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Company Law Reform Bill: Directors Duties

11th July 2006

Will directors have to take on more liabilities?

Mr. Djanogly: I shall speak to amendments Nos. 40, 39, 166, 41, 42, 43, 165, 417 and new clause 1. The issue of directors' duties is the area of the Bill that has courted the most controversy. It is also the issue that, rightly or wrongly, has political as much as financial or administrative implications. I do not believe that the Government really wanted that, but gradually over the last few years, they have dug themselves into a hole on these provisions and they are now finding it difficult to extricate themselves.

In another place during the later stages of consideration of the Bill, Lords Hodgson and Freeman introduced amendments that would have removed the six considerations to which a director must have regard under the clause and returned the position towards the existing common law. The Government rejected that outright, so we have had to make a basic choice here. Do I just stand here today and say the same things as we said in the Lords and get another negative answer, or do I attempt a more constructive approach as to how the provisions could be improved? I shall take the latter route, although the issues are not straightforward and we reserve our position on this, depending on the Government's approach.

These mainly probing amendments therefore initiate debate on how to improve the drafting to take account of the still widespread concerns throughout the legal and business communities, which can be seen on the pages of most of the financial press, including The Economist and the Financial Times, which have both attacked the clause.

We have six primary concerns with this part of the Bill. The first involves the technical problems arising from the codification of the existing common law duties in statute. The second is over the seemingly random choice of factors and duties that a director must consider; these new duties could cloud the directors' paramount duty to look after the best interests of the company. The third is over the confusing new language that the Government have introduced and how it will be interpreted.

Our fourth concern is that the clause has been inserted as an offering to various, albeit often worthy, different agendas when those issues could be more effectively advanced by means other than distorting what is essentially a legislative framework built for companies. There is also the fear that over-regulation will make this country less able to compete in the global marketplace. Finally, we think it would be a great pity if this country went down the route of over-regulation that has been taken in recent times in the United States with Sarbanes-Oxley, which results in companies being driven overseas. That is a real fear.

I shall deal first with codification of the common law. Part 10 of the Bill aims to codify existing common law principles relating to the responsibilities of directors. That has led to vociferous and growing complaints from across the legal and business communities that this could cause company law to be dramatically altered for the worst. Historically, judges have had the discretion to deal with complicated issues relating to directors' duties case by case. That system has been adaptable and effective in dealing with cases that are often complicated and highly technical.

The existing duties found in common law rules and equitable principles, which have been built up in the courts over the years, are to be replaced by the statutory statement in part 10. A flexible system is to be replaced with an inflexible one.

As my noble Friend Lord Freeman pointed out in the Lords, there is an inherent danger in cross-referring to case law but not defining it-a situation he aptly described as a minefield. On the one hand, the Government have said that there will be no change in the common law position, but, on the other, they have introduced the concept of enlightened shareholder value, which all experts seem to agree will alter the common law position on directors acting in the best interests of their company. That is no better illustrated than by a letter sent to me by the Minister herself on 9 June, in which she wrote:

"We had two main intentions in introducing a statutory statement of directors' duties.

First, it will provide much greater clarity on what is expected of directors and make the law more accessible. The duties are at the moment found in case law-that is, decisions in individual court cases over the years-rather than in the Companies Act. Many directors are understandably unaware of, or unclear about, what their duties are, and we want to address this both through the Bill and through non-statutory guidance.

Secondly, it enshrines in statute a concept called 'Enlightened Shareholder Value'. This recognises that directors will be more likely to achieve long-term sustainable success for the benefit of their shareholders if their companies behave responsibly. Directors will therefore be required to promote the success of the company in the collective best interests of shareholders, but must in doing so have regard to wider factors such as the interests of employees and the environment."

There is a fundamental gap in the Government's train of thought: either they are introducing a new concept called enlightened shareholder value, an extension of the common law, or they are simply codifying existing common law. I hope that the Minister makes clear which course they are taking.

From our consultations on the Bill with many interested parties, the position seems clear. If the audience is business oriented, the Government's message is, "Don't worry, nothing is going to change. This is only a restatement of the common law position." If the audience is a campaigning body, the tactics change and the emphasis is on explaining how the concept of enlightened shareholder value will change things.

The Chairman: Order. The hon. Member for Montgomeryshire (Lembit Öpik) cannot come within the curtilage of the Committee. Would he care to leave? [Interruption.] I am sorry, but he really cannot come into the curtilage of the Committee during its consideration of the Bill.

Mr. Djanogly: We may examine what the Government's supporters believe they are doing. I refer to the TUC briefing of 6 June, which says:

"The TUC supports codification of directors' duties, and considers that putting them into statute is the best way of ensuring clarity on what is expected of directors and giving the duties prominence in the eyes of directors and stakeholders."

It goes on to say:

"Making an explicit link between the success of the company and the interests of employees and the other matters for consideration listed in clause 158, and making it clear that directors should have regard to these matters, is a significant step that the TUC welcomes. Backed up by clear and comprehensive guidance and reporting requirements, the TUC hopes that clause 158 will contribute to raising standards of corporate behaviour."

The Opposition have no problem with, and indeed support, many of the good intentions voiced by the Government whenever they talk about enlightened shareholder value. However, in the context of sound law, such intentions can easily slip into meaningless platitudes. That is reflected in the Association of British Insurers paper of 14 June 2006, which states:

"These clauses propose that the general duties owed by directors to their company will be set out in statute reflecting the 'enlightened shareholder value' approach, which recognises that boards need to take account of the impact on the company of non-financial social, environmental and ethical issues.

The ABI supports the 'enlightened shareholder value' approach. We have nevertheless had concerns that codification might lead to a compliance-driven approach to the exercise of directors' duties rather than one based on the making of good-faith judgments. This could lead directors to take expensive and time-consuming legal advice, impair efficient decision-making and add an unnecessary layer of bureaucracy to board practices. Codification of directors' duties would not then achieve its goal of greater transparency and accountability, but instead create new uncertainties and larger administrative burden. The ABI welcomes the efforts made by the Government at the time of the House of Lords deliberations to amend the Bill to lessen these risks. However, we consider this remains an area where further Parliamentary scrutiny is necessary."

The Law Society's June briefing says:

"The Law Society doubts that the savings for business which the Government anticipates will be achieved. On the contrary, the new provisions on directors' duties will result in new uncertainty, increased legal costs and additional bureaucracy.

In particular, the Law Society believes that the new code is inflexible-at present, the courts have considerable freedom to develop the law on directors' duties to suit changing needs and expectations and in practice the code will not be more accessible than common law rules, as its meaning will over time become less and less clear to a reader who does not also understand how it has been interpreted and applied by the courts."

Clearly, although the Government protest that they are not changing the common law position, they are in fact doing just that. That will lead only to confusion where there should be clarity. Also, and in some ways even less helpfully, the clause could impede the development of common law.

The six factors in clause 158(1)(a) to (f), to which the director must have regard, seem arbitrary. It has been calculated that directors have had some 650 duties laid down through the common law and various statutes over the years. Why have those six been deemed more important than the other 640-odd? We recognise that putting those duties in one format will give clarity to company directors. That is why we supported the Law Society proposal to publish a non-statutory guide to directors' duties. The Government have said that they intend also to give non-statutory guidance to directors, but have not yet done so.

We support fully an official guide to the roles and responsibilities of directors, and have tabled amendment No. 417 to have that requirement set out in the Bill. The duties, roles and responsibilities that directors of UK companies face are great and myriad. The Institute of Directors published a helpful guide to directors' duties, responsibilities and liabilities called "The Director's Handbook". It was endorsed warmly by none other than the ex-Secretary of State, who now has responsibility for the Department for Education and Skills and who called it a

"valuable and reliable source of information and guidance."

Do the Government consider it adequate for an area of business law that can fill an entire book to be set out in six lines of statute?

The Bill contains heavily edited common law duties. I believe that we should give some consideration to those roles, duties, responsibilities and liabilities that the Government do not consider important enough to be enshrined in statute. Why have they not been included in the clause? For example, here are a small number of common law directors' duties that the Government have not included in that list-the Minister might like to explain why she does not consider each duty worthy of codification in statute: duty to act for proper purposes; duty to prepare true and fair accounts; duty not to make secret profits; duty not to act ultra vires; duty to supervise the discharge of delegated functions; duty to pass on relevant information; duty of mutual trust and confidence; duty to ensure that undertakings are complied with; and duty not to profit from their position without approval.

David Howarth (Cambridge) (LD): I am not sure about all the duties to which the hon. Gentleman has referred-he might be right about some of them-but surely they are covered by the duties to

"act in accordance with the company's constitution"

and to

"only exercise powers for the purposes for which they are conferred",

as set out in clause 157, which we have just passed.

Mr. Djanogly: They are but, as the hon. Gentleman will remember, we had problems with how those were set down. Furthermore, the statute differs from the common law position. By the way, that is relevant to a further clause that we will come on to in part 10.

To continue the list, duty to declare an interest in contracts; duty to account to company for property under control; duty to attend board meetings-directors have a general duty to attend board meetings, but do not need to attend every one; duty to account for profits while taking advantage of his position as director; duty to exercise reasonable care and skill while carrying out his duties; duty not to oppress minority shareholders; and duty not to abuse powers, including powers to issue shares for not the right purpose.

I have set out a few of the extra duties, but there are hundreds more. For example, there are a number of insolvency-related duties that the Government have chosen to exclude from the provisions, as well as the duty to consider the interests of creditors above those of members, to take steps to avoid loss to creditors, and not to enter into transactions at an undervalue or make preferences.

10.45 am

The factors to which directors must have regard relate to many responsibilities to which directors must already have regard, such as environmental concerns, as set out in statute. In some cases, the Government are weakening directors' existing statutory duties. That is particularly the case with the introduction of clause 158(1)(b), which states that they should have regard to

"the interests of the company's employees",

and the removal of the section 309 in the Companies Act 1985. That waters down the provisions in the 1985 Act which deal with employees and it could be detrimental to the interests of employees. That is why the first amendment we tabled was new clause 1, which aimed to reintroduce the existing employee protection language. Although the Government have taken some of the more fashionable responsibilities already imposed on directors by statute or common law, they have curiously chosen to ignore others.

Why, for example, have the Government chosen to ignore the health and safety duties to which a director must have regard? Why are they not included? I am not saying that they or any others should be, but I am asking why, using the Government's rationale, they are not listed in the clause. The possibility of corporate manslaughter is a hugely serious and important issue of which all directors should be aware.

Patrick Hall (Bedford) (Lab): Is the hon. Gentleman suggesting that the clause as drafted abolishes other statutes and wipes out centuries of common law?

Mr. Djanogly: I am saying that clause 158 abolishes some statutes that place duties on directors-for instance, employees' rights-and, in other cases, wipes out or amends the common law position. However, more importantly, it raises certain common law rights above others by placing them in the Bill. If the Government are saying that one common law right is not more important than another common law right, why are they only choosing six? That is the core of my argument.

If the Government consider health and safety to be important, will the Minister explain how a director new to his job is meant to know from the Bill as drafted that he should be aware of the importance of health and safety while making a decision? He could reasonably presume that as environmental issues have been included, the Government have incorporated all the statutory duties necessary. That is more confusing than enlightening.

Competition law is another thing that the Government have chosen to ignore. Directors can be held personally liable for breaches of EC and UK competition law. A director who is found guilty of participating in a so-called cartel offence can be disqualified from acting as a director for up to 15 years. A director who is found guilty of dishonestly agreeing to take part in hardcore anti-competitive activities in the UK can face imprisonment, but the Government have come to the conclusion that a breach of competition law is not worth mentioning above the impact of the company's operations on the community.

The Government will no doubt say that those glaring gaps in the Bill as drafted are covered by the law as it exists and, possibly, that the duties could be addressed by non-statutory guidance.

The Minister for Industry and the Regions (Margaret Hodge): I have listened to the hon. Gentleman for some time as he takes us on a complete journey through various duties which, as my hon. Friend said, are perfectly adequately expressed either in the Bill or in other legislation. Will the hon. Gentleman come to the point? Do the Conservatives support a concept of enlightened shareholder value? If so, what is wrong with having the need to have regard to those factors-whether it is the community, employees or environment-set out in clause 158(1)(a) to (f), in pursuit of the interests of the business?

Will the hon. Gentleman get to the kernel of the argument? Does his party support us having a wider view of business interests, or does that apply only to his leader? Does the hon. Gentleman have the narrow, traditional view of business interests which was articulated before the clause appeared in any legislation?

Mr. Djanogly: The Minister goes into my party's wider beliefs on corporate social responsibility. I shall come on to that. The kernel of my point is that the six common law responsibilities set out in the Bill are a statement of fashion rather than law.

Margaret Hodge: Will the hon. Gentleman give way?

Mr. Djanogly: No, if I can just finish my point. I am making the case that out of the hundreds of items that the Government could have chosen, they have decided to include only six items to which directors must have regard. They maintain that that somehow clarifies the position, but I maintain that they are doing the exact opposite.

Margaret Hodge: I shall allow the hon. Gentleman to continue after this comment.

James Brokenshire (Hornchurch) (Con): Very decent of the Minister.

Margaret Hodge: I am trying to get the hon. Member for Huntingdon (Mr. Djanogly) to the point rather than wasting our time. He is saying that it is a matter of fashion and nothing else that we should ask companies to have regard to the interests of the community and the environment as they promote the success of their company in good faith.

Mr. Djanogly: What I am saying to the right hon. Lady is that she must justify the clause to the Committee, businesses and the mainstream media, which described the clause as containing "platitudes". She must explain why she has chosen those six duties as opposed to some of the hundreds of others. We think that it will lead to even more confusion.

Are the duties and responsibilities outlined in the non-statutory guide less important than those in statute? If they are equally important, as the examples that I quoted show, why have they not been included? We are not arguing that all directors' common law duties should be put into statute. That would be nonsensical, particularly as common law duties are being advanced all the time. However, our probing amendments Nos. 39 and 41 would oblige company directors to consider all other common law directors' duties. A non-statutory guide, as provided for in amendment No. 417, could then give directors guidance on those duties without it being enshrined in statute. Clearly, the Government have considered that, as they chopped up and inserted bits into the clause at earlier stages.

The Minister might believe that the words "amongst other matters" in subsection (1) cover that concern. However, we do not accept that that is adequate, which is why we wish to assert our point in greater detail. At the moment, however, the Government's choice of listed duties in the clause puts fashion over the need for good law. That is a poor basis on which to make law. For instance, what happens when fashion changes?

David Howarth: The hon. Gentleman's point about the clause is that it is a change, and I think that we should debate it on the basis that it is a new law. However, I do not think that his other point about the other clause is well made. In the case of Benfield Greig, the judges described the Law Commission's draft of the duties as amply supported by authority. His other point seems to be based on breaking down the duties into more and more sub-duties, but it seems to me that they are all at least plausibly covered by the Bill, apart from in clause 158.

Mr. Djanogly: There is an argument about whether the clauses are adequate. However, I am making the wider point that the clause does not adequately cover the existing legal position.

In May 2006, a Financial Times lead article entitled "A Missed Opportunity" said:

"The stated aim was to make directors' duties clearer and more up-to-date. The reality is a confused list that mixes platitudes with necessary duties...the government's approach betrays an underlying mistrust of business."

That problem has prompted serious concerns from the legal profession. A host of major corporate law firms that will have the job of interpreting the clause told us that the rigid list in clause 158(1)(a) to (f) might artificially constrain the decision-making process and provide inappropriate challenges to the way in which directors exercise their discretion.

Again, on 9 May, an article in the Financial Times stated:

"The Company Law Reform Bill...requires boards to consider the effects of their decisions on employees, customers, the environment and local communities, as well as document the process.

The in-house counsel and independent legal experts say such requirements are impractical and will make decision-making more cumbersome and fraught.

Peter Kennerley, a member of the GC 100 group, which represents in-house corporate lawyers, said the bill's provisions could encourage lawsuits from pressure groups, investors and industrial rivals.

Board deliberations on anything from approving budgets to locating new production facilities would be affected, said Mr. Kennerley, company secretary as Scottish & Newcastle, the brewer.

'The area that worries me is making decisions from which someone else loses out,' he added. 'Short-term investors could seek to improve their positions by challenging a board decision, for example, on accepting a (takeover) offer.'

Under the proposals, lawyers say directors could be left in breach of their duties if they cannot demonstrate that they have considered every interest group.

Most companies accept the need to consider a range of stakeholders, where relevant, in the decision-making process, but they are opposed to the rigid codification of those duties.

James Palmer, chairman of a company law committee at the City of London Law Society and author of a letter in today's Financial Times, said: 'We are very frustrated over this element and think the government doesn't get how this would work for companies in practice.'"

The list of factors set out in the clause will apply to all types and sizes of companies, but the listed matters might not be appropriate for directors to consider in taking the best decisions in all circumstances. A director of a major plc and the sole director of a corner shop will not take into account the same factors when they make important decisions. The judgment of directors is at risk of becoming artificially fettered by their having to go through a checklist of factors that may have absolutely no relevance to what their company does. Again, the Government are taking a one-size-fits-all approach to company law. The change will lead to a new area of law, in which the courts will have to interpret circumstances and facts based on the precise and unbending words of the clause.

The argument is not new. Our continental neighbours have been working on codified law since Napoleon transported the idea with his armies. However, let us not forget that the common law system has always been at the forefront of developing company law in this country, and the question is whether that will now be under threat. By enshrining in statute the list in the clause, many believe that the Government are really saying that they do not trust UK directors to make their own decisions about what is best for their companies. By and large, directors are directors because they have shown themselves to have good judgment and we should keep trusting them to discharge their duties. Yes, we should punish wrongdoing, but we should otherwise regulate lightly and let directors get on with running their businesses.

The Law Society has pointed out that the list of factors in subsection (1) that a director must consider raises the possibility that the courts will be given the power to review business decisions made by directors, thereby undermining the well established business judgment rule. That could adversely affect the management of companies and be a significant burden to businesses in both time and cost, as they would have to examine the factors set out before taking any decision. The way in which directors make decisions would therefore be significantly altered.

The change will impact most harshly on smaller firms, which will have to expend much more of their resources in ensuring that they comply with the requirements. That is why we have tabled amendment No. 39 on the recommendation of the Law Society. It would require directors to take into account the listed factors only if they were relevant to the matter under consideration and it was reasonably practicable to do so. That would qualify the requirement to take all the factors into account. The Law Society's June briefing on the amendment stated:

"Clause 158(1), as amended at the Report stage of the Bill in the House of Lords, creates an obligation to consider the listed factors which goes beyond the subjective duty to act in the way the director considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. To say, as the Government does, that there is only a single duty rather than two separate duties does not assist because two duties have been replaced by a single complex duty which has two facets to it. In other words, a director cannot discharge the duty imposed by clause 158(1) without having regard to the factors listed in that Clause."

The Law Society continues to have serious concerns about the clause, even as amended, and believes that it will make a material change to existing law. It states:

"In our view, the introduction of a list of factors which the directors are obliged to consider makes it significantly more likely that the courts will intervene in matters previously left to the directors' judgement. We believe that this is likely to lead to wasted management time, and unnecessary expense, on the company's part."

It also says that it is concerned about the extent of the burden that the subsection is likely to impose on directors. It states:

"In particular, it is unclear how extensive are the enquiries which the directors are required to make in order to obtain information which may be relevant to the matters listed. Furthermore, it is unclear what weight the directors are expected to attribute to competing factors when reaching their decision.

As currently drafted, Clause 158(1) obliges the directors to have regard to a list of matters in deciding whether a particular course of action is likely to promote the success of the company for the benefit of its members. Although the basic duty (in Clause 158(1)) is qualified by reference to the directors' good faith judgement, the obligation to have regard to the factors now listed in Clause 158(1) is absolute. This is a significant change from the current law."

The Law Society is concerned that this change may make it much more difficult for directors to manage the affairs of their company. It also says:

"the introduction of factors which directors are required to have regard to in discharging their duty under Clause 158 may also create new uncertainties for third parties. This is because a transaction entered into with a third party who has notice of a breach of a fiduciary duty by one or more of the directors relating to the transaction is voidable at the option of the company. This may result in third parties seeking an assurance that the directors have complied with this duty and have had regard to the factors listed in Clause 158(1)."

11 am

The Law Society then says that

"directors will be more exposed to actions for breach of duty, in particular following a takeover or in the event of the company becoming insolvent. An increase in the risk of personal liability is likely to discourage many individuals from taking up directorships of UK incorporated companies and is also likely to discourage those who do take up directorships from taking decisions which might give rise to personal liability in the future if they ultimately turn out to be detrimental to the company."

It states that amendment No. 166

"would require the directors to consider only those factors which they, in good faith, considered relevant to the matter in question. Provided they acted in good faith, their decision on the relevance of a particular factor could not be called into question by the courts except to the extent that the directors acted in breach of their duty to exercise reasonable care, skill and diligence. This would meet what the Company Law Review described as its main concern in Paragraph 3.19 of Completing the Structure published in November 2000. In the absence of an amendment to this effect we believe that there is a significant risk that those incorporating companies to carry on business in the UK may choose to incorporate them in a jurisdiction with a less onerous regime."

James Brokenshire: My hon. Friend makes a persuasive case about the uncertainty that would be caused by the changes proposed in the clause. Would he care to comment on the direct cost that may be attributed to companies, particularly in seeking to obtain insurance for directors and officers in relation to such provisions? Will the uncertainty have any impact on the premiums that may be charged to such companies in those circumstances?

Mr. Djanogly: As always, my hon. Friend makes a pertinent point. Yes, areas of additional cost will certainly arise. Costs will arise, first, in relation to additional advice that boards will need to take about whether they have covered the points in the list. There will be costs in relation, secondly, to documenting the steps that they have taken and, thirdly, to the additional claims that may arise and resulting litigation. Finally, there will be additional costs for insurance. I will speak more about that when we debate clause 161, which many companies and advisers have been saying will affect the costs of directors' and officers' liability insurance.

David Howarth: To stick to the provision before us and the possibility of increased insurance costs, can the hon. Gentleman tell me the likely loss to the company in the case of a takeover where the incoming d

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