HC Deb 18 July 1985 vol 83 cc553-9

'()—(1) The directors of every public company shall secure and collate not less than once in each accounting reference period such data about the company's affairs and transactions and those of its subsidiaries and prepare such estimates of the future course of the business as are necessary to enable a reasonable assessment to be made of the future ability of the company to carry on business as a going concern and to pay its debts as they fall due.

(2) The data and estimates prepared in pursuance of subsection (1) above shall be provided as soon as reasonably practicable to all the directors of the company, to the company secretary and to the auditors.

(3) In the auditors' report the auditors shall state if it is their opinion (having due regard to the nature of the company's undertakings) that the requirements of subsection (1) of this section have not been complied with.

(4) "accounting reference period" has the meaning given in section 2 of the Companies Act 1976; and auditor's report" has the meaning defined in section 14 of the Companies Act 1967.'.—[Sir B. Rhys Williams.]

Brought up, and read the First time.

Sir Brandon Rhys Williams (Kensington)

I beg to move, That the clause be read a Second time.

The clause stands in my name and in the names of right hon. and hon. Members on each side of the House.

The Bill is entitled "Insolvency" but it also deals with important aspects of company management, and in particular the way in which problem companies are managed by the directors, and their fitness to continue in that capacity in the light of their performance when their companies are in difficulties. It also introduces a new type of manager, as I read it, in the form of the administrator, who appears in clause 21. Clause 21 says that an administration order shall not be made in relation to a company … after the company has gone into liquidation". The Bill therefore is dealing with the procedure which is open to parties concerned with the management before it has reached the point of no return. It seems to be producing a new type of company Siegfried who has to tackle the problem of the companies in difficulties at the stages where they might still be saved by the introduction of some new supervisory element, that is to say, before they have reached the stage at which they can no longer carry on business as a going concern and pay their debts as they fall due.

We must ask ourselves whether that is the best system that we can think of, bearing in mind the number of companies that seem to slide unexpectedly into acute financial difficulties. Many companies seem to reach the brink of disaster before anybody has tried to get something done. All too often, the creditors, the shareholders and even the directors do not know how deeply they are in trouble before reaching the point of no return.

The Bill, especially in clauses 7 to 9, refers to the punishment of directors who fail to carry out their functions in difficult circumstances. Anxieties about those parts of the Bill have been expressed in another place and in Committee. When difficulties arise, it is commonplace for people to ask why nobody knew the company was approaching insolvency, why there was no warning and, in particular, what the auditors were doing.

The long-standing problem of British company law is the weakness of the elements that are expected to act in a supervisory capacity on behalf of the shareholders. It is not sufficient to blame the directors in the present set-up as the only parties who should carry the blame. In the 19th century, Germany evolved the practice of appointing a supervisory board. In Britain, however, we adopted the practice of appointing auditors with specific but limited responsibilites relating to the accounts for former years.

The work of the auditors has extended into other areas related to the financial affairs of companies and, in some ways, their status has become more important. In one way, however, the position of the auditors has been weakened. I may be one of the few hon. Members here who is not a qualifed auditor and I might therefore be speaking out of turn, but I believe that what I have to say is quite widely agreed in the profession. Auditors have become more dependent on the board and oriented towards the service of management. Their duty to provide a service for shareholders in a supervisory role has correspondingly become more difficult to perform.

When things go wrong we blame the auditors—we have all read recently of a company which has been mentioned here in the past half hour—but we are possibly asking too much of them because we do not give them the status that they ought to have in helping to prevent companies from sliding into insolvency. When dealing with problem companies auditors do not have a simple duty in company law to issue a warning note to the shareholders. It is difficult, unhelpful or even improper for them to qualify the accounts with an adverse comment—if the balance sheet and profit and loss account are a correct record of how things were when the accounts were made up. The auditors do not have a clear statutory responsibility to issue a warning to shareholders and to make known their doubts about the course the business may take in the future.

Some elements of the profession would not wish that situation to be changed; they feel that they would then be taken into an area of prophesy and out of the strictly arithmetical and professional background which they are trained to deal with. The difficulties in many of our public companies that have come to light recently show a deficiency in our company law which in effect is creating insolvency, because the parties that ought to be acting to prevent it are not doing so in time.

Mr. Hanley

Auditors have the power to qualify an audit report if the auditor believes that the company is not a going concern. There is a requirement on directors to state in their report the likely developments in the business of the company and its subsidiaries and, under recent company law, the auditor must consider whether that information is fair. There are therefore some provisions by which an auditor has to consider the future in a modern audit.

Sir Brandon Rhys Williams

I agree with my hon. Friend, but there is a great deal of doubt in the profession about how those functions must be carried out. When a company goes to the market for fresh funds and has to issue a prospectus, the auditors have a well defined responsibility. When a company fails to analyse its own data, nobody is confident about what is happening. Auditors cannot act in a clairvoyant manner because the data on which they might base professional and responsible advice to shareholders has not been prepared or, if it has, it might not be reliable because, in different branches of the business, managers approach the making of estimates or the collecting of data concerning performance, costing. profits and so on, quite differently. They sometimes do that in a way which suits their comparative performance.

When the data is unreliable or the estimates of the costs of the business are based on inadequate knowledge of markets and technical factors, there is an acute difficulty for the auditors. If they sense that the company is coming under the scrutiny of shareholders or institutional investors who are anxious about the way it is going and then come out brazenly with criticisms that are made public, they simply serve to compound the difficulties of a company which might be basically sound and add to the problems which could be corrected if management knew what to do.

All too often, management does not have the necessary professional guidance from people who know what happens in other businesses. It should be noted that 90 per cent.—perhaps a higher proportion—of our public companies are already doing what I am asking. The proportion might even be 99 per cent; but some companies are not doing what I suggest. The managements of those companies might be ignorant of the fact that they are not handling the preparation of data and estimates in a way which many other businesses would regard as commonplace.

I have proposed the provisions of new clause 4 many times before and the text bears the signs of my having received very well-informed professional advice when I first drew it up. I have chosen to refer only to public companies, partly because I do not want to make new burdens for private concerns and partly because small businesses are naturally able to make their own estimates of where they are going in a way which is quite different from the practice of large companies. In regard to the preparation of data and estimates, small businesses should follow practices similar to those which I recommend for public companies, but it is not necessary to carry that idea into company law.

The great majority of public companies, and all well-managed concerns, collate their records of company performance and make projections of the future course of the business as an elementary precaution and as an automatic aspect of good management. They regard it as a matter of course and an essential element in the control of the business. Because some companies do not do that, however, we have shock insolvencies. We should not be prepared to allow that situation to continue when it can so easily be remedied with existing management and professional resources.

Companies may prepare their forecasts punctually and competently or they may rely upon the hunches of senior management. That can sometimes be a good way to run a business, but it can sometimes be a disastrous way to run a business. I am sure that anyone who has experience of industry or commerce could think of examples of companies that come under those categories.

8.30 pm

We sometimes find that a company is dominated by one powerful individual. A company created by an entrepreneur which has grown to the point where it finds it necessary to go public and which is then managed by the founder with a circle of relatively powerless or ill-informed directors and non-executive directors who do not have the knowledge necessary successfully to challenge the founder's decisions is a strong candidate for sudden insolvency. That is a well-known type of company in the City. They are sometimes profitable but sometimes disastrous.

With that in mind I have stipulated in new clause 4 that the data and estimates required under the clause should be circulated to all the directors, the company secretary and the auditors. I can think of many examples, as I am sure hon. Members can, where there is a clique of directors or members of top management who are fairly well in the know; and there is also an outer circle of people who are supposed to bear the responsibility for management but who are not kept fully informed of what is going on. That is another type of company that is a candidate for sudden insolvency.

If we are to have the doctrine of directors' collective responsibility, we must ensure that all directors are kept fully in the picture about the company's ability to pay its debts and carry on as a going concern. There will be some company secrets. I do not insist that a matter which is so private that if it were disclosed outside the firm it would damage the business should be circulated outside the company. I do not suggest that the data and estimates should be made known to the shareholders or to the public but only to those in the company who have to bear the responsibility for running it and to the auditors. All companies must gain if the directors know what is happening.

Who can decide what the company should be doing about the preparation of estimates and forecasts? Clearly, the professional accountants retained by the shareholders to supervise the way in which the company tackles its financial responsibility should do that. How can we give the auditors the power and the duty to perform that function discreetly but effectively without damaging the business? I have given that matter considerable thought, as hon. Members may be aware. What I suggest in new clause 4 is the best proposal that I can bring forward for my hon. Friend's consideration. I have been making the same suggestion for a number of years, and I should be pleased now to hear what the Department thinks of it. If it does not like my suggestion, we may hear what it recommends to fill that gap.

I suggest that the auditors must warn the shareholders where it is clear that the company's performance is inadequate having regard to the nature of the business. No two businesses are alike. Forecasts that should be made in one class of business may be superflous in another. The collection of records may be unnecessary in one type of business whereas they ought to be kept as a matter of routine in another.

If the new clause is introduced into company law, as I hope that it will be, we shall not see a rash of qualifications of accounts containing negative warnings to the shareholders. The auditors would be able to say to top management, "Unless you improve the way in which you handle your estimates and make your forecasts, we shall be obliged to warn the shareholders." At that stage, every prudent business will say to the auditors, "Drawing on your experience of what other businesses do, what should we be doing? Will you help us to do it?" That is the best cure that can be recommended for the company that is in financial difficulties.

Auditors must have this extra status. They would have additional status if the clause conferred on them not just the right but the duty to warn the shareholders when the estimates and forecasts are not being competently prepared. The auditors would advise the management that it was approaching the point where the shareholders would have to receive the statutory warning. That would be a far more effective corrective in the majority of cases than the appointment of an administrator with uncertain responsibilities and powers.

Mr. Fletcher

I am grateful to my hon. Friend the Member for Kensington (Sir B. Rhys Williams) for tabling this new clause. I am aware of the serious interest that he has taken in the matter for a number of years. I hope that he will accept that the Bill's purposes go some way towards meeting his objectives. I am sure we can agree on what we should like to achieve, although our approach may be rather different. Important as the legislation is, what my hon. Friend suggests might be more appropriate in a companies Bill. I know that that is what he has tried to achieve over the years.

New clause 4(1) requires some form of management accounts. That is intended not just to assist shareholders but to help to protect creditors from suffering unnecessary loss because of directors' mismanagement. My hon. Friend mentioned the doctrine of directors' collective responsibility. I do not believe that there is any such thing in company law; the director is a director is a director. He may suggest that he was on holiday when something went wrong but, nevertheless, he must find his own reasons for not shouldering the responsibility that might apply to him in the course of his duties.

The clause requires auditors to state that the requirements of the subsection have been complied with—that the data have been collated to enable a "reasonable assessment" to be made of the company's prospects. I believe that my hon. Friend recognises that that creates a difficulty. How can the auditor determine what information is needed to enable the directors, individually, to form a reasonable assessment of what might happen in the future? The clause does not require that information to be made public, correctly because, as my hon. Friend said, it might contain information about the company's affairs which would almost certainly be damaging if it were made known generally and reached a competitor's hands. Directors of all companies, not just public companies, should monitor their company's finances regularly, not just once a year, as would be the case under the clause.

We also believe that it should be up to each director to decide, in the light of his expertise, how best to do that monitoring to protect himself and to carry out his responsibility as a director by safeguarding the shareholders' funds. The view of the Institute of Chartered Accountants in England and Wales about management accounts was given in a memorandum issued by its parliamentary and law committee. That view was: that the question of definition of such accounts is one which would be open to endless debate as is the question of whether the accounts revealed with sufficient accuracy the state of its trading operation and financial position. That is our view of statutory management accounts, although naturally we recognise their value in assisting directors to manage their companies' affairs.

I suspect that, in most public companies, such information is already provided to the directors to enable them to prepare their report to the shareholders. Indeed, my hon. Friend said that as many as 99 per cent. of public companies already do this. Schedule 7(6) of the Companies Act 1985 requires the directors' report to contain particulars of important events affecting the company, or any of its subsidiaries, which have occurred since the end of the financial year, and an explanation of likely future developments in that company's business or its subsidiaries. That point was made by my hon. Friend the Member for Richmond and Barnes (Mr. Hanley), who also said that auditors have a duty to qualify the accounts of companies whose affairs they suspect are not in order.

The Bill will create new dimensions to directors' responsibilities. It seeks to achieve the objective that my hon. Friend mentioned at the beginning of his remarks: that directors should act at the earliest possible moment if they believe that their company is getting into difficulties. I should tell my hon. Friend that the Bill will achieve that without going down the path that his new clause recommends.

Sir Brandon Rhys Williams

I do not agree with what my hon. Friend said, but I recognise that the new clause forms part of a body of reforms that is needed in company law. It would have been appropriate to have included it in the Bill, and the Bill suffers because my hon. Friend will not be sufficiently specific about the way in which problem companies should be tackled. At present the Bill would go for the directors after their problems have overcome them: it does not give them the help that they deserve at the time when they most need it. However, in view of my hon. Friend's comments, which I shall want to study, I do not wish to press the matter further now. I beg to ask leave to withdraw the motion.

Motion and clause, by leave, withdrawn.

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