UK: Company Law Reform Bill: Update on Progress

With the Bill now officially the lengthiest ever to be considered by Parliament (and set to become longer still), we look at the major developments to date and the key themes expected to emerge in the battles that lie ahead before the Bill finally reaches the statutebook (the current target for which is late Autumn 2006, although this date may well slip again).

The Company Law Reform Bill (to which we devoted the last edition of this Review¹) is proving a mammoth legislative undertaking. Having taken seven years of deliberation to reach Parliament, the Bill then saw over 1,600 amendments being debated in the House of Lords during the first half of this year. The Government accepted many of the original concerns voiced on behalf of directors, and extensively redrafted key clauses before laying the Bill before the House of Commons in May this year.

The current Committee stage of the House of Commons is, however, expected to involve debate on a similar number of amendments again, and a wide range of concerned pressure groups have pledged to fight until the bitter end on a number of issues that will be of central importance to directors.

‘Enlightened shareholder value’ This is one of the bloodiest battlegrounds. As part of the new statutory statement of directors’ duties, clause 158 (previously 156) provides the familiar obligation for a director to act in the way that he or she considers would be most likely to promote the success of the company. However, the clause then goes on to require that the director must "in doing so have regard (amongst other matters) to" six specified factors.

Some of these factors, such as "the likely consequences of any decision in the long term" and "the need to foster the company’s business relationships", are probably unremarkable. The same cannot, however, be said of, for example, "the impact of the company’s operations on the community and the environment" – what does this actually mean, and how are busy directors to go about balancing these various possible ‘impacts’ against most companies’ overriding purpose of serving their shareholders and making profit?

Unsurprisingly, the practical effect of this concept of ‘enlightened shareholder value’ has therefore proved highly controversial. The Government has tinkered with this clause to make it, arguably, less burdensome for directors – there are certainly many still lobbying hard for a more prescriptive and onerous obligation. On the one hand, strong concerns have been expressed that, even on the existing version, these six factors will prove a bureaucratic nightmare for directors who will have to resort to ‘box ticking’ and extensive minuting of every decision, ever wary that they might need to satisfy the court that no factor was forgotten or given insufficient weight.

Whatever else can be said, there will certainly be claimants (through the new statutory derivative route) seeking to exploit these risks, and directors will have to trust in the good sense of the courts to give them the necessary room to exercise business judgement and make decisions on an appropriately flexible basis.

Intimately connected with the concerns over the clause 158 duty have been fears of a greatly expanded procedure for shareholders to initiate and pursue claims against individual directors in the name of the company. We return to the impact of the new regime in the next article.

As was widely reported at the time, the Chancellor of the Exchequer suddenly announced in November last year that the Government was scrapping its ‘Operating and Financial Review’, the UK’s gold-plated version of the European requirement for narrative reporting. Although apparently an initiative to reduce the red-tape burden on business, this move proved something of an own goal as it pleased no-one and opened an unnecessary debate over what should replace it.

We now have a new clause 399 in the Bill to include a ‘business review’ as part of the directors’ report, which is intended "to inform members of the company and help them to assess how the directors have performed their duty under section 158 (duty to promote the success of the company)". It is significant to note that the review is intended to be fundamentally forward looking, as it must contain "a description of the principal risks and uncertainties facing the company". This invokes concerns that were expressed over similar aspects of the OFR, given that making forecasts is an inherently riskier business than summarising the past.

The requirement to provide a business review applies to all companies (except those subject to the "small companies regime"), but in the case of quoted companies the business review must also deal with certain specified factors such as "information about… environmental matters… and… social and community issues". Unlike in the case of the OFR, there will not be any accompanying reporting standard to explain how to apply this loose language in practice and ensure a uniform approach is taken.

There is no audit requirement, although auditors will be required to comment on any inconsistencies with the directors’ report or the financial statements.

In a little publicised move when introducing the Bill into the House of Commons, the Government also slipped in some additional provisions intended to implement the European Transparency Obligations Directive. There was great concern when the Directive was adopted by the Council of Europe in December 2004 that it would extend the liability of companies and their directors for financial misstatements to the public at large, and thereby introduce the type of shareholder litigation that has so characterised the US liability scene.

The Government claimed at the time that it had secured last minute changes to the Directive to avert that risk. With the publication of these implementation measures, it is clear that the Government has in fact been forced to extend the ambit of liability, although to a relatively limited degree that may be manageable in practice. Whether this goes far enough, however, will ultimately be a matter for the European Court of Justice to decide. We will examine this development in more depth in the next edition of this Review, when we are able to take into account the Committee debate on the relevant provisions.

The Bill originally contained an extraordinarily wide power for the Secretary of State to amend any provision of company law by administrative order without full scrutiny by Parliament, potentially raising the prospect of bureaucratic ‘tinkering’ with fundamental principles. The Government has, however, seen sense in withdrawing this power from the current version of the Bill.

The Government has also bowed to pressure to make a better job of consolidating into the Bill the existing provisions of the older Companies Acts. This should mean that there will be a single source of reference for business leaders, and help to improve the clarity and accessibility of the law applicable to companies and their directors.

The Government still hopes that the Bill can be passed before the end of the year, with the majority of provisions coming into effect in April next year. However, although the additional codification is a very welcome development, warnings have been given in Parliament that this could cause havoc with the timetable, as up to 400 new clauses (almost 50 per cent on top of the existing number) may now need to be added to the Bill and considered by MPs.

Any further slippage in the timetable gives greater opportunities to the anti-business lobby. That is a reminder that, although the mid-term report on the CLRB legislative process is broadly favourable to directors, they cannot afford to relax in the face of renewed lobbying efforts seeking to impose greater shackles, and therefore potential liabilities, on their decision making even when, as in the vast majority of cases, they act in good faith and in the perceived best interests of their company.

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