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Clause 158

Company Law Reform Bill [Lords] – in a Public Bill Committee on 11th July 2006.

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Duty to promote the success of the company

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General 10:30 am, 11th July 2006

I beg to move amendment No. 40, in clause 158, page 70, line 7, after ‘faith’, insert

‘and as appropriate for the size of the company’.

Photo of John Bercow John Bercow Conservative, Buckingham

With this it will be convenient to discuss the following: Amendment No. 39, in clause 158, page 70, line 9, leave out from ‘whole,’ to end of line and insert

‘having regard, insofar as he considers it relevant, to the following factors (amongst others)—’.

Amendment No. 300, in clause 158, page 70, line 9, leave out from ‘so’ to end of line 18 and insert ‘must endeavour to—

(a) have regard to the likely consequences of any decision in the long term,

(b) promote the interests of the company’s employees,

(c) foster the company’s business relationships with suppliers, customers and others,

(d) minimise any adverse impact of the company’s operations on the community and the environment,

(e) maintain a reputation for high standards of business conduct, and

(f) act fairly as between members of the company.’.

Amendment No. 166, in clause 158, page 70, line 9, after ‘to’, insert

‘what he considers, in good faith, to be’.

Amendment No. 297, in clause 158, page 70, line 14, leave out ‘and the environment’.

Amendment No. 41, in clause 158, page 70, line 18, at end insert ‘, and

(g) all other common law duties of directors.’.

Amendment No. 42, in clause 158, page 70, line 25, at end insert—

‘(4) The duties implied by this section shall not apply to small and medium sized companies.’.

Amendment No. 43, in clause 158, page 70, line 25, at end insert—

‘(4) None of the duties set out in or implied by this section shall take priority over any of the other duties.’.

Amendment No. 165, in clause 158, page 70, line 25, at end insert—

‘(4) The duty to promote the success of the company shall be paramount.’.

Amendment No. 417, in clause 158, page 70, line 25, at end add—

‘(4) The Secretary of State must issue a non-statutory set of guidelines concerning the application of this section, which must be updated annually.’.

Clause stand part.

New clause 1—Directors to have regard to interests of employees—

‘(1) The matters to which the directors of a company are to have regard in the performance of their functions include the interests of the company’s employees in general, as well as the interests of its members.

(2) Accordingly, the duty imposed by this section on the directors is owed by them to the company (and the company alone) and is enforceable in the same way as any other fiduciary duty owed to a company by its directors.

(3) This section applies to shadow directors as it does to directors.’.

New clause 27—Guidance on interpretation of directors’ duties—

‘(1) The Secretary of State shall from time to time publish binding statutory guidance as to the interpretation of the duties imposed on directors by section 158.

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

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

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

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

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

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

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

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

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

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

“We had two main intentions in introducing a statutory statement of directors’ duties.

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

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

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

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

Photo of John Bercow John Bercow Conservative, Buckingham

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

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

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

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

It goes on to say:

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

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

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

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

The Law Society’s June briefing says:

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

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

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

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

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

“valuable and reliable source of information and guidance.”

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

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

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

I am not sure about all the duties to which the hon. Gentleman has referred—he might be right about some of them—but surely they are covered by the duties to

“act in accordance with the company’s constitution” and to

“only exercise powers for the purposes for which they are conferred”, as set out in clause 157, which we have just passed.

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

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

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

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

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

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

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

Photo of Patrick Hall Patrick Hall Labour, Bedford 10:45 am, 11th July 2006

Is the hon. Gentleman suggesting that the clause as drafted abolishes other statutes and wipes out centuries of common law?

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

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

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

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

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

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

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

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

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

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

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

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

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

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

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

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

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

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

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

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

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

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

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Law Society then says that

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

It states that amendment No. 166

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

Photo of James Brokenshire James Brokenshire Conservative, Hornchurch 11:00 am, 11th July 2006

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

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

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

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

To stick to the provision before us and the possibility of increased insurance costs, can the hon. Gentleman tell me the likely loss to the company in the case of a takeover where the incoming directors try to proceed against the previous directors under the clause? I am struggling to see how any of the duties might be breached in a way that gives rise to a loss to the company, in which case there is nothing to insure against.

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

I gave two examples: a takeover and insolvency. In themselves the costs will not attach to the clause; they will attach to the clause in conjunction with other provisions, particularly under clause 161  and probably in relation to other sections in the Insolvency Act. Following a hostile takeover during which there was an uncomfortable situation between competing boards, the winning party might in the course of selling off the target’s headquarters and going through papers consider how they could recoup the costs of the takeover, and it would be attractive to the incoming board to have a go at the sacked directors of the target company.

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

The hon. Gentleman is correct that in such a situation there is an opportunity for the new board to look for possible legal remedies against the previous directors, and the risk under clause 161 seems exactly the same as it is now, in that that practice already happens. The question is what loss there might be to a company under clause 158 were such a directive to proceed. There cannot be a legal action in those circumstances unless there is a loss to the company. Can he specify what that loss would be?

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

I can think of 101 different ways in the takeover scenario that I mentioned in which there could be financial loss to the company where the incoming board maintains that it wants to recoup that loss from the outgoing directors. It will be looking for areas of alleged mismanagement.

Photo of Shailesh Vara Shailesh Vara Conservative, North West Cambridgeshire

My hon. Friend may agree that an example might arise during a property recession. It is foreseeable that following a takeover the new board might accuse the former board of not having paid due diligence to a property recession, and if the company dealt in property, the new board could seek to recuperate. That would lead to a financial loss—

Photo of Shailesh Vara Shailesh Vara Conservative, North West Cambridgeshire

The Minister should appreciate that the hon. Member for Cambridge (David Howarth) asked for an example and I have given a business example.

Photo of Shailesh Vara Shailesh Vara Conservative, North West Cambridgeshire

It is; that is an example. If the board has not taken that into account, the new board can say that there has been a financial loss to the company and it can seek to claim for it. That loss can be infinite.

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

My hon. Friend makes a fair point. [Interruption.] His point is that history has shown that in an economic downturn people are more likely to become litigious and therefore in a takeover there could be more temptation to look to recoup. However, the point has been well covered.

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

The point made by the hon. Member for North-West Cambridgeshire (Mr. Vara) concerns clause 160: directors could sue because of a loss due to a breach of clause 160—the duty to exercise reasonable care, skill and diligence. The question is what losses could there be under clause 158?

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

Yes, but that does not make clause 158 any less of a worry.

Let us move on to concerns that have been raised that the list as currently drafted does not make clear the ranking of the factors to take into consideration. That is the reason for our amendment No. 43, which states that no one duty should take precedence over another. Is the first duty more important than the last? Are they subordinate to a director’s primary duty to promote the company’s success? If so, we believe that that should be made clear. As presently drafted it is not clear and will undoubtedly provide much grist for a number of court cases.

Many commentators have been asking whether we necessarily want to invite judges into the boardroom. The business community does not, as The Economist clearly sets out in its article of 21 April:

“Behind Lord Eldon's words is a neat principle, usually known in America as the business-judgment rule. This holds that so long as the directors of a company act in good faith then their decisions (even the bad ones) will not be revisited by courts with the benefit of hindsight. Directors who are dishonest get judged in court and those that are just bad are judged in the market place. Now a proposed revision of England's company law threatens to change this arrangement.

The Company Law Reform bill, which has its last hearing in the House of Lords on April 25th, proposes to charge directors with more than safeguarding the financial interests of the companies they serve. They will also have to keep in mind their employees, customers and suppliers, as well as nurture communities and the environment. And the bill makes it easier for shareholders to sue wayward directors.

Critics, generally from business, warn that together these revisions threaten to release a torrent of litigation as suppliers, customers, environmentalists and others ask the courts to reverse company decisions. The mere threat of such suits may gum up board meetings as directors pay more attention to protecting themselves from legal action and less to doing what they get paid to do—taking risky decisions that may sometimes prove wrong.”

The article concludes:

“The proposed duties are based on the notion that successful companies are also good corporate citizens, managed on behalf of ‘enlightened shareholders’. Under this doctrine there is a neat intersection between the desire of shareholders for a better world and their interest in corporate success, and reward flows to those companies that are most successful at balancing the needs of different stakeholders. But the approach bears little relation to reality.

Take tobacco and liquor companies. They supply products that, while giving pleasure, may harm their customers and others. Airlines provide convenient transport but also release greenhouse gases. Under the new law shareholders could potentially sue directors of these companies for disregarding their duty to protect the environment and the community. ‘You'll have the teetotallers taking over the brewery,’ warns Dan Prentice, a law professor at Oxford's Pembroke College.

The greater worry is that, in trying to legislate good behaviour, the bill may make business decisions subject to subsequent review in court, says Adrian Levy, a partner at Clifford Chance, a law firm. Directors will be less happy to sanction a takeover or restructuring knowing that they could suffer personal liability for honest business decisions. In effect directors may end up being held liable for decisions simply because they are wrong, rather than because they acted in bad faith.

If the bill passes, many think judges will continue to leave business decisions to businessmen. Judges ‘are no good at it and don’t want to take it on,’ says Paul Davies, of the London School of Economics. Perhaps. But mounting red tape is already deterring qualified people from accepting board appointments. If they now face the risk of being taken to the cleaners for business decisions made in good faith, even fewer are likely to step forward.”

There is a likely conflict between the factors listed in subsection (1). For instance, the long-term interests of a company may be best served by closing a factory, but this is unlikely to be in the interests of the company’s employees or the wider community.

Photo of Keith Vaz Keith Vaz Labour, Leicester East

I am following the hon. Gentleman’s argument very carefully. Is he saying that he does not believe that the average company director in the United Kingdom would be competent enough to make such judgments?

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

No. A director under the existing common law must make many judgments. Commentators argue that the formulation of some of the judgments that they have to make under the clause could confuse rather than clarify the picture.

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

Does the hon. Gentleman agree with the commentators’ view?

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

Yes, I do agree with it. It is a great concern, which is why we propose the amendments. The Minister may not have been listening.

Photo of Keith Vaz Keith Vaz Labour, Leicester East

If the hon. Gentleman were to put his arguments to the average company director in the United Kingdom they would be insulted by the view of these commentators. If directors take on the responsibilities, they will want to discharge them to the best of their ability. If they are given judgments to make, they will make them. May I suggest that the hon. Gentleman talk to some company directors, rather than academics, and put their views before us?

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

May I suggest that the hon. Gentleman should have listened to what I have said, which is exactly what he has just said?

According to Herbert Smith, a director

“will be required to give regard to all of these factors in every decision, even if a factor is plainly irrelevant and even if it would be outweighed by other considerations.

The new formulation poses a number of questions. What does it mean to ‘have regard’ to a particular factor? Can a director properly ‘have regard’ to a factor without full and proper investigation? What if the director decides not to investigate? Would the reasons matter?

What if a factor had been outweighed in the context of an almost identical recent decision? An example might be a proposal to vary a decision reached on a previous occasion, when the ultimate choice had come down to the balance between two considerations. On the second occasion, would the failure to have regard to all six factors amount to a breach?

What if the director is wrong about one of the factors? Have they nevertheless ‘had regard’ to the impact, rather than simply their erroneous perception of the impact? What if the director’s  mistake is itself a breach of the separate duty to exercise reasonable care, skill and diligence?

There is no clear answer to many of those questions. Assuming the bill is passed, they will require detailed consideration by the courts over forthcoming years. It will be some time before any certainty is achieved.”

The communication from Herbert Smith goes on to talk about derivative actions. Although that is in part 11, it establishes an important connection with clause 158. The communication states:

“Any uncertainty will be exacerbated by reforms expanding the scope of the derivative action. The Bill replaces the restrictive ‘wrongdoer control’ and ‘fraud on the minority’ preconditions with a general discretion for the courts to allow such claims to proceed. There is a list of considerations that must be taken into account by the court in exercising this discretion. Even so, the discretion is very broad.

The new provisions may mean that derivative actions become a more common feature of the corporate landscape. They will almost certainly provide a means for a disaffected shareholder to seek further public debate about the merits of a challenged decision. As the court has a general discretion, companies may well feel compelled to justify the substance of their decisions to the court, rather than simply focusing on why this applicant should not be permitted to bring the claim.

In the short term, the likely consequence of all these reforms will be an increase in the procedural requirements of decision-making as directors strive to ensure that they have records reflecting proper consideration of each factor so as to minimise any prospect for challenge by means of the derivative action or otherwise.

Even so, the result is likely to be more breaches by directors, many of which will be largely technical. This may have consequences in terms of reporting and insurance. It may also trigger contractual provisions, perhaps in joint ventures or financing arrangements.”

Photo of Louise Ellman Louise Ellman Labour, Liverpool, Riverside 11:15 am, 11th July 2006

The hon. Gentleman’s comments seem to disregard the fact that the clause deals with judgment exercised in good faith having regard to the factors to which he appears to take objection.

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

The fundamental problem with the Bill is that it clouds the directors paramount duty to consider the best interests of the company. That is the kernel of the issue.

The other duties are all important, as I made clear, but the fundamental responsibility of a director is to the best interests of their company. All other responsibilities spring from that fundamental duty. By clouding that duty, the Government will do a great disservice to company law and directors for decades to come. That is why we have tabled amendment No. 165, which states:

“The duty to promote the success of the company shall be paramount.”

There are a number of concerns about the interpretation of the new language that the Government have chosen to introduce to the Bill. For example, what does “independent judgment” mean for a director? That was taken up by Patrick Mitchell and Carl Powlson of the City law firm Herbert Smith:

“There is an unfortunate mixture of subjective and objective standards in this section. The first part of section 158(1) “A director of a company must act in the way he considers, in good faith...” is a subjective test as is the case under the current common law, whereas the test set out in the remainder of section 158(1) “...and in doing so have regard (amongst other matters)  to...” is an objective test, which would allow a court to find that a director had breached his duty even if acting in good faith. By introducing this objective requirement into directors’ decision making processes, courts may increasingly be asked to intervene on issues currently treated as matters for directors’ judgement.”

I think that they make an important point.

The law firm, Linklaters, has raised concerns also about the use of the word “success” in the clause. Does it differ from the term “best interests of the company”? There is no case law on the matter. The report that Linklaters has provided covers all the duties of directors, and I feel that hon. Members need to listen to what the legal professionals have to say. The Linklaters report of February this year states:

“Almost since the beginning of the law of companies, it has been clear that directors had a duty to act in the best interests of their company as a whole. Over time, this duty has been developed and expanded, but always in court, never in a way accessible to the thousands of directors who run small private companies.

Following one of the key recommendations of the Company Law Review, the Bill seeks to take the current state of the common law on directors’ duties and put it in statutory form, with the intention of making these duties clearer and more accessible... However, effective codification of such a complex area of law is not easily achieved. In particular... it risks creating a more rigid and restrictive regime, compared with the ability of case law to apply and develop established principles in a way that distinguishes between different situations and circumstances... the Bill uses new wording to describe the existing duties, and it is not clear whether the courts will be able to interpret the new wording in the same way as the old principles that it replaces. Thus codification creates areas of uncertainty... the statement of duties does not cover all of the duties a director may owe to a company, for example the duty to consider the interests of creditors in times of threatened insolvency. To that extent, the objective of making the law more accessible to directors is not achieved, since it will still be necessary to refer to other statutory or common law duties apart from those set out in the Bill.”

The report goes on:

“The statutory statement of directors’ duties is intended in general to be based on, and not to alter but to replace, common law... Yet, somewhat paradoxically, the Bill provides that ‘regard shall be had to the corresponding common law rules and equitable principles in interpreting and applying the general duties.’... Thus, it will be necessary to refer to the existing historic body of case law to understand the new provisions. Quite how this is supposed to work where the statutory codification and common law/equitable rules and principles do not ‘correspond’ is inevitably a matter of uncertainty.”

It continues, but the point has been made.

There are concerns about the pluralist agenda, an issue that is important to many hon. Members. We are concerned that as drafted, and certainly as proposed in amendment No. 300, the clause would allow company law to become the arena for a number of interest groups to further their causes at the expense of the best interests of a company.

Corporate social responsibility is now taken more or less seriously by all the larger companies based in this country, and it is generally agreed that it is only good business sense for them to do so. The Conservative party has shown how highly it values corporate responsibility. We support social responsibility in companies and believe that companies, in preference to the state, can be a positive driver of environmental and social change. In fact, we in the Conservative party have placed increased corporate responsibility at the top of our agenda.

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

If the hon. Gentleman is sincere in what he has just said, which I do not doubt, why does he oppose any mention of it in the clause?

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

I hate to bring this to the Minister’s attention, but there is no mention of corporate social responsibility in the clause. I am addressing the implication of the clause for that matter.

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

That is not a fair response, because the elements that the hon. Gentleman has just criticised—[Interruption.] I do not know how he defines corporate responsibility; perhaps he will tell me. The elements that he has just criticised—subsection (1)(a) to (f)—are crucial to any understanding of a corporate responsibility agenda. The long-term consequences of decisions; the need to foster relationships with suppliers, customers and others; the impact of a company’s operations on the community and the environment; and the desirability of maintaining high standards of business conduct are elements of a corporate responsibility agenda. If he has a different understanding, I do not think that anybody, except perhaps members of his party, shares it.

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

In themselves, those are elements of corporate responsibility, but I have just spent some time explaining their legal context. The Minister is asking me to develop my point and I hope that she will allow me to do so.

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

In the interests of having a fair debate, I say that the hon. Gentleman has now conceded that the elements listed in the clause are those that he understands make up our common understanding of corporate social responsibility.

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

That was what the hon. Gentleman said when I read out the list. I shall read it out again if he so wishes. He said that those were the elements that he understood. I then asked him a question: if those are the elements that help to constitute an understanding of corporate social responsibility, which he claims he and his party support, why does he oppose their inclusion in the clause?

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

The Minister must not have been listening to what I have been saying for the past hour. In themselves, those are elements of corporate social responsibility.

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

There are many other elements of corporate social responsibility that are not mentioned in these measures. I have explained how that in itself will induce confusion. If the Minister will allow me, I shall develop this point because it will be of interest to her, and I shall be interested to hear how she can reply to me in the round.

The Conservative party aims to be what my right hon. Friend the Member for Witney (Mr. Cameron) called “a critical friend” to big business. In a strong speech to Business in the Community on 9 May, the leader of the Conservative party set out our attitude to business and corporate social responsibility. However, we are also arguing that the Bill is not the place in which to legislate, placing unnecessary general mandatory burdens on the directors of all UK companies. Such measures will not just lead to uncertainty and the fear of litigation; they will set back the agenda that this party supports.

Corporate social responsibility is very important, but there are a number of reasons to be wary of non-specific mandatory obligations.

Photo of Louise Ellman Louise Ellman Labour, Liverpool, Riverside

If the hon. Gentleman is as concerned about business social responsibility as he claims, and he does not wish it to be included or defined in the Bill, where would he like it to be defined?

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

The hon. Lady pre-empts what I am about to say. What are we talking about? What is of concern to most campaigners? We are talking about the type of campaigner who has written cards asking for a more pluralist approach to the Bill. I want to spend a little time identifying some of the larger campaigns, many of which are undertaken by pressure groups that have been lobbying the Government and the Opposition for some time to include mandatory and sometimes almost punitive obligations in the directors’ duties in the Bill.

I shall give a few examples of those campaigns: the campaign against NestlÃ(c); the Greenpeace campaigns against Cargill, Kentucky Fried Chicken, and McDonald’s; the campaigns against Asia Pulp and Paper, Asia Pacific Resources International Holdings Ltd, ExxonMobil, Bayer and Lafarge, which wanted to turn the mountains of South Harris into aggregates for road building; and the campaigns against Alstom. I think that hon. Members get the picture. Those are some of the largest campaigns that have been doing the rounds in recent times.

As hon. Members are aware, there are many campaigns to improve environmental and social conditions around the world—the list that I have given only scratches the surface. From the pluralist viewpoint, there is a problem with all this: not one of the companies that I mentioned will be affected by the Bill. Why? Because every single one is not a UK company, and only UK companies are affected by the Bill.

I shall be frank. We can make our company law regime as rigid as we want, but it will not matter a jot to those foreign companies and will therefore not go an inch in helping to further any of those campaigns. Most major multinational companies that are UK listed, such as BP, already take CSR very seriously and spend considerable time and money on it.

The clause ignores the fact that many publicly listed companies sell themselves on their CSR reputation, BP being a prime example. More and more shareholders are realising that they can exert a positive influence on the companies that they ultimately control. The rise in green and ethical investment funds operated by most of  the major fund managers has made them clearly aware of that. It is now simply bad business for a major plc to ignore CSR, as the following statement from an article in the Financial Times of 21 April makes clear:

“Corporate governance is becoming increasingly important to European investors, according to a new survey.

Jean-Nicolas Caprasse, managing director of Institutional Shareholder Services Europe, the proxy voting service, said: ‘Although to date, continental European investors have lagged behind their counterparts in North America and the UK in terms of the priority they place on corporate governance, this study shows that attitudes are clearly changing.’”

The article goes on to show how things are changing in Europe, as well as in the United Kingdom.

Of the rest of the companies that will be affected by the Bill, the vast majority—probably more than 90 per cent.—are small and medium sized. Such companies, which are rarely the target of environmental or social campaigning, have enough troubles as it is, without being asked to jump through a series of new statutory hoops.

The problem is that the Bill deals with UK companies and does not provide the framework to deal with the issues on which most people have campaigned. It treats the English corner shop in the same way as the British multinational, and it is the wrong place to deal with the issues before us, important as they may be. We have therefore tabled amendment No. 40, which notes that the duties should be

“appropriate for the size of the company”, and amendment No. 40, which would exclude small and medium-sized companies from the provisions.

It is worth considering that if CSR is made statutory, as some hon. Members wish, UK companies would be less able to compete in the global marketplace. Increasingly, we are seeing the emergence of powerful multinational companies, which are becoming direct competitors to UK companies. India’s Tata bought Tetley, Hong Kong’s Cheung Kong Infrastructure Holdings Ltd. is a potential bidder for Thames Water, and the only potential saviour following the Government’s fiasco over Rover was a Chinese company.

The Corporate Responsibility Coalition has taken an active interest in the Bill, because it regards company law as the correct vehicle to deal with the wide range of issues that its umbrella group encompasses. Those groups are important stakeholders, and I was pleased to meet them to discuss the Bill. It is right that I should put forward their views. They say:

CORE and the Trade Justice Movement recognise that many UK companies take their environmental and social responsibilities seriously and play an important role both here and abroad though job creation, innovation and technological development. However, as the above examples demonstrate”—

CORE had given a lot of examples—

“left to their own devices some companies seek to minimise their costs and maximise their profits by taking shortcuts on health and safety and environmental protection and failing to respect the basic rights of their workers and the local communities affected by their operations.

UK company law is the only framework that sets the overarching terms of reference for UK companies, including the role and priorities of company directors. Following the  longstanding campaigning of our members to expose and rectify examples of corporate abuse, we no longer believe that the current legal framework is adequate to prevent irresponsible behaviour by UK companies. Legal measures are needed to set basic minimum obligations for directors and their companies in relation to their environmental and social impacts so as to ensure that UK business makes a positive contribution to the major global challenges we face this century, including global poverty and social injustice, unsustainable development, and climate change.”

The examples of India and China show that as we move into an increasingly international marketplace, we will have to compete with companies that come from an economic climate in which CSR is not often taken into account, let alone put on the statute books. The Government’s attempts to burden every UK company with a series of extra boxes to tick show that they have no concept of the true nature of the global marketplace. As Indian and Chinese companies reach around the world and the economies of those countries grow, should we really be tilting the playing field in their favour by making our company directors adhere to these extra regulations? If we are not careful, even more of our entrepreneurs will pick up sticks and reopen in China. That is happening now—it is not me speculating.

The UK should be the world leader in promoting good corporate responsibility in companies. Where we lead, other companies will follow. However, the answer to the question of how to lead the way on CSR is not to impose a heavy regulatory burden on our companies, but to encourage investors to take into account a company’s record on CSR and to encourage all the companies in the UK to understand that being socially responsible is in their best interests. I have no doubt that CSR will be moved ahead by market forces. Consumers voting with their feet will always be a more effective way than regulation of getting companies to take up their CSR responsibilities.

It is also important to consider just how damaging an over-regulated company environment can be. The strict regulatory environment that now prevails in the United States has led the US Chamber of Commerce to warn that the US could lose its leading position in global capital markets. Our companies are steadily falling from their position as the most competitive in the world and to rest on our past laurels would be fatal. At a time when our competitors, including those in Europe, are waking up to the dangers of over-regulation, we should not go down the regulation route ourselves. Over recent years there has been a plethora of often individually small changes that have heightened the regulatory environment for directors in the UK.

One impact has been the switch of companies from the London stock exchange to the alternative investment market exchange. There has also been a significant increase in moves to company de-listings and venture capital and management buy-outs. As company directors and investors have become increasingly wary of the additional regulations and structures imposed on listed companies, to impose even more costs and burdens on UK company directors would do nothing to further the course of UK plc. In fact, by imposing further burdens on UK company directors there are fears that the right people will be discouraged from becoming company directors in the UK.

Particular concerns have also been expressed about directors of smaller companies who will bear the brunt of further regulation. The Government have said that one of the Bill’s aims is to help smaller companies. This is one example of that aim being completely off target. I shall read from a letter to the editor of the Financial Times, dated 6 January. It says:

“The impact will fall unduly on the smaller sector. Also the likely consequence of 158...is that there will be an increase in the length of minutes and to a large extent those minutes will develop a standard format. The effect will be a waste of resources, including cost for no real benefit to UK plc. Even if the government does not accept it is wrong for company law to be used to regulate the environment—that should be left to environmental legislation—it ought to accept that the wording of the code needs to make it clear that the factors in 158...are subservient to the prime duty of a director to promote the success (or interests) of the company”.

There is no doubt in my mind that increased corporate regulation will do nothing but hinder our economy. When all is said and done I tend to agree with James Palmer, a partner at Herbert Smith, who chairs the City of London Law Society’s law sub-committee, and who is reported as saying on 30 March that this is one area of company law where,

“we actually we didn’t need much change”.

Photo of Patrick Hall Patrick Hall Labour, Bedford 11:30 am, 11th July 2006

I shall speak to amendment No. 300 and new clause 27 in the name of my hon. Friend the Member for Newcastle upon Tyne, Central (Jim Cousins), who for health reasons is no longer a member of the Committee. I have also signed the two submissions.

I would like to make it clear that I welcome the recognition in this first ever statutory statement of directors’ duties that, in fulfilling their primary duty to promote the success of the company for the benefit of its members, directors must have regard to a number of factors, including the interests of the company’s employees and the impact of the company’s operations on the community and the environment. Having said that, I share the concerns expressed by some commentators, such as the Corporate Responsibility Coalition—CORE—and the Trade Justice Movement that, contrary to what we have heard from the hon. Member for Huntingdon, the Bill does not go far enough in addressing the issue of corporate accountability.

As currently drafted, clause 158, welcome though it is, is unlikely to lead to a sufficient improvement in the social and environmental performances of UK companies as a whole. It may be worth mentioning that the two coalitions to which I have referred include all the major UK environmental development and human rights organisations as well as a number of trade unions, businesses and faith-based groups. In total they represent more than 100 organisations and approximately 9 million members.

The key argument is that all UK businesses should become more accountable for their wider impacts on communities and the environment, and the Bill represents a real opportunity to advance the same through the provisions on social and environmental reporting and on directors duties. I am not asking for something new; the best companies do that already. It is an important part of how business operates throughout the world and in this country.

Businesses take their social and environmental responsibilities seriously. British business is more often than not a force for good, as the hon. Gentleman said. It creates jobs here and overseas, and it is responsible for innovation and technological advance. My argument is pro-business. It looks for a high-standard level playing field where the good are not undermined by the bad. There are many examples of bad practice at home and overseas, although I shall not go into detail as they were mentioned on Second Reading in the House and in the other place.

Part of today’s debate involves the consideration of directors duties that took place in the company law review, which reported to the Government exactly five years ago. It considered a number of approaches, including the so-called pluralist approach to directors duties. Such an approach would require directors to balance shareholder interests with those of a company’s other stakeholders, such as employees, consumers and the wider community in which the company operated, including overseas.

The Government have rejected that pluralist approach in favour of an alternative, which has already been mentioned, known as enlightened shareholder value. Many see it as integral to the idea of corporate social responsibility, so I was confused when the hon. Member for Huntingdon seemingly rejected it while espousing corporate social responsibility. The clause articulates enlightened shareholder value. It clearly means that the promotion of shareholder interest remains the central priority for company directors, and it relegates other considerations, valuable though they are, to secondary status.

I acknowledge that the introduction of a pluralist approach to directors duties would be radical and one which, in light of the Government’s position on the company law review, we could not reasonably have supported or achieved in the Bill. However, I also share concerns that enlightened shareholder value relies excessively on the voluntary approach—voluntary action by companies to improve their impact on wider stakeholders and the environment. Many volunteer, and they do that well while being profitable. Some argue that if a company embraces a wider set of interests, it is more likely to succeed. Others do not.

The voluntary approach is considered inefficient in dealing with some of the worst examples of corporate social and environmental abuse throughout the world, and its weaknesses have been highlighted in several reports from leading international organisations, including the Organisation for Economic Co-operation and Development and the World Bank. Amendment No. 300 would respond to those concerns by strengthening the clause so that directors, in fulfilling their primary duty to promote the success of the company for the benefit of its members, were required not to have regard to the interests of and impacts on the company’s wider stakeholders and the environment, but to have a positive duty in relation to them. In short, directors would be required not to have regard to the factors in subsection (1)(a) to (f), but to endeavour to act on each of them.

Photo of Patrick Hall Patrick Hall Labour, Bedford

The duties would be owed primarily to the shareholders and members of the company who would be able to raise the issues. The company would be asked to look beyond the sole prime duty of maximising profit, which good companies do, and would send a message to the wider public and society in which it operates.

Amendment No. 300 seeks to ask shareholders, in fulfilling the company’s primary duty to maximise profit, to require directors actively to take steps to minimise any adverse impact on communities and the environment. Similarly, directors would be required actively to promote the interests of their employees rather than simply having to have regard to them.

A similar amendment was tabled by a cross-party group of Lords in the other place and the Attorney-General, Lord Goldsmith, expressed concern that that would point directors in two directions at once. That is certainly not the intention of amendment No. 300. The duty that the amendment would introduce would sit within the framework of enlightened shareholder value and the primary duty of directors would still be to promote the success of the company for the benefit of its members. The proposed positive duty would be secondary to that. It is important to stress that, because there seems to be a great deal of confusion and fog around these matters, which are important to us and people throughout the world.

If there were conflict between the primary duty to promote the success of the company and the positive duty to the company’s wider stakeholders, the duty to shareholders would take precedence. The difference between the requirement to have regard to the interests of and the impact on the company’s wider stakeholders—that is what the clause requires—and the requirement in amendment No. 300 for directors to endeavour to act positively in relation to those factors is important, but it is one of emphasis, with the latter requirement being more likely to lead to real improvements in corporate, social and environmental performance. I do not believe that that would be a burden—some companies are already doing that or considering moving more in that direction—and I do not believe that directors would find that too much of a difficulty to take on board and to seek to put into practice.

A requirement that directors have regard to a range of other factors while fulfilling their primary duty provides no obligation for directors to act on the information, but the proposed positive duty “to endeavour” to do so would encourage them to be proactive in their consideration of the environmental and social impact of their business.

Photo of James Brokenshire James Brokenshire Conservative, Hornchurch

The hon. Gentleman is making an interesting point about the need to ensure that we protect the environment, although I believe that it could be addressed in a different way. His amendment states that a company should

“minimise any adverse impact of the company’s operations on the community and the environment”.

Would he concede that in certain circumstances that might mean that a company would have to stop trading, full stop? For example, a company involved in waste management and landfill may be carrying out a  valuable service, but it could not say 100 per cent. that it minimised the effect on the environment, so to comply with the amendment it might have to stop trading.

Photo of Patrick Hall Patrick Hall Labour, Bedford

No, I do not see that, because a company trading in that sphere would have to comply with other law and would do so without difficulty. If the directors wanted to raise the game above the minimum standards set by the law in terms of the issues that the hon. Gentleman used as an example, obviously they would do so provided that it did not lead to a loss by the company. The fact that there would be extra pressure on them to raise their game and improve their performance is surely good rather than bad.

Photo of James Brokenshire James Brokenshire Conservative, Hornchurch

The hon. Gentleman makes a valid point about standards coming from other legislation. Does he agree that, practically, that is the most effective way to deal with the issue, rather than relying on the more general and vague language of his amendment? Obviously, the minimising provision in paragraph (d) has to be read separately. Minimising any adverse impact overrides and overarches statutory provisions elsewhere, and it might have the effects that I have already highlighted.

Photo of Patrick Hall Patrick Hall Labour, Bedford

I do not think that it would have that impact. It would focus the board on the need to address those issues, not necessarily only because there is another statute. Of course any responsible company must comply with the law. My proposal would bring the issues more into the ethos of the company and put them firmly on the agenda. Indeed, in order to continue being successful and to become even more successful, it would encourage a company to address such issues better if it could do so.

That is an important signal to give to all companies, not just the sort of company to which the hon. Gentleman referred. I do not think that there is a size issue. Conservative Members have tabled a number of amendments that seek to limit the application of these matters to large companies. Small and medium-sized enterprises can have as many as 250 employees as I understand it. That is a vast percentage of business in this country. Saying that they should be exempt is the wrong signal to send. I am talking about encouraging directors to be proactive.

Photo of Louise Ellman Louise Ellman Labour, Liverpool, Riverside

Does my hon. Friend accept that his proposals would give a stronger focus to issues of corporate social responsibility which would be entirely compatible with the more general measures recommended by the hon. Members for Hornchurch (James Brokenshire) and for Huntingdon? If their measures went forward on their own without any focus in company legislation, the impact of corporate responsibility would be diminished.

Photo of Patrick Hall Patrick Hall Labour, Bedford

There is a contradiction in the position that has been taken by the Conservative party on this issue. It is important to recall that at the recent local elections your party, Mr. Bercow, went to the country on the ticket, “Go Green, Vote Blue”. Some of the confusions about the green element of that have been  revealed in Committee today. We are all talking much the same language—we are using phrases such as “corporate social responsibility” and I am pleased that there is all-party consensus about that, but we must not leave it entirely to chance and allow individuals to say, “OK, we’ll do a little bit more about this, that and the other.” There is nothing wrong with trying to set a fair, achievable, level playing field, which is pro-business, rather than rewarding those who cannot be bothered to raise their game and leaving it just to the market for those who are more responsible in that regard.

Photo of Shailesh Vara Shailesh Vara Conservative, North West Cambridgeshire

I understand where the hon. Gentleman is coming from but does he not feel that there needs to be some specific guidelines as to what is meant by, for example,

“the impact of the company’s operations on the community and the environment” in subsection (1)(d)? They are such broad terms and so general that there will be the potential for litigation. The perception of what is in the best interests of the community and the environment can differ from one individual to another.

Photo of Patrick Hall Patrick Hall Labour, Bedford

I will come to new clause 27 shortly. It addresses the guidance and its status in terms of interpreting such words. As far as litigation is concerned, nothing in the Bill or in any of the amendments with which I am associated makes any difference to the current situation. We are trying to encourage the raising of standards and a voluntary focused requirement to examine issues in the operation of companies other than just maximising profit. We want directors to be proactive and to seek to mitigate or remove adverse social and environment effects.

The term “having regard to” will create a subjective test, based on the personal judgment of a director. The proposed wording in amendment No. 300, “must endeavour to”, would lead to an objective test. There would need to be evidence of directors seeking to carry out the additional duties, even if they were unable to. Such duties are now on the agenda, either on a voluntary basis under the clause as drafted or in a slightly stronger way as proposed in amendment No. 300.

The amendment would make no difference to the way in which a director’s duties are enforced and, as I have said, it would not lead to an increased risk of litigation. It is intended to provide a stronger signpost for directors on the type of behaviour that is likely to lead to success for their companies in the long term, and to provide protection for directors who act responsibly and seek to raise the standard of their companies’ performance by broadening what they do. That would protect them from shareholders who say, “Well, the only thing you’re here for is to maximise profit.” That is another matter of long-term interests and responsible behaviour.

The stronger emphasis on action that amendment No. 300 would deliver would encourage a more active approach by directors to the social and environmental impact of their businesses. It would therefore be more likely to lead to real improvements in the social and  environmental performance of poorly performing companies and create a more level playing field so that the many UK companies that take seriously their social and environmental duties are less likely to be undercut by less scrupulous competitors.

To ensure that there is no confusion on what the clause requires of directors, new clause 27 would introduce a requirement of the Secretary of State for Trade and Industry to publish statutory mandatory guidance on how the duties in clause 158 should be interpreted. That guidance would help directors to understand in practical terms what the enhanced duties will mean for them, and it could be updated freely and easily.

A similar proposal was tabled in the other place, in response to which the Attorney-General committed the Government to publishing non-statutory guidance on the statutory statement of directors’ general duties in clause 158 and to consulting relevant parties. I look forward to confirmation from my right hon. Friend the Minister that that is still the position. I welcome that commitment, but the benefits of amendment No. 300 in corporate social and environmental performance would be likely to be maximised if there were a stronger incentive for directors to comply with guidance; that is, if it were statutory, mandatory guidance. In the face of statutory guidance, compliance indicates compliance with the law, but if the guidance is voluntary and non-statutory, directors will be able to pick and choose whether to comply. Mandatory guidance is therefore more likely to lead to the responsible corporate behaviour and long-term business success that we all hope for.

Finally, I know that my right hon. Friend the Minister takes a close personal interest in the matter and that she has had a lot of discussions with a number of people including, briefly, myself. I also know from our discussion last week when she, I and a small band of others voted on the title of the Bill in clause 923, that she is one of a small number of true reformers in the Committee. That being so, although we lost the vote on that occasion, we can put it right today with her assistance. I look forward to the comfort that she will give to a fellow reformer when she comes to make helpful remarks in response to the debate.

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry 12:00 pm, 11th July 2006

The proposals are of great importance, but I fear that I will deliver a somewhat hard-nosed legal speech. A lawyer once told me that the main thing that someone has to remember if they are told that there is a risk of litigation is to ask two questions. The first is: who is the plaintiff? The second is: what is the loss? If there is no plausible plaintiff and there is no loss, there is no risk of litigation, so do not worry.

We need to be clear about who will be suing for what. We must go back to clause 156 to see the fundamental liability regime that we are dealing with. It has established that the duties concerned are duties “to the company”. The duties are not to the shareholders. It is a common misapprehension that shareholders are the same as the company. They are not. The company is a structure of rules that allows certain people in certain circumstances to make decisions about the assets that  the company holds. The company is, in effect, a bank account and a set of rules that establish who can take money out of that bank account in what circumstances.

A key point to remember about companies is that usually the directors are in control of the company, and they represent the company for the most part in company law. Article 70 of table A in the Companies (Tables A to F) Regulations 1985 states:

“the business of the company shall be managed by the directors who may exercise all the powers of the company”.

The belief that the company is somehow the shareholders goes back to the 19th century, but it has not been true in practice for a long time.

However, sometimes the shareholders are in charge. Article 70 allows a supermajority of shareholders—75 per cent., by special resolution—to give directions to the board. We are not talking about a mere majority, although an ordinary majority can remove a director at any time, and we just reaffirmed that principle in clause 154. Some other actions require votes by the shareholders as opposed to votes by the board of directors, and when we reach chapter 4 of this part we will see a few examples of those.

Majority shareholders are therefore in a powerful position, but they are not the same as the company itself. When the company becomes insolvent, for example, the creditors take control through the administrator or liquidator. What matters for the purposes of the discussion we are having on clause 158 is who can speak on behalf of the company in the relevant circumstances and who can sue on its behalf. That is what determines what counts as “the company” for the purposes of the clause, and that is who is the plaintiff.

There are basically four possibilities. The first is the board. For the most part, however, directors owe their duties to the board, because it decides when the company will take legal action against anybody. The second possibility is that in some unusual circumstances shareholders can begin legal actions. Almost always a special resolution involving a 75 per cent. supermajority of shareholders can do that, and there are some circumstances in which the majority of shareholders can take legal action on behalf of the company. The second possibility therefore involves the directors and the majority of shareholders, although that will more often be a supermajority than an ordinary majority.

The third possibility is of minority shareholder legal actions. Under existing law, that happens under the very rare exceptions to the rule in Foss v. Harbottle. That is being replaced by statutory derivative action in clause 243 and subsequent clauses, which is fortunate because we will not all have to know the exceptions to the rule in Foss v. Harbottle. If we read those clauses, however, we see that it is not at all easy to get a derivative claim going against the wishes of the majority of shareholders. Clauses 243 and 246 in particular make it clear that the likelihood of ratification by the shareholders, particularly independent shareholders who are not involved in the dispute, is a key factor in determining whether a derivative action should continue. If we want to know what ratification is, we go to clause 222, which tell us  that it can be done by a majority of shareholders. It turns out, therefore, that minority shareholder action will be very rare. In a sense, it is just a minor variation on the second option, which is action by the majority of shareholders. It will come into use when the majority is a majority only because of the votes of a particular shareholder, who will be the person whose actions are in dispute. In those rather rare circumstances, the derivative action might come into use in court.

The fourth option, which will be by far the most important in practice, involves the liquidators who act on behalf of an insolvent company. When a company goes broke, as the hon. Member for Huntingdon said, the creditors take over, and their representative collects all the money that is owing to the company, which might include suing past directors for breaches of their duty.

How likely are such legal actions to take place in reality? As the hon. Gentleman mentioned, it is only during a takeover that there is any prospect at all of the board of directors or the majority shareholders using the clauses to bring legal action against a director. That is because, in the ordinary course of business, they have far better remedies than suing under those clauses. They can remove the director at any time under clause 154, for example, and the threat of dismissal is far more effective than the threat of legal action. Aside from takeover cases, therefore, we are really only talking about the threat of legal action by the liquidator.

We now come to the important point that I tried to raise in interventions on the hon. Gentleman. We have established that some people, such as the liquidators or the new board after a takeover, might occasionally be in a position to sue. The question, however, is what the loss is. It must arise from the breach—otherwise, there is nothing to sue over—but it is difficult to imagine a breach purely of clause 158 by a director giving rise to a loss to the company, and we should remember that the loss must to the company, not to anyone else. That is why the hon. Member for Bedford (Patrick Hall) was right to say that the clause is about enlightened shareholder value, not pluralism. A pluralistic approach would allow other people to sue on the basis of losses to them. Here, however, it is only losses to the company that count.

One can imagine circumstances in which the company might incur losses because it had neglected environmental legislation, been subject to a massive fine and gone into liquidation. However, clause 158 does not seem to add to that risk because it would be an action under clause 160 “Duty to exercise reasonable care, skill and diligence”. So I cannot see clause 158 adding to the risk of litigation.

Photo of Shailesh Vara Shailesh Vara Conservative, North West Cambridgeshire

I would welcome the hon. Gentleman’s comments on clause 158(1)(a), which states:

“the likely consequences of any decision in the long term”.

As I read it, that will have an impact on a loss. Decisions can be taken in any manner; it is a broad spectrum. If a board of directors takes decisions that prove to be commercially wrong in the long term, will that paragraph not provide room for them to be sued?

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

I am not sure that that is the case because the clause also reads:

“in the way he considers, in good faith”.

All the duties are then expressed in that way. In any case, presumably, that would be subject to the standards in clause 160. I cannot understand how that adds anything extra to the problem that directors will have anyway under clause 160 when making decisions that turn out to be bad. Usually, in those circumstances, the law helps directors. It treats them as reasonable people and asks, “Did they act reasonably?”, not, “Did they act perfectly?”

I come to the real effect of the clause. This is a slightly paradoxical argument, but it seems that the clause is deregulatory and will protect directors. We must go back to section 309 of the Companies Act 1985. It allows directors to have regard to the interests of employees. The cases that arise under that section are not about directors who fail to have regard to the interests of employees, but rather the opposite—cases in which the director does have regard to their interests, but the successful takeover bidder objects to that because it results in the company losing money.

Let us take a well known example: the decision of Mr. Justice Hoffmann, as he then was, in the re Welfab Engineers Ltd case, in which the liquidator alleged that, faced with the prospect of insolvency, the directors wrongly sold the business for less than the maximum amount that it might have fetched at auction. The directors did that because they thought that the highest bidder wanted only the company’s property and would asset strip the business. They preferred the second bidder who promised to carry on the company’s business and preserve employees’ jobs. The liquidator claimed that that decision caused a loss to the company.

The court—Mr. Justice Hoffmann—agreed with the directors on the grounds that section 309 allows directors to have regard to the interests of the employees and therefore that the decision was not illegitimate. That is why the clause is a protective deregulatory clause. In effect, it extends the protection offered by section 309 in those circumstances from simply directors who have regard to the interests of employees to a whole host of other circumstances, including the environment. So a director who has regard to the interests of the environment, but in doing so gives rise to a loss to the company, can say to the liquidator or the successful takeover bidder, “I acted legitimately and you cannot sue me personally in order to recover that loss.”

Photo of James Brokenshire James Brokenshire Conservative, Hornchurch 12:15 pm, 11th July 2006

I have been listening carefully and avidly to the hon. Gentleman’s detailed comments and legal analysis. Does he accept that section 309 said that the company should have regard to the interests of its members and employees, and almost puts them on a level playing field, whereas clause 158 emphasises the regard to the success of the company, and then to certain subservient interests? Does he accept that there is a difference, and that it might lead to different interpretations, such as the one at which Lord Hoffmann arrived in the case to which the hon. Gentleman alluded?

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

I do not think so. I would have to go back to the details of the case, but my memory is that the judge assumed that there was an overriding duty to the members, but thought that the clause allowed some regard to the interests of employees. In effect, that is what clause 158 says. There is no risk in a clause 158 case, if we may call it that, of any variation from the approach that Mr. Justice Hoffmann, as he then was, took in the Welfab case. The approach would be the same, because Parliament’s intention seems to be to create that protection.

The clause is deregulatory. It reduces the amount of legal pressure on directors. This is an empirical matter and a question of how we judge the risks. On one hand, there is the remote risk that breaches of clause 158 would be used as the basis of legal action. I cannot see how that would happen. I suppose that in unusual circumstances it might, but the risk is remote. On the other hand, there is the risk of an action by a liquidator, acting on behalf of creditors whose interests are short-term, against directors who have acted on behalf of employees and the environment for the long term. That is a greater risk and that is why, on balance, the clause is deregulatory.

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

Is the hon. Gentleman suggesting that the irrelevance of the clause means that we should not be bothered about it?

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

Certainly not. It is legitimate for company law to offer directors that protection. The issue comes down to what we think is the purpose of company law. Some people say that it should maximise the value of companies for shareholders. However, shareholder value is only an interest. The question is whether shareholder value maximises aggregate social welfare—whether it is for the good of everyone.

My mentor on such matters, Professor Henry Hansmann of Yale law school, provides an example. He said that corporate law would be very unattractive if it allowed shareholders to gain $1 for every $2 that they took from creditors and employees. It would not maximise aggregate social welfare. The question is whether the provisions help to maximise aggregate social welfare as opposed to mere shareholder value.

The notion of enlightened shareholder value is admittedly a bit of a fudge, but it provides a useful exercise in making company law take account of the interests of society as a whole, not just the short-term interests of creditors and shareholders. I say creditors first, because in practice, in terms of who is suing whom, creditors, not shareholders, sue through the liquidated and insolvent company.

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

Yes, but on behalf of the creditors the duty of the administrators and liquidators is to collect all the money that is owed to the company. Their purpose is to further the interests of creditors, and that is why in reality, we talk about creditors, rather than shareholders, against directors.

I suppose that that analysis means that I have a slightly paradoxical view of some of the amendments.  Amendment No. 40, for example, which deals with small companies, and amendment No. 42, which has a similar effect, would not help directors of small companies. They would do quite the opposite and expose them to more liability than the directors of large companies, because the welfare defence against an action by a liquidator would not be available. Directors of small companies seem to me to be just as entitled as those of large companies to claim the benefit of the clause 158 defence, as I see it, of acting in the interests of the environment, against a liquidator, a takeover bid or, in the case of a small company, a buyer. On the other hand, amendment No. 39 and similar amendments that would make the test more obviously subjective would help directors. They would help them to claim the benefit of the protection of clause 158 more easily. For that reason they are better worth considering.

As to amendment No. 300, which was tabled by the hon. Member for Bedford, I have some basic sympathy with what he said, but it should be clear from what I said about how the rule works in this context that the amendment will not add much one way or the other to the protection offered to directors. I suppose that a duty would make it more obvious to a liquidator that perhaps no attempt should even be made to sue in the circumstances. There might be an advantage in that, as opposed to the formulation “have regard”. There are, however, disadvantages to the precise wording.

One disadvantage is that the amendment seems to set up the possibility of a conflict of duties. It is possible to “have regard” to contradictory things. It is a quite simple mental process to think about one thing, think about another, and reach a conclusion about the balance between the two. However, asking someone to “endeavour to” do two things that point in opposite directions seems to me closer to asking the impossible.

I am worried by one possible example of contradictions between duties in the amendment, and that is a conflict between employees’ interests and those of the environment. Idealistically we might all wish that that was not a problem, and that in all circumstances the interests of employees could be in line with those of the environment. I am afraid that that is not so. There are jobs in environmentally unfriendly sectors of the economy that depend on environmentally unfriendly activities continuing. That sets up a conflict. A conflict of that kind can be resolved using the formulation “have regard”, but it is more difficult to resolve it using the formulation “endeavour to”.

Photo of Patrick Hall Patrick Hall Labour, Bedford

I am not sure that I understand that point. Surely in endeavouring to do one’s best one does just that, in good faith, going as far as possible without disturbing the rest of the balls that one is trying to keep balanced, including the performance of the company and the interests of employees.

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

That is a possible interpretation, but the hon. Gentleman spoke about his amendment being more active. That is where the difficulty comes in; one can do only one thing at a time.

My second doubt is only a small one, and I should be grateful if the hon. Gentleman returned to the matter if  he speaks again. The very fact that the word “endeavour” sets a higher test than the phrase “have regard” might reduce the protection under the clause. There is a risk, although only a slight one, that a court might say, “You have not endeavoured, so you do not get the protection”, whereas perhaps “having regard” might otherwise have meant that the same person would get the protection. Since it is harder to endeavour than to have regard, that might have the paradoxical effect of reducing the protection.

Finally, I would like some assistance, because I am not entirely clear about the purpose of the amendments referring to guidelines and would be grateful for further comment. I have two questions.

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

Quite simply, the concept is that it would be better to remain within the existing common law structure and have non-binding statutory guidelines on how that common law should be applied in practice.

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

The amendments refer not to binding or non-binding or to mandatory or non-mandatory, but to statutory and non-statutory. I am unclear about the meaning of those words. There is a bigger problem with “non-statutory”, because there seems to be an inherent contradiction. Non-statutory guidelines in statute are, by definition, statutory. I do not understand what that is about. The amendments should be about something being binding and mandatory rather than something in a statute. There is a problem there.

To whom are the guidelines addressed? There are two possibilities and the two speeches covered one each. One is that they are addressed to the courts, but they are governmental interpretations of the law. I am not too happy about that, because the Government should address the courts via Parliament and not just issue guidelines now and then about what they think the law should be. That is especially important in company law where there has been a tradition of putting important rules in an Act rather than using secondary legislation. Such guidelines would not even be secondary legislation; it would be tertiary legislation and legislation by circular. If that is the aim, I have a constitutional twinge about whether that is the right way to do it.

On the other hand, the hon. Member for Huntingdon had a slightly different view: that the guidelines would be addressed to company directors and would attempt to describe the existing legal obligations on directors. That seems to be an attempt at cheap legal advice and undercutting the legal profession. That has a great deal of merit, but the important question is whether it would work. Would people read and take notice of it, or would they go back to lawyers when they got into trouble? Would it in the end have much practical effect?

My final point about guidelines is that there is always a temptation to make rules rather than standards—to make specific detailed rules rather than vague standards that are clarified later by courts. Sometimes, that temptation should be given into if it is the right thing to do, especially when it involves events that happen over and again in exactly the same way. In  such cases, it is a cheap and efficient solution to tell people in advance what their rights and obligations are and what the consequences of not following them would be. However, when there is enormous variety, enormous differences in circumstances and almost unimaginable variety of problem cases it is impossible to write such rules and it is a trap for the unwary because it wastes everyone’s time. People attempt to write a few rules but in fact they do not help anyone. Although it is annoying for legislators, in the end the most efficient and effective thing to do in complicated circumstances is to leave decisions for the future to the courts.

My overall conclusion is that clause 158 is a protective and deregulatory provision, which is why I welcome it, and many of the amendments would have unintended effects.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

It is a pleasure to follow the hon. Gentleman. I agree with many of the things that he said, but I disagree with him on two points. One is a point of principle, not an abstract point of theory, and one is a practical point on which I only partially agree with him.

The point of principle is the false and dangerous distinction that the hon. Gentleman tried to make between a company and its shareholders. I am sorry if he taught that to his pupils. He was less than logical in trying to make the entirely spurious distinction between a company’s directors administering it on behalf of shareholders, and the shareholders themselves. Five minutes later he said that when a liquidator or administrator is in charge of a company because its creditors, rather than its shareholders, have taken it over, that distinction does not apply. He ignored the role of the administrator or liquidator and said that it is the creditors who sue. That was illogical and I hope that he reflects on it.

On the hon. Gentleman’s practical point, he is perfectly right that in certain cases clause 158 will protect directors who reach a judgment in good faith and can show the court that they have done so. However, although he did not seem to think it likely, it is very plausible that the reverse situation could arise. Directors could be more likely to be successfully prosecuted as a result of the clause than would otherwise be the case. Take the case of asbestosis, which resulted in the liquidation of a large number of companies, particularly in the United States, including big names such as Babcock & Wilcox and Owens Corning. There have been a lot of class actions against directors in the United States as a result of asbestosis. If a provision such as clause 158 had been in effect at the time, it could have provided a case against a director accused of having neglected health and safety by allowing his employees to work with asbestos. Such a case may not so easily have been made under provisions such as clause 160 alone.

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry 12:30 pm, 11th July 2006

I understand why directors might have such a fear, but I believe that it is unfounded. The  actions against directors would be dealt with under general, court law. The duties set out in the Bill are specifically stated in clause 156 to be duties to a company, which means that the circumstances that were mentioned would not arise.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

Of course they are duties to a company, but the suit made by shareholders would be that the company had lost money or gone into liquidation because a director had failed properly to take into account the interests of employees or the interests of the environment as specified in clause 158(1)(d). That is the countervailing argument.

As I said on Second Reading, I approve of the clause, which is a good piece of law. Like any good law, it will protect those who, in good faith, go about their business and try to do a good job from malicious or vexatious prosecution, but it will open the possibility of legal sanctions when people default on their duties and obligations in a marked way. That is what law should do and what the clause will do.

I greatly admire the enormous amount of work that my hon. Friend the Member for Huntingdon has put into the Bill. It has been extremely impressive and throughout our debates he has made good and pertinent suggestions. It was therefore with great regret that, when we reached clause 158, I found myself parting company with him. He is not on entirely the right rails. He described the duties of directors set out in the clause as “seemingly random and arbitrary.” They seem to me a good distillation of the essential duties of directors. He then lost me completely by saying that in common law there are 650 duties owed by directors to their companies. He argued that it would be much better to leave a situation in which nobody knows which of the 650 duties should be performed. We probably do not know what the 650 duties are—probably no human being could comprehend 650 duties at any one time. If there was no guidance at all on the hierarchy of those duties, the law would have no influence on company directors in the pursuit of their obligations. There would be no certainty about what conclusion the court might come to if it were asked to decide whether a director had performed his duty.

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice), Shadow Solicitor General

My hon. Friend slightly misses my point. I am not saying that any of the duties are not important in themselves. The question I would ask is why choose six as opposed to any of the others.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

It seems to me that the six have been well chosen. As someone who has sat on the board of companies on a number of occasions and does so now, if I were presented with a blank sheet of paper and asked to spend an hour or two setting out what I thought were the essential duties of directors, I would pretty much come up with this list.

I would start off by saying that the fundamental duty of a director is to contribute to the success of the company in the interests of its members and shareholders. A director works for the shareholders and has a fiduciary obligation to them. That is an absolute duty. In conducting that duty, he must have regard to a large number of matters, which could run  to hundreds or even thousands. They cannot all be codified or predicted in advance. The Bill sets out 11 duties, six in this clause and five in the subsequent five clauses. That is a good distillation and good guidance. What is most important is that the clauses establish clarity. That is a prime purpose of good legislation.

As I said perhaps slightly mischievously on Second Reading, there is possibly one profession in this country that does not necessarily have an interest in removing legal uncertainty and creating legal clarity, but we should not be influenced by that any more than we should be influenced by any other special interest group that may lobby us from time to time. We need to maintain a proper degree of scepticism about all the lobbying that we get from different quarters. As it says in clause 159, directors need “to exercise independent judgment”, which is also what we are supposed to do in Committee.

My hon. Friend gave a number of examples of duties that are not mentioned in the Bill. I listened attentively to those with my mind as open as possible to persuasion. However, I was persuaded that my original stance, as set out on Second Reading, was correct. Among the duties he cited, which are not specifically mentioned, are the duty to prepare accurate accounts and the duty not to make secret profits. If accurate accounts are prepared, there obviously cannot be secret profits. The obligation to produce accurate accounts is elsewhere in the Bill. The obligation not to go in for false accounting is a general provision of the law. Anybody, not just a director, but an accountant, a manager, a banker or anyone else who prepares false accounts, is rightly subject to the full sanction of the law.

I hope that I am being helpful to my hon. Friend, but it does not seem to me that the clause should concern itself with the duties that all citizens have. There would be terrible confusion if we started including in the list of 11 the 650 duties of directors, which are duties that apply to all citizens.

My hon. Friend mentioned health and safety and competition law obligations. Those are obligations in statute law and the regulations that have been made within the ambit of statute law. They apply to everybody, not just directors. Equally, duties to comply with undertakings is clearly an obligation that everyone who is a party to an undertaking has. There is nothing special about directors in that case. It does not need to be set out in great detail.

The duty to consider minority shareholders, which my hon. Friend said is important and fundamental, is well covered by subsection (1)(f):

“the need to act fairly as between members of the company.”

That is a good protection against any suggestion that a director should give greater weight to the interests of a majority of shareholders. It is extremely dangerous when directors who are connected to a majority shareholder are tempted to look to the interests of that shareholder rather than to those of the totality and generality of shareholders. Of course, all directors are under an obligation at all times to consider the totality of their shareholders’ interests and to ensure that everybody—even the smallest shareholder—is treated entirely fairly and equally, and it is important that that is in the Bill. However, we should not go down the road  of saying that there should be 650 duties that directors must follow. That would produce anarchy and chaos. There would be a lack of legal certainty and it would not be good law-making. Instead, we should face up to the challenge of seeing whether we can distil directors’ essential duties into one clause, and that has been done rather well on this occasion.

I was also slightly surprised when my hon. Friend said that he wanted non-statutory guidance. Since I have been in the House, I have heard official spokesmen for the Conservative party say over and over again—indeed, I have said it myself as an official spokesman for my party—that any obligations or constraints that we place on the citizen through the law should be made explicit in the relevant Bill, debated explicitly by Parliament and faced up to, so that any citizen who reads that Bill will know exactly what his or her obligations are.

Non-statutory guidance is a very regrettable halfway house. It is not part of the law of the land, and nobody is under a legal obligation to follow it, because, by definition, it is non-statutory. Would a court take it into account in practice? Nobody knows. Once again, there is a great area of legal uncertainty. Perhaps some courts would say, “But Mr. Davies, you should have had regard to the non-statutory guidance.” Other courts might take a much stricter view and say, “We are in the business of enforcing the law of the land, and it is perfectly reasonable for Mr. Davies not to take account of non-statutory guidance. If Parliament had meant it to be part of the law of the land, it would have said so and put it in the Act.” Non-statutory guidance is not a good way of creating obligations on the citizen, and I do not agree that we want it in this case. Indeed, we do not want it all. What we want are clear, general principles that are set out in as unambiguous a way as possible, and that is what we have. Inevitably, the courts will continue with jurisprudence and will add to the common law, but we want to provide the minimum scope for that by giving guidance that is as clear, authoritative and unambiguous as possible.

Finally, my hon. Friend said that conflicts could arise between the different obligations. He mentioned a case in which a firm might need to sack employees to survive, and that is, indeed, sometimes the case. However, his remark led me to reread the clause, and the fundamental duties are quite clear. The director must, “in good faith”, do what is

“most likely to promote the success of the company for the benefit of its members as a whole”— in other words, for the benefit of its shareholders as a whole. He must also have regard to the other considerations. It would therefore be a full defence for the director to say—indeed, this is what I would say as a director—“My job is to maximise the return for the shareholders and shareholder value. Of course, I took into account other considerations and looked at other desirable objectives, such as giving people a job for life, but it was not possible to reconcile those with the obligation to maintain the success of the company. Indeed, the company might have gone down the tubes if I had not fired people, which, regrettably, is what I had to do. Therefore, I did think about the matter and I decided that, on balance, to carry out my duties I had  to take the regrettable decision to make some redundancies.” The Bill provides entirely for that process.

My hon. Friend’s criticism would have been very valid not against the Bill, but against the amendment tabled by the hon. Member for Bedford. As the hon. Member for Cambridge said, the hon. Member for Bedford introduced his amendment very charmingly and lucidly, and I hope that he puts it to a vote because, as he rightly said, a lot of people are riding on it and anxiously hoping that it will become part of the law of the land. If it is put to a vote, however, I hope emphatically that it is defeated, because including it would be a bad move. The amendment would be open to the exact criticism that my hon. Friend the Member for Huntingdon rightly made—that we would have potential conflict and it would be unclear how it would necessarily be resolved.

I take a slightly stronger view than the hon. Member for Cambridge about the language that the hon. Member for Bedford has used and the word “endeavour”. It could normally be interpreted as requiring some effort to be made in a direction. For example, “I endeavour to swim the channel” means not that I thought about it, but that I got into the water and started out. In my case, I would not get very far, but I might at least claim that I had endeavoured after I had done 50 yd, given up and got into the first boat that came along. It would be wrong to impose on directors the obligation to make an effort in directions that might be contradictory. It would be a bad day’s work if we included such a provision in the law of the land.

I am glad that the hon. Member for Bedford spoke to his amendment, because, as we all know, many people outside this House have been expecting us at least to take into account and to have regard to this point of view. We have an obligation to say explicitly why we do not accept the arguments that have been put to us in that context.

My hon. Friend the Member for Huntingdon quoted a lot of letters from law firms—I think that they were letters, although they might have been legal opinions provided by distinguished City law firms. It is important for us always to remember when we are dealing with such things that at least 50 per cent. of legal opinions are by definition wrong. Every point of law that has ever been in dispute has two contradictory sets of legal opinions about it. One says, “My client has a good case” and the other says, “Your client has a very bad case, and my client has a good case.” Some opinions might be worse than wrong; they might be complete rubbish—although they will always be expensive rubbish. A reasonable modicum of scepticism about legal opinions is in order.

Photo of Quentin Davies Quentin Davies Conservative, Grantham and Stamford

I guarantee to my hon. Friend that if I were a very rich man, which I am not, I could procure  an equal number of opinions saying exactly the opposite to the opinions that he has procured. We all know how that game can be played. There is a perfectly understandable interest of a particular profession in selling its services, which is respectable. It is no less respectable than the desire of ice cream manufacturers to sell ice cream. The fact is that the legal profession has an interest in selling its advice. It does not have an interest in clarifying the law or in reducing the scope for jurisprudence and legal uncertainty.

I must emphasise to my hon. Friend that if there are already 650 possible duties of a director, it would be El Dorado for company lawyers. They are probably the pupils of the hon. Member for Cambridge, who I am sure is a kindly tutor and professor who takes an interest in their careers, and no doubt he has some mixed feelings on this subject. I have no interest to declare on this matter, except to say that as a director, as declared in the Resister of Members’ Interests, I do not wish to incur excessive or unreasonable legal costs for my shareholders or excessive insurance premiums for having in future to insure against directors’ liability.

I come now to my amendment No. 297, about which hon. Members will be expecting me to say a few words. I was not going to say much about it, because I do not intend to put it to the vote. I put it forward for discussion, because I hoped it would be helpful. A possible criticism of even the good piece of work in clause 158 might be that some of the duties as set out are not sufficiently closely defined. They could be considered too extensive, giving rise to the kind of legal uncertainty that I want to avoid. That is particularly so in the case of the environment.

In most of the clause, the duties are clear and there is not much scope for difficulties. However, subsection (1)(d) refers to

“the impact of the company’s operations on the community and the environment”.

“Community” is specific and refers to something that one can see or hear—companies making a lot of noise or smells, or blocking the traffic. Local people know about such activities and it is reasonably clear what is meant.

Unfortunately, “environment” is a concept of almost limitless bounds, as we know. Is it conceivable that a director could be accused of not having taken into account the potential impact of a small business in Lincolnshire or Liverpool on the Arctic ice cap? It may be said that some molecules from the company’s emissions had an effect on the Arctic ice cap or contributed to creating windstorms in the Sahara. It opens up an indefinable limit to the definition, which is undesirable.

Therefore, I tabled a probing amendment that would leave out “and the environment” in order to get reactions from members of the Committee and to ensure that people focused on the possibility, but I do not wish to press it further. I would be happy to vote for the clause as it is if it is put to a vote—perhaps it will not be. I acknowledge that it is a good piece of work, and I recognise that there is a certain risk in saying that in my profession in case it all turns out badly and ends in tears. Given the difficult choices before us—choices were presented by the hon. Member for Bedford and by my hon. Friend the Member for  Huntingdon—the clause is the right one to make. Corporate Britain should be able to live with it comfortably for the foreseeable future.

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

We have had a wide-ranging and long debate this morning. I agree very much with the hon. Member for Grantham and Stamford (Mr. Davies). His comments on the clause involved a huge amount of common sense, and I am grateful to him for that.

The purpose of the clause is to introduce certainty and transparency to company law so that directors know what is expected of them when they do their job. In the long gestation—eight years—between the Government’s introducing the company law review and the Committee’s consideration of the clause this morning, the issue of certainty has been uppermost in the minds of many who contributed to the debate.

I pressed the hon. Member for Huntingdon on his concern about provisions, because we set out clearly what we intend—even I as a non-lawyer understand it. The clause states:

“A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole”.

We put two clauses together in another place, so that the provisions would not remain the overriding priority for and purpose of directors, in order to say precisely what the hon. Gentleman feared we were not saying: the range of other factors are secondary to the overriding and overarching purpose of the interests of the company. That is why we had the debate with my hon. Friend the Member for Bedford as to whether there should be competing duties on directors or one overriding duty.

Our other purpose was to introduce the concept of enlightened shareholder value as part of the business of companies, those who work in them and those who have responsibilities to them and to their shareholders. We want to introduce into companies a long-term investment culture. That is the ethos of the clause.

On the one hand, we have been accused of the heavy hand of regulation by the hon. Member for Huntingdon, which he says might kill off companies, and on the other, my hon. Friend the Member for Bedford thinks that we are undertaking too voluntary an approach and destroying our environment. In the middle, the hon. Member for Cambridge, to whom I always enjoy listening, is telling me that I am deregulating, when I thought that I was regulating. I am grateful to him for that contribution and for the fact that he believes, as I do, that clause 158 begins to encapsulate the societal impact and benefit of companies’ endeavours in order to ensure that their narrow concerns protect also the wider ones.

Photo of James Brokenshire James Brokenshire Conservative, Hornchurch

I am finding the Minister’s comments interesting and, in some ways, quite helpful, but I wonder whether she could deal with the apparent dichotomy in her comments. She says that the clause seeks to codify and bring together existing common law duties, but suggests at the same time that  something new is being added. That confusion is the cause of some of the issues raised in this morning’s debate.

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

The clause does not codify all the common law duties, as pointed out by the hon. Member for Huntingdon in his long contribution on the 650 or so directors’ duties—I did not realise that we had got to 650. The clause does codify and bring into law for the first time duties around corporate social responsibility. I do not run away from that; it is a deliberate act by the Government.

That is at the heart of the Bill. For me, one of the key issues is how we marry the commercial success of individual companies and the resulting benefits to, and growth and prosperity of, the economy, with sustainability and social justice. Again, for me, that is a good example of what lies at the core of what this Labour Government are about: trying to see those two issues as part of a single whole and, despite uncomfortable tensions, trying to integrate them as consistent principles, rather than allow them to be competing ambitions with no commonality.

Photo of James Brokenshire James Brokenshire Conservative, Hornchurch

What the Minister has said is interesting. I think that she is making it clear that actually that is codification and that effectively the principle of enlightened shareholder value, which was talked about separately, is in essence the codification of statutory duties, rather than the introduction of brand new or extended provisions. Effectively, we are bringing together those issues and showing that they are relevant.

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

Well, perhaps we agree; I pause to see whether that is the case.

I also wanted to say was that, for me, the best businesses already do what the legislation provides for—I think that a number of Members have said that. It will bring the behaviour of all businesses up to the behaviour of the best. Our view—I think that it is shared across parties, and certainly by individual Members—is that businesses do best when they can operate on a clear, well defined and level playing field and when they are not placed at a commercial disadvantage by doing the right thing and promoting corporate social responsibility objectives. Again, that is the purpose of the provisions.

I have to say to Opposition Members that that matter was discussed at length in the House of Lords, and amendments were passed to clarify the primary responsibilities of directors and the clause in a whole range of ways. I shall go into the detail so that we are all clear: at the end of that very long debate, the Opposition said that clause 158, as amended, is the right way forward.

It being One o’clock, The Chairmanadjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at half-past Four o’clock.