HL Deb 23 October 1985 vol 467 cc1244-9

211ZA* Line 20, after ("unless") insert ("any of the directors of the company knows, or ought to have concluded, that")

Lord Mishcon

My Lords, in moving Amendment No. 211ZA, with the permission of the House I shall also speak to Amendments Nos. 211ZB and 211ZC. 211ZB* Line 23, leave out ("becomes") and insert ("will become") 211ZC* Line 29, at end insert ("Subsections (4) and (5) of section 9 (responsibility for company's wrongful trading) shall apply for the purposes of this subsection as they apply for the purposes of section 9(2) above.") May I at once thank the noble Lord the Minister for what he said in regard to the matters raised by the Law Society and, I believe, in some cases, also by other bodies. I thank him very much for having taken note of what was said by those organisations and for the accommodation he has made to them.

The amendments to which I am speaking relate to Clause 84 and the absence in that clause, as we see it, of the clarity that there should be in regard to what the lawyers call the mens rea element; namely, the guilty intent element.

Again, this is the view of the Law Society's Company Law Committee and I again ask for the respect which I am sure your Lordships and the Minister would want to pay to that committee.

10.45 p.m.

I believe that it is no secret that the Department of Trade and Industry has more than once indicated to the bodies which have made representations to it, and certainly to the Law Society's Company Law Committee, that in the department's view the effect of Clause 84 is that any undervalued transaction or preference, if it is capable of being avoided under the section, must have been made at a time when the directors were conscious of impending failure, that is, that they "have in mind that all the company's creditors will not be paid in full".

It is the view of the Law Society's Company Law Committee that it is very doubtful whether that interpretation is actually sustainable, given the Bill's present wording. I understand that the department relies on Clause 84(4), which provides that, in deciding to make a preference, the company must have been influenced by a desire to produce, in relation to the person who is preferrred, the effect mentioned in subsection 3(b) above". That effect is, putting the person into a position which, in the event of the company going into insolvent liquidation, will be better than the position he would have been in". This provision postulates a hypothetical liquidation and does not relate to any actual expected liquidation. Any payment to a creditor will put him in a better position than he would be in a hypothetical liquidation, and there is and must be a strong argument that any payment to a creditor would have been made by a company as a result of its being influenced by a desire to put him into such a position.

The second reason, if I may say so for the necessity of this amendment, is that for the purposes of ascertaining whether a transaction may be challenged under the section, the relevant time is expressed in subsection (7)(a), as amended by the other place, by reference to whether the company was, or following the transaction would become, insolvent. There is, however, no requirement that the directors should have any reason to suspect insolvency.

The problems are compounded by the fact that one of the tests of insolvency is a balance-sheet test—that is, whether the value of the assets of the company exceed its liabilities. There is no guidance as to how the assets are to be valued or the liabilities assessed. Therefore it might very well be that, with the benefit of hindsight, a company's net assets are seen to have been worth less than its liabilities at a particular time, although the directors had no reason to suspect it at the time when they looked at that balance-sheet.

The committee's suggested amendments, which I am putting before this House, seek to meet these problems by imposing a requirement that a director knows about the insolvency or ought to have concluded that the company was or would be insolvent. As your Lordships will see, the amendment also incorporates the tests in Clause 9—which is the clause that deals with wrongful trading—as to what a director ought to know or conclude. I beg to move.

Moved, that this House do agree with the Commons in their Amendment No. 211ZA.—(Lord Mishcon.)

Lord Milne

My Lords, before we leave this block of amendments, may I say that I had considerable discussion with one of the accounting bodies today on the telephone just before coming to your Lordships' House on the question of Commons Amendment No.458? It feels that clarification is required on this amendment.

The point of the Commons amendment is to expand the definition of insolvency in Section 518 of the Companies Act 1985. The first part of the amendment to Schedule 5, on page 178, line 32, (Bill No. 127), effectively deletes the words in brackets in Section 518(1)(e) of the Act, inserting, "as they fall due", at the end. That has the effect of confirming the first part of the definition as being on a cash flow basis, whereby both positive and negative flows may be matched and solvency or otherwise diagnosed.

But the introduction of new subsection (1A) is a further test on a valuation basis which is static at a moment in time. The institute feels that the inclusion of contingencies and prospective liabilities at a point in time, without taking into account anything on the other side of the equation, extends the definition of insolvency to a quite unreasonable degree. It appears already to have made representations, but it feels that its point has not been taken.

Lord Lucas of Chilworth

My Lords, I am grateful to the noble Lord, Lord Mishcon, for explaining his amendment, and also to the noble Lord, Lord Milne, for putting his point. If I may, I shall come to it in the order in which we are proceeding. That is not to imply any criticism.

I have to say at the outset that I am not able to agree with the noble Lord, Lord Mishcon. I listened carefully to what he had to say, but I do not think that there is any doubt about the necessity for a preference to be shown to have been given; in other words, for there to have been an intention to give that preference. The insolvent liquidation mentioned in Clause 84(4) is hypothetical. It must be so, as by definition no liquidation can yet have occurred. But what the company must have in mind when making the payment, or doing any other thing that might give rise to a preference, is that in its doing so the recipient will be better off than his fellow creditors in a liquidation.

The company must also be influenced by the desire to produce that effect. The provision requires that the company must intend that the consequences of its course of action occur, in other words, it must contemplate that a liquidation, from the effects of which its action will save the preferred creditor, will take place. The provision will be activated only if an actual liquidation takes place in the time period, and it is unlikely that the necessary state of mind will occur unless the directors knew that there was no hope of paying the other creditors in full.

As the noble Lord, Lord Mishcon, himself said, it has been suggested to the department that the clause ought to refer to circumstances where the directors knew, or ought to have known, that the company was insolvent. In our view, knowledge of insolvency or impending insolvency must be present for the company to be influenced by the desire to create a preference. I would suggest that any reference to circumstances about which the directors ought to have known is inconsistent with the provisions of this clause. If the directors did not know the company was so badly off that it would not be able to pay its other creditors in full, they could not possibly be influenced by a desire to create a preference even if as prudent men they ought to have known what the circumstances truly were.

We are in fact really satisfied that the clause clearly and effectively establishes the necessity of a desire on the part of the directors to create a preference for a payment or another benefit to become a preference. It is upon those grounds that I invite the noble Lord to withdraw his amendment.

The noble Lord, Lord Milne, discussed the words, taking into account its contingent and prospective liabilities". Of course this has a very long history. These words first appeared in the Life Assurance Companies Act 1870, I am advised, and in the Companies Act 1907 They have remained in the Companies Act and are now contained in the Act of 1985. They are necessary to ensure that the court, when considering whether or not a company is insolvent, can have regard not only to liabilities presently due, but also to contingent and prospective liabilities. Commons Amendment No. 458 gives effect to the way in which the courts have interpreted Section.518 of the Companies Act; that was previously Section 227 of the 1948 Act. We are not seeking to amend the law by this amendment; merely to give effect to that interpretation by the courts, namely, that Section 518 contains both a cash flow and a balance sheet test.

I take this opportunity of reassuring the noble Lord that the courts have not interpreted Section 518 as meaning that all contingent and prospective liabilities have to be brought into account. I can do no better than quote from the decision of Mr. Justice Nourse in re Bond Jewellers, when he said, and I quote: What I am required to do is to take into account the contingent and prospective liabilities. That cannot mean that I must simply add them up and strike a balance against assets. In regard to prospective liabilities, I must principally consider whether, and if so when, they are likely to become present liabilities. The courts are not under a duty to make a winding-up order under Section 518 as it stands at present, nor will they be under such a duty under Section 518 as it is proposed to be amended by this Amendment No. 458. The courts do have a discretion whether or not to make an order and it is vital that in exercising that discretion they have regard to contingent and prospective liabilities in the manner I have described, which merely expresses quite clearly the current law and practice in the matter. I hope that will be helpful to the noble Lord, Lord Milne.

I do apologise to the House for having to cover perhaps rather a wide area on one or two points which have been put to me.

11 p.m.

Lord Bruce of Donington

My Lords, I am sorry that the noble Lord cannot follow and cannot agree with the amendments which have been put forward by my noble friend Lord Mishcon. It seems to me that, when relying on value of assets and of liabilities and stipulating that a company shall be insolvent if the value of its assets is lower than the value of its liabilities, some important considerations are very often forgotten. Value implies a judgment by someone. It is not merely an entry in a book. Were it to be a question of book value, that is a definite term. It is a value to be ascribed to an asset or a series of assets put down in the company's primary books of account as Section 221 of the Companies Act 1985 requires to be done. That is one value. The amendments put forward by the Commons do not stipulate which type of value. They leave the matter open.

There is another kind of value. There is a break-up value. Is a director going to be called into account because at a given date the value of the assets at a break-up value is much less than the value of the liabilities, whereas the value of the assets assessed on a going concern basis may be higher than the liabilities? On this neither the Commons amendments nor the Government nor anyone else, afford us any guidance at all. It is very dangerous that these words should be left in without the safeguards that have been brought forward by my noble friend Lord Mishcon.

Reverting to the term to which attention was drawn by the noble Lord, Lord Milne, himself a distinguished accountant, what are prospective liabilities? It is not a term known in professional accountancy. Contingent, maybe. And how does one assess a contingent liability in relation to determining whether a firm is insolvent or not? I give an example. A firm with a surplus of assets on the basis of a going concern over its liabilities nevertheless has a writ issued against it for damages in respect of some alleged omission on its behalf. Let us say that a statement of claim goes in, in the sum of a quarter of a million pounds, whereas the surplus of the assets above the liabilities, assessed on a going concern basis, is perhaps only £100,000. A statement of claim goes in for £250,000, or maybe half a million, or even perhaps a million. Is it a contingent or prospective liability to which the courts have to have regard?

It is all very well for the noble Lord to say that this gives any flexibility at all. The judge cannot form a view and, if he does form a view, he cannot articulate as to whether that statement of claim is going to succeed or not. If he did state that he thought the contingent liability would materialise to its full extent he would be pre-judging the case which had still to be considered on the basis of the statement of claim and after all the interrogatories, the discovery and so on, and the actual hearing of the case in court. How can a judge assess, or have regard to, a contingent liability expressed in those terms? He cannot. The whole concept of bringing prospective liabilities into an assessment of a company's solvency on an asset liability basis is thoroughly unsound and would be condemned, not only by the Law Society but by any reputable professional body of accountants in the United Kingdom or elsewhere. It is wrong that it should remain.

I therefore hope that better counsels will prevail and that the noble Lord will see fit to accept the amendments of my noble friend; and also in due course take further account of the representations that have been made by my noble friend Lord Milne.

Lord Lucas of Chilworth

I gather that I have probably satisfied the noble Lord, Lord Milne, since he does not want to reply further. I very much regret that I have not been able to satisfy noble Lords opposite. I am not an accountant, as the noble Lord knows. I respect always his experience and knowledge of matters of his kind. However, I have to say to him on this occasion that if he sought to confuse me with the hypothetical situations which he envisages under which assets may be valued this way and that, he did not do so because I think in fact that he was deliberately trying to lead me into admitting something which he knows very well I neither have the authority nor indeed the desire to admit.

I remind the noble Lord that the way in which assets are valued is deliberately not specified either under the present law or under the Bill; and the courts have never applied rigid accounting rules in this area.

I have already explained that the term "prospective liabilities" has been in the legislation for over a century. I hope that the noble Lord, Lord Bruce of Donington, will not tempt me further this evening in this area.

Lord Bruce of Donington

My Lords, I am very disappointed in the noble Lord in this regard. I have to dispute his last statement that the law itself has never stipulated any way, and the decided case laws never determined, the basis of valuation that should be used. This I am afraid is contrary to legal practice, as anybody knows who has studied the various taxation cases in which the valuation of stocks, for example, has to be taken into account. There are a number of cases of which I am quite sure the learned lawyer in his box will be aware—at least those in the Treasury ought to be aware—where repeated reference has been made in decided cases both in the original court and in the Court of Appeal to good commercial practice and to accounting standards. Reference is repeatedly made to those basic methods of valuation which have been established and accepted by the courts by common consent enshrined in the various SSAPs which have been agreed by the accountancy profession. It is not as though the courts are without guidance and have made no determination as to the method of valuation used in the case of assets.

Lord Mishcon

My Lords, I am most grateful to my noble friend Lord Bruce of Donington for the way in which he has supported this amendment. Again I hope that the Minister would not have cause to regret the fact that this amendment was not accepted because of of the doubts that will be cast in the future on the interpretation of this section. However, I have no alternative in all the circumstances, bearing in mind the stage we have reached and the Minister's response, but to ask the leave of the House to withdraw the amendment.

Amendment, by leave, withdrawn.

[Amendments Nos. 211ZB and 211ZC not moved.]

On Question, Motion agreed to.