Company Law Reform Bill [Lords]

Public Bill Committee, 13 July 2006.

Standing Committee D

Jonathan Djanogly (Conservative, Huntingdon)

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.

Eric Illsley (Labour, Barnsley Central)

Order. That is not a point of order for the Chair.

Jonathan Djanogly (Conservative, Huntingdon)

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.

Margaret Hodge (Labour, Barking)

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.

Jonathan Djanogly (Conservative, Huntingdon)

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 (Labour, Barking)

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—

Jonathan Djanogly (Conservative, Huntingdon)

You forced it upon us.

Margaret Hodge (Labour, Barking)

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.

Eric Illsley (Labour, Barnsley Central)

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

Jonathan Djanogly (Conservative, Huntingdon)

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.

Mike O'Brien (Labour, North Warwickshire)

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.

Jonathan Djanogly (Conservative, Huntingdon)

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.

Clause 219

Clause 220

Clause 222

Jonathan Djanogly (Conservative, Huntingdon)

I beg to move amendment No. 423, in clause 222, page 101, line 34, leave out subsections (3) and (4).

Eric Illsley (Labour, Barnsley Central)

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’.

Jonathan Djanogly (Conservative, Huntingdon)

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.’”

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.

Mike O'Brien (Labour, North Warwickshire)

We do not accept the hon. Gentleman’s point about increasing derivative actions; the approach in the clause is appropriate. However, I have not had the opportunity to consider the letter, which, I agree, is well argued. It would be useful if a copy could be given to my right hon. Friend the Minister for Industry and the Regions, who will give serious consideration during the summer to the points raised.

Jonathan Djanogly (Conservative, Huntingdon)

I am not sure whether I said during my speech that the letter was to Lord Goldsmith, so a copy should be somewhere in his Department.

Mike O'Brien (Labour, North Warwickshire)

It may well be, but I have not seen it. My noble Friend the Attorney-General would not normally be the person who considered the proposal. It would be referred to the Department of Trade and Industry to be dealt with by my right hon. Friend the Minister for Industry and the Regions. It is probably being transferred between Departments at the moment. The appropriate way to deal with it is to say that we shall consider the points raised. My right hon. Friend has indicated to me that she is prepared to do so, and I hope that on that basis the hon. Gentleman will feel able to withdraw the amendment, which we are not in a position to accept.

Jonathan Djanogly (Conservative, Huntingdon)

This is an important point for us. The application of the clause with the provisions of part 11 could present problems, and more importantly the Government’s approach is blunt and indiscriminate. I was going to ask for a Division on the amendment, but the Solicitor-General has responded positively to one of our two points—the type of person who will count as an interested party. He said that a relative will not necessarily be considered someone who will take direct advantage and therefore excluded. On the basis that we will consider the matter before Report, I beg to ask leave to withdraw the amendment.

Clause 225

Jonathan Djanogly (Conservative, Huntingdon)

I beg to move amendment No. 258, in clause 225, page 103, line 7, leave out paragraph (b).

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss amendment No. 279, in clause 225, page 103, line 8, at end insert

‘save as otherwise provided for in this Act or regulations made pursuant to this Act.’.

Jonathan Djanogly (Conservative, Huntingdon)

The clause is about restrictions on the use or disclosure of protected information by the registrar. We have previously debated access to directors’ home addresses, and we acknowledge that the overall proposed framework represents a step in the right direction. As I said in earlier debates, more needs to be done, and this clause is one of the mechanical follow-up provisions.

Clause 225(2)(b) states that the registrar is not obliged

“to omit from the material that is available for public inspection anything registered before this Chapter comes into force.”

The amendments are intended either to delete that provision, through amendment No. 258, or to add the words set out in amendment No. 279. The problem is that there are concerns that, without the amendments, the registrar will not need to remove directors’ home addresses already on the register once the law changes. That view is held by many outside interested parties.

Margaret Hodge (Labour, Barking)

We have had a long discussion on the protection of names and addresses on the public record. If I am honest with the hon. Gentleman, the amendments are difficult because of the practical constraints that we face. Once the information for a director is on the record, it could be embedded and appear on hundreds of documents filed over the years or decades. It would be an understatement to say that it would be difficult to remove snippets of information from old paper records and microfiche, and it is important to keep information for enforcement agencies.

Clause 741 contains the power to provide for historic records of addresses to be made unavailable for public inspection. We have discussed that clause, as the hon. Gentleman knows. We accept that there may be exceptional circumstances in which it is appropriate for an address to be taken off the public record. However, each case needs to be considered individually, taking account of practical consideration, the director’s need for privacy and the implications of the loss of information. We do not expect there to be more than 10 or 20 such cases. We will consult on the regulations, but we do not think that the hon. Gentleman’s suggestion is desirable or practical.

I fully agree that, if a provision in the Bill or regulations under it required the Registrar of Companies to omit protected information from the material available for public inspection, the clause should not relieve her of that obligation. Amendment No. 279 is not necessary. Clause 741(1) provides:

“regulations requiring the registrar, on application, to make an address on the register unavailable for public inspection.”

We do not consider that clause 225(2), when read in the context of the other provisions of the clause, casts doubt on that. I therefore hope that the hon. Gentleman will withdraw his amendment.

Jonathan Djanogly (Conservative, Huntingdon)

For us, this involves a point of principle. We made that point earlier. On that basis, I ask for a Division on amendment No. 258.

Clause 243

Jonathan Djanogly (Conservative, Huntingdon)

I beg to move amendment No. 485, in clause 243, page 110, line 22, leave out paragraph (b).

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss the following amendments: No. 494, in clause 243, page 110, line 26, leave out ‘or proposed’.

No. 487, in clause 243, page 110, line 29, leave out

‘or another person (or both)’.

No. 488, in clause 243, page 110, line 30, leave out subsection (4).

No. 495, in clause 243, page 110, line 38, at end add—

‘(6) A derivative claim under this Chapter may only be brought if the directors have been requested by a member of the company to bring a claim in respect of an act or omission specified in subsection (3) and have not agreed to the request after the expiry of a reasonable period from service of the request.’.

Jonathan Djanogly (Conservative, Huntingdon)

We move on to part 11, another significant new area of the Bill, which is complex and has brought much interest and no little concern from the City among others. I should especially like to thank Farrar and Co solicitors for the advice they have given us on the analysis of this part. Let me set the scene. It applies equally to all clauses in this part, but I shall not repeat it.

A shareholder can only bring a claim on behalf of a company in limited circumstances. Part 11 sets out a new procedure of derivative actions that enables shareholders to bring a claim on behalf of the company for breach of duty if that breach has not been authorised or ratified by the company. Together with part 10, we believe that that has significant potential to increase the liability of directors. Before I go any further, I should like to explain the current common law position and set out what the Government aim to do.

Derivative claims are proceedings brought by a shareholder. Under the Bill, they must be in respect of a course of action vested in the company, for the purposes of seeking relief on behalf of the company, and brought only in respect of courses of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company.

To bring a derivative claim, a shareholder must commence proceedings in the usual way and then apply to the court for permission to continue the claim. In determining whether to grant permission, the court is required to take into account the series of factors set out. There are two major concerns. The first is that it advances the common law in undesirable ways. The second is that the effect of the clause, particularly when combined with part 10, will be detrimental to directors generally. We have tabled amendments to address those concerns, but the leading common law case on which codification attempts to build and on which the hon. Member for Cambridge (David Howarth) is clearly dying to speak, is that of Foss v. Harbottle. If the Bill’s intention is to enshrine in statute the well established exception to the rules set out in that case, our view and that of the lawyers who have advised us is that this is not immediately achieved by the current drafting.

The rule in Foss v. Harbottle is that a member cannot bring in an action on behalf of the company for an injury done to the company; the company is the injured party and the action vests in it. The exceptions to the rule in Foss v. Harbottle are, broadly speaking: an infringement of personal rights of members; ultra vires or illegal transactions on the basis that the majority cannot ratify such transactions; transactions requiring the sanction of a special majority; and, importantly, the fraud and control test whereby the transaction constitutes a fraud on the minority. This includes fraud proper as well as breach of fiduciary duty as a director and when the wrongdoers are in control of the shares of the company.

The non-inclusion of the fraud and control test in the Bill represents a radical departure from the previous thresholds to a member making a derivative claim. The result of that non-inclusion is that it will be easier for shareholders to bring claims against directors. Furthermore, it is the view of many law firms that the current form of part 11 does not address concerns about the court having an unlimited discretion in deciding whether to allow derivative actions to proceed. The non-inclusion of the fraud and control test represents a fairly radical departure from the previous thresholds to a member making a derivative claim.

The court will still be required to consider the evidence and merits at the earliest stage, and there is a danger that that part of the Companies Bill will simply create a more complex procedure without any corresponding reduction in the potential administrative burdens for companies. It therefore makes sense to amend part 11 to preserve the traditional thresholds of fraud on the minority and wrongdoer control, as that would make it clear in statute that the new regime is not intended to sweep away the existing case law.

As the new legislation does not replicate existing case law, it will take some time for a body of case law to develop. Although of persuasive nature, the previous rules in Foss v. Harbottle and other case law will not be directly relevant in determining whether the provisions of the legislation have been applied. That will create uncertainty for some period as to the extent of the derivative claim provisions, and the burden of that will largely fall on the company. That could, in part, be remedied by the Bill more closely mirroring existing law.

In practice, derivative claims have been relatively rare to date. It has been pointed out to us that the Government will achieve relatively little by enshrining this rare bit of case law into statute. Granted, they will have codified a part of the common law, but any potential benefit that that will have—it will be minimal—will be far outweighed by the possible damage that will be wrought by increased shareholder litigation and by reducing the number of people who are willing to take up company directorships in the UK.

A further key change in the Bill is that the persons engaging in fraudulent conduct need not have received a benefit. Members will therefore be allowed to make claims for an honest act or omission of a director if it results in a breach of duty, regardless of whether they received a benefit. Under Foss v. Harbottle, it is not permissible to make a derivative claim as a result of negligent action unless the person in breach of duty receives a corresponding benefit. The Bill represents a shift from the existing position, in that the focus is much more on allowing member control of directors’ actions.

The range of circumstances under which a derivative action may be brought will be much wider than is currently the case. A shareholder who brings proceedings must apply to the court for permission to continue the claim. If the court judges that a person seeking to promote the success of the company for the benefit of the shareholders would not continue the claim, permission must be refused. Permission must also be refused if the conduct complained of has been authorised or ratified by the company—that is, by the shareholders.

Eric Illsley (Labour, Barnsley Central)

Order. The Committee is suspended for one minute. We are inquorate; there is not a sufficient number of Members in the room.

Mike O'Brien (Labour, North Warwickshire)

On a point of order, Mr. Illsley. The speech by the hon. Member for Huntingdon has cleared his own Back Benches. It has cleared all but one Liberal Democrat and many Labour people from the room, and even encouraged some to get out their newspaper. He may feel slightly aggrieved, but I assure him that it is a fascinating speech. I was listening to him with great care, as I am sure you were, Mr. Illsley, although I saw your head start to droop slightly.

Eric Illsley (Labour, Barnsley Central)

I call Mr. Djanogly to respond.

Jonathan Djanogly (Conservative, Huntingdon)

I am delighted by that reassuring point of order from the Solicitor-General. I shall do my best to keep up the heightened tension.

As we debated earlier, there will also be a significant tightening in the law in relation to the ratification procedure which will make it more difficult for a director’s act to be ratified. On any resolution to ratify a director’s negligence, default, breach of trust or breach of duty, the votes of shareholders who are personally interested in the ratification must be disregarded. The consequence of that is that ratification will be more difficult to achieve and that there are therefore likely to be more derivative actions. The consequences of the prospect of more derivative actions for company directors is grave, especially when the prospect is made more likely by the extension of possible liabilities that face directors under part 10. This is once again an area of law about which the Government have said that the intention is to codify the existing common law position. Unfortunately, once again they are overturning the common law position.

Parts 10 and 11 in effect create what my noble Friend Lord Hodgson referred to as a “double whammy”—an exciting term for the House of Lords—for company directors. The codification of both the basis on which to bring a claim and the means by which that claim is brought will serve only to make it easier for claims to be brought against company directors. There is a real concern that that will act as a disincentive to people who might want to become directors in the future, which can only be detrimental to UK plc.

The concern about the interplay between parts 10 and 11 and the effect that that will have was well set out by Neil Fagan, a partner in the law firm Lovells, in his article in Insurance Day on 16 December last year. After discussing the part 10 duties in some details, he went on to say:

“Significantly, there is now a provision for derivative claims to be brought. A derivative claim may be brought in respect of a cause of action arising from an act or proposed act or omission involving negligence, default, a breach of duty or breach of trust by a director of the company. The cause of action may be against the director or another person (or both). Thus the rule in Foss v Harbottle, that shareholders cannot sue directors (subject to certain exemptions), is presumably to die after approximately 150 years.

A member of a company who brings a derivative claim must apply to court for permission to continue it. Among other factors the court must consider whether the member is acting in good faith in seeking to continue the claim.

There are other provisions in relation to derivative claims but this is clearly a significant change in the law. One can only hope that the provision that the member should act in good faith is sufficient to stop spurious or speculative claims.”

The fear that increased litigation might lead to increased insurance costs is also real for company directors. My hon. Friend the Member for Hornchurch (James Brokenshire) mentioned that when we discussed part 10. Should the rates that directors and officers have to pay go up, there will be a further disincentive to people becoming company directors in the UK. That is becoming a consistent theme of parts 10 and 11, and it is not a happy one.

To illustrate the potential problem, I shall read from an article in Insurance Times from November of last year, which states:

“Proposed company law reforms could lead to a rise in directors’ and officers’ (D&O) premiums, Heath Lambert has predicted.

The Company Law Reform Bill attempts to clarify directors’ duty of care.

Mark Hardinge, Heath Lambert’s chief executive of financial and professional risks, said it was inevitable that insurers would seek to increase rates as the Bill could increase the scope of negligence claims against executive management.”

Now that there is a statutory basis for a derivative action, it will be easier for shareholders to sue directors or others for a broader range of conduct than would be possible under the common law.

The implication of that extended right to sue has been well set out by city solicitors Norton Rose in their briefing note of December 2005, which states:

“In extending the conduct in respect of which shareholders can complain, there is a concern that the new provisions may be abused by disgruntled or activist shareholders. In addition to the possibility of claims for negligence, the ability to claim for breach of duty would allow a shareholder to bring a claim (although the court might not allow it to continue) for breach of any of the new general statutory duties...as well as regulatory obligations, such as environmental or health and safety obligations, of which there are many. Shareholders in quoted companies could bring claims for matters such as breaches of the Listing Rules or the Disclosure Rules. The new statutory right provides another tool for use by activist shareholders to push for change at underperforming companies. How useful this will be will depend on the court’s willingness to exercise its discretion to intervene in what, in many cases, will be simply commercial decision-making by the company, its directors and majority shareholders. In any event, boards should review the wording of their D&O insurance policies to ensure that defending derivative claims is covered.”

The Government claim that the new statutory derivative procedure is aimed at making the law

“clearer and more accessible, but will not result in a major change in the law.”

That statement was made by the then Minister, the right hon. Member for Cardiff, South and Penarth (Alun Michael), in a letter to the Financial Times on 9 November 2005.

It is now clear from our analysis and the comments that we have received from a significant number of stakeholders in this area that the then Minister was wrong to claim this. In fact, the proposed statutory claim is wider, but there are a number of other significant changes that I would like the Government to comment on. The question of cost has been raised by the solicitors Farrer and Co. In May 2006, it wrote:

“The legislation does not specifically deal with the question of costs. In the event that a member is granted the right to take a derivative action (whether or not successful), the assumption is that the court would require the company to pay the costs of the action. Does this extend to the costs of the defendant if the derivative claim is not successful? Will the company be required to bankroll an action which may last for some years with significant costs in circumstances where the duly elected board has no control? This could be clarified.

The costs of a derivative action will ultimately be borne by the company in circumstances where it is obliged to take action to defend a claim or simply to make representations. In particular, given the lack of information that a member may have, this may lead to an unduly bureaucratic and costly process (both in terms of cash and management time) for companies.”

The concern that part 11 will increase the potential liabilities for directors and the chance of tactical and vexatious litigation by activist shareholders is well expressed in this June 2006 briefing from the law firm Allen and Overy:

“We are concerned that Part 11 empowers shareholders to commence litigation against the directors without consulting or informing the board. This firstly increases the chances of tactical litigation, secondly creates the capacity for disruption and thirdly gives the shareholder a primary (rather than a derived) right to bring a claim in the company's name. To elaborate on the third point, it is a fundamental principle of company law that directors owe their duties to the company and that therefore the company has the primary right to sue them in respect of wrongdoing. At present a shareholder derives a right to sue in the company’s name in particular circumstances, including because the wrongdoers who control the company will not exercise the company’s primary right to sue. By failing to include a requirement that the board be consulted or informed about a shareholder’s intention to sue the directors in the company’s name, the company will be deprived of an opportunity to exercise its primary right to sue in any circumstance where the shareholder chooses not to consult the board.”

In summing up how dangerous this part of the Bill may be for company directors, I would like to quote from an article by Robert Watts in The Daily Telegraph on 29 January 2006.

Louise Ellman (Labour, Liverpool, Riverside)

The hon. Gentleman has been speaking for nearly 15 minutes on this issue, which is clearly important to him, but I note that he does not have a single supporter here. Is he really intent on scrutiny, or is this some kind of monologue, which none of his own side is interested in?

Jonathan Djanogly (Conservative, Huntingdon)

No, my own side are very interested in this, but they know what I am going to say. The hon. Lady does not, so I thought that I would give her the full benefit of my considerations. This is a matter of great importance to companies and company directors, and I trust that she will bear with me.

The article states:

“Meanwhile, there are even greater concerns about the part that relates to derivative claims. These are court actions that, the bill says, may be brought by shareholders against the directors in relation to ‘an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company.’

In fact, the bill goes on to say that the action can be brought against a ‘director or another person (or both)’. Former directors, consultants and even lowly employees who own stock could also face these actions, it states.

It will be relatively easy for a shareholder to launch a claim, but any such action would need a court’s permission to continue.

Such actions could be costly, distressing and last for years. Equitable Life, for instance, pursued 15 former directors, initially claiming damages of £1.7bn, in an action that lasted for more than four years before the two sides settled.

Lawyers are divided on whether such actions could become commonplace. It would all depend on how the courts interpreted what almost all parties agree is badly drafted legislation.”

Many company lawyers are concerned that the Bill might spawn an industry of “ambulance-chasing” legal firms similar to those that have fed off personal injury claims. Richard Ufland, a corporate finance partner at Lovells, said:

“Law firms will be able to take on ‘no-win no-fee’ claims in this area... This is an important consideration for the Government in deciding whether to extend these actions. There is also the concern that activist shareholders may grab at any chance to use court actions as a means of trying to force through changes they want.”

Our amendments would rectify the problems that I have highlighted. Amendment No. 485 was originally tabled in the Lords and would remove subsection (2)(b). This is what Lord Hodgson argued in Grand Committee in the Lords:

“This first amendment would remove subsection (2)(b). Section 459 of the Companies Act 1985 provides a separate cause of action to shareholders where their company’s affairs have been conducted in an ‘unfairly prejudicial’ manner. Section 461”

of that Act

“then gives the court wide powers to grant relief in respect of the matter complained of. There is, therefore, no place or need for a derivative claim as provided in Clause 243(2)(b) of the Bill—the court has all the appropriate jurisdiction under Section 461.

It has been argued to us that the existence of Section 459 is another reason why the codification of derivative claims need not take place: there is already a working method whereby aggrieved shareholders can exercise their rights. If this codification goes ahead, the Bill should not muddy the waters with such a reference to Section 459, which is a stand-alone procedure unrelated to derivative claims.”—[Official Report, House of Lords 27 February 2006; Vol. 679, c. GC 3.]

David Howarth (Liberal Democrat, Cambridge)

I have some sympathy with at least one of the hon. Gentleman’s amendments, but amendment No. 485 is puzzling. As I read it, clause 243(1)(b) restricts the scope of derivative claims by putting in an additional requirement that such a claim can be proceeded with only when the claimant seeks relief on behalf of the company. I may have misread it, but it seems to me that the amendment implies that derivative claims could be brought on personal rights. That would be a broader right than that in the Bill.

Jonathan Djanogly (Conservative, Huntingdon)

No. I think the hon. Gentleman has misconstrued our amendment, which basically says that the clause is confusing the derivative process with the section 459 process and that they should be kept separate.

David Howarth (Liberal Democrat, Cambridge)

It seems to me that the opposite is the case and that the purpose of clause 243(1)(b) is precisely to separate personal rights, which come under section 456, or whatever it will be when the legislation is consolidated, and bringing true derivative claims on behalf of the company. If clause 243(1)(b) were removed, the confusion that the hon. Gentleman seeks to avoid would be more likely to exist.

Jonathan Djanogly (Conservative, Huntingdon)

The hon. Gentleman has his view and I am not sure that I agree with it, but it is certainly worth thinking about further.

Clause 243(3) states:

“A derivative claim under this Chapter may be brought only in respect of a cause of action arising from an actual or proposed act or omission involving negligence, default, breach of duty or breach of trust by a director of the company.”

Our view is that the wording of that subsection is not sufficiently precise and is too wide. In particular, the use of the words “or proposed” go too far. A member should not have a statutory right to make a derivative claim to restrain some proposed act or omission. The intention should be to provide a remedy for a member when there has been an actual act or omission. To include the words “or proposed” may be a charter for members to take action at any time to restrain what they think is a potential future breach of the relevant duties. We propose to amend the clause as set out in amendment No. 494.

The Institute of Chartered Accountants in England and Wales raised some concerns in its April 2006 briefing, which form the basis of several amendments. Amendments Nos. 487 and 488 are ICAEW amendments and I want to read from the institute’s briefing of 27 April, which sets out its concerns and which we support:

“We are concerned that the draft clauses in the Bill do not reflect the DTI’s intention as stated in its explanatory material and agreed during the Committee stage debate, codifying existing common law principles on derivative actions. They create new rights for members to bring a derivative action against persons other than directors and against directors in cases of negligence, default, breach of duty or breach of trust, as well as fraud. An actual or alleged breach of duty by a director (for example, in preparing incorrect accounts) could effectively be used as a ‘springboard’ for the member to bring a derivative action against others (for example, an auditor). We believe this will encourage nuisance claims against directors in order to open up a route to others.”

The purpose of amendment No. 487, therefore, is to tie the clause down to directors. However, I would be interested to hear from the Solicitor-General who he thinks could be caught by the last line of subsection (3).

The briefing paper continues:

“In addition, allowing an action in respect of a cause which arose before the person seeking to bring the derivative claim became a member of the company, could attract people to become members purely to make a claim, after the event.”

That is why amendment No. 488 would delete subsection (4).

Amendment No. 495 was suggested by the City law firm Allen and Overy to ensure that the company retains an opportunity to exercise its primary right to sue the directors. Although it is easy to get carried away with arguments for and against members being able to seek relief on behalf of the company, we should not forget—

Steve McCabe (Labour, Birmingham, Hall Green)

On a point of order, Mr. Illsley. Is there anything you can do to ensure that we concentrate on scrutinising the Bill rather than having to listen to a repetitious, time-wasting monologue from the only Tory in the room?

Eric Illsley (Labour, Barnsley Central)

That is not a point of order for the Chair and the hon. Member who is speaking is completely in order.

Jonathan Djanogly (Conservative, Huntingdon)

Thank you, Mr. Illsley. I am doing my best to put across a comprehensive explanation of our amendments.

Mike O'Brien (Labour, North Warwickshire)

I think the hon. Gentleman is doing his best. This is an important part of the Bill and unfortunately he is the only Conservative Member present. It is a sad reflection on his colleagues that on a serious matter such as this they have allowed him to read out—at great length, in what appears to be merely a time-wasting exercise—a series of rather repetitious notes from various solicitors’ firms.

However, the hon. Gentleman has made some important points, which I shall be happy to deal with in due course. However, the Committee has been treated with some contempt by the Conservatives, who have simply cleared the room and gone away. They appear not to be concerned about what the hon. Gentleman claims is an important issue.

Jonathan Djanogly (Conservative, Huntingdon)

The Solicitor-General has jumped in and made his political point. I have not been repetitious and I have brought up some matters that are very important to many stakeholders.

We should not forget that the primary right is that it is for the company itself to initiate the action. Amendment No. 495 would embed that right in primary legislation by reiterating that the company should be given a reasonable period in which to decide to take action before a derivative claim is stated.

David Howarth (Liberal Democrat, Cambridge)

The hon. Gentleman thought that I was dying to intervene to explain the law on Foss v. Harbottle. When I lectured on the subject, it took several weeks to explain the law on that case. I am far from dying to intervene at such great length.

Jonathan Djanogly (Conservative, Huntingdon)

The hon. Gentleman makes my point: he said he spent weeks talking about the case. I spoke for a mere 20 minutes on Foss v. Harbottle, yet the Government Whip complains that I took up too much time.

David Howarth (Liberal Democrat, Cambridge)

My point, which is rather different, is that because the law is so complex it is perfectly reasonable for the company law review and the Government to attempt to put it in statutory form. However, there is a problem with that exercise, which leads to some of the queries that have been raised. The statute does not say what the purpose is of the rule in Foss v. Harbottle, and, because it lacks that statement of purpose, questions about the scope of the statute come into play.

It has to be remembered that the purpose of the rule in Foss v. Harbottle is to prevent legal actions that waste everyone’s time and effort. Legal actions being brought by shareholders on behalf of a company for claims that are the company’s claims, which claims are doomed to failure if the company takes action or is capable of taking action, would make those breaches of duty moot—because, for example, they had been ratified.

The key point that is missing from the Bill, because it is legislation rather than a set of common law cases, is that basic statement of purpose. It is the job of the Solicitor-General and the Minister to say what the purpose is. If the Government were to reaffirm that the purpose of the statutory provisions is to maintain the existing law—that the purpose of the exercise is to prevent legal actions that are a waste of time—many of our fears would be reduced.

We have other uncertainties about Foss v. Harbottle—for instance, whether the rule is about procedure or whether substantive elements are hidden within it. That is why it took so long to explain. The procedure elements and the substantive elements—for instance, about directors’ duties—tend to get confused in case law, which is why it is a good idea for the Bill to separate the two.

The Solicitor-General should state that, in the Bill, the view being taken of derivative action is purely procedural and that the underlying substantive rights are dealt with elsewhere. For example, when the hon. Member for Huntingdon raised the benefit point, it was about the underlying substantive legal actions rather than the procedure for derivative action, which is what these clauses are about. That is precisely the kind of confusion in case law that the Bill is trying to sort out.

Mike O'Brien (Labour, North Warwickshire)

I assure the hon. Gentleman that we are reaffirming the purpose behind the rule in Foss v. Harbottle, and that we do not in any way seek to repeal it. The courts will still be referring to it.

David Howarth (Liberal Democrat, Cambridge)

I thank the Solicitor-General. That statement will help us in interpreting the provisions.

Jonathan Djanogly (Conservative, Huntingdon)

Does the hon. Gentleman not think that the omission of the fraud control exclusions will in practice change the law?

David Howarth (Liberal Democrat, Cambridge)

That is an interesting point. We shall come to it in a later clause, and I may remark on it then.

There have always been problems in defining fraud on the minority. Indeed, a leading academic thinks that it should never have been called fraud on the minority, but that it should be fraud on the company. One explanation of why that is not being sorted out in the Bill is because it is not that easy to define fraud on the minority.

Jonathan Djanogly (Conservative, Huntingdon)

If we are going to codify and move away from the common law, should not the issue that the hon. Gentleman says is difficult be addressed?

David Howarth (Liberal Democrat, Cambridge)

That is a good point, and I would be interested to hear the Solicitor-General’s comments on it. That brings me back to the question with which I started—whether the fraud is part of the substantive law or part of procedural law.

Amendment No. 495 is helpful. It provides that a claim could be brought only after the claimant had approached the board. That brings me back to Foss v. Harbottle. It is about trying to prevent legal action from being brought by shareholders if action is being taken by the appropriate organ of the company. As I said when discussing directors’ duties, in most cases that organ will initially be the board of directors.

To stop mischief of the sort that Foss v. Harbottle is designed to prevent, the amendment would require people who wish to bring derivative claims to approach the board of directors first, and only if the board turned down the request to bring an action in the company’s name should there be any question of derivative action being taken by the shareholders.

I have explained why I do not think that amendment No. 485, which would leave out paragraph (b), is helpful. It would tend to create precisely the confusion that it seeks to prevent over the difference between a personal action by a shareholder and an action brought on behalf of a company. That brings us back to one reason for it taking so long to explain the law in Foss v. Harbottle to those trying to learn it—it is not entirely clear what the exceptions to the rule in that case are. Three of the four are not really exceptions, but simply examples of the rule not applying in the first place. The only real exception is the fourth, so-called fraud on the minority.

I am not sure that amendment No. 494, which would leave out the words “or proposed”, is helpful. There are circumstances in which it would save everyone’s time and effort for disputes to be sorted out before damage occurred. It might be helpful if there were at least discussions on action early, particularly if the damage might not be able to be remedied later. The amendment is not helpful, but I understand the point.

Amendment No. 487 is a probing amendment to find out who the other person referred to might be. I suppose that the obvious suggestion is that it would be the company secretary, who is an officer of the company.

Jonathan Djanogly (Conservative, Huntingdon)

I will also be interested to hear what the Solicitor-General has to say. The definition of “another person” could go much further than auditors, a law firm or employees who own a few share options.

David Howarth (Liberal Democrat, Cambridge)

The question is whether a company will have a claim against such people. We return to the central idea of shareholders trying to sue in the company’s name. The underlying claim must be a claim of the company, not of another person. That is why the question arises who the other person might be.

Amendment No. 488 would leave out subsection (4), which allows late-coming shareholders to make a claim. The problem, to which leaving out the subsection is not the answer, is the amount of information about the situation of the company that might be available to a late-coming shareholder. If we believed in perfect information and perfect markets, we would say that in buying shares, a late-coming shareholder takes on the risk for which the market has discounted the price, and we could therefore reasonably say that a late-coming shareholder should not be allowed any such claim. The market transaction would already have taken account of the risk.

Jonathan Djanogly (Conservative, Huntingdon)

Is there not also a problem in establishing loss in such a situation?

David Howarth (Liberal Democrat, Cambridge)

No, because the loss is the company’s loss, not that of the individual shareholder. We keep returning to that point.

The point to consider is whether a late-coming shareholder takes on any underlying risk of loss to the company, as the company’s value will already be less having been discounted by the market. The counterpoint to that, on which I will be interested to hear the Solicitor-General’s comments, is the extent to which the clause is aimed at companies whose shares are not freely traded and whose value might therefore not represent all the information that might have been available. Trades occur in circumstances in which information does not fully discount the price of shares, which might cause difficulties.

Jonathan Djanogly (Conservative, Huntingdon)

Does the hon. Gentleman agree that the provision will encourage vexatious activists to take small stakes and arrive, as Johnny-come-latelies, on the back of something that happens?

David Howarth (Liberal Democrat, Cambridge)

I suppose there is a risk of people doing that—for example, those who object to the idea of corporate social responsibility. There are investors of that sort who might want to challenge, for instance, directors’ decisions to follow environmental policies. The question, however, is whether the safeguards in the rest of the Bill will discourage such people. It seems unlikely that such a person will be able to meet the requirements in the other clauses, particularly those relating to the initial hearing.

Jonathan Djanogly (Conservative, Huntingdon)

Is it not the point that well-funded activists will not be dissuaded by the cost position, because they will not meet the costs in any event? They will be making a political point.

David Howarth (Liberal Democrat, Cambridge)

There is an issue about how much people are prepared to pay to make such political points—it might become very expensive, not only for the individual claimant, but for that person’s solicitor, assuming that the rule continues after the Bill comes into force.

There is the problem of the solicitor’s personal liability for bringing derivative claims or claims under the exceptions in Foss v. Harbottle when they should not have done so, because they have, in effect, claimed to be the company when they are not. In a way, however, the deterrence and the value of claims are matters for the cost rules as much as for the procedural rules.

The underlying point on subsection (4) concerns the belief in the efficiency of markets, particularly share markets. The question is whether that is different, depending on whether we are looking at companies that are publicly quoted on the stock market or companies that are not, and whether further thought might be given to the application of the rule.

Mike O'Brien (Labour, North Warwickshire)

I find myself in broad agreement with quite a lot of what the hon. Gentleman has said, and he has also dealt with some points raised by the hon. Member for Huntingdon. The provisions will not produce a substantial increase in derivative claims—as he said himself, such claims are rare, and we expect them to remain relatively rare. The introduction of the provisions will not be a significant deterrent to people becoming directors.

Jonathan Djanogly (Conservative, Huntingdon)

One solicitor told me that anyone who called a solicitor now to ask how to make a derivative claim would be told, “This is all common law. It’s very complicated. It’s not down in statute.” He told me that putting the procedure in statute will make it more straightforward, so more people will take it up.

Mike O'Brien (Labour, North Warwickshire)

In other words, the hon. Gentleman’s view is that the more confusion there is, the better, but I do not accept that that is the appropriate approach. The Government’s view is that we should set things out in statute; indeed, the Conservative party said that it wanted certain provisions on company law put in statute. We have included the derivative actions provisions, and I appreciate that the Conservatives might not like that, but this area of law is important and people should know what it is all about.

I want to deal with a couple of the points raised by the hon. Gentleman and with some of his amendments. He quoted from the Insurance Times and Insurance Day, but I should point out that those quotes are from before the Government tabled amendments on Report in the Lords to address some concerns that he mentioned.

The hon. Gentleman also suggested that the rule in Foss v. Harbottle would die after 150 years, but that is not the case. The principle that only the company can sue remains. We are discussing the exceptions to the rule, which have developed over 150 years, and in a rather confused way, as the hon. Member for Cambridge said. That is rather unhelpful because there are exceptions that are not really exceptions, and the situation has become somewhat confusing. That is why the Law Commission thought that there should be a new provision. However, the basic rule remains and it is the cornerstone of this area of law. Our overall aim is implementation of the recommendation of the Law Commission that the right to bring a derivative action in common law should be replaced by a new derivative procedure with more modern, flexible and accessible criteria for determining whether a shareholder can pursue an action.

We agree with the Law Commission that it is important that procedural requirements for bringing a derivative claim are accessible and clearly set out so that they can be understood by shareholders and directors. It is important to emphasise that this part of the Bill does not introduce a wholly new mechanism. The derivative claim is a well established procedure by which shareholders can, in certain circumstances, bring an action in the name of the company. It is in effect a failsafe mechanism rather than a weapon of first resort. It is important to remember that although members who bring an action can be required to bear heavy legal costs, damages are paid to the company rather than to the individual shareholders. So inherent in the whole procedure is a deterrent against bringing frivolous actions.

There will also continue to be very tight judicial control of cases brought under the new procedure. A derivative action is not the same thing as a shareholder or class action in the American courts, which is brought in the name of a group of shareholders. Under the reforms of directors’ liabilities introduced by the Companies (Audit, Investigations and Community Enterprise) Act 2004, companies may already indemnify directors against any liability incurred in respect of such actions, even if the judgment is given against the director. The new statutory procedure differs from the common law in two key respects.

First, we do not want the claimant to have to show wrongdoer control—that the directors whom the claimant believes have acted in breach of their duties to the company are in control of the company—as this may make it impossible for a derivative claim to be brought successfully by a member of a widely held company, including almost all major quoted companies. We also want it to be possible to bring a claim in cases of negligence, even if it cannot be shown that the directors have profited from the negligence. In doing so we want to achieve a proper balance between the ability of directors to take business decisions in good faith and the right of minority shareholders so that shareholders can bring meritorious claims on behalf of the company.

It is clearly important that we protect directors from vexatious and frivolous claims, but we must also protect the right of shareholders. [Interruption.] May I just point out that I am absolutely delighted that, as I have risen to speak, the Conservatives have trooped in. The Conservative Front-Bench spokesman, the hon. Member for Huntingdon, cleared the room. I stood up to speak and Members rush back in. I take that as a compliment.

We do not accept that putting the derivative action on a statutory footing will lead to more claims against directors. It is important that there is greater clarity about how a shareholder may bring a derivative action. It is unlikely that the proposal will result in a significant increase in the number of actions. However, we have made it clear from the beginning that we want claims to be dismissed by the courts at the earliest possible opportunity and without involving companies. The reforms introduced to civil procedure by Lord Woolf, however, mean that certain unmeritorious cases may get further before being thrown out. We have therefore tabled a number of reforms to those procedures to ensure that unmeritorious claims can be dismissed at an early stage.

I am in broad agreement with the hon. Member for Cambridge on his analysis of amendment No. 485 and I will not burden the Committee by repeating it. Amendment No. 494 is based on a misunderstanding of the current law and of the position under the statutory statement of directors’ general duties. Clause 164 provides that the consequences of breach or threatened breach of the statutory duties are the same as would apply if the corresponding common law rule or equitable rule applied. The reference to threatened breaches is important.

Under the present law companies may be able to take pre-emptive action to drop a breach of duty from taking place before it happens and the damage is done. There could, for example, be a threatened breach of duty if a director is refused permission to exploit a corporate opportunity but announces that he is going to go ahead anyway. The remedies in such cases, which include an injunction or declaration, provide an important safeguard of the company’s interest against wrongdoing by a director. A derivative action is an action brought by the company, as the hon. Member for Huntingdon repeatedly said, and there is no sensible basis on which the remedies available to the court should be limited in the way proposed in the case of a derivative claim.

On amendment No. 487, we followed a clear Law Commission recommendation in drafting the clause. It may be helpful if I set out a couple of examples cited by the commission. In the first, relief is sought from a third party for knowing receipt of money or property transferred in breach of trust. It seems correct that the member should be entitled to pursue a remedy against a third party that is holding assets belonging to the company that it has obtained in such circumstances.

In the second example, a profitable company is a victim of a tort by a third party. The directors, although otherwise committed to the well-being of the company, have ulterior motives for not wishing to enforce the remedy for the tort. Although the directors would in such circumstances be in breach of duty, the breach would not give rise to a claim. Therefore, it would not be open to a member to bring derivative proceedings against the third party. Again, we believe that that is the right outcome.

I hope that those examples help to show that it is possible to uphold important principles while placing reasonable constraints on the application of the provision, and that it will not result in members seeking to bring derivative claims against third parties simply because they disagree with a board.

Jonathan Djanogly (Conservative, Huntingdon)

Does the Solicitor-General consider that the provision will likely be expanded to cover auditors and, indeed, employees other than directors?

Mike O'Brien (Labour, North Warwickshire)

I shall consider that, but as far as we are concerned, it is not open to people to bring derivative actions merely because of a disagreement. There must be a clear view that something is damaging, not to individuals but to the company itself. On that basis, I hope that the hon. Gentleman is able to withdraw the amendment.

Jonathan Djanogly (Conservative, Huntingdon)

What about amendment No. 495?

Mike O'Brien (Labour, North Warwickshire)

The hon. Gentleman is quite right. I have not dealt with amendment No. 495 or, for that matter, amendment No. 488.

On amendment No. 488, clause 243(4) responds to the request from some respondents to the company law reform White Paper, including the Law Society, that part 11 should state clearly that it is immaterial whether the cause of action arose before or after the person seeking to bring or continue the derivative claim became a member of the company. That reflects the position in the common law on derivative action.

On amendment No. 495, at present a derivative claim is not available to the minority shareholder unless he can show, to put it briefly, that the wrongdoers are in control. The Law Commission observed that the meaning of “wrongdoer control” is not clear, and as long ago as 1962 the Jenkins committee said that it would be extremely difficult to devise a satisfactory general provision expressing the concept and the remainder of the exception to the rule in Foss v. Harbottle in wider terms. That is why the Law Commission proposed a new statutory remedy and why the clause is drafted as it is. I hope on that basis that the hon. Gentleman will withdraw the amendment.

Jonathan Djanogly (Conservative, Huntingdon)

The Solicitor-General spoke rapidly towards the end of his comments on the latter amendments. I found it difficult to understand what he was saying, so it will be very much a matter of reading Hansard and perhaps returning to some issues on Report.

The Solicitor-General suggested that I would sow confusion by removing certain words from the Bill. That is not what I intended at all. I am simply recognising the widely held view that the Bill will increase the amount of litigation and that there will be consequences arising out of that such as, for example, high insurance costs. He did not face up to that, answer the question or analyse whether that is likely. He may not have any research on the subject, but it would have been helpful to have had some, as we have heard from many people that it is of great concern.

On amendment No. 494, the Solicitor-General said that the reference to “proposed act” reflects the common law position.

Standing Committee D

Clause 243

Eric Illsley (Labour, Barnsley Central)

I remind the Committee that with this we are discussing the following amendments: No. 494, in clause 243, page 110, line 26, leave out ‘or proposed’.

No. 487, in clause 243, page 110, line 29, leave out

‘or another person (or both)’.

No. 488, in clause 243, page 110, line 30, leave out subsection (4).

No. 495, in clause 243, page 110, line 38, at end add—

‘(6) A derivative claim under this Chapter may only be brought if the directors have been requested by a member of the company to bring a claim in respect of an act or omission specified in subsection (3) and have not agreed to the request after the expiry of a reasonable period from service of the request.’.

Jonathan Djanogly (Conservative, Huntingdon)

I was winding up my remarks.

Mike O'Brien (Labour, North Warwickshire)

I am grateful to the hon. Gentleman for giving way. He referred to a letter from my right hon. Friend the Member for Cardiff, South and Penarth (Alun Michael), suggesting that it was misleading. In fact, the issue was raised in another place with my noble Friend the Attorney-General, who agreed to consider the letter. The fact that he did not feel it necessary to correct the letter confirms that what my right hon. Friend wrote still stands. I am happy to put that on the record.

Jonathan Djanogly (Conservative, Huntingdon)

I thank the Solicitor-General for putting that on the record.

We will want to review amendment No. 494 in light of the Minister’s comments. The same is true of amendment No. 487. From what the Solicitor-General said, it is clear that the breadth of the parties that could be included within the ambit of the clause is wider than many realise, and we will want to consider the implications. I have made it clear that, overall, we are not happy that the clause is quite right.

If there is one amendment that re-establishes the principle that we want to assert, it is amendment No. 495. In that regard, I agree with the hon. Member for Cambridge (David Howarth). It is amendment No. 495 that I shall press to a Division. I beg to ask leave to withdraw the amendment.

Clause 244

Jonathan Djanogly (Conservative, Huntingdon)

I beg to move amendment No. 489, in clause 244, page 111, line 2, leave out subsection (1) and insert—

‘(1) A member of a company who wishes to bring a derivative claim under this Chapter must receive permission (in Northern Ireland, leave) from the court before proceedings are issued.’.

Briefly, this is a further amendment that has been brought to us by the Institute of Chartered Accountants, which we propose on a friendly basis. It notes that in Scotland leave is needed to commence proceedings. It would seem sensible that permissions from the court be required elsewhere before proceedings are even issued. That would be an effective mechanism to deter members of the company from making frivolous or vexatious claims.

Mike O'Brien (Labour, North Warwickshire)

These provisions reflect the implementation of Lord Woolf’s wider civil procedure reforms. Currently, a derivative claim brought in England and Wales is commenced by the issue of a claim form under part 7 of the civil procedure rules, which must generally be served within four months after it has been issued. There is no requirement to obtain leave before such a claim may be issued. Civil procedure rule 19.9(3) provides that after the claim form has been issued the claimant must apply to the court for permission to continue the claim and that the application must be supported by written evidence. No further steps may be taken in the proceedings until permission has been obtained. The relevant documents must also be served on the defendant at least 14 days before the court is to deal with the application.

The effect of part 19.9 of the civil procedure rules is to require the claimant’s entitlement to bring the derivative action to be determined at the preliminary issue at the earliest possible time after commencement of the proceedings. Notwithstanding the Woolf reforms, we have been clear from the beginning that we want claims that are motivated by reasons other than the commercial success of the company to be dismissed by the court at the earliest possible opportunity and without involving the companies. That needs to be underlined. That is why we tabled a package of reforms in another place which, by introducing a two-stage procedure for permission to continue with a derivative claim, ensure that the courts can dismiss unmeritorious claims at the earliest possible stage. That is essentially what this is all about.

I hope that, as I believe the hon. Gentleman and I will broadly agree that that should be the position, he will withdraw his amendment.

Jonathan Djanogly (Conservative, Huntingdon)

I am happy with that clarification. I beg to ask leave to withdraw the amendment.

Clause 245

Jonathan Djanogly (Conservative, Huntingdon)

The drafting of the various criteria that the court should consider in determining whether to allow derivative action leaves an extremely wide discretion for the court. There is a wide basis on which the member can choose to take an action and a great deal of uncertainty as to whether a claim will be allowed. For example, subsection (2) states that a member may continue a claim as a derivative claim where, in paragraph (b),

“the company has failed to prosecute the claim diligently”,

or, in paragraph (c), where

“it is appropriate for the member to continue the claim as a derivative claim”.

Will the Minister explain the meaning of those two provisions?

Mike O'Brien (Labour, North Warwickshire)

The clause addresses the possibility that, where a company has brought a claim and a course of action on which the claim is based, it could be pursued by a member as a derivative claim. The manner in which the company commenced or continued the claim may amount to an abuse of process. For example, if the company brought the claim with a view to preventing a member from bringing a derivative claim, the company may fail to prosecute the claim diligently and it may be appropriate for a member to continue the claim as a derivative claim. The clause provides that in those circumstances, if that member is seeking to continue the claim, a member can apply to the court to continue the claim as a derivative action. The court has the same powers to hear such applications as it has to hearing those under clause 244. A member of a company may continue a derivative claim on the grounds that the manner in which the company commenced or continued the claim amounted to an abuse of the process of the court, or if the company failed to prosecute the claim diligently. Abuse of the court would be, for example, if a company brought a claim to prevent a member from bringing one and to frustrate that member.

Jonathan Djanogly (Conservative, Huntingdon)

My question was what prosecuting a claim diligently would involve. I believe that that is new law.

Mike O'Brien (Labour, North Warwickshire)

Essentially, a company would have to pursue the claim in a reasonable way. If somebody were merely to issue a writ and then take no further action to lay subsequent pleadings, or were to delay unduly the serving of pleadings with a view to frustrating someone else’s capacity to bring a claim, there would clearly have been a lack of due diligence. A member would then be able to seek consent, but would have to show that there had been such a lack of due diligence. If he failed to do that, the court would take the view that the member could not take action.

There is broad latitude available to companies in how they pursue claims. We know that some claims before the courts can take a long time because all the evidence has to be got together, pleadings have to be gone through and various issues resolved. The issue is whether a reasonable amount of diligence is used and whether the company is willing to take action. If a company acts in a way that enables someone to say, “You are not being diligent. You are not being reasonable about this. You are deliberately taking the view that you will not pursue this claim”, that person will be able to seek a derivative claim instead. I hope that that provides some element of reassurance.

Jonathan Djanogly (Conservative, Huntingdon)

I thank the Solicitor-General for that clarification.

Clause 246

Jonathan Djanogly (Conservative, Huntingdon)

I beg to move amendment No. 490, in clause 246, page 112, line 13, after ‘company’, insert ‘in general meeting’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss the following amendments: No. 492, in clause 246, page 112, line 13, after ‘occurred’, insert

‘, save in circumstances where it is clear that such decision was one that no reasonable board could have reached in which event such authority shall require to be approved in general meeting’.

No. 491, in clause 246, page 112, line 14, after ‘company’, insert ‘in general meeting’.

No. 493, in clause 246, page 112, line 14, after ‘occurred’, insert

‘, save in circumstances where it is clear that such decision was one that no reasonable board could have reached in which event such authority shall require to be approved in general meeting’.

No. 486, in clause 246, page 112, line 14, at end insert ‘, or

(d) that the directors have decided not to pursue the claim, unless the court considers that there is a substantial risk that in reaching their decision they acted in breach of their duties to the company, or

(e) that the claim is one which the company in general meeting could validly decide not to pursue, unless the court considers that there is a substantial risk that a decision not to pursue the claim would only be taken as a result of votes cast by members with a personal interest, direct or indirect, in the decision, or

(f) that pursuing the claim would not be in the interests of the company.’.

No. 500, in clause 246, page 112, line 14, at end insert ‘, or

(d) that the directors have decided not to pursue the claim, unless the court considers that there is a substantial risk that that transaction constitutes a fraud on a minority of members of the company, or

(e) that the claim is one which the company in general meeting could validly decide not to pursue, unless the court considers that there is a substantial risk that a decision not to pursue the claim would only be taken due to the majority of the shares being in control of those with a direct or indirect interest in the transaction.’.

Jonathan Djanogly (Conservative, Huntingdon)

Amendments No. 490 and 491 were brought to us by the Institute of Chartered Accountants, and we have tabled them on a probing basis. It has been pointed out to us that the current wording of the clause prevents a derivative claim by a member if the act or omission in question was either authorised or ratified by the company. If that means authorisation by the board of directors and those directors have authorised the fraud in question, a shareholder’s right to bring an action for fraud against the minority might be threatened.

Amendments Nos. 492 and 493 probe an alternative approach to the matter, recommended by two partners from Allen and Overy in a letter to the Financial Times of 3 February. They wrote:

“This new provision in effect requires a court to make a judgment as to what is, or is not, the course of conduct most likely to promote the success of the company. Surely only the directors, rather than courts, are properly equipped to make such a judgment.

The difficulty created by this new provision could be solved relatively easily by amending the text so as to ensure that the court could only overrule a decision of the board not to pursue to such a claim where it was clear that this decision was one no reasonable board could have reached.”

If amendment No. 492 were accepted, the clause would state that permission must be refused

“if the court is satisfied where the course of action arises from an act or omission that has already occurred, that the act or omission”

was authorised by the company

“save in circumstances where it is clear that such decision was one that no reasonable board could have reached in which event such authority shall require to be approved in general meeting.”

Amendment No. 486 is aimed at resolving some of other problems that we have highlighted. The Law Society helped to draft the amendment, which was first tabled by Lord Hodgson in the other place. It would insert into clause 246 three new provisions obliging the court to refuse permission to continue a claim: first, where the directors have decided not to pursue the claim; secondly, where the shareholders have decided not to pursue the claim; and thirdly, where the court concludes that pursuing a claim is not in the company’s best interest.

The first provision is where the decision not to pursue the claim has been taken by the directors of the company, unless the court considers them to have been in breach of their duties in taking that decision. The purpose of that is so that the court does not second-guess the directors’ commercial judgment unless it considers that by deciding not to proceed they are in breach of their duties. The second provision, where the decision not to proceed can be taken by the shareholders, is for when the court believes that the majority of the shareholders, excluding those with a personal interest in the decision, would not have wished to proceed with a claim. The third provision is, I hope, self-explanatory and common sense. The purpose of the amendment is to introduce a threshold test that does not involve expense.

The Government have added new reasons why the court can reject a derivative claim, but are the tests strong enough? We think that they are not. There is a concern that only after years of jurisprudence will it be possible for firm advice to be given on the court’s approach to the exercise of its unfettered discretion in relation to this matter. Uncertainties will be damaging to business confidence. Amendment No. 500, tabled on a probing basis, would reintroduce the fraud on the minority and wrongdoer control tests contained in Foss v. Harbottle. I spoke at some length on an earlier clause about how that radical departure from the common law has worried a number of stakeholders. Will the Solicitor-General explain how the Government intend to deal with those concerns?

We have consulted widely on the provisions and the Government must realise that there are major concerns about how things will work in practice. I end with the comments that we received in June from Herbert Smith:

“In our view the current form of Part 11 CLRB does not address concerns as to the court having an unlimited discretion in deciding whether to allow derivative actions to proceed. The court will still be required to consider the evidence and merits at the earlier stage and there is a danger that this part of the CLRB will simply create a more complex procedure without any corresponding reduction in the potential administrative burden for companies.”

David Howarth (Liberal Democrat, Cambridge)

There are some serious issues about the meaning of the clause, which I hope that the Solicitor-General will be able to clear up. It is certainly true that one of the most complex problems in the law relating to Foss v. Harbottle and shareholders’ actions was who could authorise the actions that were being challenged: was it the board or the shareholders? The clause is not absolutely clear on that. I think I know what the intention is, but it would be helpful if the Solicitor-General could explain the approach.

I see some merit in amendment No. 486. Subsection (3)(e) reads:

“whether the company has decided not to pursue the claim”.

It is not clear whether that is a good thing or a bad thing. Lawyers will know, given the background case law, but it is not clear to anyone simply reading the Bill what that means. There is some merit in being clearer about the various possibilities, although perhaps not in the exact way that the amendment proposes.

I am glad that the hon. Member for Huntingdon (Mr. Djanogly) said that amendment No. 500 was tabled on a probing basis. The phrase “fraud on a minority”, which the amendment would put back into the statute, is an old favourite of lawyers and extraordinarily vague and difficult to define. Professor Sealy, in the seventh edition of his casebook on company law, says:

“The scope of the concept is not clearly settled”,

and he refers to

“the confused state of the law.”

That is the case after 100 years of case law, going back to Atwool v. Merryweather and Menier v. Hooper’s Telegraph. The idea of putting that contested phrase back into the law in these terms would not add to the clarity of the law in the way that the hon. Gentleman thinks it would.

The concept of fraud in this context goes much wider than the concept of fraud as addressed in the Fraud Bill. We are not talking just about dishonest actions which cause loss or gain. In certain circumstances, we are talking about negligence, at least where it leads to a benefit. The most important confusion that the phrase causes is the idea that the fraud is on the minority. It is clear from all case law that the fraud is not on the minority, but on the company. As a phrase it does not express what the underlying law is, and I regret any attempt to insert it into statute.

Mike O'Brien (Labour, North Warwickshire)

Clause 246 sets out the criteria that must be taken into account by the court in considering whether to give permission to continue a derivative claim. Subsection (2) provides that the court must refuse leave to continue a derivative claim if it is satisfied that a person acting in accordance with the duty to promote the success of the company would not seek to continue the claim; or, where the cause of action arises from an act or omission that has not yet occurred, that the act or omission has been authorised by the company; or, where the cause of action arises from an act or omission that has already occurred, that the act or omission has been either authorised or ratified by the company.

All the amendments would amend the grounds which, if established to the court’s satisfaction, would constitute a bar to the continuation of a derivative claim. Amendments Nos. 490 and 491 would require the authorisation and ratification by the company to be in general meeting. They therefore fail to reflect two important reforms introduced by the Bill, under which, first, private companies are not required to hold general meetings, and, secondly, the duty to avoid conflicts of interest is not breached if, subject to the company’s constitution, authorisation has been given by directors who are genuinely independent. That is quite an important point which I hope Opposition Members will take into account. Clause 161, on the duty to avoid conflicts of interests, permits authorisation by independent directors, subject to the articles, and it would not make sense to permit authorisation while at the same time providing that such authorisation is not a bar to the bringing of the derivative claim. Authorisation should mean just that.

Just as importantly, the amendments seek to introduce a “reasonableness” test. We do not think that that is the right way forward or that it would benefit directors. Under the duty to promote the success of the company, the weight to be given to any factor is a matter for the good faith judgment of the director. Importantly, his decision is not subject to a reasonableness test, and, as now, the courts will not be able to apply a reasonableness test to directors’ business decisions. This is in sharp contrast to the position in respect of public law decisions, where the courts can apply a reasonableness test. We feel very strongly that it would be a retrograde step to introduce a reasonableness test in relation to the bringing of a derivative claim.

The hon. Member for Cambridge asked whether we will consider the points he raised on amendments Nos. 486 and 500, and whether the clause is clear enough. I am happy to have a look at that. The amendments would add to the list of factors those things that, if established to the satisfaction of the court, would constitute a bar to the continuation of a derivative claim. The Bill’s approach follows the recommendation of the Law Commission that, whereas ratification of a breach should constitute a bar to the bringing of a derivative action, the fact that a breach of duty is ratifiable should not constitute a bar, but should feature as one of a list of factors to which the court should have regard in considering whether to grant permission for the claim to continue.

Amendment No. 486 would add three further grounds which, if established to the court’s satisfaction, would constitute a bar to the continuation of a derivative claim. I will consider each briefly. The first new bar to the bringing of a derivative claim would be a decision by the directors not to pursue the claim, unless the court considers that there is a substantial risk that in reaching their decision they acted in breach of their duties to the company. That is, of course, a factor which already appears on the list of matters which the court must take into account in considering whether to give permission.

In subsection (3)(e), the court must take into account whether the company has decided to pursue the claim, which would include a decision taken by the directors not to pursue the claim. We consider that, while such a decision should constitute a relevant factor for the court, it should not constitute a bar to the bringing of such a claim. It is all too likely that this factor would pertain in most, if not every, case brought before the courts. Although we acknowledge that the drafting attempts to carve out the case in which the court considers that there was a substantial risk that the directors acted in breach of their duties to the company, we consider that the amendment might still prevent meritorious claims from being granted permission for leave. On that basis, we ask that the amendment is not pushed to a vote.

The second new factor would be a claim

“which the company in general meeting could validly decide not to pursue unless the court considers that there is a substantial risk that a decision not to pursue the claim would only be taken as a result of votes cast by members with a personal interest, direct or indirect, in the decision.”

It is not clear whether the amendment refers to a claim relating to a breach of duty, which the company might ratify in general meeting and from which legal consequences flow, or to something short of that—a decision not to sue, for example. In either case, we do not consider that it is something that should bar a derivative claim.

The clause already provides that where a breach of duty has been ratified, then that will constitute a bar and the claim can go no further, but the possibility of ratification or a decision not to sue is something which should not, in our view, be determinative of the matter. The clause provides the courts with the power to adjourn the proceedings and it is envisaged that this power may be used in precisely those circumstances where the company has not yet considered the issue in general meeting in order to ascertain their decision.

Finally, the third factor that the amendment would insert is that pursuing the claim would not be in the interests of the company. In our view, that overlaps in an unhelpful way with the existing factor in paragraph (a), namely that a person acting in accordance with section 158—the duty to promote the success of the company—would not seek to continue the claim. It is surely important that clause 158 and part 11 use consistent wording. On that basis, I hope that the hon. Member for Huntingdon will feel able to withdraw the amendment.

Amendment No. 500 would add two further grounds which are variants on those proposed by amendment No. 486. Once again, we are not persuaded that, even with the suggested safeguards, these factors should constitute a bar to the continuation of a derivative claim. We believe that the Bill’s provisions, which are rooted in the Law Commission’s recommendations, strike the right balance between factors which constitute a bar to the continuation of a derivative claim and those which the court must take into account. In particular, we believe that the provisions as drafted will protect both the ability of directors to take business decisions in good faith and the rights of minority shareholders.

There was a reference to fraud on minority. That relates to amendment No. 500. As the hon. Member for Cambridge said, the terms are somewhat unclear. I can do no better than to quote from page 74 of the Law Commission report. It states:

“But we considered that the rule was complicated and unwieldy. It could only be found in case law, much of it decided many years ago; the meaning of terms such as ‘wrongdoer control’ were not clear; and there were situations which appeared to fall outside the fraud on the minority exception when it might be desirable for a member to be able to bring an action.”

Jonathan Djanogly (Conservative, Huntingdon)

Am I right in thinking that the law remains as it is in terms of fraud on minority and that it just will not be put in the Bill?

Mike O'Brien (Labour, North Warwickshire)

Let me examine that. Our aim will be to ensure that we get the provision correct, and it is important that this area is clarified. It will not remain as it is, in the sense that, at the moment, we and the Law Commission are saying, as the hon. Member for Cambridge suggested, that there is a certain lack of clarity. We are seeking to make this somewhat clearer and the objective of the exercise is to move towards that position. I want to ensure that we have got it clear enough, so I am happy to look at the matter to achieve a degree of satisfaction that we have got it as clear as we reasonably can.

Jonathan Djanogly (Conservative, Huntingdon)

In relation to the last point on amendment No. 500, I find the arguments of the hon. Member for Cambridge and the Solicitor-General on the difficulty of tying down the language persuasive. Having said that, we need clarity on what the legal position on fraud on minority will be following implementation of the legislation. I am grateful to the Solicitor-General for agreeing to have another look at that, and it would be helpful if he sent a note on it to members of the Committee.

Mike O'Brien (Labour, North Warwickshire)

I am happy to do that.

Jonathan Djanogly (Conservative, Huntingdon)

I thank the Solicitor-General for his kind offer.

We will also wish to consider the Solicitor-General’s comments on the inappropriateness or otherwise of the reasonableness test in amendments Nos. 490 and 491. As to his general point about the amendments inserting more bars to derivative claims, they are not particularly intended as such, but, as I said, were are concerned that the provisions require additional clarity.

As for amendment No. 486, the hon. Member for Cambridge identified the advantage of clarity and definition in terms of the court refusing permission to continue a claim in the various circumstances. In reply to the Solicitor-General’s response on that, I would say that this is very different from saying that it constitutes a bar. I hold some sympathy with his drafting point on subsection (3), but it is just that, not a point of principle. On the basis of what I have heard, I would like to press amendment No. 486 to a Division, but first, I beg to ask leave to withdraw the amendment.

Clause 364

Margaret Hodge (Labour, Barking)

I beg to move amendment No. 433, in clause 364, page 162, line 8, leave out subsections (1) and (2) and insert—

‘(1) A company qualifies as small in relation to its first financial year if the qualifying conditions are met in that year.

(2) A company qualifies as small in relation to a subsequent financial year—

(a) if the qualifying conditions are met in that year and the preceding financial year;

(b) if the qualifying conditions are met in that year and the company qualified as small in relation to the preceding financial year;

(c) if the qualifying conditions were met in the preceding financial year and the company qualified as small in relation to that year.’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss Government amendments Nos. 434, 450, 451 and 454.

Margaret Hodge (Labour, Barking)

This series technical amendments will ensure that the existing position concerning qualification as a small or medium-sized company or group is maintained. We are grateful to one of the large accountancy firms for drawing this to our attention.

Amendments Nos. 433 and 434 concern the ability of a company or group to qualify as small and thus benefit from all the provisions and exemptions available, including exemption from audit. The Companies Act 1985 sets thresholds within which companies and groups must fall to qualify as small. It allows a company or group that has previously qualified as small to fall out of those thresholds temporarily, for one year only, but still qualify as small. That gives a company a year’s grace before it fails to qualify as small and avoids a company yo-yoing between the different size classifications.

Without the amendments, a company or group that has qualified as small for many years, and which will qualify again after one year out, will in certain circumstances fall out of the small company regime. Amendments Nos. 433 and 434 will restore the current position. The same point applies to the definitions of medium-sized companies and groups, which are dealt with in amendments Nos. 450 and 451.

Amendment No. 454 inserts a reference to the clause 363 definition of the small companies regime for accounts and reports on the index of defined expressions in schedule 9 to make this list more complete.

Justine Greening (Conservative, Putney)

I am delightedto take a Front-Bench role under your exalted chairmanship, Mr. Illsley.

Conservative Members welcome the amendments and will not challenge them. They are a wise mechanism for tidying up this part of the Bill and resolving the remaining uncertainties.

Clause 365

Clause 375

Margaret Hodge (Labour, Barking)

I beg to move amendment No. 435, in clause 375, page 169, line 38, leave out from third ‘the’ to end of line 40 and insert

‘undertakings included in the consolidation as a whole, so far as concerns members of the company’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss Government amendment Nos. 436 to 446 and 453.

Margaret Hodge (Labour, Barking)

This is another group of amendments that responds to concerns raised with us by one of the large accountancy firms. The need for the amendments arises because there are differences regarding which undertakings are consolidated in group accounts, depending on whether a parent company is preparing those group accounts using international accounting standards or UK law and standards, which is UK GAAP—generally accepted accounting principles. These result in some circumstances where the populations of the group differ depending on whether IAS or UK GAAP is used.

In the case of group accounts prepared under UK GAAP, the population of the group will be the parent company and its subsidiary undertakings as defined in part 32, but excluding subsidiary undertakings that meet any exclusion in clause 387. Those definitions derive from the seventh European Community company law directive on consolidated accounts. The definition of “subsidiary” under IAS 27 is slightly different, which could lead to different entities populating a group for the purpose of consolidated accounts.

The amendments will ensure that the legal provisions in part 15 concerning group accounts relate to the populations of entities that are included in the relevant group accounts, whether prepared under IAS or UK GAAP. There is additional wording in the amendment to clause 375 to reflect the requirement of clause 386(2) that the true and fair view of a group must be looked at from the point of view of the members of the holding company, not from that of shareholders in the subsidiary companies.

Justine Greening (Conservative, Putney)

Once again, we very much welcome the amendments. They are needed to resolve any confusion and to ensure that the concept of group accounts is as broad as it needs to be.

Justine Greening (Conservative, Putney)

I beg to move amendment No. 498, in clause 375, page 169, line 43, at end add—

‘(3) If compliance with the regulations and any other provision made by or under this Act as to the matters to be included in a company’s individual accounts, or in notes to those accounts under subsection (1), would not be sufficient to give a true and fair view, the necessary additional information must be given in the accounts or in a note to them.’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss amendment No. 499, in clause 379, page 171, line 18, at end add—

‘(2) If compliance with the regulations and any other provision made by or under this Act as to the matters to be included in a company’s IAS individual accounts, or in notes to those accounts under subsection (1), would not be sufficient to give a true and fair view, the necessary additional information must be given in the accounts or in a note to them.’.

Justine Greening (Conservative, Putney)

These probing amendments seek clarification of the concept of “true and fair”. One thing the Bill does is move the auditing profession increasingly to a tick-box approach to auditing whereby, if accounting and auditing standards are fulfilled, the accounts and the business of the audit, as well as the accountants, are, by definition, deemed to be successful. I understand that, nevertheless, the concept of “true and fair” still underpins financial statements.

Under clause 375, directors now have an express duty to ensure that annual accounts give a true and fair view. Clause 375 requires auditors to take account of that duty on directors when they themselves are forming and giving their audit opinion. Clause 485 similarly requires the auditor to give an opinion on whether the accounts give a true and fair view. Therefore, there seem to be a number of indications that “true and fair” remains the underpinning principle.

We are moving increasingly to an IAS basis for international companies, and IAS 1 includes the concept of fair presentation, which is not exactly the same, potentially, as “true and fair”. I understand that when this has been debated at European Union level, “true and fair” has predominated over even “fair presentation”. Again, it would be helpful to get clarification from the Minister that, irrespective of the fact that all accounting and auditing standards might have been followed, the accounts that emerge from that process must give a true and fair view of the financial position of the company at the date of those accounts. That must predominate, and I would be grateful if she gave the Committee that assurance.

Margaret Hodge (Labour, Barking)

I, too, welcome the hon. Lady to her Front-Bench post. It is good to have two women talking about accounting, for a change.

In no way will the provisions in this part of the Bill lead to the tick-box mentality that the hon. Lady fears and which we will doubtless discuss a little later, although I fear that some of the amendments might do so. That is not the intention or the purpose, and I do not think that we will end up with it.

The hon. Lady is right to say that clause 375 makes it an express duty on directors, who we have included, to give a “true and fair” view of a company’s financial position. I am aware of the “fair presentation” language that comes into the IAS requirements, and I assure her that there is no practical difference and that the “true and fair” principles will still be the key thing that directors and auditors have to consider before they sign off accounts. Nothing in company law or in international accounting rules requires anything other than that.

Justine Greening (Conservative, Putney)

I am very assured by the Minister’s statement. There is no doubt that the concept of “true and fair” has underpinned all the work in respect of directors, accountants and auditors over the years. It is a concept that is well understood not only within the profession and the business world, but outside them. That is why it is so valuable to ensure that it is enshrined in the Bill.

In view of the Minister’s comments, I beg to ask leave to withdraw the amendment.

Clause 380

Clause 381

Clause 383

Clause 391

Clause 397

Clause 398

Clause 399

Justine Greening (Conservative, Putney)

I beg to move amendment No. 282, in clause 399, page 183, line 12, leave out subsection (2) and insert—

‘(2) The purpose of the business review is to inform members of the company and to help them assess how the company has performed.’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss the following: Amendment No. 177, in clause 399, page 183, line 12, leave out ‘is to inform’ and insert ‘includes informing’.

Amendment No. 180, in clause 399, page 183, line 12, leave out ‘and help’ and insert ‘, helping’.

Amendment No. 181, in clause 399, page 183, line 14, at end insert

‘assisting potential investors to decide whether to invest in the company and assisting potential customers to decide whether to purchase the company’s goods or services’.

Amendment No. 283, in clause 399, page 183, line 16, after ‘fair’, insert ‘and reasonable’.

Amendment No. 458, in clause 399, page 183, line 24, leave out subsections (5) to (7) and insert—

‘(4A) The business review must, in a manner consistent with the size and complexity of the company, include—

(a) the main trends and factors likely to affect the future development, performance and position of the company’s business;

(b) information about—

(i) environmental matters (including the impact of the company’s business on the environment),

(ii) the company’s employees,

(iii) social and community issues, and

(iv) persons with whom the company has contractual or other arrangements which are essential to the business of the company, including information about any policies of the company in relation to those matters and the effectiveness of those policies;

(c) analysis using financial key performance indicators; and

(d) where appropriate, analysis using other key performance indicators, including information relating to environmental matters, employee matters, supplier matters, and social and community issues.

“Key performance indicators” means factors by reference to which the development, performance or position of the company’s business can be measured effectively.

If the review does not contain information of each kind mentioned in paragraph (b)(i), (ii), (iii) and (iv), it must state which of those kinds of information it does not contain.’.

Amendment No. 178, in clause 399, page 183, line 24, leave out from ‘must’ to ‘include’ in line 26.

Amendment No. 284, in clause 399, page 183, line 25, after ‘for’, insert

‘the members of the company to have’.

Amendment No. 285, in clause 399, page 183, line 28, leave out ‘company’s business’ and insert ‘company’.

Amendment No. 290, in clause 399, page 183, line 35, leave out ‘effectiveness’ and insert ‘success’.

Amendment No. 179, in clause 399, page 183, line 39, leave out from ‘must’ to ‘include’ in line 40.

Amendment No. 291, in clause 399, page 183, line 39, after ‘for’, insert

‘the members of the company to have’.

Amendment No. 292, in clause 399, page 183, line 40, leave out ‘company’s business’ and insert ‘company’.

Amendment No. 293, in clause 399, page 183, line 41, leave out ‘using’ and insert ‘incorporating’.

Amendment No. 295, in clause 399, page 184, line 16, at end add—

‘(11) The directors responsible for preparing the review, whether required by subsection (5) or prepared voluntarily, shall not be liable as a result of—

(a) the review not complying with the provisions of this section relating to the preparation and contents of the review; or

(b) any statement in the review being true or misleading.

(12) Subsection (11) does not apply if the directors who signed the directors’ report in accordance with section 392 knew that the provisions of this section relating to the preparation and contents of the review were not complied with or that any statement in the review was untrue or misleading.

(13) Nothing in this section shall impose upon any person responsible for preparing the business review a duty to update any statement which has been included in the review.’.

Amendment No. 296, in clause 399, page 184, line 16, at end add—

‘(11) “Future”, in relation to a company’s “future development”, means a period of time over which it is possible for the directors to make fair and reasonable comments.’.

Clause stand part.

New clause 21—Auditors’ report on business reviews—

‘(1) A business review must—

(a) state whether it has been prepared in accordance with relevant reporting standards, and

(b) contain particulars of, and reasons for, any departure from such standards.

(2) The auditors must state in their report—

(a) whether in their opinion the information given in the business review for the financial year for which the annual accounts are prepared is consistent with those accounts; and

(b) whether any matters have come to their attention, in the performance of their functions as auditors of the company, which in their opinion are inconsistent with the information given in the operating and financial review.

(3) In this section, “reporting standards” means statements of standard reporting practice which—

(a) relate to business reviews, and

(b) are issued by a body or bodies specified in an order made by the Secretary of State.

(4) References in this section to relevant reporting standards, in relation to a company’s business review, are to such standards as are, in accordance with their terms, applicable to the company’s circumstances and to the review.

(5) Where or the extent that the directors of a company have complied with a reporting standard, they are presumed (unless the contrary is proved) to have complied with the corresponding requirements of this Part relating to the contents of a business review.’.

New clause 33—Guidance on content of the business review—

‘(1) The Secretary of State shall from time to time publish binding, statutory guidance as to the information of each kind mentioned in section 399(4A) to be included in the business review.

(2) Before publishing the guidance referred to in subsection (1), the Secretary of State shall consult such persons or bodies as he considers relevant.’.

Justine Greening (Conservative, Putney)

We have a number of amendments to get through this afternoon, and I am conscious of the time.

The background to the clause is the business review, which was heavily debated in the Lords and on Second Reading in the Commons. In the interests of the Committee’s pressing timetable, I shall not spend a great of the precious time remaining reprising those arguments.

Suffice it to say that the ham-fisted way in which the Government finally got around to introducing the business review was not their finest hour and has cost many companies an awful lot of money on the preparations they had under way for operating the financial review. That could have been avoided if the Government had given more thought at the beginning to the regulatory aspect of not imposing too many burdens on business. However, it seems that we have arrived at roughly the same destination.

Conservative Members broadly support the business review as we now see it in the clause. It more or less strikes the right balance, which is difficult to find, between establishing for the first time a formal narrative of a company’s development risks and uncertainties and the broader impact of its behaviour and its relationship with its employees and the local community and environment.

We think it is right to strike a balance between that and the regulatory burden. Companies, by definition, will not always be successful and are often close to break-even, so we must be careful about placing additional regulation on them without adding an awful lot extra to what people seek from the business review.

We have further issues with the clause. The amendments would strengthen the Bill so that the business review worked in practice as the Government intend it to work under the clause.

I turn to amendment No. 282, which raises a fundamental issue. Clause 399(2) says:

“The purpose of the business review is to inform members of the company and help them assess how the directors have performed their duty under section 158 (duty to promote the success of the company).”

We are broadly happy with the content of the business review as set out in the remainder of the clause, but subsection (2) is arguably in danger of scuppering it by setting out a purpose for it—to demonstrate what directors’ duties are and whether they have been fulfilled. That does not exactly dovetail with the rest of the clause.

My amendment would clarify the purpose of the business review, which is to ensure that the members have an understanding of the business as opposed to the directors’ duties. I believe that Viscount Bledisloe correctly highlighted in the other place the difference between the two. The directors do not equate to the company. There is clearly a direct relationship, but they are not one and the same. A host of factors can affect the performance of a company, as well as that of its directors, ranging from the capabilities of managers to general economic and market trends.

I have some knowledge of this matter, having sat on the Work and Pensions Committee when it was involved in considering the draft Corporate Manslaughter Bill. A main reason for the original Bill being unable to work effectively was the impossibility of being able to tie down what was the directing mind of a company, so there was a mismatch between having to consider the directors’ behaviour and the corporate manslaughter. That was such a fundamental weakness that that Bill has not worked as it was intended to, and we are trying to establish how we can get corporate manslaughter legislation that will work.

I am concerned that this measure has the same potential weakness. The business review is intended to achieve one thing, but that is not necessarily to do with the performance of directors in relation to their duties under clause 158. It is important to take a clear look at that. The business review does not include any assessment of whether directors have fulfilled their duty under clause 158(1)(f) to act fairly between members of the company. Technically, therefore, the business review has a hole there, in enabling the members of the company to assess whether the directors have been successful in discharging that duty.

Similarly, clause 399 arguably does not directly enable the reader to assess whether directors have fulfilled their duty under clause 158(1)(c) to foster the company’s business relationships with suppliers, customers and others. Neither does it specifically mandate the company to provide any real narrative on the quality of its decision-making process, which might well be necessary if the member is to assess to what extent the directors had regard to the likely consequences of decisions in the long term, as set out in clause 158(1)(a).

The business review, as set out in clause 399, does not fully equate to delivering the purpose that subsection (2) says it should. As we are essentially happy with the business review as laid out in clause 399, my amendment would ensure that subsection (2) reflected the purposes of the review, which are, to my mind, to help the members of the company to assess the company’s performance and prospects.

There is no doubt in my mind that the business review requires narrative from directors on how well the company is positioned for the future. The business review is forward looking, whereas the stated purpose of assessing how directors have performed their duties under clause 158 is, by its nature, essentially a retrospective assessment.

The purpose of the business review, as set out in subsection (2), does not exactly mirror the requirements in clause 158, which could end up being a fundamental weakness. It poses a risk that the Government could end up with a legal conflict between company members saying, “This business review does not enable me to assess whether the directors have fulfilled and discharged their duties successfully,” and directors saying, “We have included everything set out in clause 399.”

Which view will predominate, that of subsection (2) or that of the remainder of the clause? The amendment urges the Government to close any gap between them. I hope that the Minister will consider it.

Amendment No. 283 is a probing amendment to find out what the Government mean by the word “fair”, which is included in subsection (3)(a):

“The business review must contain—

(a) a fair review of the company’s business”.

It could be presumed that the review should be balanced, with an assessment of both positive and negative issues relating to the business’s performance and its position. It could also be presumed that “fair” means the relative extent to which issues are covered in detail. For example, the narrative could spend more time on a highly important aspect of the company than on another, less important aspect of its performance and prospects. Is that what we mean by fair?

There is a slight additional confusion. Subsection (4) uses the phrase “balanced and comprehensive”, which could be taken to mean more or less the same as “fair”, but the question is: who knows? I hope that the answer will be, “The Minister.” I should like clarification on what “fair” means in the Government’s eyes. It would be useful to have that on record. It would also be helpful to know how we will contrast the concept of “fair” with “balanced and comprehensive”. Will she give us some guidance and a bit more detail about precisely what those terms mean? That would be useful.

Amendments Nos. 284 and 291 are related and tie in with subsection (2), which says that the review will

“inform members of the company and help them assess”

the directors’ performance. As I said during debate on a previous amendment, it should be the company’s performance that is assessed, but clearly the business review’s customer is primarily the company member. The amendments would clarify that in other subsections. For example, subsection (5) will provide a benchmark. The business review will have to give

“an understanding”,

presumably to the member reading it,

“of the development, performance or position of the company’s business”.

The subsection goes on to say exactly what that should include, but our amendments are clear cut about the fact that the understanding will be required by the member.

David Howarth (Liberal Democrat, Cambridge)

May I ask the hon. Lady a question about the purpose of the amendments? They seem to expand the range of the business review from allowing members to decide whether to vote to re-electthe company directors—that is, simply assessing the directors’ performance as directors—to assessing the company in general. Does that not imply that she wants the business review to allow shareholders to decide whether to sell their shares, for example? Are investment or disinvestment decisions part of what she has in mind?

Justine Greening (Conservative, Putney)

It will be up to members to decide how they want to use the information. At the heart of their relationship with the company is an investment decision, so that will be central to the way in which they use the information. They may have an interest in simply developing their understanding of the sector in which the business operates. Shares might have been given to them, of which they might have a limited understanding. The hon. Gentleman is right that, at the heart of it, there may be an investment decision.

Throughout the rest of the clause, however, there is the aspect of corporate social responsibility, and investors may value things other than the pure, immediate financial returns that the company make. They may value reputation, for example, because the fund is ethical. The business review tries to find the balance between the investment and reputation aspects of the company and its relationship with the community.

There is no doubt that others will also be lookingat the business review, and there is potential forconflict, because the company includes not onlydirect stakeholders—the members—but indirect stakeholders. The latter may have an entirely different and—dare I say it—lower level of understanding of the company. Additional burdens might be placed on directors to obtain the understanding of someone who has only a tenuous link with the company—for example, someone who is perhaps just interested in the product and not even a customer.

It would clear up any lack of clarity in the two clauses, it would be safer and it would achieve certainty if we were to adopt the amendment. However, even as a stand-alone provision, the understanding required is the understanding of the company member above all. The purpose of amendments Nos. 284 and 291 is to close down any potential for confusion.

Amendments Nos. 285 and 292 are related. I am trying to do the Government a favour and ensure that there are no loopholes that directors for whatever reason might use to try to reduce the amount of information in their business review. Companies are often involved in multiple businesses—Virgin, for example, has franchises in a range of business areas—and they change over time. Sometimes companies acquire new businesses in an acquisition spree; at other times, for various reasons, they sell and focus on core activities. The term “company’s business”, which appears several times in the clause, arguably roots the business review in the company’s activities today. There is a risk of directors saying, “I’ve written the business review about my company’s business and I can omit the fact that we have made a commitment to buy a brand new business in a different area with different risks.” The review might end up as a statement of fact about the company’s business today, rather than the businesses that it might select going forward.

The review might need a narrative about the risks and uncertainties of the businesses in which the company will be involved but is not involved at the time of writing. The company might be about to open branches in a new territory, with its own economic and political risks, but has not done so at the time of writing. It is a probing amendment, but it raises a serious point. We must ensure that the review is about the company, and we must exclude from the clause any syntax that might close down the concept of directors talking about the company as a whole.

An example might be a company involved in high street retail that is about to branch into selling insurance or even buying property. It might be about to commence investment in an overseas branch. Those types of business decision mean that the company will face new risks and uncertainties that it might not face when it is writing a business review about today’s business. The amendments would remove any uncertainty by making it clear that the review is about the company as a whole and is not restricted to the businesses that it happens to have participated in to date.

Amendment No. 290 is largely a probing amendment designed to find out exactly what the Minister understands by the term “effectiveness” specifically as it relates to clause 399. That is crucial because when it gets to the corporate social responsibility section of the business review, it refers to

“policies of the company in relation to those matters and the effectiveness of those policies.”

I pick that out merely because subsection (2) talks about the

“duty to promote the success of the company”

and that seemed to be the language that was used to gauge whether things had a positive or negative impact. I am trying to find out whether there is additional significance in using the word “effectiveness” rather than “success”, which presumably could have been used instead and would at least have meant that the language in subsection (5) was aligned with that in subsection (2). If the Minister could clear up the question whether there is any reason for using “effectiveness”, that would be helpful.

Amendment No. 293 is, to some extent, a probing amendment, but in many respects one born out of many years—in my case—of experience in business. The Government need to be careful because you can often lead a horse to water but you cannot necessarily make it drink. The amendment would take out the word “using” in the context of the company using key performance indicators. It proposes that more aggressive language should be used and that the review must incorporate key performance indicators. A business review could, for example, have a table of key performance indicators as part of it. It could have a sentence saying, “See key performance indicators in table 1”, but not really tie it in any further than that to the narrative in the remainder of the review.

I wonder whether it would be wise to have more explicit terminology in the Bill to the effect that the company should fully incorporate KPIs—that they are a fundamental part of the business review. Perhaps the language should be strengthened to reflect that more fully. As I said, the amendment is intended to be a probing amendment and the Minister may well be able to give assurances today that the Government expect KPIs to be fully integrated into the business review, not merely plonked at the end to be taken or left by the reader.

Amendment No. 296 was slightly entertaining to have to think about, because it seeks clarification of the term “future”. I am sure that there are many scientists in the world who could give me an incredibly interesting time-bound definition of “future”. Clause 399(5)(a) refers to

“the main trends and factors likely to affect the future development...of the company’s business”.

It seemed to me that it might be sensible to define “future” might mean. We all know that business can change rapidly and that different businesses have different time scales over which change takes place, so we need to be careful to ensure that directors are not forced to talk about time scales that are so far in advance that the concept of future that they are having to use undermines the integrity of the business review. If they are forced to make predictions over such a long time scale that their comments become speculative rather than forward looking, the quality of the review could be undermined.

Instead, we need clarity to underpin the need to include the main trends and factors that influence the future development of the company. We need a reasonableness test on what it is possible to expect directors to see with a level of certainty, so that the narrative included in the business review is far more useful than mere speculation.

Companies change over time in ways that could never have been predicted. In the 1980s it might never have been possible to envisage the rise of Microsoft when considering IBM. Somebody looking at a business review could say, “Well, you didn’t predict that.” Would it have been reasonable to expect the directors of IBM in the early 1980s to understand that the contract that they signed with Microsoft would be so fundamental in the development of the software and hardware IT industry in the 1980s and 1990s? Most people would say that it would not.

The definition of “future” could become a bone of contention when members believe, for instance, that directors have not covered a long enough time scale. They may say, “What about ten years’ time?”, whereas a business review may cover only five years. Similarly, some members may feel the opposite—that directors are looking too far into the future, undermining the business review. They might prefer it to concentrate on the near future. It would be useful to clarify the matter so that there is no need for conflict to arise. The amendment would give that clarification, setting the term “future” in the context of what is fair and reasonable for directors to be able to comment on.

It may be that, in using the term “fair and reasonable”, I have not chosen the best phrase. I accept that, but the amendment captures the essence of my point that the Bill should carry a more careful definition of the concept of “future” to avoid any conflict in what directors feel they need to do to discharge their duties and to give members a better understanding of what they can expect when they pick up a business review to read it.

I look forward to the Minister’s comments. I have raised a number of issues on the business review, of which we are broadly supportive. It will be helpful if the Minister responds to them.

Lorely Burt (Liberal Democrat, Solihull)

I want to make a few brief comments, as I now know how much I do not know about company law. In the past four years, my Liberal Democrat colleagues and I have been waiting excitedly for this moment, because it represents what we feel to be one of the most important parts of the Bill.

I wish to speak to new clause 21. The hon. Lady seems happy with the majority of the Bill, but we are not. Last autumn, the operating and financial review was kicked into touch by the Chancellor, who appeared to be seeking to ingratiate himself with the City by dropping that requirement. That was done to the anger of many companies that had gone a long way towards producing their reviews for the consumption of their customers and investors. We now have the proposed business review, which is very much better than nothing at all. However, some might argue that it is not a great deal better. Our key concern is that there is no requirement to audit the reviews. The new clause would remedy that.

Reports like the Tesco corporate social responsibility report are being produced. If you will pardon the pun, Mr. Illsley, one would think that butter would not melt in Tesco’s mouth from the way that it describes its activities. However, only this week much concern was expressed about fruit picking in South Africa and many other activities in which Tesco, Shell and other large companies engage.

Keith Vaz (Labour, Leicester East)

It is not just what the companies are known to be doing abroad; it is what companies like Tesco do in this country. In my constituency, few people know what Tesco is up to. They know that it wants more and more planning permissions to build bigger and bigger stores, but they are unaware of what the company is actually doing. Better reporting is one way of enabling people to find out exactly what is happening.

Lorely Burt (Liberal Democrat, Solihull)

The right hon. Gentleman makes an excellent and eloquent point. That is exactly the sort of thing that I am trying, falteringly, to express. Unless we measure what companies say about themselves, they can basically say what they like. The Government’s assessment of the cost of producing the reviews in terms of the audit is £33 million, which when one considers the potential benefits to these companies, is a relatively small amount.

Customers and investors often want the full information about the activities of the companies they are buying from and investing in. A proportion of people would describe themselves as ethical investors and ethical customers. That number is growing exponentially, year by year. In our household we have switched to green energy. The energy supplier professes to be a green energy supplier, but unless the information that it gives us is audited, how can we tell how green it is?

I hope that the Minister takes new clause 21 seriously. The right hon. Member for Leicester, East (Keith Vaz) has also tabled an excellent amendment. I hope that we can find a way to satisfy the needs and requirements of customers and investors in companies who want their company to grow and achieve profits in an ethical and socially responsible way.

Keith Vaz (Labour, Leicester East)

New clause 33 in a sense it complements the points that the hon. Lady has raised. It requires the Government to publish clear, mandatory standards on how companies should report on non-financial issues in the business review. I am quite convinced that this is a Government who believe in transparency.

May I say what a pleasure it is to serve on a Committee that is led by the my right hon. Friend the Minister for Industry and the Regions? It is little known fact that I was one of her employees when she was leader of Islington council. When she led that great council in those days, when Labour had a large majority—no doubt because of her leadership—she was famed for transparency. I can remember as a very junior solicitor attending committees that she chaired. The mantra of all the committee chairs concerned the need for openness and transparency, so that as much information was provided to the people of Islington as possible.

New clause 33 seeks to provide information about companies, many of which, I am afraid, operate in secret. The business review and the need for mandatory standards will allow many people to understand what such companies get up to. It is not just a matter for the Liberal Democrats; it is a matter for all of us who believe that it is important that these organisations are held to account. The shareholders and the public may not do very much with the information; they may only read the reports, but they need the information in order to make informed judgments.

Quentin Davies (Conservative, Grantham and Stamford)

The right hon. Gentleman’s new clause states:

“The Secretary of State shall from time to time publish binding, statutory rules”

as to further disclosure requirements. Is not that an invitation to Governments in response to pressure from the Daily Mail,for example, to go on adding indefinitely to the regulatory and compliance burden on companies, reducing the predictability of the content of the accounts, so that people no longer know in advance what information they have to produce? They will never know when they will suddenly be faced with a new demand and a new cost burden.

Keith Vaz (Labour, Leicester East)

The hon. Gentleman makes an important point, but he has a touching faith in the energy of Government. I have been dealing with the DTI for the last decade and a half on the subject of the closure of BCCI, which was 15 years ago. Departments do not move very quickly. Even if we retain the clause that allows them to do what is proposed, Secretaries of State and Ministers—even those as distinguished as my right hon. Friend—will not issue directives on a weekly basis or in response to a campaign run by the Daily Mail or The Guardian. However, the power should be in the Bill to enable them to do so if the need arises.

New clause 33 is drafted to allow reasonable latitude in framing the reporting standard, which I hope will address concerns that too strict a reporting standard would place too heavy a burden on business, which I think deals with the point made by the hon. Gentleman. I know that business feels that there are too many regulations, but new clause 33 will not place more regulations on business. Instead, it will give it a capacity to show that it is prepared to release information to enable people to make an informed judgment.

I hope that the Minister’s pragmatism and ability get things moving. I have greatly admired my right hon. Friend for almost 30 years. I was in awe of her when I worked for her many years ago because she was the person who would get things done, but not to the extent that she would ask her fine officials at the Department of Trade and Industry to rush off and issue directives on a weekly basis, which would upset the hon. Member for Grantham and Stamford (Mr. Davies).

I hope that the Minister takes our points on board. I come here as a friend—she may not regard the Liberal Democrats as friends—trying to make the Bill better. Governments believe that when they produce a measure that has been considered for the past seven years, it must be perfect, even though Government amendments seem to be tabled on a daily basis; I wonder what they have been doing for seven years.

My right hon. Friend and other Ministers have worked hard on this Bill, but this is a win-win situation. It is the kind of new clause that new Labour would be proud of because it allows citizens to make an informed judgment so that the consultation process will result in a statutory framework that will give people the information to make those decisions themselves. The new clause is more new Labour than new Labour.

David Howarth (Liberal Democrat, Cambridge)

Despite the hon. Gentleman’s closing comments, I think that he has tabled a good new clause and a good amendment. However, I shall speak mainly to amendment No. 181—Nos. 180 and 177 are consequential to No. 181—and briefly mention amendments Nos. 178 and 179.

Before I do that, could I add to what has already been said about my new clause? Its main object is to return to the situation that I believe was originally intended by the Government, in which information contained in the narrative reports that companies will be obliged to produce will be audited and can be checked by auditors in the standard way. As a consequence of the original Government proposal, the Accounting Standards Board produced detailed guidance that would have been used for that purpose. It laid out in appropriate detail what it would mean for companies to report on environmental, social and community aspects of their work.

As my hon. Friend the Member for Solihull (Lorely Burt) said, the Government’s assessment of the financial burden on companies seems to be only£33 million. Given the number of companies that are involved, that regulatory burden is quite small, compared with the benefits that would be produced for the public and the economy as a whole were such information to become more credible.

That brings me to our amendment No. 181. Its purpose is to expand the scope and purpose of the business review. It became clear in the speech of the hon. Member for Putney (Justine Greening) that at present the purpose of the business review is very much focused on the company itself and on relationships between existing members of the company and the board of directors. Amendment No. 181 seeks to expand the audience—the recipients of the review—to include future investors in the company and the company’s customers. The reason for proposing an expansion is simple: we believe that the Government have a legitimate role in helping to create a market for ethical investment and consumption.

There is already a growing market for ethical investment and consumption. Estimates vary, but the minimum estimate is that 5 per cent. of consumers consider themselves to be ethical. However, there is a problem with the degree to which potential investors in companies and potential buyers of companies’ goods and services can rely on the information that they are given by companies about their activities, so the best thing that the Government can do to help establish a growing market for ethical investment and consumption is to guarantee to underpin the information. That seems to be a legitimate role for them. To back that up, amendment No. 181 specifically expands the scope and purpose of the business review to include the interests of future investors and consumers.

Justine Greening (Conservative, Putney)

The amendment refers to potential customers. For some companies, anybody could be a potential customer—their stakeholder group would be incredibly wide. In fact, one could argue that for an international company it is the entire world. Is that what the hon. Gentleman had in mind?

David Howarth (Liberal Democrat, Cambridge)

In the context of our amendments and new clause, yes. The Accounting Standards Board will create its standards for the business review. The operating and financial review—the previous round of this saga—produced a certain set of standards which the ASB turned into just recommendations when the Government repealed the original OFR. That means that when we get the business review through, the ASB will have to put forward a new set of accounting standards that take into account what is in the business review as opposed to what was in the OFR. We are saying that when it designs those new standards it should have in mind not only the interests of existing members of the company, but the interests of potential customers and investors. To that extent, my answer is yes.

I hope that the hon. Lady will forgive me for saying that she might be asking whether we envisage the amendment creating an actionable obligation on companies that can be enforced by anyone in the world in a law suit. The answer to that is no, we are not intending that; we are intending it to settle the purpose of the business review for the exercise of creating those accounting standards.

Justine Greening (Conservative, Putney)

Is the hon. Gentleman aware that the ASB has already reflected on the fact that the OFR has now morphed into the business review and has issued a new reporting statement, which is obviously a non-mandatory guideline? There is already some assurance of exactly what good practice companies will be expected to follow when they are doing the business review.

David Howarth (Liberal Democrat, Cambridge)

Yes, indeed, and I have the document with me. The new reporting standard is close to the original draft, just with a different title. If our amendment were to be agreed to, there would need to be further amendments to the text that would reflect the new purpose: to help to create an investment market and a consumer market based on ethical principles. We recognise that further amendments would be necessary.

Justine Greening (Conservative, Putney)

Does the hon. Gentleman agree that the fact that that reporting statement exists gives potential customers and investors something clear cut that allows them to ask companies whether they are following it as part of their business review? As an example of that we have only to look at page 44 of the reporting statement, which gives the clear example on CO2 emissions. Does he need to proceed with the amendments given that incredibly powerful albeit not mandatory document?

David Howarth (Liberal Democrat, Cambridge)

I agree that the document is very good, but it could be expanded in scope were the purpose of the review to be expanded in the way that we suggest. While we are on the point, to be fair to the Government, I should say that the scope of the business review in the Bill is much wider than many people might have feared when the OFR was removed. There is already broad scope in the business review for going in the direction that we want to go. It is simply that we think that we could go much further and we could be clear about the purpose of the review.

Amendments Nos. 178 and 179 also relate to the question of what the business review is for. They are more in the way of probing amendments, which aim simply to find out what the Government believe the words in the Bill mean. We suggest that the words

“to the extent necessary for an understanding of the development, performance or position of the company’s business”

in subsection (5) should be removed, because it is not clear what they are intended to achieve. If they are intended to restrict the scope of the business review, the use of the word “necessary”, for example, is slightly dangerous. If that is the intention, what is the reason for it? However, if that is not the intention, why are those words in the Bill at all? The clause would make perfect sense if it said simply that the business review should include the other matters in the subsections. Some people have read the provisions as restrictive; they could also be read as not very restrictive.

Keith Vaz (Labour, Leicester East)

Does the hon. Gentleman agree that, in this day and age, people want such information? There is much anecdotal evidence that when they find out that, for example, Sainsbury buys its bananas from a country that deals in Fair Trade, they then buy its bananas. The more information that we can give to consumers, the better. No one is harmed by it.

David Howarth (Liberal Democrat, Cambridge)

Absolutely; people use the information for their own purposes. It will improve their ability to make such decisions. In the end, it comes down to whether people can trust the information that is being offered to them by companies. That is the fundamental point that we are trying to get across. When people want to take part in consumer boycotts, for example, can they trace a company’s products? Sometimes people ask others if they are taking part in a particular boycott, such as that against NestlÃ(c). It is difficult for people to know whether they are taking part in a boycott, because it is difficult to know exactly which products companies produce.

As my hon. Friend the Member for Solihull said, if people want to make a choice in favour of green energy or buying green electricity, it matters a lot whether the claims of a particular company can be believed. Friends of the Earth used to have a website that showed whether the firms that claimed to be providing green electricity were doing so. As a research project, and given the information available to Friends of the Earth, it found that it was becoming far more expensive and too burdensome to continue. In fact, when it closed the website, it suggested that the Government take on the task. I suspect that their response was that, if it was too burdensome for Friends of Earth, it would probably be too burdensome for the Government.

Our approach would not impose the burden on the Government. It does not propose that voluntary organisations take on a research burden that is plainly beyond them in the present circumstances. We simply propose that the information be made available to consumers in general, and that they could use it to further their ethical and political campaigns.

Margaret Hodge (Labour, Barking)

This has been a good debate, although I must say to the hon. Member for Cambridge that, if he does not know which products are made by NestlÃ(c), he should go shopping a bit more. Its name is on the bottom of its products.

David Howarth (Liberal Democrat, Cambridge)

Because of the subsidiary structure of NestlÃ(c), that is often not the case. We would be surprised to find that certain products were produced by NestlÃ(c). I shall not go into detail, because I might be advertising.

Margaret Hodge (Labour, Barking)

The hon. Gentleman intrigues me. Before the Company Law Reform Bill, I was the shopper in the house and I am sure that I could identify the products.

As my right hon. Friend the Member for Leicester, East said, we are committed to improving company reporting and transparency. I was particularly grateful for his kind words. I shall have to show a report of them to my husband so that he believes that the midnight oil that I am burning on the Bill is in a good cause.

One of the most important ways in which directors will be accountable is through improved corporate reporting, which is the purpose behind clause 399. That is why we streamlined the arrangements for narrative reporting and introduced the changes relating to the business review in the House of Lords. A broad range of amendments has been tabled to the clause. Some were tabled on behalf of environmental and corporate social responsibility groups seeking to strengthen the reporting requirements of the business review and to introduce further elements of the operating and financial review; others may have been tabled on behalf of the corporate lobby, which seeks to weaken the scope of the requirements and provide more protection for directors.

Seeing those two ways reinforces my belief, as has been the case a number of times during our consideration, that we might have got the third way just about right and that the package that we have introduced on narrative reporting represents a consistent and balanced policy in light of the consultations. It always has been our aim—I stress that it continues to be—to encourage the provision of meaningful, strategic and forward-looking information to assist shareholder engagement while avoiding disproportionate burdens on business. That is consistent with Government regulations.

I shall quickly answer the points raised by the amendments, starting with amendments Nos. 282, 177, 180 and 181. The Government have included subsection (2) on the business review for two reasons. First, it specifies for whom the business review is intended: it is an important part of the package concerning liability, specifying that the review is to inform members of the company. It is also intended to make it clear that the business review is designed for the benefit of members as a whole, so that they may more effectively hold the directors to account. It is not designed to help individuals to make investment decisions, nor it is targeted on the wider public in the sense that they should be entitled to rely on it.

The effect of the provision, taken in conjunction with clause 447, is to limit directors’ liability to the company only, ensuring that neither individual investors nor anyone else is entitled to sue. That is an important point.

Secondly, we want to make an express link between the business review and the directors’ duties under clause 158. As I said in our debates on that clause, that is part of a package of proposals embedding the concept of enlightened shareholder value in the Bill. Directors have to have regard to the factors set out in clause 158, and will demonstrate that in the review linking the two. That gives legal expression to the view that, in looking at the long-term success of a company for the benefit of its members, directors should have regard to the factors set out in clauses 158 and 399.

Clause 399(2) is a response to the view of stakeholders during our consultation on narrative reporting earlier this year. Business and investor groups alike called on the Government to clarify the position on liability. As I said, specifying the purpose of the business review is one element of the package that makes clear the extent of directors’ liability.

The direct link to directors’ duties was pressed for by a significant number of interest groups. They echo the company law review in seeking a clear and important link between enlightened shareholder value and narrative reporting. In removing or expanding subsection (2), amendments Nos. 282, 177, 180 and 181 would risk running counter to what stakeholders have, on balance, been saying.

The hon. Member for Putney asked whether there is conflict between clauses 158 and 399. The answer is no. The directors’ job is to run the company’s business. As the hon. Lady said, the company is the members collectively. The company’s business may be subject to external factors, and clause 399 provides that the business review has to cover the company’s business. The purpose of doing so, however, is to enable the shareholders to hold the directors to account, not to inform the public more generally. In other words, the directors have to concentrate on what the shareholders need to know to hold the directors to account.

The Bill encapsulates what the directors have to do to promote the success of the company as a whole, as the hon. Lady said. There is therefore no conflict in referring to that. The purpose of the review is to enable the shareholders to know that the directors are performing in the shareholders’ interests.

Justine Greening (Conservative, Putney)

Does the Minister believe, therefore, that all the duties in clause 158 will be reflected in the business review so that members of the company can assess whether those duties have been discharged properly? That is the question I raised.

Margaret Hodge (Labour, Barking)

The answer is that we have left it to the discretion of the directors to decide whether they incorporate all those factors. It will be a matter for their judgment whether all the factors need to be incorporated to fulfil the requirements in subsections (3)(a) and (b) and (4)(a). So, that will be for the directors to judge and their requirement will be to fulfil those provisions—it is at the directors’ discretion.

The hon. Lady asked for a definition of “fair and reasonable”. I am told that the concept of the directors’ report giving a fair review is well known. It was introduced to company law by the Companies Act 1981 and implementation of article 46 of the fourth European Union company law directive. Its meaning is well known to companies and the accountants who advise them, and we think that little would be gained from changing it. There is no specific definition, and we think it right not to define the meaning because companies and auditors are calling for principles, not rules on financial reporting.

My right hon. Friend the Member for Leicester, East tabled amendment No. 458, which would replace subsections (5) to (7). In our view, the amendment would impose a requirement to report on all specified matters, regardless of whether such information was necessary for an understanding of the company’s business. In a sense, that goes back to the comments that I just made to the hon. Member for Putney—it will take away a director’s ability to judge whether such information is relevant. In our view, it could turn the whole thing into a box-ticking exercise, rather than a serious review of the company’s business. I am sure that my right hon. Friend would not want that.

Proposed new subsection (4A) of my right hon. Friend’s amendment would impose also those requirements on unquoted companies. The original regulatory impact assessment undertaken for the operating and financial review estimated that if requirements were extended from the approximately 1,300 quoted companies to large private companies, the reporting burden would be imposed on an extra 5,000 companies and increase the cost per year by £35 million. That is not a small amount, as the hon. Member for Cambridge suggested, but quite a considerable burden.

It would be difficult to impose those further cost burdens on Britain’s medium-sized enterprises. I say to my right hon. Friend that that was one of the issues raised with me by a number of people that I am keeping under review. I appreciate the fact that he has raised it. We have focused on quoted companies because they trade shares on the open market, so additional reporting and scrutiny are justified.

We must be careful not to impose undue cost burdens on non-quoted companies. It is always difficult to draw the correct line when determining which classes of company should be subject to obligations. That is why we will keep the matter under review.

David Howarth (Liberal Democrat, Cambridge)

The Minister is making the point that the clause imposes burdens on publicly quoted companies because of the public trading of their shares. Does she not accept that that implies that the purpose of the business review should be wider than simply the ability of members to hold the company to account? By saying that, is she not accepting, at least partly, our case for widening the purpose to include potential investors in the company?

Margaret Hodge (Labour, Barking)

No. The hon. Gentleman is conflating two arguments, and I do not accept his.

Proposed new subsection (4A) also specifies an additional factor that companies would be required to include in their business review—information about contractual or other relationships to suppliers essential to the business of the company. That issue was raised by the hon. Member for Putney.

Again, this is a difficult judgment issue as to whether we should make the business review more onerous, but I am keeping it under review. Reporting on contractual or other arrangements essential to the business was regarded as important to some respondents to the Government’s consultation. We have been trying to weigh that up with those pressing to ensure that no undue reporting burdens are imposed on business.

Keith Vaz (Labour, Leicester East)

That is highly relevant in the proposed review being conducting by the Office of Fair Trading on the retail industry because there is concern about the pressure being put on suppliers by companies such as Tesco to ensure that they supply at the lowest possible price. I am grateful for the Minister’s words. It seems that, although the door is not completely open, she is peeking through it with a view to walking through it at some future stage.

Margaret Hodge (Labour, Barking)

My right hon. Friend is clearly trying to move me slightly forward; I hope that he reads Hansard carefully. What I would say to him, which I think will give him additional comfort, is that where contractual and other relationships are essential to the business, such information will be required by subsection (4) to be included for a balanced and comprehensive analysis consistent with the size and complexity of the company.

Proposed new subsection (4A) would increase the reporting burdens in relation to key performance indicators requiring to be used. The amendment would remove the exemption allowed under subsection (7) for medium-sized companies not to have to report non-financial performance indicators. The exemption is an option that the EU directive allows member states in implementing the business through the new requirement, and on that we see no justification for granting the exemption in the UK.

The amendment would require all companies producing a business review to include, where appropriate, KPIs—not just on environmental and employee matters, but on supply matters and social community issues. That goes well beyond the requirements of the EU directive, so we find it difficult to see a justification.

I say again to my right hon. Friend that if the directors consider that analysis using KPIs on suppliers’ matters and social community issues is necessary for an understanding of the development and performance or the position of the company’s business, they could of course include it.

The probing amendments Nos. 178 and 179 would have the same effect as amendment No. 458 in the removal of words. They would lead to a box-ticking exercise and impose unnecessary burdens on many quoted and unquoted companies. Subsection (6) uses the words

“to the extent necessary for an understanding of the development, performance or position of the company’s business”

because we want to provide flexibility in the disclosures that need to be made in the business review and enable directors to use their judgment.

Where the information is not necessary for an understanding of the company’s business, the director should not report on the matter specified. That might apply, for example, to smaller quoted companies. We think it right that it should be for the directors to judge whether to include certain information, and if not to state so, and for the shareholders to hold the directors to account.

The effect of amendments Nos. 284 and 291 would be to repeat that the specific information required of quoted companies under subsection (5) and of all companies under subsection (6) is for the members of the company to have an understanding of the company’s business. We think that it is unnecessary to repeat that in subsection (5). Subsection (2) is sufficiently clear and, in response to the question that I think the hon. Member for Putney was asking, the business review is for members to hold directors to account, and not for any other purpose.

Amendments Nos. 285 and 292 would confuse directors of a quoted company about what they should report. When we refer to the company we mean, in company law terms, the members. That has always been the case. The directors are appointed by the members to steward the business of a company, and the business review essentially requires the directors to report their stewardship of the business of the company.

The hon. Lady also asked whether the provisions would cover new branches, new territories or new areas of the business. The argument is that it would probably have to do so, because such development may well be crucial to the company’s future. Again, subsection (4)(a) would cover whether that would have to be included. Subsection (3)(b) would also cover it. The hon. Lady’s concern that that might not be covered is unfounded.

On effectiveness and success, apparently we think that the word “effectiveness” is better in relation to the particular policies and whether they achieve the effect that they set out to achieve. This is lawyers’ paradise. “Success” is a wider concept, implying that the policy itself must be judged rather than whether it worked. Let us all think about that. That is the answer to that one. [Laughter.]

Amendment No. 293 would insert “incorporating” in place of “using”. The effect could be that directors might present their analysis in a variety of formats and the performance indicators might be less discernible. That would make it more difficult for members to assess the information and for directors to have clarity on the information that should be included. That seems contrary to the purpose of the review, and it is contrary to the requirements of the EU directive. I hope that that explains the matter.

The cheekier amendment No. 295—I cannot remember the expression that the hon. Lady used, but she said that it was a probing amendment—has two limbs. It seeks to limit the liability of the directors in relation to the business review. It limits the directors' liability to the company only and specifies that the directors will be liable only for untrue or misleading statements or omissions—that is in clause 447—made in bad faith or recklessly or when there is a deliberate and dishonest concealment. We shall debate clause 447 more comprehensively when we come to part 15, but I note that the hon. Lady has obviously been having second thoughts because she has tabled a rather different amendment to clause 447.

Proposed new subsection (13) in amendment No. 295 expressly states that there is no obligation to update any statement in the business review. We think that that is unnecessary because there is no requirement under clause 399 to update any information disclosed in the business review. More importantly, we are concerned that such a provision could cast doubt on whether there was a requirement to update other reporting obligations under part 15. That is very different from, for example, the continuing disclosure obligations under the Financial Services and Markets Act 2000 and the market abuse regime under which issuers must ensure that price-sensitive information is disclosed as soon possible.

Amendment No. 296 refers to “future development”. Under clause 447, a director will be liable only if he deliberately or recklessly makes “untrue or misleading” statements in the report or dishonestly omits information. Similarly, knowledge or recklessness is the test for criminal liability under clause 401. A director has to meet that standard in making statements about the future in the business review. Nobody is asking a director to do the impossible; I am happy to put that on the record.

With new clause 21, the hon. Member for Cambridge and other hon. Members are attempting to reintroduce the OFR, which we will not do. We do not want the new clause. Statutory standards are not required, because they would create too much of a burden on business. We have discussed the matter and the ASB has made its statement, which will give good guidance to those responsible for putting together the business review. It also draws attention to issues that are inconsistent with the information in the review, which are burdensome, expensive and one reason why we withdrew the OFR to create a real saving.

On the new clause tabled by my right hon. Friend the Member for Leicester, East, we believe that the non-statutory guidance is appropriate. Everybody thinks that the guidance document is good, and we would like to work in that way rather than introduce statutory requirements for companies.

Patrick Hall (Labour, Bedford)

I am trying to follow my right hon. Friend as best I can from the far corner of the room, because I want to be clear about something. When we discussed clause 158 on Tuesday, she confirmed that non-mandatory guidance would be prepared with regard to director’s duties. Has she just said that, in respect of new clause 33, she does not accept the need for mandatory or statutory guidance? Does she accept the same principle in respect of clause 399 that she accepted in respect of clause 158—that guidance will be produced—because the logic of one applies to the other?

Margaret Hodge (Labour, Barking)

I understand that, in its report, the ASB has produced what we call best practice guidance, which will have to be updated regularly and will be available for companies to ensure that they fulfil the requirements of clause 399 which will enable them to fulfil the requirements under clause 158.

I hope that I have dealt with the amendments, but I am afraid that we can accept none of them.

David Howarth (Liberal Democrat, Cambridge)

I am disappointed with the Minister’s response to our new clause, although not surprised. We will need to return to this important matter. I shall consider carefully what she said about the issues that we raised in amendments Nos. 178 and 179.

We had an interesting discussion on amendment No. 181, which suggests that there is some sympathy on all sides of the argument with the point of view that we are advancing. The hon. Member for Putney regarded the interests of investors as a legitimate aspect of the business review. In her response to amendment No. 181, the Minister seemed to say that her main reason for being against it was that it was not suggested by stakeholders. It is true that people outside this place do not always come up with the answers that we on the inside would prefer, but that is not a knock-down argument against going in that direction. If the opportunity arises, Mr. Illsley, I would like to press that amendment to a vote. If, by any mischance, it were to be passed, I would then have to press consequential amendments Nos. 180 and 177 to a vote, to make the clause make sense.

Justine Greening (Conservative, Putney)

We have had an interesting and wide-ranging debate. The key to the success of clause 399 is striking the right balance between the need for companies to be more transparent than ever regarding their corporate social responsibilities, and not imposing burdens on them that do not really enhance the evidence or narrative that they give to their members.

I fully appreciate the concerns expressed by the right hon. Member for Leicester, East and the Lib-Dem spokesman, the hon. Member for Cambridge. There was a touch of irony to the Lib-Dem position, because they fully supported the business review in the Lords. Indeed, Lord Sharman, who is named on the Lib-Dem website as their spokesman on trade and industry in the Lords, said:

“My Lords, I congratulate the Government on rebranding a part of the Bill.”

David Howarth (Liberal Democrat, Cambridge)

I think that was sarcasm.

Justine Greening (Conservative, Putney)

Perhaps I should continue the quotation. Lord Sharman said:

“My Lords, I congratulate the Government on rebranding a part of the Bill. To the average man in the street we now have the business review, formerly known as the OFR. I also congratulate the Government on having the balance about right.”

David Howarth (Liberal Democrat, Cambridge)

That is irony, rather than sarcasm.

Justine Greening (Conservative, Putney)

Lord Sharman continued:

“This series of amendments gets the balance about right. It is a welcome addition and I support it.”

He continued for some time, before ending by saying:

“I go back to my first remarks that the Government have got the balance about right, and I congratulate them on that. —[Official Report, House of Lords,10 May 2006; Vol. 681, c. 922.]

It is ironic that the Lib Dems propose an audit of business reviews; perhaps we should propose an audit of Lib Dem statements to establish to what extent they are inconsistent with reality.

We have had a full debate. The Conservatives feel that the business review is about right. The Accounting Standards Board reporting statement on the business review, which was previously the OFR, is extremely helpful, because companies that are concerned about having good reputations and high standards of corporate and social responsibility will follow that reporting statement. There is no doubt that the business review will be used. It is a matter of information, so of course people will read it, and when they do so it will be clear to members and wider stakeholders which companies have not taken the time to follow the ASB’s reporting standard and spent resources on that.

One could argue that we should not try to save companies from themselves, and that we should allow them to demonstrate whether they are interested in corporate and social responsibility, because those that are not will clearly stand out from those that take it seriously.

Lorely Burt (Liberal Democrat, Solihull)

As I said earlier, unless they are in some way audited and empirically held to account for their statements, companies can say whatever they like.

Justine Greening (Conservative, Putney)

The hon. Lady made that point, but clause 447 clearly covers misleading statements. One of the Government Members is a financial journalist. The media play a role in uncovering companies’ bad behaviour and in many respects that has been far more effective than cumbersome regulation in highlighting the companies that do not take corporate social responsibility seriously. Other clauses will clamp down on directors who make misleading statements, so although I appreciate the hon. Lady’s concerns, I think that the Bill will address them.

Jonathan Djanogly (Conservative, Huntingdon)

My hon. Friend is making a very persuasive speech. We are tending to look at the downside and at what companies do not do. There is also an upside, and the approach that is being taken will encourage companies to do more than the minimum rather than just meet the minimum requirements.

Justine Greening (Conservative, Putney)

My hon. Friend makes a valid point. I have not doubt that once the Bill is enacted many companies will take the view, as do many hon. Members, that corporate social responsibility is now a fundamental part of how companies run their affairs. It is important for two reasons—its innate importance and the value that customers and stakeholders attach to it.

Jonathan Djanogly (Conservative, Huntingdon)

I thank my hon. Friend for her patience and for allowing me another shot. I recently spoke to a very large company which said to me that it uses its CSR as a selling point. Its concern about everyone being treated the same is that it would lose that selling point. It sells itself to its customers and puts itself above competitors through its good CSR record, which is a unique selling point.

Justine Greening (Conservative, Putney)

Absolutely. Many companies are realising that they can develop their reputation by genuinely taking seriously high ethical business standards.

I thank the Minister for taking the time to go through the amendments. I shall not press them to a Division, but I still have concerns on a few matters. I am still concerned about the matter covered by amendment No. 281. There is a gap between what clause 158 says about directors’ duties and what is to be in the business review. Similarly, I was not entirely persuaded by the argument on “effectiveness” and “success” in amendment No. 290. I am sure that after Hansard is made available tomorrow we shall all take time over the weekend to try to understand the argument.

Margaret Hodge (Labour, Barking)

No doubt, while we will all cogitate on that, we can return to the matter on Report. The two words are pretty similar.

Justine Greening (Conservative, Putney)

I thank the right hon. Lady for that input. As she says, we might return to certain issues on Report. I certainly reserve the right to bring back the proposal in amendment No. 281, and that in amendment No. 293 on whether we should incorporate key performance indicators or merely use them. We have had a good debate. I beg to ask leave to withdraw the amendment.

Clause 419

Clause 429

Margaret Hodge (Labour, Barking)

I beg to move amendment No. 447, in clause 429, page 200, line 16, at end add—

‘( ) This section does not apply to companies within section 428 (filing obligations of companies subject to the small companies regime).’.

This is another technical amendment to clarify the requirements in the law on the accounts and reports that small companies must file with the registrar of companies. Its purpose is to make clear that small companies are not also subject to the filing regime for medium-sized companies. This part of the Bill sets out thresholds for medium-sized companies that are higher than those for smaller companies.

Clause 428 specifies the filing obligations for smaller companies; clause 429 specifies those for medium-sized companies. The amendment adds an element to the clause dealing with filing obligations for medium-sized companies, to make it clear that although small companies fall within the threshold for medium-sized companies, they are not caught by its requirements.

Clause 445

Margaret Hodge (Labour, Barking)

I beg to move amendment No. 448, in clause 445, page 210, line 17, leave out from ‘the’ to end of line 23 and insert ‘following exceptions’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss Government amendment No. 449.

Margaret Hodge (Labour, Barking)

The intention behind amendment No. 448 is to reverse amendments made in another place. That is not something that the Government undertake lightly, but the amendments that were made to the clause would have a seriously detrimental effect on the operations of the Financial Reporting Review Panel.

The FRRP performs the vital role of investigating apparent breaches of Companies Act 1985 requirements on the annual accounts and reports of public and large private companies. It will continue to perform that role after the Bill is enacted. The amendments would have affected the onward disclosure of information obtained by the FRRP in the exercise of its compulsory powers under clause 443. The Bill as it now stands imposes additional requirements on the FRRP that we think are unworkable. Were the FRRP to pass on information to other bodies within the prescribed limits of clause 445, and should those bodies need to disclose that information onward to other bodies, the Bill as currently amended requires that the FRRP first authorises onward disclosure and secondly satisfies itself that onward disclosure is in the public interest.

I appreciate that the requirements introduced in another place were based on the requirements that currently apply to the Revenue and Customs, but they do not work in this context. The Revenue provisions only apply to disclosures that the Revenue makes itself, but in the context of the Bill, the restrictions would apply to further disclosures by bodies to whom the FRRP had made disclosures. However, the FRRP would not necessarily be in a position to made judgments about the merits of the onward disclosures, and it has expressed considerable anxiety about the new requirements.

For instance, is the FRRP the correct body to judge whether information that is quite properly passed to the Secretary of State should be further disclosed by the Secretary of State? It will be for the Secretary of State to judge whether that information can and should be further disclosed—indeed, the Secretary of State might be constrained from disclosing to the FRRP the reasons why onward disclosure is necessary. In those circumstances, how could the FRRP authorise disclosure and satisfy itself that disclosure was in the public interest? So far as disclosures by the FRRP are concerned, they must of course act properly and responsibly in ensuring that any disclosure is permitted, and they face criminal sanctions under clause 444 if they do not.

There are particular concerns about how the amendments would have affected the system of financial regulation. Responsibility for the enforcement of financial information is shared between the FSA—the securities regulator—and the FRRP. A key outcome of the considerations of the Government committee on audit and accountancy reports was the way in which the FSA and the FRRP work together to present a seamless approach to financial regulation in the UK. Provisions in the Companies (Audit, Investigations and Community Enterprise) Act 2004, including those on disclosure of information obtained by the FRRP, were included to reflect that approach. Clause 14(2) of that Act obliges the FRRP to monitor certain financial information, and to inform the FSA of its findings. That was considered essential in view of recent developments in the EU. Two standards regarding financial information have since been issued by the Committee of European Securities Regulator with which it is desirable that UK regulators comply.

The C(AICE) Act sets out the key responsibilities of the FSA and FRRP, which have been further developed through a public memorandum of understanding. The memorandum includes details of how the two bodies co-ordinate their work, and sets out the points at which the FRRP may refer specific company matters to the FSA. It must be asked whether the Bill as amended would require the FRRP to conduct a public interest test in respect of every piece of information that it contemplates disclosing to the FSA. If so, such a requirement would damage the co-ordinated and informed approach to financial regulation that we have developed in the UK.

If the UK could not demonstrate a high level of co-ordination and co-operation in its regulatory map, the alternative would be a more expensive and rules-driven approach which we do not consider suited to the UK culture of compliance. I do not believe that that was what was intended, and I therefore trust that hon. Members will support the proposal to revert to the position as it was when the Bill was originally introduced in another place.

Amendment No. 449, likewise, concerns clause 445. It honours an undertaking given by Lord Sainsbury in the House of Lords. As Baroness Noakes observed, the Bill contains inconsistencies between provisions concerning the FRRP so far as references to the Data Protection Act 1998 are concerned. Clause 648 in part 24 of the Bill provides expressly that nothing in that clause authorises the making of a disclosure in contravention of the Data Protection Act. That is in similar terms to section 449(11) of the Companies Act 1985. Amendment No. 449 would bring the provisions into line as we promised, and provides explicitly that nothing in the FRRP gateway provisions on disclosure of information that is obtained under its compulsory powers authorises the making of a disclosure in contravention of the Data Protection Act.

Justine Greening (Conservative, Putney)

I am grateful for the Minister’s ample explanation of why the Government are proposing the amendments. The issues are clearly complex and we need to take great care with them. I think that I should therefore probably follow my own advice in that respect and scrutinise what the Minister has said in more depth. We might consider revisiting the point on Report if necessary.

Clause 447

Justine Greening (Conservative, Putney)

The clause is clearly intended to act essentially as a safe harbour clause. I want some clarification from the Minister of whether it will apply to all companies, not just quoted companies and those who have to do a business review. Clearly, we would like to see the business review used as a method of promoting corporate and social responsibility among as many private companies as possible. It is therefore important that the safe harbour will apply to all companies, not just quoted companies doing the business review. If the Minister can provide that assurance, it would be very helpful.

Margaret Hodge (Labour, Barking)

The answer is yes.

Justine Greening (Conservative, Putney)

I am pleased to receive that assurance. It is extremely good news for the companies.

Clause 449

Clause 450

Clause 453

Quentin Davies (Conservative, Grantham and Stamford)

I beg to move amendment No. 356, in clause 453, page 216, line 19, after ‘up’, insert

‘and it must be made clear that this is the case and that the company has not accounted in euros.’.

My amendment is not a new substantive provision, but a request and potential requirement for a further explanation so that there should be no confusion in the minds of people reading companies’ accounts. I think that we would all agree that in principle that is an important purpose. I am in favour of the clause, which provides that companies “may” translate their accounts into euros. It is not in any way an onerous provision because anyone with a pocket computer and an exchange rate can make the requisite calculations in an hour or two. Some companies who either have or hope to have shareholders in the euro area, or do a lot of business there, may want to take advantage of that.

I have tabled the amendment because I see a slight danger of confusion in subsection (3), which states that:

“In both cases...the amounts must have been translated at the exchange prevailing on the date to which the balanced sheet is made up”.

The potential mischief is that it is very easy to translate a balance sheet, which is a simple snapshot from a particular day of the net worth of the company, as the liabilities and assets would normally be translated to the exchange rate on that day with no problem at all, but it is a different matter to try to convert to another currency a profit and loss account or a cash-flow statement, which are a summation of transactions extended over a whole year. It can make an enormous difference as to whether one is accounting in the currency concerned or translating into it at the end of the year. There would be wild discrepancies in the two figures if one was dealing in a currency, say, from some Latin American country that was subject to high inflation or depreciation rates. However, here we are talking about sterling and euro. Even between those two currencies, the differences could still be significant for fairly obvious reasons. If a typical British company that accounts and transacts in sterling translates its profit and loss account, as stated in the annual report of accounts, into euros at the end of the year, that would yield a very different result than if it were accounting in euros throughout the year.

If during that year, for example, the average exchange rate for the euro had been higher against sterling than it was at the end of the year—at the balance sheet make-up date—the profits would have been less than those produced by the mechanism proposed in the Bill, for the simple reason that the sterling profits, when recognised, would have bought fewer euros at that time than they would at the end of the year. The reverse would be true if during that year the average exchange rate had been lower than the one prevailing at the balance sheet make-up day. On the other hand, if a company transacts in euros and accounts in sterling—the reverse position—the profits, if the value of the euro had been higher on average during the previous year than at balance sheet make-up day, would be shown to be higher if the accounts were calculated in euros rather than sterling. It makes a considerable difference. It is not clear to me, on the basis of the provisions in the Bill as drafted, that people reading the balance sheet and accounts, particularly the profit and loss account and cash-flow statement, would be alive to the difference between the two things.

The differences do not stop where I have suggested because all types of contingent results would flow from a decision to account in a different currency. If one decides to account in a different currency, one’s foreign exchange exposures will be different because they relate to a different currency. One might have engaged in hedging one’s foreign exchange exposures by borrowing in a different currency so that your interest charge would be different because the interest rate applied to that borrowing would be different and so on. I do not need to go into all the complications.

Suffice it to say that if we leave matters as they are, people may get a false impression of what is going on. It needs to be drawn to people’s attention that the information they are being given is of limited use—although I am all in favour of information being given to people and I do not want to vote against clause stand part. The information has to be treated with a sufficient degree of scepticism, because the position might be different if the company concerned were accounting in a different currency as opposed to translating its accounts into that currency at the end of the year.

In addition, it is impossible for people to know the extent to which there might be a difference. One would have to know not merely the exchange rate on every day of the year—that might be impossible—but the weighting of all the sales and purchases throughout the year. No one could derive that from the information available to any normal reader of the accounts. It would be impossible to know the extent to which the two figures might vary. It might even be possible in certain circumstances to know in which direction they might vary.

What is needed is a warning sign, a kind of yellow light to make them hesitate when they look at the corresponding euro figure. It is the intention of my amendment that there should be that warning light included in the statement of accounts.

Margaret Hodge (Labour, Barking)

The clause was inserted as a result of the European directive. Its purpose is to provide additional information, not the base information that is required. Therefore we had to balance the provision of the additional information that could be of use with an over-regulatory regime to take up all those matters that the hon. Gentleman quite rightly raised.

The Government have taken a pragmatic approach. I offer the hon. Gentleman the comfort that although the clause does not specifically require that the method of translation be given, it requires that the exchange rates be disclosed in the notes to the accounts. It is difficult to see how one could disclose them without putting them into context. For example, the company might say, “The exchange rate used to translate these particular figures, as included in the statutory accounts, into euros was XYZ.” It would then be easy for any reasonable user of the accounts to work out the base on which the directors made that calculation. I hope that after that short explanation, the hon. Gentleman will be happy to withdraw his probing amendment.

Quentin Davies (Conservative, Grantham and Stamford)

I did not refer to it as a probing amendment, actually; the right hon. Lady was gracious enough to do so. However, it is not the sort of amendment that I would press to a Division, as it would not make any sense to do so.

The trap that I have just outlined may well be clear to the wary. My amendment was intended to point out the matter to those who are perhaps less wary about such matters. I hope that in practice, companies will ensure that there is no trap in the accounts and that people are not likely to fall into any misunderstanding, and will err on the side of being explicit. I hope that well managed companies will adopt something like the wording that I proposed, even if the Government do not include it in statute. I beg to ask leave to withdraw the amendment.

Clause 462

Vera Baird (Labour, Redcar)

I beg to move amendment No. 478, in clause 462, page 221, line 45, leave out from ‘5))’ to end of line 9 on page 222.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss Government amendment No. 479.

Vera Baird (Labour, Redcar)

The amendments are minor technical amendments to remove duplicated provisions about companies prevented from taking advantage of audit exemption. Unless anyone requires to know more, I urge that they be accepted.

Justine Greening (Conservative, Putney)

We have no objection to the amendments. I see how they tidy up the duplication in the Bill.

Clause 467

Clause 493

Justine Greening (Conservative, Putney)

I beg to move amendment No. 368, in clause 493, page 237, line 26, after ‘name,’, insert

‘or in the name by which he practises,’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss amendment No. 369, in clause495, page 238, line 7, after ‘auditor’, insert

‘or (when the auditor is a sole practitioner) the name by which he practises,’.

Justine Greening (Conservative, Putney)

The amendments are technical amendments, in response to which I hope the Minister can give us some clarification. The clause deals with who needs to sign the auditor’s report and in what circumstances; it states that if the auditor is an individual, the report must be signed by that individual, but if the auditor is a firm, it has to be signed by the senior statutory auditor in his name and on behalf of the firm.

That raises questions regarding the position of a sole practitioner, especially one who trades under another name. A situation could easily arise in which a sole practitioner had bought the practice of a previous sole practitioner for perfectly good commercial reasons and chosen to keep the original name. The Bill defines a firm as an entity, whether or not a legal person, which is not an individual. The question then arises: what does an individual who is using another name as a sole practice name do? Does he sign the report himself or does he sign it in the name of the sole practice company name? The sole practitioner does not fit well into the clause, and in fact clause 495 would also need to be amended if the Government accepted the need for clarification.

Vera Baird (Labour, Redcar)

There is no change, as I understand it, from section 236 of the 1985 Act. We are not aware of any problem, either for an individual auditor or a reader of audit reports. If someone wanted to check on an auditor’s credentials or take legal action against Fred Smith trading as Bloggs and Co., the way in which Fred Smith had signed the audit report would not be a problem. To be frank, we cannot see what the amendment is all about and we resist it.

Justine Greening (Conservative, Putney)

The amendment is about a sole practitioner who has a sole practice that does not carry his name. Is he an entity or should he sign as an individual? The intention to clarify how sole practitioners should sign off audit reports as auditors.

Vera Baird (Labour, Redcar)

A sole practitioner is not a firm and can sign either way.

Justine Greening (Conservative, Putney)

That was very helpful indeed and I am grateful to the Minister for clarifying the issue. I beg to ask leave to withdraw the amendment.

Clause 497

Justine Greening (Conservative, Putney)

I beg to move amendment No. 362, in clause 497, page 239, line 3, leave out ‘knowingly or recklessly’ and insert ‘dishonestly or fraudulently’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss the following amendments: No. 363, in clause 497, page 239, line 5, leave out ‘misleading,’.

No. 364, in clause 497, page 239, line 7, leave out ‘knowingly or recklessly’ and insert ‘dishonestly or fraudulently’.

Justine Greening (Conservative, Putney)

The three amendments relate to the same subject. The clause was debated at length in the other place and also on Second Reading in the Chamber. I still have grave concerns about it, and I have a number of questions on how it will work in practice. Some of my queries result from the comments of Lord Sainsbury, who said:

“That is wrong, not because prosecutors would have to prove dishonesty—they would not.”—[Official Report, House of Lords, 10 May 2006; Vol. 682, c. 1032.]

That subtly changes the well understood definition of what reckless means, which is that there would generally be some underlying dishonesty. It was suggested in the other place that that might not need to be the case. Concerns were naturally expressed that still need to be cleared up, and I hope that the Minister can do so.

Audits are essentially risk-based work, and they allow the auditor and the audit company to sign off, or otherwise, company accounts. Audits involve considering random and non-random samples of transactions that the company has engaged in, so that it can get a feel for the overall materiality of the figure on a balance sheet and ensure that it is correct. All that involves making judgments. I am concerned that simply exercising judgment badly could lead to a potential offence.

The other aspect is that existing fraud law and the duty of care and negligence could arguably give a legal remedy for anyone who suffers a loss as a result of an auditor’s negligence. The clause may be about catching auditors who turn a blind eye when carrying out an audit, but Baroness Noakes said:

“The Government have produced no evidence that there is a problem with auditors who are not fraudulent or dishonest, but who turn a blind eye to problems. I do not believe that it is appropriate to create a criminal offence on the basis of an unproven hypothesis.”—[Official Report, House of Lords, 10 May 2006; Vol. 682, c. 1026.]

I have to say that I agree. If the clause remains unamended, it may lead to an unforeseen negative impact on companies. I shall endeavour to demonstrate some of my concerns.

I have no doubt that if the clause remains unamended, there is a danger that auditors will need to do more work to be more assured that the financial statements that they are signing off are indeed true and fair. For example, when deciding whether to write off bad debts that are provisional on the balance sheet, auditors are likely to take a far more risk-averse approach to financial reporting. That will not necessarily be of help to British companies.

The clause may lead to more qualified audit reports, as auditors will be unwilling to take the level of risk that they might do now. By definition, if they sign audit reports but do not flag up worries about whether a company is a going concern, they themselves might create real problems for companies. Audits would be at risk of becoming more burdensome as more work is required to deliver a full, clean audit—that could damage audit quality. There is the risk of changing fundamentally the relationships in the audit teams—several people are necessary to conduct audit tests and to deal with the multiple layers of review and risk assessment—that undertake audits. There is a danger that the provisions will not even work as intended in the courts.

I return again to the corporate manslaughter Bill. It is very difficult to place a duty of care on any one individual successfully and to demonstrate that they had taken the action that led to the breach of the corporate manslaughter regulations. In reality, if auditors were being pursued for recklessness, it would be difficult to say which one had committed the offence. Was it the audit junior who had not carried out the right test or followed up an invoice containing a suspicious item? Perhaps it had not been recorded properly in the ledgers or accounting records. Or was it the audit senior who did not tell their junior to go back and follow it up with the client? Or was it the audit manager who reviewed the audit file and noticed the item, but in the context of the overall audit felt that it was probably an isolated case, that it could be discounted and that it did not necessarily lead to a negative audit opinion? Or was it the partner who reviewed the work of the audit manager and reached a similar conclusion? Which one of those auditors would have committed the offence of recklessness? It would be difficult to point a finger at a particular individual.

That could lead to a culture in which auditors did not race towards risks when they saw them and looked at them in detail to understand whether they might damage their ability to sign off an audit report as “true and fair”, but instead had an incentive not to look at risks in detail in case they uncovered problems leading to the perception that they failed to follow up sufficiently on those risks. That would be a very bad thing.

I shall offer an example: an audit manager is carrying out an audit and receives an anonymous e-mail saying, “You ought to check out whether the level of stock is at the level on the balance sheet”. They check it out and find that everything is fine. They then receive another e-mail saying that another aspect of the debtor’s activities is inaccurate. So, again, the auditor checks it out but, again, everything is fine. They receive another nine or 10 e-mails and finally think, “This is ridiculous. I have had so many of these and they have all been wrong so I am going to ignore it and get on with the audit work”. What happens if it is subsequently proved that that final e-mail, which they did not follow up, was correct and material? Would the auditor be viewed as having acted recklessly?

That demonstrates that, in reality, during an audit, an auditor must make fine judgments often in the light of many years of experience. At the moment, the system works very well and we need to be careful not put that at risk unwittingly with this new offence. It might be that we need some clarification of Lord Sainsbury’s comments. I hope that we will get that.

Our amendments propose to replace “knowingly or recklessly” with “dishonestly or fraudulently”. We think that that would capture better the offence that the Government want to hone in on. I hope very much that the Minister will respond sensibly to Lord Sainsbury’s comments in the Lords and provide some clarification. If we do not receive clarification, there is a grave risk that auditors will not be willing to put themselves at personal risk of committing the offence in question. We may therefore lose some of our best and brightest people and people will be less willing to enter the audit profession. Companies will find that their audits take significantly longer and are far more detailed than has ever been necessary in the past, and are therefore also more costly. The irony is that at the end of the process, the audit might be less robust than in past. That is a risk. I hope that the Government will consider the amendments in detail and respond to my points.

Quentin Davies (Conservative, Grantham and Stamford)

My hon. Friend has made an extremely good speech that was well thought through. She made some powerful arguments, which I hope the Committee will weigh up carefully. I agree that we do not, in principle, want to increase the cost to companies if we can avoid doing so, nor discourage people from going into the auditing side of the accounting profession. I know that my hon. Friend is herself an accountant, although I do not know whether she is an auditor. My experience has been that bright young accountants are increasingly not drawn to the audit side of the profession, because they can make more money in tax or management consultancy and perhaps because those areas do not have the same risks as auditing.

The whole integrity of our financial system—it is not too much to say the whole viability of capitalism—depends not merely on the honesty of accountants, which we must take for granted except in exceptional circumstances, but on their thoroughness and professional competence. My hon. Friend argues that it would not be right to create criminal liability for auditors when there is no criminal intent. I believe that that was the essence of her very reasonable argument. The word “recklessly” does not involve criminal intent, dishonesty, corruption or a deliberate decision to deceive.

I take a balanced view of the issue, because I am conscious that we do not want to increase the cost to companies of compliance with the Bill. We have rightly said so in many contexts. We do not want to drive bright, young, ambitious accountants away from the essential job of auditing to other aspects of the profession. I am also conscious of the potential unfairness of giving someone a criminal conviction in a case in which there was no criminal intent. That raises issues of legal philosophy that we should all consider.

On the other hand, the idea of recklessness in an accountant is terrifying. It is like recklessness in a doctor, surgeon or airline pilot. There are certain professions in which it has horrific consequences, and we should send a message from the Committee that we regard recklessness among auditors as terrifying. We do not want an Enron or a WorldCom in this country. Such scandals and disasters do enormous damage not only to their immediate victims, but to the credibility of the financial system, and ultimately to the cost of capital and therefore the wealth of everybody.

There are strong arguments on both sides, and I shall tell you why I stood to speak, Mr. Illsley. The right way to resolve the matter is for the Government—I do not often ask for their attention, but I would be grateful for it for the next 20 seconds—to explain in Committee that recklessness will have a very high threshold. It will be when an accountant does something that he knows from his professional training he ought not to do or, more likely, when he does not do something that he knows from his professional training that he ought to do. An example would be if he does not ask essential questions and pursue anomalies and discrepancies. If he sees that liabilities do not make much sense when compared with a declared charge, he must ask questions and need to be persuaded as to why the discrepancy exists.

There needs to be an explicitly high threshold so that honest people doing an honest job do not have to lose sleep and have the nightmare that they could open themselves to prosecution by making an inadvertent mistake that any of us could make, let alone by themselves being victims of fraud or conspiracy to defraud on the part of directors, managers or others who lie to them and produce false invoices and bank statements. There have been examples of that on both sides of the Atlantic recently. Which of us can say that we will be able to tell whether an invoice is forged? When we get a bank statement from Bank of America, which was a famous case, and it looks perfectly all right, we cannot ring the chairman of Bank of America.

Quentin Davies (Conservative, Grantham and Stamford)

I was saying that auditors are vulnerable to the mistakes of others, and indeed sometimes to the fraud of others. It would unreasonable if, every time an auditor looked at a letter from a bank stating that a facility had been granted or whatever, they had to ring up the bank to check that the letter was genuine. It would be impossible for them to do so, and such a requirement would be impracticable.

I shall give another striking example. A few years ago, Shell greatly overstated its oil reserves. If an auditor is told by the directors of a reputable oil company such as Shell and by its geological head—I am not sure what he calls himself, but he is a man who appears to have had many years’ experience of evaluating oil reserves—that the oil reserves are X, the auditor is entitled to believe that. If it turns out that they are Y, it would be totally unreasonable for anyone to have a go at the auditor.

What I have in mind is that auditors should set themselves the highest professional standards. They should always probe any clear discrepancy, as well as anything that is slightly odd, anomalous, out of line or inconsistent, and they should not be fobbed off. They should ask questions that need to be asked and pursue matters. That is what we require.

Recklessness should apply only to the most egregious examples of non-criminal behaviour. There is already provision in respect of criminal behaviour in the clause, and we all agree that it should be sanctioned. Recklessness, while not requiring any criminal intent to be proven, should be egregiously greater than ordinary negligence or ordinary mistakes. If the Minister can put some assurance of that kind on the record, she might well solve the problem.

It is a general opinion that the response of the Minister’s colleague in the other place, Lord Sainsbury, on this subject, to which my attention was drawn a moment ago in the interval that we just had, was not adequate, did not do the necessary job or provide for that sufficiently high threshold. I hope that the high threshold will now be set out in clear and unambiguous language by the Minister.

Lorely Burt (Liberal Democrat, Solihull)

I rise to echo, to some degree, the point made by the hon. Gentleman. In the House of Lords, Lord Sainsbury mentioned that it is possible to commit an offence knowingly or recklessly without being dishonest. People were confused by that and were trying to imagine how accounts could be put out knowingly or recklessly, but not dishonestly. In which circumstances could such an event take place?

Let us draw a comparison with the Fraud Bill. An important element of fraud is the intention to make a gain or cause a loss, but under clause 497 it does not appear that one has to act in that way. We are trying to ascertain what Lord Sainsbury meant. Perhaps the Minister will explain.

David Howarth (Liberal Democrat, Cambridge)

My hon. Friend is making an important point. It seems possible that what Lord Sainsbury meant is precisely that the offence under clause 497 is different from that of fraud under the Fraud Bill. Fraud under that Bill requires the specific intention to cause a loss or to make a gain. If that is what he meant by it being possible to commit the offence without dishonesty, what he said was perfectly harmless, because the offence we are talking about would be slightly stricter than true fraud, but not go as far as the hon. Member for Grantham and Stamford feared it might.

Lorely Burt (Liberal Democrat, Solihull)

I am grateful to my hon. Friend for that elucidation. We are seeking to ascertain whether the Government intend to create a crime that can be committed negligently or inadvertently. If so, we cannot support the provision.

Vera Baird (Labour, Redcar)

I shall answer the hon. Lady in the negative straight away and then turn to issues raised by others.

The hon. Member for Grantham and Stamford is concerned about the absence of criminal intent. I know what he means—the absence of deliberate criminal intent—but recklessness is of course an element of the state of mind in many, many crimes, so it is in that sense a criminal state of mind across the board in criminal offences, as long as they are not ones of specific intent. Therefore, there is nothing particularly unique or scary about this provision.

Recklessness is certainly a high threshold, which I shall set out for the hon. Gentleman in a moment, and it is certainly not what the hon. Member for Putney suggested. She referred to the possibility of someone making an error of judgment after years of being in practice and getting something slightly wrong. That is really the same question as the hon. Member for Solihull asked, so I shall set out what recklessness is and how dishonesty does or does not come into it. I think the hon. Lady also mentioned that there are penalties already and asked why we need an offence. I shall try to deal with all that.

It is important to make it clear what “recklessly” means. It has been suggested that the provision is so broad that it is criminalising negligence. That is not the case. It has also been asked whether making misleading, false or deceptive statements recklessly must involve dishonesty, so let me elaborate on what Lord Sainsbury said and talk about the difference between recklessness and negligence.

“Recklessly” does not mean “carelessly” or “negligently”. It does not involve not thinking of something or not noticing it. Negligence is not thinking of something. Negligent auditors are ones who do not do their job to the required standard through inattention and incompetence. It may be simply a momentary absence of mind with serious consequences. The hon. Member for Putney said that that is a disciplinary offence, but it is not recklessness. A person who is merely negligent will not be guilty of this offence, even if the negligence is gross.

I suppose that that almost touches on the issue of corporate manslaughter. When I define recklessness, the hon. Lady will appreciate the state of mind that has to be found in an individual before the crime can be committed, so there is no question in this case of any kind of attributable responsibility to a firm. This is not like corporate manslaughter at all; it is about an individual.

The hon. Lady asked who in the whole sequence of events will be responsible or criminally liable. It will be any person who is found to have the state of mind that I shall set out. Any such person will be criminally liable and anyone who does not have that state of mind will not.

The test of recklessness will catch only auditors who consciously do not care about doing a good job. To prove that an auditor has behaved recklessly, it is necessary to show that the auditor was aware that an action or—as the hon. Member for Grantham and Stamford said, this is far more frequent—a failure to act carried risks and that, having known that those risks were present and not reasonable ones to take, he none the less consciously decided to go ahead. Therefore, someone cannot be reckless inadvertently; they have to have directed their mind toward it, become aware of the risks and gone on regardless. It cannot be done by inadvertence or carelessness.

Justine Greening (Conservative, Putney)

Does the Minister have any indication that what we are discussing is a serious problem in the audit profession at the moment, that it has been in the past or that it will be in future? Does she have any indication that swathes of auditors consciously do not care about doing a good job? My experience is that we do not have any such indication, but I want to understand what the problem is in the auditing profession that the Government believe they might be solving with this measure.

Vera Baird (Labour, Redcar)

The hon. Lady has already made that point and I shall come to it in due course, but I hope that, at the moment, I have accomplished my task of setting out what recklessness is and establishing that it is a high threshold.

Jonathan Djanogly (Conservative, Huntingdon)

I am no auditor or expert on auditing, but when auditors do their job they might find a number of possible leads. They will not know whether a lead that they find will necessarily produce a problem, and I suppose that at some point they will have such a number that they have to find a ratio or level at which they start asking questions. There are only so many questions that they can ask. Given what the Minister said, my concern is that it might be argued that an auditor who does not follow every single lead is reckless.

Vera Baird (Labour, Redcar)

I do not think so.

Quentin Davies (Conservative, Grantham and Stamford)

You do not think so?

Vera Baird (Labour, Redcar)

I was just being courteous. The answer is no. Let me repeat what I said; that is not difficult, as I have been reading my brief, although I do understand the issue.

To prove that an auditor had behaved recklessly, it would be necessary to show that he had been aware that an action or failure to act—much more likely, a failure to act—carried risks and that he had known that the risks were not reasonable. That relates to the matrix of small risks that was mentioned and the question whether an auditor would have to follow up every lead. Clearly, it would not be reasonable to suggest that he would.

The failure would have to be fairly gross, involving a risk that a reasonable person would think ought to be followed up. The auditor, having apprised himself of the risk, would have to have gone ahead without following it up. If he had made a conscious decision to go ahead despite having turned his mind to the risk—seen it and acknowledged that it was not reasonable—he would be guilty of recklessness.

David Howarth (Liberal Democrat, Cambridge)

The Minister answered my point in her final words. It is important that the definition that she is using should include the idea that the unreasonableness of the risk must be subjectively known by the defendant. If that is the case, I do not think that there will be the problems that people fear will arise from the clause.

Vera Baird (Labour, Redcar)

If the risk was not required to be objective but was subjectively linked to what was going on in the auditor’s mind, we would be reducing this to negligence because it would fall short of a reasonable standard—that is pretty well the definition of negligence, which is not what we are talking about, though we are considering the state of mind of the individual in question, so we must consider how it appeared to him, as it were. That is what juries frequently have to do. I hope that that is satisfactory.

Justine Greening (Conservative, Putney)

I fully appreciate what the Minister has said and her clarification is helpful, but audits regularly come across a particular invoice that has not been properly accounted for, purely because there is always an element of human error.

The difficulty for an auditor is how he would be expected to make a judgment between what was almost certainly a human error, for which a reasonableness test could apply, and something that could be not just an isolated case, but symptomatic of an underlying problem. That is the reality of how audits take place.

I understand the Minister’s explanation that there will be this reasonableness test, but in reality it is sometimes difficult to say, hand on heart, “That is definitely an isolated example of a problem with an invoice, and I am certain of that.” Often, that is very likely to be true, but one can never be absolutely certain. An audit can never test every single invoice; it can check only a sample.

Vera Baird (Labour, Redcar)

If in the ordinary course of events such human errors occur frequently, it does not sound as if they would be likely to indicate an unreasonable risk that the auditor had acknowledged and decided not to act on. If he was in any doubt, the safest thing would be to check things through, and he would be in danger of being negligent if he did not. The hon. Lady’s scenario falls a long way short of the offence.

I cannot realistically deal with every conceivable factual position. If, from the evidence, it was realistic to suppose that an auditor was more than 50 per cent. likely to be convicted of being reckless according to the test, that would be a matter for a court to deal with. Otherwise, no action would be taken. I cannot envisage every scenario, but the one suggested by the hon. Lady does not sound as if it would fit the test. That is just my view.

The test is fairly clear. The auditor would have to know that a failure to act carried unreasonable risks and consciously decide to go ahead despite that. The real point is that that is a long way above negligence. One cannot be reckless inadvertently; a degree of consciousness has to be proven. In criminal law, although not in the Bill, the phrasing is usually that a person has to have “directed their mind” to the risk—become aware of it and its unreasonableness and carried on regardless.

In another place, it seems to me that the Government went further. My noble Friend Lord Sainsbury said that the guidance to be issued under the clauses would say that for a prosecution to be brought, there should be specific evidence of recklessness, and that no one should seek to prosecute in reliance on an inference of recklessness from hindsight, even when such hindsight showed a judgment to be so wrong that it was not credible that the auditor did not know the risk.

Vera Baird (Labour, Redcar)

Because of the obviously serious interest in how recklessness is defined, I went to the Library and looked at “Archbold Criminal Pleadings”, which is the criminal lawyer’s bible. I can confirm that the latest authority, the Crown v. G [2004] 1 appeal cases, deals with the point raised about the subjectivity or objectivity of reasonableness. It was held in that case

“that a person acts recklessly with respect to (i) a circumstance when he is aware of a risk that it exists or will exist, and (ii) a result when he is aware of a risk that it will occur”—

this is the important point—

“and it is in the circumstances known to him, unreasonable to take the risk.”

The fact that that is a subjective test is clear and conclusive. I will give a copy of that ruling to anyone who wants it. I hope that I have dealt with the meaning of recklessness. There is a sharp distinction between that and negligence, and the levels of conduct that were being canvassed as possibly getting unwitting auditors into trouble.

Let us consider recklessness and dishonesty. In every day colloquial speech, we would expect that someone who makes a false assertion without knowing whether it was true or false was not being honest. In that sense, we would describe as dishonest most actions that would be caught by the new offence based on inter alia recklessness. In law, however, dishonesty has a more developed meaning. It means acting for personal gain to which one knows one is not entitled, and that is not an element of recklessness.

An auditor who is reckless is most unlikely to be acting honestly, but we do not believe that it should be necessary to show that the person was motivated by the prospect of unfair personal advantage that would be the effect if dishonesty had to be proven. That is recklessness as opposed to dishonesty. I hope that I have put people’s minds at rest. Good auditors who behave honestly have nothing to fear from the offence. If they genuinely believe what they are saying is true, that they had made reasonable, honest judgments about risks and had undertaken the appropriate level of work to assess them, they will not have behaved recklessly and need not worry—nor need they do any more than comply with the standards of their profession.

“Knowingly or recklessly” is a well established phrase. It is referred to many times in the Bill. It is used under the 1985 Act and it has not had the chilling effect that the hon. Members for Grantham and Stamford and for Putney suggested would be the consequences for the audit profession. It has been in place since 1985, so such a suggestion does not seem well founded. I have already said that there are existing disciplinary procedures. Negligence is a different case entirely from recklessness and anything under the amendment tabled by the hon. Member for Putney that was dishonest or fraudulent would be caught by existing offences, so in that sense the amendment is redundant.

The hon. Lady’s other question was whether there was any need for such a provision. It was a reaction not to a particular scandal but to major worries that had been expressed about the integrity of auditors and the need for effective sanctions to underpin matters. There are 700,000 audits carried out annually. Auditors are keen to do a good job and to report what they find in a straightforward manner. However, there can be pressures from directors, for example, to bend the truth in order to conceal or minimise problems. If even a small percentage of such people were tempted to give into pressure, there could be a significant number of inaccurate audit reports. If the offence persuades even a small number of auditors to resist temptation, it would have contributed to improving standards of financial reporting.

The hon. Lady did not refer to the question of misleading, which is the substance of amendment No. 363, but she indicated to me privately that she regards it as part and parcel of her argument. For the sake of completeness, if the word “misleading” were removed, the clause would not apply to material in the audit report that was misleading and only to material that was false or inaccurate. The auditor’s report should not contain misleading material—material which may itself be true but which misleads the reader because other material is left out. It is like the earlier comment of the hon. Member for Grantham and Stamford about not doing something—not showing the full picture.

If “misleading” were deleted, the offence would no longer catch auditors who manage to give the impression that there is no problem with the accounts—that there is nothing seriously wrong—without saying anything that is untrue. I am sure that the hon. Lady believes as we do that it is important that shareholders and other readers of the audit report should not be misled. If an auditor is concerned that the audit report might be misleading, the remedy is to redraft it so that it is clear. That would be an altogether positive change in behaviour. There is no justification for departing from the normal phrase, which includes “misleading”. It is used elsewhere in the Bill and in the 1985 Act.

I hope that I have dealt with everyone’s concerns. If I have not, I am sure that they will tell me, but I respectfully suggest that the amendments are not necessary and that the Bill includes the high threshold that the hon. Member for Grantham and Stamford sought.

Justine Greening (Conservative, Putney)

It has been useful to get further clarification from the Minister on what the offence will mean in practice. There was a great deal of uncertainty when the clause was debated in the other place, so it has been helpful to discuss a little more practically how the concepts will work in reality. The debate has given me some confidence that there has been some genuine thought about the practicalities of the offence in relation to conducting audits.

I am not fully convinced that there is any evidence that the auditing profession in this country shows any signs of needing such an offence to encourage it to behave responsibly; there seems to be every indication that it is responsible. Nevertheless, I shall not press the amendment to a vote. I will take time to study exactly what the Minister said and to reflect and consult on it. I beg to ask leave to withdraw the amendment.

Clause 500

Vera Baird (Labour, Redcar)

I beg to move amendment No. 480, in clause 500, page 240, line 32, leave out subsections (1) and (2) and insert—

‘(1) The members of a company may remove an auditor from office at any time.

(2) This power is exercisable only—

(a) by ordinary resolution at a meeting, and

(b) in accordance with section 501 (special notice of resolution to remove auditor).’.

Again, this is a minor technical amendment to clarify that a private company must hold a general meeting to dismiss an auditor.

Clause 515

Vera Baird (Labour, Redcar)

I beg to move amendment No. 481, in clause 515, page 249, line 14, leave out from ‘audit’ to end of line 16 and insert ‘—

(i) the Secretary of State, or

(ii) if the Secretary of State has delegated functions under section 881 to a body whose functions include receiving the notice in question, that body;’.

Again, this is a minor technical amendment. We are in a strong position with it, as it was tabled to clarify an ambiguity pointed out by the Opposition in another place. Consequently, I imagine that they do not want further explanation.

Justine Greening (Conservative, Putney)

I am delighted to see the Government incorporate a badly needed amendment from the other place.

Clause 525

Justine Greening (Conservative, Putney)

I beg to move amendment No. 371, in clause 525, page 253, line 30, leave out ‘negative’ and insert ‘affirmative’.

Eric Illsley (Labour, Barnsley Central)

With this it will be convenient to discuss amendment No. 372, in clause 528, page 255, line 2, leave out ‘negative’ and insert ‘affirmative’.

Justine Greening (Conservative, Putney)

The amendments would ensure that future changes in regulations are subject to the affirmative rather than the negative procedure. They affect two clauses. First, clause 525 provides for the terms of a liability limitation agreement and specifically for the Secretary of State’s powers going forward. It says:

“The Secretary of State may by regulations—

(a) require liability limitation agreements to contain specified provisions or provisions of a specified description;

(b) prohibit liability limitation agreements from containing specified provisions or provisions of a specified description.”

Given that the legislation is new, we should ensure that as it beds in, the House has ample opportunity to debate any changes. It remains to be seen exactly how the liability limitation agreements will work in practice, and to give new regulations and powers to the Secretary of State via the negative procedure is not that helpful.

It would give the House much more comfort if we knew that we could fully debate any changes to that aspect of the law. There has been some debate outside the House about the new concept of a limited liability agreement, and it would reassure the business community if we could debate any contentious changes within the House.

Secondly, clause 528 is concerned with a company’s disclosure that it has entered into a limited liability agreement. It relates to amendment No. 372, and any change should also be subject to the affirmative resolution. The provision is important and welcome, but we must be careful to ensure that it is fully debated, because it is fundamental to the relationship between company directors and the auditors that they employ to help audit their accounts.

Vera Baird (Labour, Redcar)

The power in clause 525 that the hon. Lady has described was introduced on Report in another place as part of a series of amendments to meet concerns expressed about the original wording. The Opposition warmly welcomed the amendments, and included special mention of the new power, but no one proposed that it should be subject to the affirmative procedure. Clause 525 was disclosed to the Delegated Powers and Regulatory Reform Committee, and it, too, did not suggest the affirmative procedure.

Clause 528 is altogether simpler. It provides that a company with a liability limitation agreement with its auditor must disclose it in a way specified by regulations. The regulations will specify exactly what information must be disclosed and whether it should appear in the accounts, in the directors’ report or elsewhere.

The chapter sets out clearly all the important features of the change in the law on auditors’ liability, and the two powers are available only for filling in certain details. Again, the power in clause 521, which was included in the Bill on its introduction, was included in the memorandum to the Delegated Powers and Regulatory Reform Committee in another place. The Committee saw no problem with the negative procedure, and I should think not, bearing in mind the scale of the matter and the need to apply parliamentary time to rather more major things. I invite the hon. Lady to consider that there is no need for the amendment.

Justine Greening (Conservative, Putney)

That is a helpful clarification. I take on board the Minister’s comments, but just because other people have not raised the issue does not indicate that it is not an issue. However, I accept her comments regarding the level of other people’s assurance in other places. I beg to ask leave to withdraw the amendment.

Clause 642

Jonathan Djanogly (Conservative, Huntingdon)

We move on to part 24, which deals with takeovers. I congratulate my hon. Friend the Member for Putney on her first foray on the Front Bench. I think that we will hear a lot more of her from the Front Bench in due course; she was remarkably competent and polished.

Part 24 was the subject of significant debate in the other place. In Lords Grand Committee, Lord Goldsmith spent some time explaining the reasons for the statutory codification of the takeover panel’s rule-making power. Lord Hodgson and Lady Noakes gave the provisions no little attention, and many amendments were considered.

Therefore, I do not propose a total rerun of the Lords debates, although I recognise at the outset that City lawyers and many others still have concerns that the act of codification will lead to more court cases and precedents and that aspects of the European directives still remain unclear. We wish to cover some areas, albeit in a more directed and limited way than in the other place.

The explanatory notes confirm that the Bill will not affect the availability of judicial review by the courts. In the 1987 Datafin case, the Court of Appeal concluded that the courts could limit themselves only to reviewing the panel’s decision-making process after the bid has been concluded. Does the Minister consider that the Bill’s provisions will lead to further restriction of the grounds for judicial review?

Also, there was a discrepancy between the timing of the Bill and the need for the provisions, which resulted in the provisions being introduced by statutory instrument. Can the Minister confirm that no implementation problems that we should consider have arisen since the order?

I note that the substantial acquisitions rules have now been abolished by the panel. That seems to have been generally well received. Will the Minister confirm that that is so?

Margaret Hodge (Labour, Barking)

Clause 642 confers regulatory functions laid down in the remainder of part 24, deals with the Panel on Takeovers and Mergers, and is a key part of the proposed package to implement the European directive on takeover bids that requires the Government, among other things, to designate a body competent to supervise takeovers.

Since 1968, takeover regulation in the UK has been overseen by the panel administering the rules contained in the non-statutory City code on takeovers and mergers. The Bill will place the regulatory activity panel within a statutory framework for the first time. The Government recognise the considerable strengths of the existing system of takeover regulations which is overseen by the panel, including its flexibility, speed and certainty in decision making, the independence of the regulatory autonomy of the panel, and the professional expertise of business and City participants that the panel is able to harness in undertaking its regulatory functions.

A key objective of the Government in implementing the takeover directive has been to preserve those strengths. The City has welcomed that. The regulatory functions conferred on the panel under part 24 are designed to cover broadly those matters for which the panel has historically had regulatory responsibility, including takeovers of companies whose shares are traded on a regulated market, as required by the takeovers directive. It goes wider, too, and includes takeovers of other public and former public companies and certain other types of corporate restructuring transactions, such as mergers. That approach will preserve the single regime for non-directive-related takeovers that receive support from the City.

Consistent with the implementation objective maintaining the regulatory independence of the panel, the clause does not deal in substance with the panel’s constitution and internal arrangements. The panel will be able, as it does now, to delegate functions to committees, members of staff and so forth. The panel will remain an unincorporated body as constituted from time to time and, as such, will have rights and obligations under common law that are supplemented by specific provisions in the Bill.

We are not aware of any problems arising since the implementation of the interim regime in May 2006. Will there be more judicial reviews? The Bill is not supposed to change, limit or alter the position regarding judicial reviews, and substantial acquisition rules have been abolished.

The rest of the debate is in Hansard.