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Executive Summary

ACCA is pleased to comment on the contents of the White Paper and in particular on the draft clauses for the planned new Companies Bill.

We are encouraged that significant progress on company law reform now appears be being made, so long after the Company Law Review (CLR) project was initiated. The great majority of the proposals and draft clauses contained in the White Paper have now been the subject of extensive consultation over several years and for this reason are likely to prove politically uncontentious. Overall, we support the direction that the Bill is taking and look forward to legislation being presented to Parliament in the near future, as was suggested in the recent Queen’s Speech.

In a number of cases, individual proposals appear to have been strengthened by further reflection on the part of the Department since the previous White Paper on this matter in 2002. The new White Paper also includes some very welcome new proposals with regard to the filing of false information on the public record and the co-relation of companies legislation and the Business Names Act.

The Department would be missing a great opportunity if it failed to ensure that the planned new legislation was a fully consolidating exercise. In seeking to tackle the issue of accessibility of company law to users, the CLR had identified as a weakness the fragmented state of current legislation. In addition to the primary statute, the Companies Act 1985, which has been amended substantially since its introduction, we now have two further statutes and extensive amounts of secondary legislation. It now appears that the Department’s intention is to introduce a new Act which will exist side by side with a number of the Acts and Regulations which we already have. Business had been expecting the reform exercise to both simplify and rationalise UK company law.

We support the Department’s proposal to enable companies and their auditors to agree to limit the liability of the latter to the client company on a proportionate basis. Contracts entered into on such a basis would establish a fairer basis for determining an auditor’s liability for negligence since it would expressly provide for the responsibility of all parties involved in causing financial loss to be taken into account by the courts. While we support the principle of the proposal, we are very conscious that the whole audit process exists to protect the interests of the company’s shareholders. In view of this, it is vitally important that any initiative which affects the shareholders’ rights of redress where they have suffered loss should be made subject to their explicit approval. Appropriate rules must be set out in statute to ensure that shareholders give their approval for the entry into a proportionate liability contract before an audit engagement commences. Further, given that the proposed arrangement is to be governed by contract, it is essential that the two sides enter into it freely and without undue influence from either side. The Department should be prepared to monitor the working of the proposed reform and if necessary to introduce safeguards, statutory or otherwise, to ensure that both sides retain real discretion in the process of approval of any contract.

The proposals with regard to the legal duties of directors and auditors with regard to company accounts will further strengthen the statutory reporting framework and we support them. The wording of the proposed new offence of knowingly or recklessly giving an ‘incorrect’ audit opinion needs, however, to be re-thought to make it more appropriate to the nature of the audit opinion. The additional proposals put forward by the Audit Quality Forum also require further consideration and should not at this stage form part of the proposed Bill.

The new Bill should be used to give new impetus to the UK’s anti-late payment legislation. The disclosures which public companies are currently required to make are increasingly ineffective in influencing the payment practices of such companies. The opportunity should be taken to strengthen the current disclosure rules and to introduce more effective enforcement of them.

Company law reform provides the opportunity for a radical re-think of the statutory rules on capital maintenance for private companies. While change for public companies is dependent on wider change being agreed to the EU Second Directive, that process need not restrict reform to the rules which apply to private companies. The Department should consider the replacement of the current rules on distributable profits, which are highly complex and linked to tests of assets and realised accounting profits, with a simpler test which would be based on the directors’ assessment of their company’s solvency.

Our comments on individual aspects of the White Paper are set out on the following pages. Since we have commented on many of the issues concerned on previous occasions, we only comment here on matters which are new or with which we have problems.

Specific points

Structure of the legislation

It appears from the draft clauses that the Department’s intention for the new Companies Bill is not now for it to consolidate existing statutes, as did the Companies Act 1985, but to exist side by side with them, albeit with substantial repeals being made of earlier provisions. We would be disappointed if this were the plan. We understood that one of the key themes of the Company Law Review project was the need to tackle the fragmented state of companies legislation and to make it more accessible and coherent to users. The new Bill would not be the step forward that it could be if users had to refer, simultaneously, to the various other Acts and Regulations as well as the new statute.

Directors’ duties (section 3.3 and clauses B1-B11)

We remain supportive of the plan to codify directors’ legal duties in the new Bill. We believe this could prove to be of substantial help in raising standards of
awareness among company directors of what the law expects of them. The introduction of an objective test of skill and care is also long overdue in UK company law.

We are pleased to see that the draft statement of directors’ duties set out in section B1 contains a reference to the need for directors, in certain circumstances, to consider or act in the interests of creditors. It would have been incomplete for the statement to fail to include any reference to creditors, and the wording of B3(4), making the foregoing provisions subject to any enactment or rule regarding responsibilities to creditors, is practical.

We note that, in B3(3)(b), the text calls on directors, in fulfilling their duty to promote the success of the company in the interests of its members, to take account (where relevant and so far as reasonably practical) of ‘any need of the company‘ (to consider the specified stakeholder-related factors). We do not consider that it is helpful for the text to include the word ‘any’ in this passage. It could be construed as suggesting that directors only have to act on the basis of any need which they decide exists, rather than on any general need, thus potentially reducing the circumstances in which directors feel they are expected to take account of these additional factors. Alternatively, it could be construed as If the Department’s intention is to ensure that directors are not burdened with irrelevant responsibilities, then the matter is already adequately covered in the introduction to B3(3), where the text reads that the requirement for directors to take account of the following matters only applies ‘where relevant and so far as reasonably practical’. This, we feel, is sufficient to make clear that the requirement to consider the stakeholder factors listed in sub-paragraph (b) is subjected to criteria of relevance and reasonableness. The inclusion of the word ‘any’ would therefore serve to further dilute these criteria, which would be undesirable.

As an overall drafting point, it is remarkable that the provisions on the general duties are presented in a wholly different style to the other provisions of the Bill. By using the direct ‘You must’ style, the provisions read more like the sort of material one would expect to see in the planned non-statutory guidance than in legislation. While there may be nothing in legislative protocol to prevent this approach being adopted, there would inevitably be a stark difference between the styles adopted in this section and that used in the rest of the Bill. Inevitably, too, the passage on general duties can not avoid dealing with some overtly technical terminology, which means that the apparent object of presenting the text in plain English style inevitably has to be tempered. On balance, we would prefer the general duties to be framed in more traditional style with the plain English interpretation left to the planned supplementary guidance.

On a related point, we note that the Department has provisionally decided to retain the entitlement for companies to act as directors of other companies (as long as one other serving director is a natural person). We agree that being able to appoint corporate directors is administratively convenient for companies, in group situations in particular. But we query whether it would be logical to apply the codified statement of directors’ duties to corporate bodies, particularly given the very personalised approach currently adopted in the drafting of the statement. We suggest that, if corporate directorships are to be retained, the Department consider providing separately for how the codified rules are to apply to corporate directorships. We suspect that there may be a particular difficulty with the application of clause B7 (duty not to accept benefits from third parties).

Proportionate liability by contract (section 3.5)

We agree with the rationale behind the Department’s proposal that the law be changed so as to allow auditors to be held liable on a proportionate basis for any economic loss caused to the company by their negligence. We consider that this approach to liability is justifiable on the ground that it acknowledges the reality that there may be (and often are) parties other than the auditor that share actual responsibility in cases where loss is caused to shareholders.

The proposed approach does not involve affording favourable treatment to the auditor since, where the negligence of the auditor is solely responsible for the company’s loss, the auditor will remain solely liable in damages. As we understand the proposal, a negligent auditor’s share of the liability will only be reduced where other parties have also been negligent and a court decides that they should share the blame. This seems to us to be eminently fair and reasonable, and corrects a situation which is neither.

A practical consequence which we foresee from the proposal to make proportionate liability (PL) dependant on a contract entered into by the auditor and the company, as opposed to being applied generally to audit assignments, is that there is likely to develop a situation in which some audits are carried out under PL contracts and some are not. Provided that both sides are always aware of the option for them to apply PL to their relationship, and the bi-lateral negotiations are carried out properly, there may be nothing wrong in that outcome.

What would be problematic would be if there were to be introduced into the negotiating process any element of undue influence, which could have the effect of creating disputes and unenforceable contracts. The Department should be concerned to ensure that all contracts under the proposed regime are entered into freely and that the negotiating process is not distorted from either side. The situation needs to be monitored and the possibility of non-statutory guidance should be explored.

As regards the procedure for entering into PL contracts, it is essential that shareholders, as the primary legal stakeholders in the audit report, give their approval to the entering into of a PL contract. The approval must be given prior to the audit assignment commencing. Both these elements must be legal requirements.

Given that the Government’s intention is to provide for PL by contract, and not by direct statutory option, the chosen procedure will inevitably have to involve some delegation of authority from the members to the directors. We consider that the appropriate procedure would be for the shareholders at the AGM (or in writing, where the company does not hold an AGM) to approve simultaneously a resolution or resolutions i) to appoint the auditor, ii) to authorise the directors to settle his remuneration (if appropriate) and iii) to authorise the directors to enter into a contract with the auditor whereby the liability of the auditor for economic loss suffered by the company accruing from any negligence on his part should be limited to such an amount as is determined by the courts to be just and equitable, having regard to the relative extent of the auditor’s responsibility for the loss suffered. We suggest that it would be appropriate for the resolution or resolutions on these matters should be put to the members on the recommendation of the company’s audit committee (where there is one) – at the moment this would need to be dealt with outside legislation.

The position of auditors who are appointed to fill casual vacancies will have to be addressed separately. One option would be to give statutory authority to directors to enter into PL contracts with a new, ‘casual’ auditor with the proviso that that contract must obtain the retrospective approval of shareholders at the next AGM in order to be effective. We would, however, favour retaining the principle of approval before the event, which would mean that directors who could not gain the standard shareholder support at the time of making the casual appointment would not be entitled to enter into a PL contract with the new auditor.

The procedure for approving PL contracts should, as far as practically possible, reflect the direct reporting responsibility of the auditor to the company’s members, and should limit the potential for shareholder interests to be compromised in the course of contract negotiations. While shareholders routinely delegate individual company functions to the directors, the audit process is unique in the corporate environment since it has a direct purpose to act as an independent check on the executive’s stewardship for the benefit of the members. The wording of the authority to be given by the shareholders to the directors should, accordingly, have the object of creating a ‘standard’ basis of PL.

We agree that a company which has entered into a PL contract in respect of a set of its annual accounts should be required to disclose that fact in those accounts. This information will be useful to shareholders and any third parties who might have cause to bring a claim against the auditor.

With regard to the proposal that auditors themselves disclose, in their own annual accounts, a list of all companies with whom they have entered into PL contracts, we do not think that this would be as useful. The vast majority of audit firms are still partnerships, and do not publish their financial statements (although LLPs do). Requiring partnerships to disclose the said information in a document which is not made public and which is not itself audited would not, in our view, produce the stakeholder-orientated disclosure which we suspect the DTI is looking for. The result would be that some firms would publish the information and some would not. This would be unsatisfactory.

A new criminal offence for auditors (section 3.5)

We do not believe that the proposal to introduce a new criminal offence for auditors who knowingly or recklessly give an ‘incorrect’ audit opinion will, if implemented properly, cause problems for the vast majority of competent and conscientious auditors. The offence is not likely to cause problems for any auditor who carries out his or her work competently and in accordance with technical and ethical guidance. If the real intention in this proposal is to catch the small minority of auditors who still sign audit reports on behalf of unqualified practitioners, then we would wholeheartedly support that aim. Our only concern lies in the wording used in the White Paper, viz the Department intends to apply the offence to cases where an auditor has given an ‘incorrect’ opinion. It is inappropriate for the law to use such terminology in respect of an audit opinion, which is not presented as any form of guarantee and is neither ‘right’ nor ‘wrong’. It would be more appropriate for the new provision to apply to cases where auditors give an opinion which they know to be flawed (or perhaps unreasonable) or where they are reckless as to whether it is flawed or not. Whatever alternative terminology is used, the essential point is that the provision needs to address the fact that, in signing the report, the auditor gives an opinion which he or she arrives at on the basis of the performance of the whole audit engagement, which itself should be carried out in accordance with applicable technical standards.

Improvements in audit quality and value (section 3.5)

We have the following comments on the four specific proposals from the Audit Quality Forum.

• Publication of audit engagement letters
  
  We do not see what would be gained from the publication of audit engagement letters. The respective responsibilities of auditors and directors as regards the accounts are already disclosed, in standard form, in the auditor’s report. Details of non-audit services bought from the auditor, and the fees paid for those services, are soon to be the subject of new statutory disclosure rules.
  
• Shareholders’ right to question auditors
  
  There may be governance-related benefits in introducing such a right, but we would not regard it as being a driver of audit quality. If the right to ask questions was to be conditional on relevance to the audit or subject to a test of reasonableness, as suggested in the White Paper, there would have to be provision for some form of filtering mechanism, which would have to apply during and before the meeting. It might be easier to achieve this via best practice guidance rather than legislation.
  
• Publication of auditor resignation statements
  
  We would support a move to make public resignation statements more useful, provided a way could be found of ensuring that fuller disclosure was not likely to attract litigation.
  
• Audit lead partner’s signature on audit reports
  
  This proposal might carry some logic with reference to LLPs but not, in our view, to partnerships. Given the liability situation within partnerships, we do not see that the proposal would have any positive impact on audit standards. We consider too that there would be practical difficulties in legislating for the proposal. Specifically, a perception may be created that the standard of audit work within a firm varies depending on which partner signs a report. It could also serve to downplay the importance of the quality control arrangements of the firm as a whole.

Overall, our view is that the Forum’s proposals do not, in their present form, merit translation into law and should be left for the moment for the audit profession to develop further.

Capital maintenance (section 4.8)

The White Paper proposes a number of changes to the capital maintenance rules for private companies, on the basis that such rules are largely irrelevant to the vast majority of private companies. There is no commitment, however, to making what we would regard as a further useful reform, which would be to revise the rules which apply to distributions by private companies. The current Second Directive rules on distributions, which are currently in the process of being reviewed at EU level with a view to replacing them with a solvency-based test rather than a test based on asset values and accumulated realised accounting profits, need not apply to private companies. Notwithstanding the CLR’s previous recommendation that any reform for private companies should proceed in tandem with reform for public companies, it would still be feasible to reform the law as it applies to UK private companies in isolation from any EU initiative in this area. Making private company distributions subject to a solvency test, supported by a directors’ declaration of solvency, rather than making them subject to the complex technical rules designed for public companies, would be consistent with the Think Small First approach adopted by the Department. It would also help to address the issue, now recognised by the European Commission and the EU Accounting Regulatory Committee, of the potential effects of IFRS on companies’ ability to pay dividends to shareholders.

Information on the public record (section 4.9)

We welcome the commitment in the White Paper to introduce new powers to combat the filing of false and misleading information at Companies House. It is being proposed, inter alia, that Companies House be given a new power to seek the removal of inaccurate and misleading information and that it become a criminal offence to file information which is misleading, false or deceptive in a material particular. We consider these could prove to be useful measures to address what is, increasingly, an area of concern to accountants and businesses, namely the ease with which information on the public record at Companies House can be manipulated for fraudulent purposes. The weak link which currently encourages fraudsters is, however, that before Companies House can be in a position to take action in a particular case, it needs to be aware of the false information which has been filed.

Given the number of companies and LLPs on the register, and the amount of information which they all have to file with Companies House, it is evident that policing all the changes to the public record would be an immensely difficult task. We are aware that Companies House is aware of our concerns and is investigating the feasibility of instituting new controls, perhaps exploiting new possibilities offered by electronic filing techniques. But securing the integrity of the information on the public record will almost certainly depend on additional action, not just by Companies House but by companies themselves, as well as on changes to the law.

Presentation of accounting rules (section 4.10)

We consider that the approach adopted in Part G of the draft clauses, of presenting the statutory rules on company accounting for small companies separately from the rules for other companies, is likely to be helpful to the vast majority of companies that will qualify as ‘small’. The proposal to supplement the basic rules with a dedicated schedule of rules on form and content is likely to be similarly helpful. Our only reservation about the terms of Part G is that some of its provisions, viz the rules in chapters 2 and 3 on accounting records and the company’s financial year, are not exclusive to small companies and it is arguably misleading to users to state explicitly that these rules apply to ‘small companies’ (with the suggestion that they apply to those companies only. If this were seen as a problem, an alternative approach to the presentation of the accounting rules might be to start off with a section containing rules which are uniform for all companies and then proceed to deal, in Part G and its equivalent sections, with those rules which are exclusive to small companies and other companies.

Adopting the same approach as has been adopted in Part G for all other categories of company – large private companies, public companies and listed public companies – would involve a very high degree of duplication. It should be feasible to devise a basic set of rules for these three categories of company – or at least for large private companies and unlisted public companies - with separate provisions setting out applicable exemptions and additional requirements for the specified categories of company.

On a point of detail, we query the reference, in section G16, to the need for financial reporting by companies within the same group to be carried out using ‘the same financial reporting framework’. This term, not currently used in company law, needs to be defined separately.

With regard to the proposal to retain the option for companies to file abbreviated accounts on the public record (albeit with a new requirement to disclose details of turnover), we accept that this may be welcomed by many small companies. We would point out, though, that preparing abbreviated accounts represents an additional expense for the companies concerned and thus the proposal should not be seen as in any way a de-regulatory measure. We would also point out, in cross-reference to the Department’s simultaneous consultation on extending the range of companies which may use the summary financial statement, that the small company reporting regime risks becoming, if anything, more rather than less complicated to users.

Disclosures in the directors’ report (section 4.10)

We welcome the review of ineffective or superfluous disclosure requirements in the directors’ report. We believe that, following the introduction of the OFR for listed companies, it is timely for there to be a re-think of the whole purpose and content of the directors’ report. In considering which of the current disclosure elements can be discarded, though, the Department should also consider whether any of the current provisions can usefully be strengthened. One aspect which, in our view, should be re-examined urgently is the requirement for public companies to report their policies and practices for paying creditors, with emphasis on the latter element. The existing formula for determining a company’s average payment time is unhelpful since it enables companies to smooth their figures so as to produce a more attractive figure. Perhaps more importantly, very many public companies do not, according to research, disclose any information at all on their payment practices, possibly because there is no sanction for non-disclosure and no express requirement for the auditor to comment on the non-disclosure.

The present Government came to power in 1997 with a strong public commitment to combating late payment, leading to the enactment of the Late Payment of Commercial Debts (Interest) Act 1998. Studies have shown that the Act has failed to bring about any material change in companies’ payment practices and that the average payment time remains at 45 days. This, added to the finding, by the Federation of Small Businesses, that the majority of public companies choose to ignore their statutory responsibility to disclose information about their payment practices, suggests to us that many large companies no longer feel they are under social or political pressure to improve their payment practices.

It is therefore time that the Government refreshed its commitment to fighting late payment in UK business. One element of this new initiative should be a re-examination of the disclosures which public companies are to make in their directors’ reports. There needs to be a requirement for new, more meaningful information to be disclosed on companies’ payment practices. Such information could include, for example, information on whether or not its own contractual payment times (if any) exceed the statutory default terms (30 days), on the extent to which it adheres to its contractual terms, and on frequency with which suppliers brought action against it for statutory or contractual interest. Whatever information is to be required in the directors’ report, there must be some sanction for non-compliance with the disclosure rule, whether this be via fines or an express requirement for the auditor to comment on the non-disclosure.

Public companies (section 5.1)

It is proposed that, in future, it will be possible to form a public company with a single member, as is already possible with private companies. Despite this, draft clause B56 provides that a public company will still have to have two directors. Given that a public company will still have to have a company secretary, we consider that the two director requirement will have become obsolete in the single member regime.

On a related point, we welcome the proposal in section 4.9 that public companies will be able to take advantage of the voluntary strike off procedure. Currently, public companies which wish to do this have first to re-register themselves as private companies and then enter into the s652 procedure. The proposal will therefore save companies time and money.

Interaction of company law and business names law (section 5.2)

We very much welcome the proposal to rationalise the interface of the Companies Act and the Business Names Act. It is currently the case that a company can be legally prevented from using a particular corporate name because it is misleading to the public, yet it may continue to use that same name as a trading name. This is a potentially harmful anomaly and we support its correction.

New secondary legislation powers (section 6.1)

We opposed strongly the Department’s proposals to bring in new secondary powers to reform and re-state company law when they were consulted on in 2004. We questioned the appropriateness of allowing primary law to be changed by any form of streamlined procedure. Another of our concerns was that it could be dangerous to ‘re-state’ primary law for the consumption of one group of stakeholders, i.e. small companies, alone. Given that the White Paper states that the Department intends to issue, side by side with the new legislation, a series of plain English guides on what the legislation means, we again query what additional purpose would be served by issuing secondary legislation to re-state the law. It seems to us that if parts of the new legislation turn out to be difficult for some readers to understand, even with the new drafting emphasis on ‘accessible language’, then these difficulties should be capable of being resolved by the plain English guides. If companies still fail to understand what the law is saying, then we feel that the reasonable solution should be for them to take professional advice. We suspect that adding more legislation to the equation will needlessly complicate the situation for all concerned.

Liability for offences under the Act (draft clauses Part J)

The White Paper proposes that the law should provide for liability to be attributed not only to officers of a company but to ‘senior executives’ and ‘responsible delegates’. We acknowledge that the extension of liability could have advantages in certain defined circumstances, for example where a company engages an accountant to prepare its accounts for it – in such a case, the directors may not have the resources to fulfil their legal responsibilities themselves and it may be entirely reasonable that they delegate their functions in this matter to a third party. But the proposals to widen the circumstances in which directors may delegate their statutory responsibilities are, we think, too wide. We believe there is a particular danger that directors may delegate responsibility to employees and third parties who are unaware that they are assuming legal liability for performing the task in question. This would be wholly unreasonable. We consider further that changes to the law in this area should await the conclusion of the Equitable Life case which is currently before the courts. For the moment, we believe that the principle should remain that directors should remain ultimately responsible for the discharge of the duties which have been delegated to them by their company.

Supervision of small companies

We have on previous occasions registered our concern that, under the new regime, all small companies will be able to operate without an auditor or a company secretary. We believe that this will risk lowering standards of financial management and legal compliance among small companies, and in particular among those small companies which do not at present take these issues seriously, often to their own and their creditors’ detriment. This risk stands to become greater if small companies are led to believe that it is the functions of the company secretary that are to become optional, and not just the office itself. The Department should consider stressing this distinction to small companies, possibly through the planned ‘plain English’ guides.

With regard to small company finances, the abolition of the small company audit has created a situation whereby the great majority of companies are entitled to operate without an independent check on their accounts and underlying procedures. If a private company’s turnover is below £5.6 million, it need not have an audit. We believe that the gap between companies which are subject to the full audit requirement and those which are free from any legal review requirement is now too great. We are aware that a limited assurance procedure was tried in the mid 1990s, when audit exemption was re-introduced for small UK companies. This limited review was not successful, largely because shareholders did not understand its purpose and because the full audit was considered to be the only realistic option for companies which wanted or needed an external assurance report. We do not argue for the restoration of such procedures. But we consider that there is a strong argument for requiring companies that are not audited to have their accounts prepared by a qualified accountant. The financial statements could contain a statement to the effect that a named accountant or firm had prepared the accounts. The directors would continue, as now, to approve the accounts on behalf of the company. But the formal delegation of responsibility from the directors to the accountant would, in addition to any statutory sanction, serve effectively to make the accountant liable to the company for any failure on his or her part to comply with preparation rules.

It would additionally be useful if the law identified which ‘accountants’ were to be eligible to prepare accounts on behalf of limited companies. This would in turn create an opportunity for much-needed reform of the unqualified accountant sector. We would not argue that eligibility to prepare accounts should be restricted to registered auditors or to members of CCAB bodies. Other, well-established bodies could fairly be added to these if they met reasonable minimum conditions. But there are a number of organisations in the UK which promote themselves as accountancy bodies, and which award qualifications to their ‘members’ in return for no evidence of competence at all, and no requirement for indemnity insurance, experience or continuing professional development. We believe that this situation is a recurring threat to fair trade and also to the consumer interest, in that such bodies are exploiting consumer ignorance of the lack of regulation of the title ‘accountant’ in the UK.

The Department has recently declined to take action in response to our suggestion that legal restrictions be introduced on the title ‘accountant’. We consider, however, that it would be feasible to introduce a new requirement for non-audited companies to involve a qualified accountant in the preparation of their annual accounts. We suspect that this would be an attractive proposition to the tax authorities and to Companies House, as well as an initiative which would help to further rationalise the UK accountancy profession.

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