§ Order for Second Reading read.
§ THE SECRETARY TO THE BOARD OF TRADE (the Earl of DUDLEY)
said, it was with a considerable amount of misgiving that he rose to ask their Lordships to give a Second Reading to this Bill. He did not suppose there was anyone who had been without some such feeling on finding himself standing for the first time at the Table of this House charged with the duty of explaining a Bill put forward by the Government of the day. But in his case that feeling was accentuated by the fact that the Measure he had to explain was one of considerable complexity, containing, in a very technical form, constant references to a large branch of the existing law. He was, however, somewhat comforted by the thought that under these circumstances it was the habit of their Lordships to make very generous allowances for any defects that might be apparent, and he most earnestly pleaded that such custom might not be departed from on the present occasion. This Bill, with the exception of certain differences to which he would refer later, was to all intents and purposes the result of the labours of a very strong Committee appointed by Mr. Bryce in 1894 to investigate the working of the Companies Acts. That Committee was very ably presided over by the noble and learned Lord opposite (Lord Davey) and included, in addition to himself, two Judges of the High court and a number of gentlemen, both 1315 lawyers and laymen, possessed of great acquaintance with the operation of the existing general law, and of considerable practical experience in the formation, management, and termination of Joint Stock Companies; in fact, an abler and more representative body of men could hardly have been found to investigate a question of this kind. The appointment of that Committee was due to the fact that for many years past the Legislature had been pressed to take action with regard to certain evils that were alleged to be springing up under the Companies Acts; in fact, those evils were so apparent, that as far back as 1877 a Select Committee of the House of Commons was appointed to inquire into them. That Committee reported that they were much impressed with the importance of securing as far as possible in the formation of Companies a full disclosure of anything likely to influence anyone proposing to become a shareholder, and they found that frauds and losses which had accompanied limited companies rendered further regulations in the formation of companies under the Acts expedient. From that time down to the present numerous amending Bills, principally at the instigation of the Associated Chambers of Commerce, had been introduced into both Houses of Parliament, a fact which he thought clearly showed that, for some time past, at any rate, the general opinion of the business world had been that some important amendments were required in the laws which regulated the formation and management of companies trading under limited liability. Prior to 1855, the policy of the Government, was not to encourage the formation of limited companies; such companies, indeed, could only be formed either by special Act of Parliament or by Charter from the Crown, and great care was exercised in insuring that their deed of constitution contained adequate safeguards for the protection of shareholders and creditors. In 1855, however, an Act was passed which facilitated the formation of these companies, but which at the same time subjected such formation to five very stringent conditions. Those conditions were that in each case the deed of settlement should be signed by no less than 25 shareholders, holding at least three-fourths of the nominal capital of the 1316 company, and that there had been paid up on such shares no less than one-fifth of their nominal amount; secondly, that the directors should be liable for dividends paid after the company was insolvent; thirdly, that the directors should be liable for losses on loans granted to shareholders of the company; fourthly, that the company should be wound up after three-fourths of the capital was lost; and fifthly, that one of the auditors of the company should be approved of by the Board of Trade. It might be wearisome to quote these conditions in full, but it was important to note that they existed. They supplied, he thought, very clear evidence that, in the opinion of those who framed the Act of 1855, the establishment of limited companies might, if unchecked, lead to considerable abuse, and open the door to a considerable amount of fraud. These considerations, however, did not seem to have prevailed for long, for in the following year a Bill was introduced by Mr. Lowe abolishing four of the restrictions contained in the former Act. Parliament at that time regarded the maxim of caveat emptor as applicable to the case of these companies, and declined to assume any responsibility for loss that might, be entailed by their formation. Moreover, the same principle was followed in 1862, when the law on this subject was practically brought into its existing shape. The Act of that year was indeed mainly a consolidating Act, and was evidently regarded as such at the time, since it passed through both Houses of Parliament without discussion. But whatever changes it did make were rather in the direction of greater freedom, since it abolished the fifth remaining restriction to which he had referred. It still contained, it is true, certain provisions intended to safeguard the interests of creditors and shareholders, amongst them a very excellent table of model articles of association, but the fact that the adoption of that table was left purely optional, rendered it of no value in just those cases where it was most needed, while many of the other safeguards, besides being of a much less stringent character than those they replaced, had been proved by experience to be practically inoperative. The tendency, therefore, of the Acts of 1856 and 1862 was to sweep away the restrictions which had previously 1317 been considered necessary for the protection of shareholders and creditors. The facilities offered for the formation of limited companies had undoubtedly been of enormous advantage and value to the commercial community as a whole, but the fact that, under the provisions of the existing law, enormous investment of capital had taken and was taking place, the fact that the country had become the head centre of the commercial enterprise of the world, naturally made any question of amending legislation a difficult and delicate matter. Any proposals which tended to hamper legitmate enterprise or to check the How of capital were strongly to be deprecated, and this was a point which both the Committee and the Government had kept clearly in view. It was a far more debatable question whether it was necessary or wise to give such large liberty for the formation of limited companies as the present law allowed—a law which swept away many of the restrictions imposed by earlier legislation. No doubt under the present law a number of companies were formed which were doomed ab initio to failure entailing loss on shareholders and creditors alike. It was reported officially that one-third of the companies formed became permanent; in other words, two-thirds became insolvent. That was a very serious state of things, and the necessity for imposing restrictions became urgent. It was true that no legislation, however drastic, could absolutely shut out all possibility of fraud. A clever swindler would probably find his way through any Act of Parliament, and it was impossible to guard people against the consequences of their own folly or negligence. But this by no means covered the whole ground. There was fraud which might be prevented or mitigated by statutory provisions. The evidence also showed that in a great many cases failure, was not due to fraud at all, but to other causes of a much more preventible character, and this was a justification of the Government in bringing forward this Bill. He had said enough, he thought, in justification of the introduction of the Bill, and he should next proceed to lay before the House one or two of the main provisions of the Bill. The first provision of the Bill to which he should refer dealt with allotments. There was no evil 1318 which called more loudly for remedy than the power which directors at present possessed of proceeding to allotment in face of the fact that only an infinitesimal portion of the capital had been subscribed. The elementary fact was disregarded, with the inevitable result of failure and disaster to the unfortunate shareholders, who were totally ignorant of the fact that their subscriptions represented the total capital of the company. He took the case of the National Mutual Banking Society. The capital was £100,000 and the subscription on allotment was £548. [Laughter.] The Harvey Oyster Company, with a capital of £30,000, went to allotment when £365 had been subscribed. Clause 4 provided that 5 per cent. of the nominal amount of each share should be payable on allotment, and clause 6 provided that three-fourths of the 5 per cent. should be paid in cash before the company could proceed to business. It might be said that 5 per cent. was a small amount, and he believed it was true the Stock Exchange required 10 per cent. before recognising a company. That was a matter in which the House could express itself in Committee. It was also proposed to forbid waiver, and this was one of the points on which the Government had differed from the views of the Committee. The next clauses were 13 and 14, and they related to the issuing and the contents of prospectuses. He need hardly point out the importance of these clauses. They aimed at remedying an evil which had inflicted great suffering on many. It was evident that, before a prudent investigation could satisfy his judgment as to the merits of a company, he must be supplied with full information, and he must be informed of all the important facts. For instance, it was essential that the true value of any property should, as far as possible, be revealed, and that any contract made by the directors on behalf of the company should be made known to him. At present, however, many prospectuses contained no such information, with the result that people were often induced to pay far more than the real value of the property they required. Let him give one illustration of this. At the public examination of a bankrupt in Manchester some interesting information was given as to the way in which excessive 1319 value was fixed. The man carried on the business of a bleacher. It was admitted that the value of the property was not over £500, but the price the vendor put on it was £2,500. The attempt to start the company was not successful. Two months later, an attempt was made to purchase the same property at £5,000—£2,000 in cash and £3,000 in shares. This also failed. On a third attempt, made more publicly, he was more successful. This time the public were invited to pay £5,000 in cash and £5,000 in shares, and on this basis the company was formed. The frank admission of this gentleman afforded some evidence as to one manner in which the public were defrauded. ["Hear, hear!"] Then as to contracts, the necessity for disclosure was recognised in 1867, and a clause was inserted requiring every prospectus to state the date of and names of parties to any contract entered into by the directors. The Bill proposed to repeal this clause and to substitute one which would limit the operation of the law to material contracts, but would require not only the names and dates, but also their short purport and effect. The words of the clause they proposed must be read in the light of judicial decisions which had limited and defined the scope of their application. This clause contained two important modifications of the Committee's Bill—first, that in cases where a director's qualification was held in shares of which he was not the beneficial owner such fact should be stated; and, secondly, that circulars or notices inviting existing members of a company to subscribe further shares should be exempted from the provisions of a former section which proposed to include circulars of a private character inviting subscriptions to new companies. It was exceedingly difficult to define what a private circular was, and the Courts were not likely to treat mere private communications which did not purport to explain the objects of a company as prospectuses. It might be objected that the requirements in this clause would make prospectuses unduly long, but it had been thought that any disadvantage of that kind would be more than outweighed by the enormous advantages to be derived from securing greater publicity of the material facts in the prospectuses. 1320 ["Hear, hear!] One of the most prominent defects in the present law was that at present no opportunity was given to shareholders for considering at an early stage the facts relating to the formation of a company, or for taking concerted action in case of any irregularity. Clause 39 of the Act of 1867 provided that a meeting should take place within four months of the registration of a company, but as no provision was made that adequate information should be supplied to such a meeting by the directors it had to a large extent become formal. As a safeguard to shareholders, therefore, they proposed in the present Bill to shorten the time within which a meeting must take place to one, month, to give shareholders certain statutory powers of inquiry and action, and to provide that full information should be sent to the shareholders at least seven days before the meeting. The proposal had been made that no moneys out of the funds of the company should be paid away until after the statutory meeting; both the Committee and the Government had carefully considered that proposal, but they had concluded that, in consequence of the uncertainty that would ensue, honest vendors might be put to considerable hardship, and even loss, and they had therefore determined to reject it. At the same time it was hoped that, by the provisions of Clause 18, many of the advantages to be derived from such a system would be secured without incurring the possible unjust effects. There were also some clauses specially drawn in the interests of creditors. First, there was the subject of mortgages. The Act of 1862 provided that every company should keep at its office a register of the mortgages affecting their property; but, as had been pointed out by Lord Davey's Committee, this had virtually become a dead letter. Again, such register could only be inspected by an actual member, or an actual creditor, and was, therefore, of no value to an intending creditor. Moreover, charges on chattels were exempted from registration, although private individuals were compelled to so register under the provisions of the Bills of Sales Act. Of this there were numerous illustrations. To remedy the present defects the Bill provided that mortgages, other than 1321 liens by law or charges contracted in the ordinary course of business, should be registered within seven days at the office of the Registrar of Joint Stock Companies, where they would be visible on the payment of a small fee. Priority to mortgages would be given in order of registration, and not in order of execution. In regard to accounts, balance sheets, and audits, there were no statutory provisions at present, their regulation being left to the model articles of association, the adoption of which was optional. The clauses intended to remedy this state of things provided, among other things, that a balance sheet should be drawn up on certain specified lines, registered at the office of the Registrar of Joint Stock Companies, and sent to the shareholders before the meeting. All reasonable information as to a company's financial position was to be placed within reasonable reach of those who had an interest in obtaining it. Parliament had allowed the liability of those companies to be limited, and surely, therefore, it was not unreasonable to ask that in return they should be required to state the assets upon which they traded. Subject to these limitations, the requirements of publicity were made as little onerous as possible. The principle upon which the Bill was based was that of publicity in the interests of the shareholders and the creditors. It was but just that those who had embarked, or might be asked to embark, their money in an enterprise should be given every reasonable opportunity of investigating the nature of the security offered to them. It was impossible to protect people against the consequences of their own folly, but it was possible to place prudent people in a position to determine whether they could safely invest their money in these concerns. Publicity alone would not suffice to remedy the evils that had grown up under the existing law, and it had been found necessary to impose certain restrictive conditions, which, however, would not tend to hamper the free flow of capital or to prevent men of standing or reputation from undertaking the duties of directors. ["Hear, hear?"]
§ LORD HERSCHELL
said, that it was impossible for any Measure to have been more clearly explained or more 1322 ably defended than this one had been by the noble Earl. ["Hear, hear!"] He did not rise for the purpose of offering any opposition to the Bill. Their Lordships should, however, endeavour to see clearly how far the evils which had been indicated in the existing company law were capable of being met by legislation, otherwise it would be impossible for them to judge whether such a Measure would not do more harm than good. Nothing could be more dangerous than for people to suppose that any amendment of the company law would protect them when they invested their capital in hazardous undertakings. He believed that a vast amount of the capital that had been lost had been so lost on account of the great attraction which a high rate of interest offered, and, if they could only din into the minds of the British public that they could not get a high rate of interest without obtaining very doubtful security for their capital, he believed that they would do a great deal more good than they would do by any amendment of the Companies Acts. ["Hear, hear!"] The loss resulting from companies did not always involve fraud, because a vast number of companies which failed were started by honest although over-sanguine persons. He did not mean to say that companies might not be so carried on as to pay 5 or even 15 per cent., but a large majority of them could not even pay 5 per cent. He merely wished to warn the public that they could not invest their money in undertakings offering a high rate of interest without incurring considerable risk of the loss of their capital. Those provisions of the Bill which related to the formation of a company he regarded as most valuable, because they required a full statement to be made as to the security which the company had to offer to the shareholders. He was more sceptical as to the value of the clauses which related to the audit, because it was impossible for auditors to be experts able to judge of the value of various kinds of properties—such, for instance, as the bills and other securities held by bankers. It would be a mistake to require too much from auditors or to believe that an audit, however well conducted, could enable absolute reliance to be placed upon balance sheets. He did not, however, mean to say that there 1323 ought to be no provisions in the Bill with regard to audit, or that audit should not be made compulsory; neither did he say that the provisions of the Bill sinned in the direction he had indicated, of encouraging the public to place too much reliance upon an audit. There was another matter on which he would like to say a word. He gathered that it was proposed to increase the liability of the director in respect of his conduct of the business of the company. There was a provision in the Bill that he should be liable to the company, unless he used due and reasonable care in his management. It seemed to him that if a man incurred too great a liability in that respect, there was a risk of excluding from the direction of companies many men of ability and character. When a company failed, there would be a great disposition to think that some person must be to blame, and generally, the directors must be to blame. Now that need not really be the case. Many sanguine expectations came to be disappointed without any fault on the part of those who entertained them in the conduct of the business of a company; yet, when the circumstances were looked at after the event, when it was so easy to be wise, the aspect of them is so different, that there was a danger that disaster might be supposed to be the result of the want of the exercise of proper skill and care, when in reality it was not so at all. Then as to the last matter to which the noble Earl referred, namely, the publication of a balance sheet, he did not wish to express a decided opinion upon it, but he thought it would require very careful consideration. The noble Earl admitted that traders were not bound to publish their affairs to the world in the manner in which it was proposed to require of limited companies. The noble Earl said truly that companies enjoyed the privilege of a limited liability; but, on the other hand, with private, concerns, the limit of liability was the limit of their means, and the partners could be proceeded against for the whole of the means they possessed. But the experience of the Bankruptcy Court should satisfy anybody that those means were often very small when the transactions were very large. A company might be perfectly sound, its affairs might be well conducted and be perfectly able 1324 to continue to pay its shareholders, and he could conceive that there might be times when it might be a very dangerous thing if the company were compelled to publish a statement of affairs. It might be that the requirement was so limited that that danger would not arise; but then there was always this difficulty, that if a full disclosure was not required, the details of the business might be left undisclosed, and the question was whether very much was gained by a disclosure such as the Bill required. That was a matter which he thought would have to be very carefully scrutinised. He had made these criticisms in a spirit by no means unfriendly to the Bill. He rejoiced at its introduction, and he believed that if it was passed into law, it would be a very beneficial change.
§ THE LORD CHANCELLOR (Lord HALSBURY)
agreed that it was quite true, as his noble and learned Friend had said, that people must incur some risk in taking shares in companies, but his experience was that most prospectuses stated that there was no risk and it was upon that that a great many foolish people were induced to put their money into concerns of the soundness of which they had no opportunity of judging. It was on that account that such a Measure as that proposed had become necessary. It was perfectly true that all companies that came to an untimely end did not fail by reason of fraud; that was to say, the construction of the company was not always fraudulent. Very often some very sanguine person adopted an idea and the people to be guarded against were those people who clustered round him and the company promoters. This sanguine person sold his idea—and very often it was only an idea that he sold—for a very large sum of money to a company which started with a very inadequate working capital. That was one of the evils which the Bill sought to check. He confessed he was one of those who thought that something in the nature of provisional registration might be a remedy for the existing evils. He would not say that he had abandoned his belief in it, but he had abandoned the hope of ever getting anybody else to believe in. it. [Laughter.] He believed the opinion of the commercial classes was absolutely against any such system. 1325 With reference to the question of the audit and the responsibility of directors, two observations, he thought, arose. He agreed that directors ought not to be unduly attacked, because there was the danger of getting responsible men to act in that capacity. On the other hand it was manifest from the revelations in the Courts of Justice that sometimes a gentleman, who became a director, received money for his services and knew absolutely nothing about the affairs of the company. Such a person, he thought, ought to be made responsible for the conduct of the concerns of the company of which he was a director. Then there was the question of the audit. It was of course quite true that an audit might be relied on too much, and the records of the Courts of Justice showed that the office was sometimes an absolutely illusory one. In many cases the auditor took everything from the secretary, who took it from somebody else, and the Bill aimed at the prevention of scandals of that description. He hoped the Bill would prove a useful Measure. He did not at all dissent from the opinion that it proposed alterations in the law which would require to be carefully considered; but he hoped the labour which had been bestowed upon it by the Committee and by the noble Earl who introduced it, would not be thrown away. So far as he was concerned it seemed to him a very useful attempt to get rid of evils which were certainly affecting the interests of the commercial classes very seriously.
§ LORD DAVEY
hoped that the noble Earl opposite would allow him to offer him his compliments for the way in which he had explained the Bill to the House. Perhaps he was better fitted than others to judge of the noble Earl's skill, because the Bill, with some trifling alterations, represented the labours of the Committee over which he had the honour to preside. The difficulties of legislation of this sort were very great. It was difficult to know how to do enough without doing too much. The interests to be dealt with were so vast. The large majority of companies were honestly formed and honestly managed, but their affairs did not come before the public. The public knew nothing about them and the only people who did were 1326 the directors, shareholders and creditors. Therefore, when the large amount of business that was done in that way was considered, he thought that Parliament could not be too careful to avoid legislation by which honest persons might be trammelled in their work or by which companies might be put into leading strings, in order to avoid some loss to imprudent and ignorant persons. On the other hand, it must be admitted that when a company offered its capital to public subscription, those who were invited to subscribe had no real opportunity before they sent in their applications, and were fixed with contracts to take shares, to examine the soundness of the undertaking, or to discover what amount of reliance ought to be placed in the prospectus. As the Board of Trade Committee had pointed out, the maxim caveat emptor applied only to a very limited extent to such cases. This Bill contained provisions for the purpose of insuring that persons, before they were fixed with contracts to take shares, should have an opportunity of obtaining information as to the soundness of the Company. There were two typical kinds of fraud committed by company promoters. In the Bill there was a provision that in the prospectus there should be a minimum subscription, and that if the subscription for shares offered should not reach that amount, the company would not go to allotment. But there was at present nothing to prevent promoters who offered shares to the amount of £100,000 from going to allotment although £10,000 only was subscribed. Another difficulty which had to be combated was presented by the existence of nominal vendors, and the way in which purchases could be loaded by companies. The ''nominal vendor'' was now one of the regular dramatis persona of the play. A man had property to sell, and a person took what was called an "option" from him, that was to say, an offer was made but the contract was not to be binding until a certain future day. But supposing this person eventually purchased the property for, say, £100,000; he proceeded to form a syndicate, called the vendor's syndicate, who purchased the property at an enhanced price. The vendor's syndicate then set to to form a company, and they got hold of someone 1327 who was their own nominee, the nominal vendor, who was called a trustee for the company, which of course he was not. Then the syndicate sold the property to that nominal vendor, again at an enhanced price, and the nominal vendor, whose name appeared in the prospectus as the real vendor, sold it again at an enhanced price to the company, so that it was loaded with the profit of the intermediate syndicate and the profit of the nominal vendor before it reached the hands of the company. The clauses of the Bill which dealt with this matter had been very carefully considered, and they certainly did not err on the side of not being full enough. Indeed some people might think that they were too minute and too full. But their aim and object was to strip off the mask from the nominal vendor, who figured in the prospectus as the real vendor, and to enable the purchasers to find out how much the real owners had given and how much money had found its way into the hands of intermediate parties. Lord Dudley had referred to the question of waiver of the minimum subscription. The noble Earl had said that there should be no waiver of the minimum, either before the application or after. The Board of Trade Committee thought that there might be waiver after application, under certain limited conditions. The Government, however, had struck out that exception, and proposed that in a contract every condition precedent for the waiver of the minimum subscription should be void. This question was one which, no doubt, would be considered in Committee. The clause relating to the registration of mortgages did not, he regretted to say, provide for the registration of all mortgages. The business men on the Board of Trade Committee were very much opposed to registration without exceptions, and the clause provided only, speaking broadly, for the registration of mortgage debentures and mortgages charged on the general assets and unpaid capital. He would be glad if the Government could see their way to make the clause apply to all the mortgages of a company. The question of the publication of the balance sheet he did not regard as extremely important. It was a detail upon which opinions might differ reasonably, and its importance had been exaggerated. But 1328 he was bound to tell the noble Earl that the clause relating to this question would be very much opposed, and he doubted greatly whether the Government would succeed in passing the clause in the form in which it now stood. Certainly, there was no clause in the draft Bill which was more discussed, and respecting which there was more divergence of opinion on the Board of Trade Committee. The question of provisional registration was also fought out fairly in the Committee, and opinions were obtained upon it from Chambers of Commerce and many men of business, and, as the noble and learned Lord on the Woolsack had said, commercial opinion appeared to be against the proposal to which he had referred. To the clauses which endeavoured to express in a declaratory form the existing law as to the duties and liabilities of the promoter's and directors he attached extreme value. Speaking broadly, Clauses 8 to 11 of the Bill purported to declare the existing law upon the subject as administered by the Courts of law and equity. The Board of Trade Committee recognised that this task was a very difficult one, and expended much time and attention upon it. He inferred, from the fact that the Government had not thought it necessary to alter a single word in these clauses, that the draft had met with the acceptance of the legal advisers of the Government. The experiment made in these clauses was novel, but was likely to be very useful. No doubt a lawyer knew what were the liabilities of a promoter who stopped money on its way, or a director who neglected his legal duties, or misappropriated funds, but it was not everybody who possessed such knowledge, and therefore it was well that there should be placed within easy reach of the public a succinct and accurate statement on the subject. The whole Bill would require careful consideration in Committee, but these clauses were specially open to criticism, and he trusted that they would receive criticism from the noble and learned Members of their Lordships' House. These clauses purported to contain the results of a long series of legal decisions. To compress so much matter into so small a space was, of course, a very difficult thing to do.
§ Bill read 2a, and committed to a Committee of the whole House.