Liability of Holding Company for Defaulting Subsidiary

Orders of the Day — COMPANIES BILL [Lords] – in the House of Commons at 7:30 pm on 26th February 1980.

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'(1) Subject to subsection (3) below, if any sum required by any judgment or order to be paid by a company which is a subsidiary of a holding company is not paid by the company concerned within the period of fourteen days beginning on the date on which the judgment or order becomes enforceable by execution or (in Scotland) by diligence, the holding company shall be liable to pay that sum and that judgment or order shall be enforceable against the holding company accordingly.

(2) Where any such sum as is referred to in subsection (1) above is required to be paid in respect of a liability arising under a contract made by the defaulting company, the cause of action shall be regarded, for the purposes of this section, as having arisen at the time when the contract was made.

(3) Subsection (1) above shall apply only if the holding company or the subsidiary company has not given notice in writing to the creditor of the subsidiary company prior to the inception of the liability on which the judgment or order is based.

(4) For the purpose of subsection (1) above the expression "holding" shall mean any company which is the holder of one quarter or more of the shares of the subsidiary company or of the shares of any company which holds a quarter or more of the shares in the subsidiary company'.—[Mr. Clinton Davis.]

Brought up, and read the First time.

Photo of Mr Bernard Weatherill Mr Bernard Weatherill , Croydon North East

With this it will be convenient to take the following:

New clause 8—Liability of related companies:

'(1) Subject to subsections (2) and (3) of this section if any sum required by any judgment or order to be paid to any creditor by a company is not so paid within the period of fourteen days beginning on the date on which the judgment or order becomes enforceable by execution or (in Scotland) by diligence, every related company shall be jointly and severally liable to pay that sum, and that judgment or order shall be enforceable against any related company accordingly.

(2) In the event of a related company being wound up, nothing in subsection (1) of this section shall entitle the creditor to recover any part of the sum until the claims of the other creditors have been satisfied.

(3) Subsection (1) above shall apply in the case of a debt arising out of a contract only if the related company has not given to the creditor notice to exclude the operation of this section prior to the making of the con- tract on which the judgment or order is founded.

(4) For the purpose of this section, "related company" in relation to any company means any body corporate which is that company's subsidiary or holding company, or a subsidiary of that company's holding company, but for the purpose of this subsection no company shall be deemed to be the holding company of a subsidiary unless it is the holder of one quarter of the shares of that subsidiary, and the expression "subsidiary" shall be construed accordingly.'.

New clause 9—Liability of holding company in case of fraud:

'(1) If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose the court, on the application of the official receiver, or the liquidator or any creditor or contributory of the company, may if it thinks proper so to do, declare that any holding company shall be responsible without any limitation of liability, for all or any of the debts or other liabilities of the company as the court may direct.

(2) For the purpose of subsection (1) above the expression "holding company" shall mean any company which is the holder of one quarter or more of the shares of the company which is the subject of the winding up, or of the shares of any company which holds any shares in the company which is the subject of the winding up.'.

Photo of Mr Clinton Davis Mr Clinton Davis , Hackney Central

This series of new clauses seeks to provide that a holding company should, in certain circumstances, be liable for a subsidiary of that holding company which defaults in its legal obligations. We sought to provide a number of alternative routes which the Government might be able to consider. In essence, the clause provides that the holding company would be liable for the defaulting subsidiary, unless the holding company had given notice to the creditor to exclude the operation of the clause before the inception of liability on which a judgment order is founded. I should like to return to the details later.

I acknowledge that this is a difficult concept, especially for an Opposition, to draft into legislative form, and I have no doubt that the Minister will be able to point to certain defects of draftsmanship. Previously he was able to point out that he could embrace an idea that the Opposition put forward and improve on it. Perhaps he will be able to do the same here. The Minister is a fair man. He would concede this point as we are discussing the principle involved.

The basic principle that the current state of the law establishes is that a holding company and its subsidiaries must be regarded as separate entities. That is sometimes a difficult concept when one translates it into practice. It can lead to abuse. If the law insists on always treating each company as a wholly distinct legal entity, ignoring the fact that the group is a true economic unit, the results can be palpably absurd. The situation may result in a total lack of realistic information, and possibly misleading information being forthcoming.

Where a holding company has two subsidiaries one of which makes a loss of £50,000 and the other a profit of £10,000 and that profit is wholly distributed by way of dividends to the holding company, the holding company's individual accounts will show a profit of £10,000, unless there are expenses, although the group as a whole made a loss of £40,000. That is an example where mischief can arise. Where there is a deliberate holding out by the holding company, the principle that I have adumbrated is qualified in respect of group accounts, for example. There can be no doubt that the whole question of control with which we seek to grapple is very difficult. The law has constantly had great difficulties in this respect.

The concept does not necessarily mean that one has to have a majority of the shares. Control can exist without majority shareholding. An extreme example of that situation occurred in 1935 in the case of Investment Trust Corporation v. Singapore Traction Company, where a £1 management share was able to outvote the remaining 399,999 shares. That is a somewhat extreme example. It nevertheless found its way into the Chancery Division.

Section 154 of the 1948 Act seeks to define a holding company. But it contains certain anomalies in relation to that definition, particularly in a control situation where a person holds more than half the equity share capital in a company. The Jenkins committee of 1962 recommended that the anomalies that arose out of that situation should be abolished. We have not yet dealt with that.

The anxiety that has arisen about the ability of a holding company to distance itself from a subsidiary has been expres- sed on numerous occasions over a long period. The Jenkins committee reflected on the inadequacies of section 332 of the Companies Act 1948 and recommended that it should be extended to cover the situation where reckless behaviour resulted in creditors being defrauded.

Part of our case is that the burden of proof of a creditor seeking remedy under section 332 is far too heavy and operates as an effective deterrent to the search for such a remedy. The plaintiff, under subsection (1) of section 332, has to establish actual knowledge. Taking into account the fact that he is pursuing a case against a powerful and financially well endowed defendant, that can be not only evidentially difficult but enormously costly. This represents a deterrent.

The judiciary expressed recently some grave doubts about the current position at law. In the course of an application to stay execution of an order for damages in the recent Esperanza case now settled, Mr. Justice Parker, in granting the application, said that it was the right of a holding company to stand aside from its subsidiary, but he added: It may well be that it is an attitude which is unfortunate. I agree with that proposition. The Opposition say that this situation needs to be rectified. The Government concede, interestingly enough, that section 332 needs to be re-examined. But the Government say that the timing of our proposals must be challenged. They pray in aid the Cork committee which the previous Labour Government established to look at the whole scope of insolvency law. The Government say that they do not want to engage in piecemeal reform. The trouble with that argument is that we know that the Cork report is not due to be presented to the Government until about the end of 1980. The Government will then have to consider it. They will no doubt present it to the House of Commons and then engage in detailed consultation.

The Government will have to consider what Cork has reported in relation to the insolvency law of other European countries because they would seek to harmonise bankruptcy law. It is difficult to expect that there will be any legislation on the insolvency front in this Parliament. The issue to which we are addressing ourselves should not wait for several years to be remedied. It is an abuse which has caused considerable anxiety, because there seems to be an increasing tendency on the part of holding companies to refuse to honour debts of their subsidiaries.

Photo of Douglas Hogg Douglas Hogg , Grantham

I have studied the clause with considerable interest. Am I not right in saying that if the clause became law a holding company could become liable without there being any misfeasance or culpability on the part of the holding company?

Photo of Mr Clinton Davis Mr Clinton Davis , Hackney Central

That is right. We provide a qualification in new clause 7(3) which is repeated in new clause 8. Some people say that effectively the rule of caveat emptor should prevail, but I believe that that is too simplistic. It ignores what happens all too often in everyday practice. That is why the Government concede that there is a case for reform.

Small firms become impressed by the connection of a subsidiary with a substantial, highly prestigious holding company, a connection that is often mercilessly exploited by the subsidiary for its own commercial purposes to give the impression that it has backing from the parent company. It is only when that subsidiary is unable or refuses to meet its obligations and the holding company disclaims any responsibility that the full hideous truth dawns on the small business man, and this may be accompanied by disastrous effects on his business.

I am able to cite some recent examples which have thrown the issue into sharp relief. One is the case of George Hensher Ltd. In the early 1970s, a company called Hensher (Furniture Trades) Ltd. appointed a receiver to a major subsidiary, George Hencher Ltd. A sum of £100,000 had been lent to the subsidiary by the parent company. Eventually, the parent company appointed a receiver to recover that money, but no intention was ever evinced on the part of the holding company to assist the trade creditors in any way. I believe that those trade creditors still have debts totalling about £400,000 outstanding to them.

I have already referred to the case of Esperanza. There, an award of $2·1 million in damages was made against a company called Kaleb Brett and Son Ltd., a subsidiary of Esperanza. As soon as that happened, the holding company sought to wind up the subsidiary on the ground that it had a duty to the shareholders to avoid incurring responsibility to pay the money due unless there were overwhelming commercial considerations for so doing. Business morality did not intrude into those considerations. Yet there was a time when it was thought that such considerations had some validity and that creditors, particularly small business men, should not be placed in this position. That case was eventually settled because of the enormous moral pressure that was brought on Esperanza. Public enterprises are expected to apply the same mores in this respect as are private enterprises, and rightly so. Several statements have been made recently in the House about the liability of British Leyland for its subsidiaries and so on.

I would argue that, whatever defects the Government might find in the new clauses, there is an overwhelming case for using the Bill as a means of remedying an abuse which can so severely prejudice the interests of the small business man, about which both sides of the House—the Government in particular—rightly profess concern. This is their opportunity to show that that is not merely election verbiage on their part. They have to overcome the hurdles of 15 per cent. VAT and 17 per cent. bank rate.

The Government have a chance to make some compensation in a small way. I hope that they will respond to the debate in a positive manner. Let them choose from the new clauses. I do not mind what permutation they take. Let them produce ther own remedy, but they must not use the argument that we should wait for Cork.

Photo of Mr Nicholas Budgen Mr Nicholas Budgen , Wolverhampton South West 8:45 pm, 26th February 1980

I hope that the hon. Gentleman will comment on the proposition that his new clause would prevent established large companies from going into high-risk activities, knowing that there was a risk of failure. It would tend to diminish the flow of risk capital.

Photo of Mr Clinton Davis Mr Clinton Davis , Hackney Central

I do not accept that argument. There is a strong case for lifting the veil, as company lawyers would say, in this instance. I do not accept the proposition that damage to risk capital would result. We are providing for a qualification—to which the hon. Gentleman does not appear to have addressed his mind—that the holding company would be able to give notice that it was not liable for the debts and other obligations of its subsidiary. The hon. Gentleman can make his own speech about that.

New clauses 7 and 8 owe much of their parentage—it is a little reticent to announce its parentage, because it might destroy the case—to the Government's British Aerospace Bill. Despite that, it has some respectability. New clause 7(1) provides for the time from which the availability of the remedy will flow. Subsection (2) deals with the time from which liability will run. Subsection (3) provides for the point that I have made in answer to the hon. Member for Wolverhampton, South-West (Mr. Budgen), namely, the question of notice.

Subsection (4) provides for a definition of the holding company. I concede that there are no hard and fast rules. It may be that if the Government are prepared to embrace the new clause in principle they will wish to qualify the way in which we define the holding company.

New clause 8 is not very different. It refers to a related company. New clause 9 repeats the new clause that we introduced in Committee.

Photo of Douglas Hogg Douglas Hogg , Grantham

I have the misfortune to dissent from the hon. Member for Hackney, Central (Mr. Davis) on all three new clauses. I oppose the new clauses for a variety of reasons.

I wish to deal with new clause 9. It is objectionable for two basic reasons. First, should it become part of the statute, it could be oppressive to the holding company. Secondly, there is no need for it.

On the first point, namely, that the provision of new clause 9 as presently formulated could cause injustice to the holding company, I wish to make five points. First, if one looks at the definition of the holding company, one sees that it is a company for the purposes of the new clause if it holds a quarter or more of the shares in the relevant company. That is not a high threshold. It means that many companies which will be regarded as holding companies are, in practice, in no way in control of, or able to supervise, the practice of a company in which they hold shares.

Secondly, it takes the principles of vicarious liability too far. Under new clause 9, the holding company, at least in theory, can be liable for the fraudulent acts of officers who were never appointed by the holding company and who were perhaps people whom the holding company itself was unable to dismiss. A further objection to the new clause is that the discretion given to the courts is very wide. I think that the word that is used is "proper". That word does not mean the same as the word "just". I suspect that if the courts were to interpret the word "proper" in a fairly broad way—and there is nothing to prevent them from so doing—they could use that word in order to impose a liability upon a holding company when the holding company was guilty of no negligence or culpability, simply in order to make an example—let us say an object lesson—of holding companies.

That brings me to my two final points in relation to the new clause. Holding companies under new clause 9 can be made liable for fraudulent trading when in no sense are they to blame. In principle, I find that a worrying extension of the law. There is a further point which I suspect the hon. Member for Hackney, Central has not really turned his mind to. It seems from a careful look at new clause 9 that the liability on the part of the holding company can also apply to acts of fraudulent trading which pre-date the time when the holding company acquired any shares in the company with which we are concerned. Therefore, if new clause 9 becomes law, I suggest that its effect could be, and probably would be, to cause considerable injustice to a number of holding companies.

There is the related point that I have suggested, namely, that the new clause is unnecessary. That point was touched on by the hon. Member for Hackney, Central, but it was hastily departed from. As the hon. Gentleman well knows, there are provisions within the company laws which make fraudulent trading by officers of a company not merely a criminal offence but also an act which gives rise to civil liability, in the sense that officers guilty of fraudulent trading can be ordered to compensate those of the company's creditors who have suffered loss thereby. Therefore, one must ask whether, when we already have the existing provisions under the 1948 Act, it is necessary to introduce new clause 9. I therefore oppose the new clause on the grounds that it is unnecessary and unjust.

I turn briefly to new clauses 7 and 8. The objections to those new clauses are very similar to the objections to new clause 9. Once again, one asks to which companies these new clauses apply. They are defined as being holding companies and related companies. When one asks "What is a related company?", one finds the same kind of threshold of shareholders, namely, one-quarter. That gives rise to precisely the same point as I previously made, which is that related companies may find themselves liable for judgment debts when in no sense have they been in control of the defaulting company or, in practice, able to supervise.

That is an objectionable principle to advance. Moreover—again, this applies to both new clauses—it is hard to make anyone, even if it is a corporation, liable for acts not merely which it did not control but in respect of which it is in no sense culpable. In that case there is no requirement that those seeking to make the holding or related company liable should establish negligence, culpability or misfeasance.

I find it objectionable that this concept of absolute liability should be imported into this rather esoteric area of company law.

I make one final point, which applies to judgment debts. It would seem, if we look at the new clauses carefully, that, notwithstanding the points made by the hon. Member for Hackney, Central, who introduced the new clauses, the liability of the holding company could be a liability in respect of judgment debts arising from debts that pre-dated the time when it entered into a relationship with a defaulting company. In practice and in principle, that must be highly offensive to hon. Members. I hope that the House does not endorse any of the new clauses.

Photo of Mr Ernest Roberts Mr Ernest Roberts , Hackney North and Stoke Newington

In putting forward new clauses 7, 8 and 9, my hon. Friend the Member for Hackney, Central (Mr. Davis) is providing a basis of protection for small businesses. The hon. Member for Grantham (Mr. Hogg), who said that this may stop risk capital being injected into companies, must bear in mind that small companies are risking all their capital and losing it all as a result of the effects of major companies not facing their responsibilities.

It is reported in the financial press that a growing number of businesses are failing due to bad debts—debts owed in many cases by the subsidiaries of parent companies. Generally, businesses that fail are small businesses. The Government claim to support small businesses, and this is the time for them to show their support.

Hon. Members have referred to the National Enterprise Board. In some cases it has been responsible for the collapse of companies such as British Tanners Ltd. and a number of other small leather companies. The companies that supply British Leyland are also becoming concerned lest the NEB leaves them holding the baby and because of the possibility of a cutback in financing British Leyland.

There should be a moral and legal obligation on the parent company to be responsible for its subsidiaries, just as a parent is expected to be responsible for his children and for the acts of his children. Some subsidiary companies build their businesses on the well-known name of the holding company, which then refuses to accept responsibility for any debts that may be incurred. That is a loophole for dishonest dealing in the same way as insider dealing is a loophole. Small and weak companies must be given protection by the Government in the Bill. Incidentally, the strong holding company enjoys the benefits and the values from the subsidiaries. Why should it not share the losses incurred by its subsidiaries?

Photo of Mr Nicholas Budgen Mr Nicholas Budgen , Wolverhampton South West

I hope that the hon. Member for Hackney, North and Stoke Newington (Mr. Roberts) will forgive me if I begin by saying that I know that my hon. Friend the Member for Grantham (Mr. Hogg) wished to be present to hear his speech, but unfortunately he was asked to leave the Chamber a moment ago, and he had to do so immediately.

However, the hon. Member for Hackney, Central (Mr. Davis) will understand that I disagree fundamentally with the way in which he put his point of view. He does not understand the nature of risk in company finance. The hon. Gentleman talks about a subsidiary's relationship to its holding company as though it were a young child relating to its parent. Even in the most paternalistic societies, there is some limitation on the obligations that the parent feels towards its child. The hon. Gentleman is speaking of a subsidiary company as though it were able to call upon the parent company to a total and unlimited extent, as though in every instance the son were able to call upon the father to the total limit of his capacity, wealth and honour.

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The reality is this. If these new clauses were put into the Bill, we should be putting holding companies in a completely different position from that of individuals. We should be telling individuals that they may invest their money in a company on the basis of limited liability, knowing the extent of their potential losses, but we should be telling a holding company that, once it put its money into a subsidiary company, there might be no limit to its liability.

However the hon. Member for Hackney, Central puts his point of view, there must be disincentive to investment of risk capital if these new clauses are enacted. I am sure that I do not carry the hon. Gentleman with me, but let me assume for a moment that in different circumstances I agreed with him. For the sake of argument, let us concede that the system by which large companies tend to proliferate subsidiaries has got out of hand in recent years. That is a disagreeable product of our present tax system. If, for the sake of argument, GEC finds itself sitting on a cash mountain, it will be extremely difficult to distribute that cash mountain, because of the shareholders' potential liability for capital gains tax.

I hope that the Chancellor will abolish capital gains tax in the next Budget. It may be that he will not. I hope also that British companies in general will be moving into a more profitable period, but in the past shareholders' rights have been undermined by dividend restraint. Once again, it has been difficult for large companies to rid themselves of cash in such a way that it is tax-effective for shareholders.

It is, therefore, almost inevitable that the present system drives companies into becoming what they should not be, which is really something like merchant banks. Instead of distributing their cash to shareholders, they set themselves up as punters in their own right, investing limited sums in subsidiary companies. I regret that, but the system will not be changed overnight. As long as the system has that disadvantageous effect, it is important that subsidiary companies should be able to trade on the same limited liability basis as companies that receive investments from private individuals.

Photo of Mr Clinton Davis Mr Clinton Davis , Hackney Central

Is the conclusion that we are to draw from the hon. Gentleman's remarks that it is hard cheese as far as the small creditors of subsidiaries are concerned?

Photo of Mr Nicholas Budgen Mr Nicholas Budgen , Wolverhampton South West

No, it is not hard cheese. The point to which the hon. Gentleman does not attack proper importance is that when these large companies invest money in smaller subsidiaries they wish to retain their good name. The hon. Gentleman a moment ago gave an instance of a large holding company that settled as a result of pressures put upon it. Indeed, I would argue that the probability is that large holding companies that diversify into subsidiary companies are much more likely to be a soft touch than, for instance, an individual who invests in a small company, because they have their good name to uphold.

I hope that the hon. Gentleman will not persist with these proposals. They will only cause large and respectable companies to become reluctant to risk cash sums in businesses about which they know little.

Perhaps my next remarks are contrary to the ethos of my party. However, it is inevitable that some of those who start small businesses will take substantial risks. Those who are engaged in small businesses do not always dot the "i"s and cross all the "t"s of legal requirements. They still need risk capital. If these proposals are enacted, small companies will not get risk capital from large organisations. We should therefore enforce the principle that people should risk capital in the hope of gaining proper reward in the market place.

Photo of Mr Nicholas Baker Mr Nicholas Baker , North Dorset

I do not wish to repeat the arguments that were put forward in Committee between the hon. Member for Hackney, Central (Mr. Davis) and me. Conservative Members disagree with the change in company law structure and with the trading principle that lies behind these three clauses.

I shall take up some of the points raised by the hon. Gentleman. The Jenkins committee simply recommended a change in the definition of holding companies. That does not affect the substance of the debate. The hon. Gentleman referred to a case that involved a furniture subsidiary company that had gone into liquidation. The liquidator of the subsidiary company found that the company was owed money by the holding company. It could therefore make a claim against the holding company. Consequently, the example that the hon. Gentleman gave does not support his case.

Subsidiary companies do not use the name of parent companies; they are careful not to. There is a legal reason for that. If a subsidiary company uses the name of a holding company, the holding company may become legally liable for its debts. Therefore, subsidiary companies are at pains to explain the distinction. The major weakness of the Opposition's argument is apparent. They have thrown three inadequately drafted clauses at us. They hope that by spraying their fire they will meet the target.

Photo of Mr Reginald Eyre Mr Reginald Eyre , Birmingham, Hall Green

I have sat opposite the hon. Member for Hackney, Central (Mr. Davis) for many weeks in the Standing Committee and during debates in the House. I think that he has approached these clauses in a diffident manner. I hold a good opinion of the abilities of the hon. Gentleman. He earlier acknowledged that there might well be defects in the drafting of these clauses. He was absolutely correct to have that reservation. I am sure that he recognises that serious difficulties are involved in drafting. Great difficulties of principle are involved. If a proper examination of these clauses is made, all reasonable hon. Members will become convinced that the clauses are unsuitable and should not be enacted.

The intention of the new clause is evidently to make holding companies responsible for the debts of their sub- sidiaries. I have noticed a certain similarity between the wording of this clause and the wording of section 53 of the Aircraft and Shipbuilding Industries Act 1977. Quite apart from the difference between the provision governing two nationalised industries and a provision regulating all holding companies and subsidiaries, the section of the 1977 Act was continued to wholly owned subsidiaries of the new corporation.

The present amendment seeks to legislate to ensure that holding companies pick up the tab for any companies in which they hold a quarter or more of the shares. There is scope there for an interesting discussion on the relations between a company and its subsidiaries. Indeed, this is the subject of continuing debate in the commercial world. To make a company responsible for the debts of another company merely because it has a holding of 25 per cent. or more in that company would go well beyond the generally accepted relations between companies.

It is significant that the clause seeks to introduce into our company law a completely new definition of "holding company" and "subsidiary", although the latter term is not in itself defined. The definition used elsewhere in the Companies Acts is that contained in,section 154 of the 1948 Act, which deems a company to be a subsidiary of another only if the other company controls the composition of its board of directors; or holds more than half in nominal value of its equity share capital". Section 154 also contains a number of further provisions that ensure that, in effect, a subsidiary is under the control of the holding company. It is surely wrong that we should contemplate treating holding companies as responsible for the debts of companies in which they may have a significant shareholding but over which they are not in a position to exercise control. Indeed, they may well have little relevant information about the subsidiary. For example, a company may feel no obligation to inform another company, which simply holds 25 per cent. of its shares, about the details of its creditors. A similar point arises on subsection (3). How can the holding company give notice if it does not know who the creditors are? Why should the subsidiary give notice?

Unlike section 154 of the 1948 Act, the clause is weak on definition. What is meant by "shares" in subsection (4)? Does it include all share capital or only equity shares? Certainly it would be penal to put a contingency liability of this nature on a preference shareholder. In any case, what does "holder" mean? Does it mean the holder of more than 25 per cent. by number or by nominal value?

A further point arises on subsection (2), which provides that where payment is required by a holding company in respect of liabilities under a contract made by a defaulting company, the liability in effect arises when the contract is made. But subsection (1) refers to judgments or orders in general and is not confined to judgments or orders in respect of contracts. There is no provision in the clause in respect of judgments in the event of fraudulent misrepresentation, for example. I have demonstrated that the clause is misguided in principle and defective in drafting. If the matter is pressed to a vote, I must ask the House to reject the new clause.

I am very much strengthened in this view by the powerful criticisms advanced by my hon. Friends the Members for Grantham (Mr. Hogg), for Wolverhampton, South-West (Mr. Budgen) and for Dorset, North (Mr. Baker). I am grateful for their comments.

I turn now to new clause 8, since I think that it would be for the convenience of the House if I referred especially to that clause. It follows the same theme as the clause that we have just discussed, and my general observations about this clause are similar to the ones I made on the previous clause.

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The purpose of the clause appears to be to introduce into commercial relationships a draconian interpretation of the relations between companies linked by ownership of a proportion of the shares. Responsibility would be placed on businesses that might have had no control whatever on the commercial activities of a company in which it had, say, a 25 per cent. holding. That would go far beyond what would be generally recogconsiderations of good name, reputation, nised as reasonable.

As I have already explained, the definitions provided of a holding company and a subsidiary are in any event completely inadequate in themselves and are incompatible with the definitions of these terms used elsewhere in the Companies Act 1948.

It would be illogical to introduce a new definition confined to a specific provision, particularly when that definition does not bear close examination. There are some intriguing differences between this clause and the previous one. That is an indication of the complexity of provisions of this nature.

For example, we have here a different definition of a holding company from that in the previous clause. Whereas the previous clause imposed responsibility for the debts of the subsidiary on the parent company, this clause leaves responsibility at the first generation. The clause would, therefore, not apply to the wholly owned subsidiary of a wholly owned subsidiary.

Perhaps those who drafted the clause realised that the same flaws existed in subsection (2) of the previous clause to which I drew attention. At any rate, the provisions of that clause are not carried over into this clause. More seriously, in this clause only the related company can give notice under subsection (3), but, as I indicated earlier, a related company will often be in no position to know of any transactions of a company in which it has a shareholding. For all these reasons, I strongly urge the House to reject this new clause.

I turn now to new clause 9, the last of the three clauses introduced by the hon. Member for Hackney, Central. As I have said, the relationship between the holding company and the subsidiary company as defined, for the sake of argument, n the Companes Act 1948 is a subject of continuing debate. The position of a holding company when a subsidiary is forced to cease trading has been a significant element in the debate, and I appreciate the concern felt about that.

The position in law has been that subsidiaries are separate from their holding companies. Whether or not in practice a holding company stands behind its subsidiary in the event of its being unable to meet its debts has been regarded as a matter of commercial practice involving and so on.

The present law governing fraudulent trading is contained in section 332 of the Companies Act 1948. In that section the court may declare that any persons who were knowingly parties to fraudulent trading shall be personally responsible, without any limitation or liability, for…the debts or other liabilities of the company. Section 332, therefore, already applies to a holding company whether or not the company is considered by the court to have been knowingly a party to the carrying on of the business of its subsidiary with intention to defraud its creditors. The new clause would extend the potential liability of the holding company to situations in which it was not knowingly a party to fraudulent trading.

The definitions of a holding company and subsidiary in subsection (2) are as unsatisfactory for this clause as for the previous clause. The clause therefore contemplates a potentially very severe penalty for a company that simply has a significant holding in another company, over which it can have no control and about which it will have no means of ensuring that it is fully informed. I could not, therefore, commend this clause to the House.

The hon. Member for Hackney, Central quoted a number of cases which give rise to cause for concern. However, the defects in the new clauses are serious and there is potential unfair damage that could be caused by them. There are difficult problems involving the relationship of holding companies and their subsidiaries. Those problems deserve serious and measured consideration. The hon. Member for Hackney, North and Stoke Newington (Mr. Roberts) spoke of the problems of small companies in that respect. I am well aware of those problems, but I assure him that the clauses are not the proper way by which to protect the valid interests of small businesses.

Photo of Mr Ernest Roberts Mr Ernest Roberts , Hackney North and Stoke Newington

In that case, does the Minister have a method in mind for solving the problems?

Photo of Mr Reginald Eyre Mr Reginald Eyre , Birmingham, Hall Green

As the House and the hon. Gentleman know, a comprehensive review of the law relating to insolvency is being conducted by a distinguished com- mittee under the chairmanship of Sir Kenneth Cork. It would be wrong to pass new legislation in that area piecemeal in advance of the committee's report, which is expected to be published later this year. I assure the hon. Gentleman that some of the problems that he has raised will be considered carefully. I urge the House that it is entirely right and responsible for us to await the report. We shall then be in a much better position to produce proper solutions.

Photo of Mr Clinton Davis Mr Clinton Davis , Hackney Central

That will be five years.

Photo of Mr Reginald Eyre Mr Reginald Eyre , Birmingham, Hall Green

The hon. Gentleman is judging it against the time scale of the inaction of his Government. When he was in the Department of Trade in charge of company law, he did not act for about four years on company matters.

Photo of Mr Clinton Davis Mr Clinton Davis , Hackney Central

That is quite wrong. There were Companies Bills in 1976 and 1978. The 1978 Bill was frustrated by the will of the House as a whole. I could never understand why it did not want the Bill enacted rather than have an election. That seemed totally absurd. The Minister was wrong to suggest that there will be a shorter time scale in this case. By virtue of the difficult concepts that will be embraced by the Cork committee, it will take a long time for the matter to be considered.

Photo of Mr Donald Anderson Mr Donald Anderson , Swansea East

As the Minister reacted so vigorously to the suggestion that this will take five years, will he assist the House by giving an indication of when the report is expected, let alone when there will be legislation based upon it?

Photo of Mr Reginald Eyre Mr Reginald Eyre , Birmingham, Hall Green

I am pleased to tell the House that the report is expected later this year. It is my intention that there should be legislation to deal with certain outstanding problems, and I believe that we will be helped by the committee's report on those matters. Certainly the legislation will take place in less than five years.

I do not wish to be unfair to the hon. Member for Hackney, Central, because what he said illustrated the complexity of dealing with these matters. To get the important legislation right, we must have regard to the reports of expert committees. It is important that proper consideration should be given to the terms of those reports and that proper consultation with all the parties affected by the legislation should be held. We shall do that as quickly as we can to deal with certain problems. In the meantime, I recommend hon. Members to resist and reject the proposals in the new clauses.

Photo of Mr Peter Archer Mr Peter Archer , Warley West

A profound change came over the debate literally in the closing minutes. At the end of the Under-Secretary's speech it became clear that there was just one individual on the Government Benches who had grappled with the problem. Not one other speech from the Government Benches gave any indication that anyone else had appreciated the problem to which we are addressing our minds. The problem is that there are companies which trade through subsidiaries; the subsidiaries accumulate mountainous debts and the holding company then departs, leaving the company to go into liquidation and the creditors to grieve for their losses. That is the problem.

If an individual does that, he may, in certain circumstances, at least be disqualified from acting as a director in future. But we cannot apply that sanction to companies. If an individual has been guilty of fraud he may be dealt with, but we may not be discussing fraud. We may not even be discussing culpability. The objection is to holding companies being prepared to accept whatever proportion of profits they can lay their hands on while seeking an avenue of escape from any of the risk.

We had a succession of objections from Government Members to our proposals. The hon. Member for Grantham (Mr. Hogg) said that our proposals were oppressive to holding companies because, as he said, they might become liable for debts over which they had exercised no control and for which they were not to blame. I fully accept that. Our proposals do not rest on control or culpability. They rest on the fact that a holding company is prepared to take profits without risk but seeks to impose a limit on its losses.

I take the point of the hon. Member for Grantham that our proposals might entail a holding company being liable for debts that had been incurred before the date on which the holding company acquired its interest. That is a fair point and we are certainly prepared to listen to any solution that might emerge. But one does not eject the baby with the bathwater. Because that problem exists, it does not follow that the whole of our proposals should be scrapped.

Photo of Mr Nicholas Baker Mr Nicholas Baker , North Dorset

I wonder whether the right hon. and learned Gentleman could explain how a holding company could be said—in the words he has just used—to be taking all the profit out of a company where, for example, it owns only 25 per cent. of the shares.

Photo of Mr Peter Archer Mr Peter Archer , Warley West

I thought that what I said—I was listening to myself, at least, and we can check it in Hansard—was that a holding company takes all the profits which it can lay its hands on. Of course, it cannot take a higher proportion of the profits than the proportion it has of the equity capital. But holding companies are prepared to take all the profits they can lay their hands on while seeking an avenue of escape from the risk of losses. That is the point that I was making.

As to the objection of the hon. Member for Grantham, we would be prepared to listen to solutions to that problem.

Photo of Mr Keith Stainton Mr Keith Stainton , Sudbury and Woodbridge

The right hon. and learned Gentleman is wrong. There could be an agreement between the said holding company and the subsidiary company in respect of the shareholding. By that process the holding company could take the bulk of, if not all, the profits. That illustrates and underlines the complexity of the matter to which my hon. Friend the Minister drew attention and the need to move with great caution and deliberation.

Photo of Mr Peter Archer Mr Peter Archer , Warley West

I should have thought that that underlined the force of our argument. We could perhaps argue about the relevance of the perfectly proper point made by the hon. Member for Sudbury and Woodbridge (Mr. Stainton). Clearly, all sorts of deals can be done behind the backs not only of the shareholders but of the creditors, and we are particularly concerned here with the creditors. The very fact that such deals can be done behind the creditors' backs emphasises the need to protect them.

The hon. Member for Wolverhampton, South-West (Mr. Budgen) had another objection. He said that this proposal would discourage a company from investing risk capital. I fully accept that. However, I thought that the question put by my hon. Friend the Member for Hackney, North and Stoke Newington (Mr. Roberts) was very relevant. It is easy to talk about risk capital, but whose risk are we talking about? We are talking about the risk to the creditors. It is easy for us all to take risks with other people's money.

We really come back to the concept of limited liability. We discussed this on Second Reading. Limited liability is a substantial concession, an inroad on the basic rule of law that people are responsible for the debts that they incur. Limited liability says that in certain circumstances people may try for the profits, but if debts are incurred in the process they will not be liable up to the limit for those debts. In certain circumstances they can leave the creditors to whistle.

9.30 pm

I am not objecting to the concession being made. It is a fundamental part of our law and it exists for good reasons. However, we are entitled to make it subject to proper safeguards. The hon. Gentleman's objection is that people will not be prepared to take risks with other people's money if they may have to meet the consequences out of their own pockets. Surely, there is nothing basically wrong with that.

The creditors that we are speaking about may not be wealthy financiers or large companies. They may be individual customers who have answered an advertisement in the evening newspapers. They may be small companies which are not in a position to lose their money.

The hon. Gentleman produced another objection. He said that the provision is not needed because an honourable holding company will pay without any such provision. The answer to that is "In those circumstances, why should we not include the provision?" If we are talking about honourable holding companies which will pay in any event, surely they will not object to such a provision. If we are talking about dishonourable holding companies, or companies which claim that they are entitled to evade their obligations as a matter of law, it is for such companies that we are legislating.

My hon. Friend the Member for Hackney, Central (Mr. Davis) was taken to task for the example that he gave. It was argued that the holding company coughed up under pressure. The important words were "under pressure". In my hon. Friend's example, a great deal of pressure had to be applied before the money was disgorged by the holding company.

If I may say so, the hon. Member for Dorset, North (Mr. Baker) fell below the standards that we have come to expect from him.

Photo of Mr Peter Archer Mr Peter Archer , Warley West

Indeed. However, on this occasion I think that he fell below his usual standard. His basic argument was "Because you were not sure of getting one clause right, you stuck three in." That is not true as a matter of fact. We offered three possible solutions to the problem. If the Government had said "We do not like this solution and that solution but we accept your third one", we would have been happy. Surely, we cannot be criticised for offering three possible solutions.

I am not sure that the Under-Secretary of State met our arguments head on as he is accustomed normally to do. He took refuge in defective draftsmanship. We are prepared for our draftsmanship to be corrected, though if we are to swap allegations of that sort the Government's record throughout the Bill's passage is not beyond criticism. I am not sure why they should have a monopoly of defective draftsmanship.

The Minister argued that we did not provide for the situation in which deficiencies stem from a subsidiary of a subsidiary. That was not something that we overlooked. We did not want to make the debate too complicated. We knew that if we managed to persuade the House of our case the draftsmen would be able to meet us subsequently.

The Minister advanced two real objections to our proposals. First, he said that it would not help to talk about giving notice in relation to contractual obligations because the holding company would not know about every contract that the subsidiary made. That may be so. We thought that we would give it an oportunity where it was aware that there was a contractual obligation. If the holding company is happy to accept profits when it has not directed its mind to the contracts, it can hardly complain if it is landed with the losses that are sometimes incurred. If it is prepared to benefit from its ignorance, it can hardly plead its ignorance as a defence against being landed with the losses.

I do not believe that the Government think that there are no difficulties. If I had not turned over three or four pages of my notes at once, I was going to quote what the Minister of State said in Committee on 11 December. I did not have the quotation before me because I had turned over three pages at once. At that stage the Minister of State said that section 332 had its problems. I am sure that he would not seek to resile from that comment. My attention has now been drawn to the passage to which I referred. As I paraphrased it, I do not need to delay the House by reading it.

The other objection advanced by the Minister was that the threshold was too low. He said that we should not land a holding company with all the debts of the subsidiary if the holding company owned only 25 per cent. of the equity capital and received only 25 per cent. of any profits. I do not think that we would go to the wall on 25 per cent. We could probably do a deal about the appropriate proportion if the Government said what proportion of the profits a person should be able to claim before he should bear the losses and not leave the creditors with them. We could probably meet that halfway.

"We are waiting for the Cork report." This is not the first time that we have heard those magic words. Let more creditors meanwhile be left to stew in their own juice until Cork reports. I am not sure that that is a complete answer to every problem. All Governments do it. They wait for whatever it is—the Royal Commission, the inquiry, the interdepartmental committee report. This is not a complete solution to every problem.

New clause 8 represents what is reported to be the solution preferred by Sir Kenneth himself. I am not sure whether the report is accurate. We attempted to paraphrase what was reported as his preferred solution.

We do not complain that we have been taken to task for defects of which we may have been guilty. We complain that the contributions by Government supporters did not show any appreciation of the problem. If they demonstrated that they appreciated the problem, perhaps we could discuss the solution. As they did not do so, we must agree to differ and let it be so recorded.

Question put and negatived.