David Howarth (Shadow Minister (Energy), Trade & Industry; Cambridge, Liberal Democrat)

I beg to move amendment No. 221, in clause 105, page 47, line 9, at end insert—

‘and,

(d) the consent is obtained of all the company's creditors'.

Eric Illsley (Barnsley Central, Labour)

With this it will be convenient to discuss amendment No. 205, in clause 106, page 47, line 27, at end insert—

‘;

(d) a statement confirming that the company's creditors have given their consent'.

David Howarth (Shadow Minister (Energy), Trade & Industry; Cambridge, Liberal Democrat)

The subject of the clause sounds similar to the issues just discussed, but in fact it is fundamentally different. Clause 105 is about the re-registration of unlimited companies as limited. The  clause changes the existing law, but only in respect of public companies. The point that I wish to raise is more fundamental.

Unlimited companies are not very common, but they do occur in the financial services sector. The point of an unlimited company is that its creditors have recourse to the private wealth of the shareholders in the event that the company cannot meet its debts, so unlimited status is a way of attracting customers to a business in certain circumstances, because, in effect, the shareholders are underwriting that business. Given equivalent circumstances it makes the company a more attractive body to deal with than a limited company in the same circumstances.

Clause 105 allows unlimited companies to re-register as limited companies, thereby reducing the liability of the shareholders—perhaps dramatically—without any consent from the creditors. The fundamental issue is the balance of interests between creditors and shareholders, and that balance is very different in an unlimited company compared with a limited company. The amendment is therefore intended to test the proposition that creditors’ interests must be taken into account when a company moves from unlimited to limited status.

I do not want to give the impression that there is a lot of malpractice or fraud in this area at the moment, but there is a risk. It might be argued that the provision has been in place for a long time without any particular problems. However, in Tuesday’s sitting I mentioned the case of Equitable Life, which was an unlimited company. The circumstances of that case were different in that Equitable Life did not have shareholders in the same way, so the issues did not arise in precisely the same manner as I am suggesting today. Nevertheless, that example shows that there are large undertakings that are unlimited companies. There is a serious potential problem, and it would be just as well for us to consider it and try to provide for it before it turns into a real-life case.

Jonathan Djanogly (Shadow Solicitor General (Also Shadow Minister for Trade and Industry), Law Officers (Assist the Home Affairs Team); Huntingdon, Conservative)

I have some sympathy with the Liberal Democrat amendments. People often deal with an unlimited company on the basis that there is no limit to the members’ liability. If they entered into the same transaction with a company that was limited, they would want to see other elements in the transaction, such as security, or a deposit, or a charge. If the company with which they have transacted subsequently becomes limited it would be fair to take their interests into consideration.

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

I understand the point that is being raised by the hon. Gentlemen, in that with an unlimited company liability is not defined—although I do not entirely accept that that would give the sort of comfort to which the hon. Member for Huntingdon referred—whereas limited companies, by definition, have a limit on their liability. I can understand, therefore, why the hon. Member for Cambridge believes that there might be a role for creditors when an unlimited company re-registers as an limited company. The amendment would ensure that they are consulted and given a role. However, I am informed that such issues are tackled in other ways, which we believe to be sufficient. I hope that that argument will be accepted.

At the moment, the law provides that when a company is wound up within three years of having been re-registered as a limited company, having previously been unlimited, the liability of its original members remains.

Paul Farrelly (Newcastle-under-Lyme, Labour)

We have seen such situations, although more often in the US than here. Will my right hon. Friend the Minister confirm that the amendments would allow a creditor to blackmail a company and resist its move to limited status, even if that was in the wider interests of the company and perhaps those of other creditors?

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

I entirely accept that that would also create difficulties and I am grateful to my hon. Friend for raising that valid point, which had not been brought to my attention.

Whether or not the company changes status, liability remains on the original member of the unlimited company, which remains unlimited in respect of any debts and liabilities contracted up to the point of re-registration. That provision is contained not in this complex bit of legislation, but in section 77 of the Insolvency Act 1986. We have no plans to change it, as it provides proper protection for creditors without the sort of danger exposed by my hon. Friend. Arguably, it is also simpler. I hope that, with that explanation, the hon. Member for Cambridge will withdraw the amendment.

Quentin Davies (Grantham & Stamford, Conservative)

I seek clarification. I have been following the debate with much interest and the Minister has made an interesting point. Is she saying that the details of the insolvency law to which she referred provide that if an unlimited company changes its status to limited, the existing shareholders retain their unlimited liability for all that company’s debts for three years?

The implication is that at the end of those three years, unlimited liability would fall away. Let us suppose that a company, when unlimited, had undertaken a loan agreement that matured after more than three years—say, after five or ten years—and had done so on the basis that it could look to the private capital of shareholders, beyond the paid-up capital of the company. The creditor would find that that assumption had been invalidated retrospectively. If he had been well advised, he would be covered by some kind of covenant and loan agreement. I accept that, and we anticipate that response. However, in making the law, we try to defend those who are not necessarily sophisticated or well advised.

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

I accept the issues and complexities raised by the hon. Gentleman. However, if a company changed from having unlimited liability to limited liability, I would have thought that most of its creditors would take appropriate advice to ensure that they secured their interests over time, as the hon. Gentleman suggested. I accept that the eventuality that he describes may arise, but that three-year limitation runs through most of the law.

Quentin Davies (Grantham & Stamford, Conservative)

With respect, the Minister has not satisfied my concern at all. She has simply confirmed  that in my example the regime would have been changed retrospectively to the—perhaps significant—disfavour of the company creditor, who would be able to do nothing about it.

If the creditor had been sufficiently sophisticated and well advised in advance, he might well have insisted on an appropriate covenant in the loan agreement. However, if he had not, it would be too late for the creditor to protect himself once the unlimited company had declared its intention to go limited. The danger to which I have alluded is real and the law should be designed to protect those who are not necessarily sophisticated or properly and completely advised.

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

I do not know whether this is helpful to the hon. Gentleman, but if the loan was unlikely to be repaid, the company, having become limited, would presumably become insolvent.

Mr. Daviesindicated dissent.

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

The hon. Gentleman is shaking his head, but as I understand it, the three-year limitation runs through most legislation and would have an impact. I accept that, in the situation that he describes, he has a point, but I am not sure that, in framing the law, we can do anything that would better protect the interests of the individual beyond that limitation. I am not sure that the creditor having the right of veto on the change of status would be the best way forward. Presumably that is what the hon. Gentleman would suggest if he supports the hon. Member for Cambridge’s amendment.

Quentin Davies (Grantham & Stamford, Conservative)

There is another way forward that the Minister should consider. That is to stipulate that liabilities that are in existence and have been contracted on the assumption that shareholders are liable on an unlimited basis would remain indefinitely, or at least until the term of those liabilities as established in the relevant loan agreements or other contractual terms. That would mean that it would not be possible for someone who had made a loan or supply of credit in good faith to an unlimited liability company would subsequently find that the regime had been turned against them retrospectively and the quality of the asset in their hands had been degraded because the company decided to change its status from unlimited to limited. That would mean for existing liabilities that the regime that applied at the time that they were contracted would remain until the term of that liability. All new liabilities would be contracted with the company under its new status. That is another way forward.

It often happens in Committee that we come across problems that some of us had not anticipated. That is a good thing. I have not had a chance to prepare an amendment on this issue but, in light of the discussions taking place between the hon. Member for Cambridge and the Minister, I think it is a point worth pursuing. I have not just come forward with a problem; I have proposed a possible solution.

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

I appreciate the hon. Gentleman’s comments. This has been an interesting exchange. I am  happy to consider the idea further if that is helpful, but let me try to reassure him. I am advised that if a creditor finds that the loan that he made has not been repaid, that creditor could seek the winding up of the limited company. In so doing, he would have priority over the remaining assets to get repayment of the loan. In those circumstances, there is a mechanism open to him.

If the hon. Gentleman is not happy with that explanation, I will write to him and we can have an exchange of correspondence on the issue and return on Report if necessary. I will copy Front Bench spokespeople into that correspondence. It strikes me that there are other provisions that would deal with the situation. Perhaps I am not explaining very well.

Quentin Davies (Grantham & Stamford, Conservative)

I can see no provision in the text before us providing for a creditor to seek the winding up of a company simply because that company is proposing to change its status from unlimited to limited. Nor should there be such a provision because it would open up exactly the possibility of blackmail that has been raised. We do not want that. We want merely to ensure that when a creditor and a debtor contract with each other—when two firms come together under a certain regime and, in good faith, draw up a contract that leads to an asset on one side and a liability on the other—the quality of that asset and liability should not be retrospectively changed in a way that cannot be predicted by the parties to the initial contract. That is why I suggest that the existing liabilities should continue to be unlimited.

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

I think that the hon. Gentleman misunderstands. I was not suggesting that the point of transfer of the company from an unlimited status to a limited status would be the point at which the creditor would attempt to exercise their rights under a contract that they had entered into. I was suggesting—to go back to where we were—that all creditors of companies that change from being unlimited to limited are protected for three years under the InsolvencyAct 1986. The issue that the hon. Gentleman raised was what would happen if the loan that the creditor gave to the originally unlimited company only required repayment in five years. I was trying to say that, in those circumstances, the company would have been established as a limited company and a creditor with a claim against it could seek the winding up of the then limited company, if that company refused to meet the loan.

Quentin Davies (Grantham & Stamford, Conservative)

With respect, the Minister has not followed me. Let me give a precise example. On day one, a creditor—for instance, a bank or supplier— contracts with a company to lend money or to deliver goods on credit. One year later, the company decides to change its status, and three years after that, that change of status is confirmed for all purposes, so that no liability can return to the shareholders on an unlimited basis.

Let us suppose that the term of the original liability is five years. In other words, the loan is not callable  until one year after the end of the three-year grace period, which the Minister has just explained. In those circumstances, at the end of the three years, the creditor can do nothing. It cannot put the company into insolvency because the loan has not matured. Nor can it demand the prepayment of the loan. However, the credit status of the loan has been degraded by virtue of the fact that the shareholders are no longer liable for the loan on an unlimited basis.

A year later, the loan duly matures. The question then arises as to whether the company becomes insolvent, but at that point the shareholders are no longer liable for the loan on an unlimited basis. That is an enormous change and might mean that what would have been a good asset in the hands of the creditor has now become a bad asset, and what would have become a liability to be fulfilled on an unlimited basis will not be fulfilled on a limited basis a year after the end of the three-year grace period.

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

I understood that; clearly we are not reaching each other in our exchange. I have been passed a note that might be more helpful. I have not read it myself. It says that creditors will not have to wait for five years, if the company is insolvent.

Quentin Davies (Grantham & Stamford, Conservative)

It is not insolvent.

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

If a loan is due two years after a company changes its status to a limited company, the status of that loan will change.

Quentin Davies (Grantham & Stamford, Conservative)

What about four years after that?

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

It does not matter—the point is that it is after three years. At that point, although the status has of course changed from unlimited to limited, there is still a loan against that company. If the creditor does not receive the moneys due to him at that point, he can seek to have the company wound up. I accept that that is not the same comfort as with an unlimited company, but it is not like the creditor has no comfort at all.

Paul Farrelly (Newcastle-under-Lyme, Labour)

I would like to raise a different point that demonstrates why my right hon. Friend is absolutely right to resist the Liberal Democrat amendments. Any good lawyer—the hon. Member for Cambridge is an excellent lawyer—would wish to see at the end of such an amendment, “such consent not to be unreasonably withheld”. That is not there.

For example, a good reason to move from being an unincorporated to a limited liability company is to ease the path towards flotation. One reason to float on the stock exchange might be to pay off loans or liabilities with creditors. It is quite conceivable that a creditor who wished to have part of the action from a flotation, but was denied it, could veto a company’s progress and flotation. In those circumstances, consent would have been “unreasonably withheld”. Those words are not in the amendments.

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

I agree entirely. I shall have one last go with the advice that I have been given.

Let us imagine that a creditor, described in the terms that the hon. Gentleman described, is concerned that a limited company is unable to repay a loan. I am advised that that creditor, within the three years in which they are covered by the Insolvency Act 1986, could seek to have the company dissolved on the basis that it could become insolvent by not meeting the loan repayment terms. That might be the answer that the hon. Gentleman is looking for. If not, we will have to settle the matter through correspondence.

Quentin Davies (Grantham & Stamford, Conservative)

May I ask the Minister for the reference to the insolvency provision? Also, what criteria would need to be met for such a petition to be granted?

Margaret Hodge (Minister of State (Industry and the Regions), Department of Trade and Industry; Barking, Labour)

The provision is section 77 of the Insolvency Act 1986, and I am told that the criteria are as in any other case. I hope that the hon. Gentleman is happy with that. He has raised a valid point. He can write to me, and I will let hon. Members see it. We can return to it on Report if there is something that we have omitted.

Quentin Davies (Grantham & Stamford, Conservative)

I am conscious, Mr. Illsley, that you have been gracious in allowing me to intervene on the Minister on a number of occasions. I hope that that exchange has been useful in clarifying the issue. So as not to trespass too much on your patience, I thought that I would make it clear where I am coming from.

The exchange with the Minister has persuaded me not only that there is a problem but that it is probably more important than I first envisaged, and it is not adequately dealt with by the insolvency rules that she described. I think that the Committee would agree that it is important to provide a mechanism for companies to change their status from private to public without undue burdens or hindrance. An instance has already been mentioned of a company that wants to float. That is a sensible move, but we simply want to provide the maximum flexibility. We want not to inhibit but to encourage and nurture the growth of companies. That is the object of the Bill.

The Bill should not provide anybody—we have been conscious on many occasions of a difficulty in this context—with opportunities for greenmail or blackmail or to exert pressure to prevent people from doing what they seek to do in good faith and in their own rational business interests. It should not provide them with some toehold in the law that enables them subsequently to claim money from people engaged in ordinary business in good faith. We do not want the measures to form a basis for greenmail or blackmail, and we do not want to give creditors the opportunity vexatiously, perversely or exploitatively to prevent companies from changing their status. That is common ground.

This is where the Minister and I disagree. We do not want to solve the problem by creating a worse one. Above all, we do not want to create a situation in which companies are needlessly put into or threatened with insolvency. This is my central response to her: I do not believe that the insolvency rules are the right answer to my question. Nor do I think that a three-year carry-over—I shall use that word rather than the term “grace period”—of unlimited liability is adequate for  the simple reason that three years is entirely arbitrary. Some of a company’s liabilities will be for longer than three years.

Equally, it does not make any sense to protect new creditors—that is, creditors who contract with a company after the company has changed its status to limited liability—which would not normally be available to the creditors of a company with limited liability. Three years does not make any sense for either group of creditors: those who are contracted with the company concerned before the change of status or those who contract with the company after the change of status or during the first three years.

It seems to me that the simple answer is to say that a company cannot change retrospectively its relationship with a creditor by changing its status as a company, changing the basis on which its suppliers, lenders or other creditors will deal with it in future. That answer would be fair, transparent and in accordance with a common-or-garden understanding of how things work. It should not be possible for shareholders, simply by changing the status of the company, to protect themselves against any liability that they find onerous or threatening to their private wealth outside the paid-in capital of the company in which they have invested.

I shall give some simple examples. There might well be a company with a net worth of, let us say, £1 million and liabilities of £4 million. That is quite a high leverage but creditors and suppliers may well be happy with it because they know that the shareholders are people of substance. They probably do not know their exact net worth but they know that it is many tens of millions of pounds. They therefore feel totally relaxed dealing with a company on that basis and they might enter long-term contractual lending arrangements with the company.

Then suddenly one day the company announces that it will change its status. Immediately the credit quality of all the assets in the hands of the creditors deteriorates markedly. The creditors may then have worries about their claims on the company once it has changed its status. There would then only be a net worth of £1 million of assets securing their claims of £4 million. Some deterioration in the company’s position could then make their claims worthless or discountable. In those circumstances, under the Minister’s proposed arrangements, the creditors would have some protection for three years. After that they would not, and they would be completely done for.

It may well be that people outside the Committee following our debates will ensure that they are thoroughly protected against such a possibility in whatever contractual or lending arrangement they enter and ensure that there is a contractual possibility of winding up a company in the event of its changing its status. That is an enormously heavy-handed type of protection to have to propose. We want protection that is fair and deals only with the liabilities incurred by a company before its change of status. It should also be unlimited in time, because any arbitrary limit would not cover longer-term contractual or lending arrangements.

I have set out the problem at slightly greater length than I intended. I hope that, rather than expect me to send her a copy of Hansard, the Minister will take my  oral communication as an invitation to re-examine the matter and to see whether she can return with a better solution.

David Howarth (Shadow Minister (Energy), Trade & Industry; Cambridge, Liberal Democrat)

Having listened to the debate, I believe that it comes down to how one sees the original deal between and unlimited company and the person who enters a contract with it. There is a sophisticated view of such a contract that the person lending the money does so on the basis of the specific provisions of company law and those in the 1986 Act. The answer to complaints would therefore be, “Well, you contracted on the basis of the existing statute law.” The powerful objection to that view is that it is too sophisticated a way to consider the contract for an ordinary person making a deal with a company to be forced to follow and that in reality nobody makes contracts on such a basis. Under such a view, we would require anyone dealing with unlimited companies to take sophisticated legal advice to allow them do so safely.

The other equally absolutist view of such contracts is the one expressed in the amendment—that they are agreed between the lender and the company on the basis that the company is unlimited. A change in the company’s status, from unlimited to limited, is, in a sense, a breach of that agreement, changing the basis on which the agreement is reached by the creditor.

That absolutist view gives rise to the drafting of the amendment, which I concede would put a veto power into the hands of the creditor. If one wanted to defend that approach, one could say that the contract was like any other contract, and that a person who enters into a contract with somebody else has a veto in the sense that the other side is not allowed to change their promise unless that person says so and gives them permission.

I accept that the view expressed by most hon. Members today has been a third view of the contract, which is that the parties agree on the basis that the company is an unlimited company, but that each side also allows the other reasonable leeway to change their status or basis of the deal, given ordinary commercial developments, including the desire of a company to go public, for example.

Given that that seems to be the most widespread view in the Committee, it seems that the best thing for me to do is ask leave to withdraw the amendment in its present form, but reserve the right to return on Report with an amendment that does not follow the other absolutist view of the contract, which appears to be the Government’s view.

Quentin Davies (Grantham & Stamford, Conservative)

On a point of order, Mr. Illsley. I believe that we have made some progress this afternoon in clarifying the issue. In the light of the hon. Gentleman’s comments and his reference to a third way and to coming back on Report, my inclination is also to come back on Report with a third way enshrined in the form of a proper amendment. Would it be normal practice for such an amendment to be at least deemed acceptable—I cannot ask you to undertake to ensure that it is accepted—and therefore potentially debatable  on Report, even though it would cover a point that we had debated extensively in Committee? Such an amendment could advance a solution that we have not been able to debate concretely, because we have not had the opportunity to table an appropriate amendment or new clause in Committee.

Eric Illsley (Barnsley Central, Labour)

It would be for the Speaker to determine whether that was acceptable. The question is hypothetical, so it is difficult to make a decision, but I take on board the hon. Gentleman’s point, and we will provide him with some advice privately before the end of the Committee stage to clarify the issue. I hope that that deals with his point of order.

David Howarth (Shadow Minister (Energy), Trade & Industry; Cambridge, Liberal Democrat)

On that basis, I beg to ask leave to withdraw the amendment.