might be involved, which could stifle the creation of such companies.

How many companies does the Minister estimate will be set up in this form and what indications of interest in setting up such companies has he received? He said that the regulator should be in a position to start accepting applications toward the end of next month, but, hopefully, he now has some indication of
 
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the likely number of applications. That is an important question, because people who might be interested in setting up such companies could be put off by the complexities of doing so. Anybody looking at the regulations could be forgiven for being confused. For example, regulation 4 states:

“For the purposes of the community interest test, an activity is to be treated as not being an activity which a reasonable person might consider is an activity carried on for the benefit of the community if, or to the extent that, a reasonable person might consider that that activity benefits only the members of a particular body or the employees of a particular employer.”

The Minister is a reasonable person, as I hope I am, but quite how he and I would understand that regulation remains to be seen.

Alun Michael: Will the hon. Gentleman acknowledge that the regulation is carefully phrased in legal terminology, as regulations have to be, and that the sentence that I used in my speech set it out in more simple language?

Charles Hendry: The Minister is, as always, a beacon of clarity, but some people will look through the legislation carefully to determine whether they should go down that route, and they might find it rather confusing. Indeed, the sort of people to whom it will apply often will not be top-notch business people who already run their own companies, but people who are involved in the voluntary and charitable sectors and see that route as a sensible way forward. They will be concerned that they might end up spending more money on legal and financial advisors than they are able to put into the community.

Others have expressed concerns about the value of the CIC approach and the scope for confusion. I imagine that the Minister is aware that the Co-operative Union said,

“we are not convinced that the CIC is sufficiently different from the IPS to be really necessary and are concerned that a proliferation of legal forms may confuse both the wider public and people wishing to set up a not-for-profit body or a social enterprise. The difficulties with the current legal forms”—

set out in the strategy unit report—

“could all be resolved by reform of IPS legislation.”

So there is concern about the approach. PricewaterhouseCoopers said:

“We acknowledge the current lack of a dedicated structure for the social enterprise and that the IPS legislation is outdated and overdue for reform. However we are concerned that the introduction of three new forms of entity”—

the CIC, charitable incorporated organisation and co-operative community benefit society—

“will cause increased confusion both within the sector and the general public . . . Specifically, we believe that there will be a widespread lack of understanding as to how a CIC differs from a Community Benefit Society or, indeed, from a CLG with objects beneficial to the community.”

There needs to be greater clarity as to how the regulations will work in practice.

Moving on to the detail of the regulations, my heart leapt with excitement when I read in part 2 about the sort of activities that can be carried on for the benefit of the community, specifically the sort of things that
 
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would not be considered as being for the benefit of the community. For example, regulation 3 talks at paragraph (1)(a)(i) about the promotion of

“any law applicable in Great Britain”,

and at paragraph (1)(a)(ii) about the policy adopted by any Government, and says that those activities would not be for the benefit of the community. I thought that was the end of spinning—the end of the Alastair Campbell era—but my excitement was a little premature because I realised, as I read on, that it did not refer to that sort of activity at all.

There are genuine questions to be answered. Paragraphs (1)(c)(i) and (ii) of regulation 3 refer to the fact that CICs cannot provide financial support for political campaigning. Will the Minister give us more information about the ground rules he has laid down for that? Does that relate to trade union activities? They might be specifically excluded, but it is important that we understand that. What happens if an organisation inadvertently strays into political activity or changes the way in which it operates? The Minister will be familiar with the way in which the Royal Society for the Prevention of Cruelty to Animals has changed its charitable role to become more of a campaigning organisation. If an organisation changes activities in that way, does it have to lose its CIC status?

Will the Minister also clarify what constitutes a “section of the community”? Regulation 3(5) states that a section must have “readily identifiable” characteristics that other members of the community “do not share”. What precisely does that mean? Could such characteristics be race, sex, age, religion, or sexual orientation? If so, how does that tie in with the aims of social inclusivity? Could an organisation exist specifically to help middle-aged white men? What about Masons? Are there rules that would prevent masonic organisations setting up CICs? Who would decide what groups can be included or not? If all that is to fall in the lap of the regulator, a substantial amount of work will be involved.

There are also issues relating to excluded companies in regulation 3(6), which are the same as those relating to political campaigning. Does the provision relate to trade unions? How much of a company’s activity could be connected with political campaigning? The Minister said that companies could have campaigning as a secondary aspect, but that provides insufficient clarity about how much political campaigning they could do. Specifically, would it be up to the regulator to tell them how far they can go? What would be the penalties for any CIC for overstepping what is permissible? We all understand that the sort of charitable organisations that might seek to set up this sort of business will often seek to do some form of campaigning. A CIC might, for example, want to brief Members of Parliament on the sort of work it is doing, but, in the course of that, it might call for a change in certain laws. From what the Minister said, I assume that that is acceptable, but how far can companies go in campaigning?

 
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On part 3, which relates to the memorandum and articles, how do the regulations differ from those relating to the responsibilities of other limited companies? What specific benefit will a CIC receive from its status? We need to be certain whether directors of a CIC have the same legal liabilities and responsibilities as directors of other public companies. It is not clear whether they have additional benefits or whether they simply have additional responsibilities in terms of fulfilling the regulator’s requirements. The Institute of Chartered Accountants in England and Wales said:

“It would be pointless if the new entity were much the same as a company, but with more rules”.

What penalties were there be for not sending in required documents at the required time? Would there be a warning? Would people be struck off? Would they be fined? Would it lead to imprisonment? We need greater clarity about the punishments that could be applied. The same issues also apply to other parts of the regulations. Overall, they are very complicated, and directors need to feel sure that they are clear about the penalties that might be imposed upon them if they inadvertently make a mistake.

More generally, the regulations do not give us much greater understanding about the extent of the regulator’s powers. Will the Minister give us more information on that, particularly information about how large the regulator’s office will be? He has told us where it is are being set up and its name, but what how large will it be? The answer would give us a clearer understanding of how actively involved the regulator will be on a day-to-day basis in examining the activities of companies. Our overriding concern is about the extent of the bureaucracy that is being set up. What steps has the Minister taken to ensure that the cost of adhering to the regulations is as low as possible? What consultation has been carried out before announcing the details of the regulations?

More generally, in discussing the concept of community interest companies, we must be clear that they should not reduce the legitimacy of current forms of social enterprise. The Development Trusts Association said:

“It is very important that the new CICs should not reduce the legitimacy of current forms or become the only recognised form of social/community enterprises. The launch and marketing of the CIC will need to be carefully handled in order to avoid misconceptions around preferential treatment for CICs by grant makers and investors.”

In view of the likely confusion that will occur as a result of the new legal framework, what plans do the Government have to ensure that the social enterprise, charitable and not-for-profit sector is fully informed of the options open to it and how they will impact on particular organisations? Will there be a web portal or information office? How will the new framework be communicated to the sector? Where can organisations seek independent advice on the best framework for them?

I realise that I have put a substantial number of questions to the Minister and that he might not have the answers to all of them today. I should be grateful if he addressed at least some of them and replied to me
 
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in writing about the others. In general, we welcome this approach, but we must be careful that the extent of regulation does not stifle potential enterprise in an area that we are all keen to see develop.

4.55 pm

Mr. Alan Reid (Argyll and Bute) (LD): I join other Committee members in welcoming you to the Chair, Mr. Caton. I am pleased to serve under your chairmanship for the first time.

The Liberal Democrats have had a historical commitment to co-operative and mutual structures, so we welcomed the Companies (Audit, Investigations and Community Enterprise) Act 2004, which allowed CICs to be set up, and today we also broadly welcome the regulations that will allow the CICs to be established.

I have a few comments to make, however. I share the concern of the hon. Member for Wealden (Charles Hendry) about the complication of the regulations. I accept what the Minister said: regulations have to be written in concise legal language that will stand up to challenge in a court. However, we should remember that most of the people involved in setting up CICs will come from the voluntary sector and will not be able to hire expensive solicitors to interpret the legislation for them. I hope that the Government will—either themselves, or through the regulator—make available explanatory leaflets so that people who are considering setting up a CIC will be able to access free advice. I also hope that the regulator’s office will be adequately resourced and that as well as acting as adjudicator, it will be able to answer queries and offer advice to people considering setting up CICs.

Committee members have referred to regulation 3, which prevents political activity, although allows it if it is ancillary to the main activities of the CIC. Again, the regulation has been written in very complicated language. I put a scenario to the Minister. Say, for example, a CIC was set up to build and run a village hall and it applied to the council for a grant. One political party on the council was supportive of the grant and another was against it. Would the village hall CIC be in breach of the regulations if it campaigned for the council to give it a grant?

Page 2 of the regulations gives definitions, and there is a definition of an “asset-locked body”—one whereby the CIC would be allowed to transfer assets for less than full consideration—as

“a community interest company, charity or Scottish charity; or a body established outside Great Britain that is equivalent to any of those persons”.

Given that the regulations apply only to Great Britain, that would mean that the asset-locked body could be anywhere. However, under schedule 1, the asset-locked body is defined as

“a community interest company, charity or Scottish charity; or a body established outside the United Kingdom”.

“Outside the United Kingdom” would appear to exclude Northern Irish bodies as bodies to which assets could be transferred for less than full
 
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consideration. Will the Minister explain why Great Britain is in one definition and the United Kingdom is in the other?

I should also like to draw the Minister’s attention to the fact that the Scottish Parliament has just passed the Charities and Trustee Investment (Scotland) Bill. That means that the office of the Scottish charity register must keep a register of charities. For bodies to be known as charities, they have to be on that register. Paragraph 1(4)(e) on page 18 of the regulations states that

“‘Scottish charity’ has the meaning given by section 1(7) of the Law Reform (Miscellaneous Provisions)(Scotland) Act 1990”.

That Act gives the commissioners of the Inland Revenue the authority to recognise a body, which is then entitled to describe itself as a Scottish charity.

However, that power has been removed by the Charities and Trustee Investment (Scotland) Bill, which has been passed but is not in effect—it is up to a Scottish Minister to determine when that happens. Will the Minister consider the implications of that Bill? It would be simpler if legislation defined a Scottish charity as one that is on the register of Scottish charities. That does not need to be done straight away, but it would have to be done before the Scottish Ministers brought the recent Bill into effect.

5 pm

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Prepared 23 June 2005