Clause 216

Company Law Reform Bill [Lords] – in a Public Bill Committee at 7:15 pm on 11th July 2006.

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Provisions protecting directors from liability

Photo of Mike O'Brien Mike O'Brien Solicitor General, Law Officers' Department

I beg to move amendmentNo. 302, in clause 216, page 98, line 32, at end insert—

‘( ) section (qualifying pension scheme indemnity provision) (qualifying pension scheme indemnity provision).’.

Photo of John Bercow John Bercow Conservative, Buckingham

With this it will be convenient to discuss the following: amendment No. 206, in clause 216, page 98, line 36, at end add—

‘(5) This section does not apply to a provision made by a company (“Company A”) in respect of a director of an associated company of Company A—

(a) if the associated company is a wholly owned subsidiary of Company A, or

(b) to the extent that the associated company is acting or, otherwise than in bad faith, purporting to act as a trustee of an occupational pension scheme.’.

Government amendments Nos. 303 to 309.

Government new clause 29—Qualifying pension scheme indemnity provision.

Government amendment No. 310.

Photo of Mike O'Brien Mike O'Brien Solicitor General, Law Officers' Department

I shall begin by declaring an interest in respect of the clause. My wife is a trustee of Logica CMG pension fund.

The amendments concern the indemnification ofa director of a company acting as a trustee of an occupational pension scheme. They deal with worries that were raised in another place. It was said that such directors perform a vital role, often for little direct financial reward, and that directors’ and officers’ liability insurance policies currently available afford limited protection. We made it clear in another place that the Government attach importance to the work of such directors and that we were aware that it can sometimes be difficult to recruit high-quality directors for companies acting as trustees of occupational pension schemes. In view of that, and following consultation with key stakeholders, we agreed in principle to table amendments that would permit companies to indemnify the directors of associated companies acting as trustees of occupational pension schemes. That is what the Government amendments would provide.

Amendment No. 206 has two elements. I hopethat one of them, the indemnification of directors of associated companies acting as trustees of occupational pension schemes, has been dealt with by the Government’s amendments. The other element would allow a company to indemnify the directors of its wholly owned subsidiaries. We cannot accept that. The Companies (Audit, Investigations and Community Enterprise) Act 2004 closed what was an important loophole concerning the indemnification of directors by third parties.

It used to be the practice in some groups of companies for one group to indemnify a director of another company in the same group. We do not believe that that is acceptable as a matter of principle. If one company in the group were not permitted to provide indemnification, it would not be right to permit another group to do so. That is most certainly the case when a subsidiary company is used as a vehicle for indemnifying the director of a parent company,but we also believe that there would be scope for potential mischief if we permitted a parent companyto indemnify the directors of its wholly owned subsidiaries.

It is important to bear it in mind that all companies are now permitted to indemnify directors against most third-party liabilities. That is an important reform and it is difficult in light of it to see why the hon. Gentleman tabled such an amendment. Indeed, I hope that he will not press it to a Division. A parent company wishing to take action against the director of a wholly owned subsidiary will have a number of options at its disposal, possibly including the director’s dismissal. There seems to be little to be gained by the amendment to offset the potential for mischief. We therefore cannot accept amendment No. 206, but I commend the Government amendments and new clause to the Committee.

Photo of Jonathan Djanogly Jonathan Djanogly Shadow Minister (Business, Innovation and Skills), Shadow Solicitor General, Shadow Minister (Justice) 7:30 pm, 11th July 2006

We have no principled problem with the Government amendments, although we will want to have a good look at them over the summer. This is a complicated area of law and it is not easy to examine the issues arising from clauses 216 and 222 in isolation, so to discuss the amendments I shall first set out the  overall picture as it stands following the recent changes brought into force by the Companies (Audit, Investigations and Community Enterprise) Act 2004, and what changes these new provisions are designed to introduce.

Clause 235 defines what is meant by a person being connected with a director. For the purposes of the clause, that may include fellow directors. If the ratification decision is taken by way of a written resolution, the director and his connected persons may not take part in the written resolution procedure. That means that the company need not send them a copy of the written resolution and they are not counted when determining the number of votes required for the written resolution to be passed. If the ratification decision is taken at a meeting, those members whose votes are to be disregarded may still attend the meeting, take part in the meeting and count towards the quorum for the meeting if their membership gives them the right to do so.

Clause 222(6) makes it clear that nothing in the clause changes the law on unanimous consent, so the restrictions imposed by the clause as to who may vote on a ratification resolution will not apply when every member votes, informally or otherwise, in favour of the resolution. Subsection (6) also makes it clear that nothing in the clause removes any powers that the directors may have to manage the affairs of the company. Subsection (7) explains that the requirements imposed by the clause are in addition to any other limitations or restrictions imposed by the law as to what may or may not be ratified and when.

In light of the changes, companies will probably want to consider entering into individual indemnity agreements with directors and to check their articles of association. Most companies have indemnity provisions in favour of the company’s directors in their articles of association. However, although the articles in effect form a binding commitment between the company and its members, a director is not a party to that arrangement and may not therefore be able to enforce directly an indemnity in his favour.

In Globalink Telecommunications Ltd v. Wilmbury Ltd, it was held that a company’s articles of association were not automatically binding as between the company and its officers, but could expressly or impliedly be incorporated into a contract between the company and a director. To mitigate the risk of not being able to enforce an indemnity in the company’s articles, directors are therefore increasingly seeking the protection of stand-alone indemnities. Many directors already have the benefit of indemnities in contracts with the company—for example, in their service contracts, letters of appointment or stand-alone deeds of indemnity—and companies may want to consider amending the relevant indemnities to provide the increased protection permitted as a result of the changes introduced by the 2004 Act.

We have two primary concerns about this part of the Bill. The first was expressed by our noble Friends in the House of Lords: these clauses do not allow protection from liabilities for certain directors who should be protected. Our second concern relates to the changes to the law on ratification which the Bill imposes.

These clauses deal with provisions that protect directors from potential liabilities. I spoke previouslyin relation to part 10 about the importance of maintaining a corporate environment that encourages companies to stay in the UK rather than discouraging them from doing so. Ensuring that the best people still wish to take on the burdens and responsibilities of company directorships is essential in maintaining a company-friendly environment in the UK.

During the Government’s lengthy consultation preceding the Bill, two principal concerns were identified in relation to directors’ liabilities. The first related to directors’ increased exposure to liability arising from legal proceedings brought by third parties. That is particularly relevant due to the increase in class actions being brought against company directors in the United States. I have at some length made the case that the combination of new provisions in the Bill—not least other provisions of part 10 working together with part 11—will, in our view, lead to further litigation against directors.

The second major concern relates to the costs incurred by directors in defending legal proceedings, which companies could pay only after judgment was given in the director’s favour or after an acquittal. Both those factors have led to growing concerns among directors that the fees that they are being paid for their services do not justify the potential liabilities to which they are exposing themselves. That is a concern especially for non-executive directors.

An article in the December issue of the Practical Law Company’s magazine, written by two solicitors from the City firm Freshfields, examined how demands for changes to the law originally started. They said:

“The risk of a director having to bear the expense of protecting himself against claims brought by the company, liquidators, disgruntled shareholders (perhaps in the US courts) or a regulatory body were seen as a deterrent to well qualified candidates being willing to serve as directors.”

To some extent, those concerns have been dealt with by the introduction of several new clauses into the Companies Act 1985 via the Companies (Audit, Investigations and Community Enterprise) Act 2004. It would help if the Solicitor-General were to put on record how effective the DTI has found those new provisions, which came into force in April 2005.

This chapter of the Bill does not cover directors of subsidiaries and employing companies indemnifying the directors of corporate trustees of their occupational pension schemes. On Report in the Lords, Lord Freeman tabled an amendment that sought to meet concerns that the Bill goes too far in preventing parent companies from indemnifying directors of their subsidiary companies, particularly in preventing employing companies from indemnifying the directors of corporate trustees of their occupational pension schemes. That is a particular problem, as the directors’ and officers’ liability insurance policies that are currently available give only limited protection to employee directors.

The aim of Lord Freeman’s amendment was to aid the recruitment of and provide protection for employee directors of subsidiary companies, and would include  protection for company secretaries, who often act as directors of subsidiary companies. Having a company secretary as a director aids administration and compliance requirements. Furthermore, many directors often act as directors of subsidiaries before advancing to the board of the parent company. That common business practice is jeopardised by the Bill.

Lord Freeman’s amendment was tabled in the Lords both in Committee and on Report. While the Bill was being considered in Committee, the Attorney-General sought further consultation on the problems that were highlighted. In relation to indemnification by an associated company of a company acting as trustee of an occupational pension scheme, the Attorney-General agreed to accept, in principle, that aspect of Lord Freeman’s amendment. The Government accepted that the indemnification of trustees is not otherwise a controversial practice, and that concerns need to be addressed. Clearly, they are addressing this issue with their amendments today.

Despite expressing sympathy regarding some of the concerns that were raised by those in the business and legal communities who will be affected by the clause, the Government seem to have done little to meet their concerns about the other aspect of the amendment. The Institute of Directors makes that clear in these comments to us:

“The Government has said it may be prepared to extent the scope to employee directors of corporate trustees...Without such indemnity being available any well-informed person will be unwilling to act as a director or officer of a subsidiary undertaking. Becoming a director of a subsidiary is very often the route to directorship of the parent. Without the experience and development offered in subsidiaries directors will be less well-placed to take on the role of director of the parent, with the likelihood that both performance and governance will suffer.”

What is the Government’s latest position on this issue? Are they considering whether to extend the scope to employee directors and corporate trustees? The serious concerns of the party that represents company directors in the UK should not be treated lightly.

I reiterate that it is important to keep good company directors in the UK. Company directors are vital to the running of successful companies, and successful companies are vital to the running of the country’s economy. To bring in measures that will discourage good people from becoming company directors because of the liabilities that they might face would damage the economy of this country. To counter that threat, we tabled the amendment, which was drafted by the CBI and which aims to meet the concerns that I have outlined regarding the indemnification of subsidiary directors. Now that I have put forward the arguments of those at the forefront of this area of law and business, I hope that the Government will reconsider the amendment and look upon it more favourably.

Photo of Mike O'Brien Mike O'Brien Solicitor General, Law Officers' Department

I have dealt with the amendment, so let me reply in more general terms. Our reforms in the Bill strike a careful balance betweenthe interests of directors and the need to protect  companies and, ultimately, their shareholders. It is important that the law is able to deal firmly but fairly with cases where something has gone wrong, but we certainly recognise that there is a need for a diverse pool of high-quality individuals who are able to assume the role of company director, and for directors to be willing to take informed and rational risks.

A number of reforms were introduced through the 2004 Act, and they address many of the hon. Gentleman’s concerns. It is too early to say how they have worked, as they have only just been enacted. Let us wait and see how they develop.

The package of reforms is important. Companies are permitted but not required to indemnify directors against liabilities for third parties. It was a major area of concern, particularly in the case of companies with a US exposure which wished to be able to indemnify directors against liabilities arising from class actions by groups of shareholders.

Companies are permitted but not required to pay directors’ defence costs as they are incurred, which seems to run contrary to what the hon. Gentleman said, unless I misunderstood him. Even if the company brings the action or it is a derivative action, indemnification may cover legal and financial costs of any adverse judgment, subject to exceptions for criminal fines, penalties imposed by regulatory bodies, the costs of criminal proceedings in which the director is convicted, the costs of actions brought by the company when final judgment is given against the director and the costs for unsuccessful actions for release.

The package of measures ought to command widespread support. It will encourage entrepreneurial behaviour by directors and safeguard the interests of companies and their shareholders.

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

There is one point on which I should be grateful to hear the Solicitor-General’s views. In his earlier remarks, he said that one main reason why he did not like our amendment was the scope for abuse that might result from it. Will he explain in more detail where the abuse is likely to come from?

Photo of Mike O'Brien Mike O'Brien Solicitor General, Law Officers' Department

I have set out our concerns about the amendment. For example, if a parent company could indemnify the directors of wholly owned subsidiaries for whatever they liked, it would be used to get around the restrictions placed on the indemnities that companies may give to their own directors or those of other, associated companies.

Group companies can be highly interconnected, with myriad links and interdependencies—often even more so with wholly owned subsidiaries and their parents. They may share directors and officers, and they may have entered into cross-guarantees or made loans to each other. They are not in a different enough position to justify their exemption from the restriction to the indemnities that other group companies might give to directors of companies within the group. Such exemption might even encourage the setting up of artificial group structures to take advantage of it. Therefore, we oppose the hon. Gentleman’s amendment.

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

I am not entirely convinced by the Solicitor-General’s argument, but we will go away and think about it. On that basis, I beg to ask leave to withdraw the amendment.

Photo of John Bercow John Bercow Conservative, Buckingham

It does not need to be withdrawn, because it has not been moved, but I am grateful to the hon. Gentleman.

Amendment agreed to.

Clause 216, as amended, ordered to stand part of the Bill.

Further consideration adjourned.—[Steve McCabe.]

Adjourned accordingly at sixteen minutes to Eight o’clock till Thursday 13 July at Nine o’clock.