Modern Company Law - The Strategic Framework
The Consultative Document issued by the Company Law Review Steering Group
Comments from The Association of Chartered Certified Accountants
Executive summary
Chapter 5.1: Scope of company law
Non-traditional disclosure
Chapter 5.2: The needs of small and
closely-held companies
Accounting and reporting issues
Audit
Chapter 6: High level accounting
issues
Accounting standards
International accounting
standards
Directors’ report
Auditor’s report
The impact of IT
Responses to specific questions
Appendix: Initiatives in
environmental reporting – a summary
Introduction
The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to respond to the consultative document ‘Modern Company Law for a Competitive Economy: The Strategic Framework’, issued by the Company Law Review Steering Group. Our principal conclusions are set out in the following summary.
Executive Summary
• ACCA broadly supports the steering group’s provisional strategy for the company law reform project. In particular, we welcome the overall objective to produce modern companies legislation in a coherent and accessible form which provides maximum freedom for business while at the same time ensuring proper protection for interested parties.
• ACCA endorses the steering group’s conclusion that the Companies Act needs to be restructured so that it better reflects how most modern companies operate. The format of the Act needs to be changed so that the rules which apply to private companies are presented separately to those which apply to public companies or in stand-alone form. This is not to argue that small companies as a group are more important than larger companies, but to recognise the potential of rationalisation for achieving greater clarity and simplicity in the legislation.
• The review team needs to identify the overriding purposes of statutory regulation of limited companies. We suggest that there are or should be two main purposes. First, the function of the law as it applies to companies is to protect the interests of creditors and other stakeholders as well as the public interest generally. Second, the law should be framed in such a way as to help companies, in practical ways, to operate efficiently as well as responsibly.
• It is in the public interest, as well as in the commercial interests of the business community in general, that all businesses which have chosen to acquire corporate status should be required to make reasonable disclosure of their activities and to provide assurance to the public that the obligations to which they are subject are being fulfilled. What is in the public interest for a company to disclose will vary according to the size and complexity of the company and is likely to evolve over time.
• Statutory rules on accounting and reporting should be framed on the basis of their relevance both for internal and external purposes and for companies and their stakeholders alike. With this in mind, there is now a sound argument for expecting public companies to assume new responsibilities for environmental and social reporting. As for smaller companies, the law should be used to promote better financial management on their part. For external purposes, the existing small company accounting exemptions serve little useful purpose and should be reformed.
• An important contributory factor to good financial management by limited companies is the discipline instilled by the statutory external audit. For this reason, among others, we believe strongly that the Companies Act should continue to require that the great majority of limited companies subject themselves to external audit.
• Given the difficulties that some very small companies claim they have in complying with Companies Act rules, we are in favour of imposing an ‘entry test’ for incorporation, imposed via a minimum capital requirement or some form of bond. This should be considered simultaneously with consideration of alternative business formats for micro-businesses. Stricter controls on access to the company structure could help to safeguard creditors’ interests and raise standards of conduct by company directors.
• While it should be more difficult for companies to acquire corporate status in the first place, unnecessary legal restrictions on internal administration should be lifted. Companies should be free to conduct their internal affairs as they see fit. In doing so, they should be free to make full use of all forms of communication technology both in their internal affairs and in the filing of returns with Companies House. In considering how compliance rules might be relaxed, however, every care should be taken to retain, and strengthen, effective statutory checks on fraud.
• The project needs to consider how the law can help to improve overall standards of conduct by company directors. This should involve, inter alia, the statutory clarification of directors duties and increasing the efficiency of existing enforcement machinery.
We address a number of issues raised in the consultative document in more detail in the following paragraphs.
1. Chapter 5.1: Scope of company law
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1.1 We consider that the basic issue discussed in this Chapter, namely the role that the law should play in determining to whom a company should owe responsibilities, and what those responsibilities should rightly be, is crucial to the whole review. The further work to be undertaken within the project needs to based on an agreed understanding of the nature of the limited company format and of the legal relationship it has with its ‘stakeholders’.
1.2 There are two basic realities which underpin the existence of all limited companies, whether they be private or public and whether they are limited by guarantee or by shares. First, any company is set up by its incorporators in order to carry out particular activities or to achieve certain objectives. It is the company’s incorporators (and their successors) who define the company’s operational character and who provide its core financial commitment. Without the initiative of the incorporators, any company would not have come into being in the first place. Second, through the process of incorporation, the entity will have acquired material legal privileges, most notably regarding perpetual existence and limited liability for its members. These privileges mean that the law will offer a protection to those acting within the company format that would not be available to those individuals conducting business alone or within non-corporate business formats.
1.3 In our view, it is these two realities which should be paramount when discussing the proper extent of companies’ responsibilities to stakeholders. In the former case, it is the company’s incorporators (and successor members) who are directly interested in the company’s affairs, in terms of determining its range of activities, on collectively bearing its financial risk and on sharing in its profits. It therefore follows that those who manage the company’s affairs should owe responsibilities to its members to act in their best interests. In the latter case, the law agrees to extend legal recognition and protection to businesses that choose to incorporate even though the interests of individual business people or members of the public are put at risk at a result. It is, we suggest, the natural corollary of the legal act of incorporation that the state is entitled to expect that a company should owe certain responsibilities to act in what is defined as the public interest.
1.4 We agree that, in respect of both cases, there is scope for the revision and extension of current obligations. As far as duties to members are concerned, there must be a more sensible balance between rules designed to ensure legitimate member involvement in company affairs and freedom for companies to concentrate on actually running their business without unnecessary distractions. As far as responsibilities to the law are concerned, the notion of the ‘public interest’, on which all reporting obligations are, arguably, based, has to be seen as an evolving concept. If society is changing, and particular issues become socially more significant, then it is reasonable for the law’s definition of the public interest in the context of limited companies to also change. Limited companies have a huge impact not only on the economic and commercial life of the country but on society at large. We believe, therefore, that it is legitimate for the law as it is applied to limited companies to incorporate specific measures designed to reflect and promote the wider public interest.
1.5 We are, however, opposed to some of the more radical extensions of the scope of legal responsibilities discussed in Chapter 5. The review project is required by its terms of reference to, inter alia, consider how company law can be modernised while at the same time protecting the interests of those involved with an enterprise, including its shareholders, creditors and employees. We consider that it is a dramatic and ill-advised step to go from this to suggest that directors of limited companies be required to adopt a fully pluralist approach to corporate governance as it is described in the document.
1.6 In paragraph 5.1.8, the document states that, while the review project should promote competitiveness and the efficient creation of wealth within the corporate sector, it should also seek to maximise wealth more widely. It cites as an argument for change in the ‘pluralist’ direction that the law currently fails to recognise that ‘businesses normally best generate wealth where participants operate harmoniously as teams’. No evidence is put forward to justify this assertion. The document goes on to suggest that, under a pluralist approach, the interests of suppliers of goods and services to the company would need to be taken into account by directors when considering whether any decision was in the best interests of their company. It is even suggested that directors might be permitted to favour the interests of customers and suppliers even if this was detrimental to the interests of their shareholders.
1.7 We accept that the group’s principal purpose in putting forward these suggestions on ‘pluralistic’ management may be to encourage company directors to take a more responsible and longer-term view of what constitutes the best interests of their company. Decisions taken for short-term financial gain which lead to the destruction of profitable business relationships or which render the company liable to criminal penalties will, clearly, not be in the long-term interests of the company. We do not accept, however, that the current rules, which require directors to assess whether a particular action is in the best interests of the company at the time the decision is taken, preclude or discourage them from taking a long-term view. As for the suggestions that directors should be obliged or permitted to take into account other ‘stakeholder’ interests in their decision-making, we do not believe that this would be feasible or desirable, for the following reasons:
ii) As stated above, it is the company’s members who have the direct stake in the fortunes of their company, and it is they who have the pre-eminent right for their interests to be taken into consideration in corporate decision-making. This notwithstanding, it is not true to suggest that directors, when using their delegated powers to decide what is best for their company, are currently restricted to making decisions which only serve the immediate interests of members. For example, a decision to distribute funds to dominant shareholders at the expense of necessary investment or provisions, or actions by directors which had the inevitable result of losing key employees, customers or suppliers would, in all likelihood, currently constitute breach of duty on the part of directors. On the other hand, companies are currently empowered to make donations to charities and to political causes.
iii) At present, under s309 of the Companies Act, directors are required to ‘have regard’ to the interests of employees in their decision-making, but owe no duty to them. For there to be a meaningful duty on directors to serve the interests of customers and suppliers (and employees), those groups would have to have a right of recourse where they felt their interests had been adversely affected. This could impose crippling administrative burdens.
1.8 Our view is that directors should retain the discretion to decide what constitutes the best interests of their company, within the framework set down by the law to govern the nature of fiduciary duties and the duties of skill and care. While there may be scope for non-statutory action to encourage directors to widen the range of factors that they take into account, we see this as a matter for best practice guidance, or education, and we do not consider that it should be the function of the Companies Act to oblige directors explicitly to take into account an extended range of interests.
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1.9 ACCA does not believe that it is necessary to change radically the existing framework of responsibilities as between companies and their stakeholders. To move to the full pluralistic approach advocated in the consultative document would risk suffocating the corporate decision-making process. The alternative approach - the so-called enlightened shareholder value approach - is more realistic and is more likely to meet the stated objectives of the reform project. This being said, statute law has an important role to play in terms of setting benchmarks for the stakeholder responsibilities that companies should be expected to assume. The accounts disclosure framework of the Companies Act has been used increasingly in recent years to require companies to publish information on the extent to which they are conforming with various public policy ideals. We believe that this trend should be continued with new emphasis on innovative forms of corporate reporting.
1.10 ACCA has been instrumental, throughout the 1990s, in developing new, voluntary forms of corporate reporting. Initially, our efforts were concentrated in the environmental field. ACCA’s Environmental Reporting Awards, started in 1991, have proved influential in terms of promoting the cause of environmental reporting and in explaining its commercial virtues. More recently, we have expanded our interest to cover social and ethical reporting. We believe that there is now substantial evidence that it would be in the public interest for the Companies Act to require limited disclosure of the way companies impact on their environment.
1.11 In the Appendix to this submission, we set out several initiatives that have taken place in recent years to advocate the extension of disclosure in the general area of corporate social responsibility. In addition to the developments discussed, we would mention that in the Netherlands and Denmark there already exist mandatory reporting rules for the reporting of environmental matters, although in both cases the reporting is undertaken separately to the requirements of companies legislation. While the various initiatives have been successful in terms of developing a consensus as to what environmental reporting should encompass, they have so far not succeeded in encouraging widespread voluntary adoption of environmental reporting practices. A 1999 survey by Pensions Investment Research Consultants (PIRC) has confirmed that environmental and social disclosures by the top 350 listed companies remain at a relatively low level. This disappointing finding calls into question the value of voluntary initiatives alone.
1.12 Through ACCA’s work with the Department of the Environment, Transport and the Regions (DETR), the UK Government’s Advisory Committee on Business and the Environment, the UN Environment Program, UNCTAD and, most recently, the Global Reporting Initiative, we have become convinced of the need to move beyond purely voluntary disclosures. Consequently, we believe that, for there to be an overall expansion of published information on environmental performance, the law needs to lay down basic standards. In our response to specific question 6 below, we suggest a number of key disclosure points. We do not however propose, in this submission, to put forward a detailed list of environmental disclosures. What is more important now is for the reform project to accept, in principle, that there is indeed a genuine public interest case in favour of more disclosure of the way that companies interact with the environment. If this basic argument is accepted, then the detailed questions of the extent of new disclosures, their level of detail etc, can be left until later. We would merely reiterate at this stage the comments we made in response to the DETR consultative document on ‘Sustainable Business’ in 1998. On that occasion, we supported the call of Michael Meacher, the Environment Minister, for all companies with over 250 employees to publish an environmental report. In our view, this report could take the form of a short environmental review section in the company’s annual report. The review could complement existing corporate governance disclosures and would send a strong message to City institutions that the way a company manages its dealings with the environment is a significant investment-related issue.
1.13 The same arguments that can be produced in favour of greater disclosure in the environmental field can be used to support the idea of more disclosure in other, non-traditional areas of corporate reporting. If it is accepted that it is in the public interest for limited companies to assume reporting obligations in respect of their impact on the environment, then, given wider share ownership, enhanced consumer awareness and a recognition on the part of many businesses that they should be prepared to present themselves to their markets as socially responsible organisations, there is a similar case for adapting company disclosure rules to cover other areas which have the potential to influence corporate reputations. Among the individual areas that might be covered in new reporting rules are equal opportunity records, health and safety performance, policies regarding child labour, fraud and corruption policies, dealings with oppressive regimes, genetically modified foods, animal testing of consumer products.
1.14 In putting forward these thoughts on ‘non-traditional’ reporting, we are conscious of the concern among companies that they are burdened by an ever-increasing amount of compulsory disclosure. The scale of any new reporting responsibilities needs to reflect this reasonable concern.
2.Chapter 5.2: The needs of small and closely-held companies
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2.1 ACCA agrees that the application of company law to small and closely-held companies should be addressed as a special issue within the review. Most UK businesses are SMEs and this sector is responsible for creating the majority of new jobs. It is therefore entirely appropriate for the review to examine how the law could be re-drafted or re-presented to enhance the competitiveness of small companies.
2.2 We also welcome the steering group’s suggestion that companies legislation should be re-structured so as to better reflect the reality of how most modern companies operate. It is anachronistic for the Companies Act to remain presented in a way which implies that the standard limited company is one which has the characteristics of a public company with a sophisticated ownership structure rather than a closely-held private company, the latter type now accounting for 97% of all registered companies. All companies, but particularly small private companies, would benefit from the Companies Act being presented in a way which is clearer, more accessible and more relevant to their needs.
2.3 Recent initiatives to liberate private companies from otherwise standard rules on company administration mean that there exists already a distinctive body of permissive law for this sector. Care should be taken, however, in the process of simplifying and adapting legislation for the benefit of small companies, that the law continues to reflect the fact that all limited companies share the same legal status and statutory protection from creditors.
2.4 ACCA remains of the view that corporate status is practically and in principle inappropriate to many very small companies. The proper vehicle for many of these companies is not the limited company but some form of unincorporated status. A new business format which afforded legal personality and perpetual succession but not the protection of limited liability for members would suit micro-businesses better than does the limited company. As a general point, we do not believe that the agenda of reform for the law as it applies to small companies should be driven solely by a desire to reduce their statutory obligations to the absolute minimum. Rather than reducing company law requirements to a level which brings into question whether small companies are assuming the responsibilities of limited companies at all, it would be better if, in the context of a wider initiative to promote business competitiveness, micro-businesses were encouraged to disincorporate and to adopt some other business format better suited to their needs.
Accounting and reporting issues
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2.5 The consultative document states that the next phase of the review will consider the value to small companies of statutory accounts, both for internal and external purposes. Although this is an area on which much attention has already been focused, the current framework has several weaknesses and merits a thorough re-analysis.
2.6 We welcome the steering group’s acknowledgement that accounting information is valuable for small companies and represents a useful protection for those shareholders not concerned in management. We believe that financial discipline, as imposed via rigorously applied though flexible rules and technical standards, is essential to the well-being and competitiveness of individual companies and by extension to the business community generally. There is scope for the review to address how the law’s accounting and reporting framework can better serve the information needs of various interested parties. Much of the dissatisfaction that is expressed about accounting obligations stems, we suggest, from the feeling that, as they are currently framed, they amount to a routine chore which accrues no substantive benefit to the company or to users of the accounts. As an example, companies are allowed to file their accounts so long after their year end that those accounts may be irrelevant as soon as they are placed on the public record. The test for the review is, we believe, to re-frame the accounting rules so as to make reporting obligations more relevant both to companies themselves and to users of their accounts.
2.7 When reforms to the small company regime have been considered in recent years, it has been on the presumption that external reporting rules impose on companies administrative and financial burdens, burdens which might be unnecessary and which could be reduced in the interests of companies’ operational efficiency. The purported cost benefits of reducing disclosure requirements have been considered in priority to or to the exclusion of other factors. Cost, however, is not the only factor to be taken into account in the case of limited companies. What is also vital is the question of the practical value of accounting information both to small companies themselves and to their stakeholders.
2.8 Any attempt to reform the current rules should start by analysing the needs of small company owner/managers in relation to how they use financial information and in their dealings with external partners. There is much debate as to how SME owner-managers use information and about the models that they use to do so. Most agree, however, that SME owner-managers need much higher levels of financial awareness and skill. In fact, we would dispute the suggestion made in the consultative document that small companies have good management accounts. The vast majority of small companies do not produce management accounts of any kind: this is one reason, in our opinion, why so many get into financial difficulties. Research carried out for ACCA has also stressed that the financial management needs and strategies of managers of small companies differ markedly from those of their counterparts in large companies.
2.9 We believe that a core aim of any reform of the statutory accounting process should be to improve the standard of financial management in smaller companies. One obvious area in which change should be considered concerns cash management. Cash is the life-blood of business and directors must be aware of their company’s cash flows if they are to control them effectively. The statutory accounting rules should thus seek to ensure that companies collect and analyse the range of information that responsible SME owners would themselves choose to evaluate their businesses. The overall aim should be to improve standards of financial management in the interests of companies and of their trading partners and creditors.
2.10 At the same time, external users have legitimate information needs, and these too need to be accommodated in statutory reporting rules. The abbreviated accounts regime, introduced into UK law via the EU Fourth Directive in 1981, has not proved successful for stakeholders or reporting companies. As far as small companies are concerned, abbreviated accounts constitute a supplementary expense, in that they must be prepared in addition (rather than as an alternative) to the full, true and fair accounts that are prepared for shareholders. The abbreviated accounts regime cannot, consequently, be regarded as a simplification measure. Perhaps for this reason, large numbers of eligible companies decide not to file abbreviated accounts. Where a small company decides to do so, those accounts offer little useful information. They would certainly not be used by any prospective lender or trading partner as the basis for an informed business decision. They are for all practical purposes an irrelevance.
2.11 In our view, therefore, the current abbreviated accounts regime has nothing to commend it and should be abolished. Our preferred option would be for small companies to file their full, true and fair accounts. Only these will present a technically complete analysis of the company’s financial position. Where a company’s accounts have been audited, this represents the best available assurance for users as to the company’s financial state and prospects. We acknowledge, however, that in the interests of relevance to readers of small company accounts, an alternative form of statement, framed with the perceived information needs of those readers in mind, has attractions. One option would be for small companies to prepare a concise version of the summary financial statement that public companies are entitled to produce. Alternatively, the suggestion outlined in the consultative document, that small companies might file a declaration of solvency along the lines of the statement filed by directors prior to a company’s entry into liquidation, is worthy of further consideration. On the face of it, such a declaration could offer a useful assurance to short-term trade creditors. It is essential, however, that the review considers the question of filing deadlines in relation to the declaration of solvency. The current ten-month deadline allowed for the filing of private company accounts is too long to ensure continuing credibility for those accounts and should be reduced to a maximum of six months. If the declaration of solvency were introduced, the filing deadline should be fourteen days from the balance sheet date or the date of the declaration, or earlier.
2.12 The review needs also to consider the future of the annual return. There seems no reason why the return should need to be made out and filed separately from the annual accounts. The information currently included in the return, most obviously details of shareholders, could be added to the information required to be included in the accounts package.
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2.13 In reviewing reporting rules as applied to small and closely-held companies, the steering group and the working group concerned need also to consider the question of the continuing value of the external audit to small and closely-held companies.
2.14 ACCA believes as a matter of principle that the external audit, being the only available objective assessment of whether a company is conducting its financial affairs in accordance with its obligations under the Companies Act, should be seen a standard quid pro quo for the award of limited liability. We also believe that, in practical terms, the audit plays a vital role in promoting financial discipline within companies, deterring fraud and providing a form of reassurance to prospective lenders and other business stakeholders.
2.15 In our view, these arguments remain valid across the range of active limited companies. In recent years, however, there has been a re-assessment of the precise value of the mandatory audit for small, closely-held companies, which has led to exemption from the standard audit requirement for close private companies with turnover of up to £350,000. The arguments in favour of relaxation of the statutory rules have tended to focus on the perceived limited value of the external audit in situations where there are no shareholders (who are the addressees of the audit report) who are not concomitantly involved in the management of the company. While we acknowledge that owner-managers in small companies may feel that they do not need, as shareholders, an independent assurance from an auditor, the law should be very careful, in our view, in accepting that a simple preference on the part of owner-managers not to have an audit amounts to sufficient reason to permit exemption. We have previously referred to the widespread lack of financial skills among small company proprietors, a problem which is not likely to be addressed if more companies are to be encouraged to do without expert financial help. Also, without an independent audit, there can be no assurance of any kind that a small company is complying with its responsibilities to produce true and fair accounts and maintain financial records.
2.16 In addition to its function as a legal check and a valuable safeguard against fraud and mismanagement, ACCA believes that the audit has the potential to act as a constructive business process for companies. Recently, ACCA commissioned a survey, undertaken by MORI, to test this belief. The objective of the survey was to gain a clearer impression of how those with the most direct interest in the matter - auditors themselves, small business proprietors and banks - viewed the small company audit, the value of the service provided by auditors and the merit, if any, of further extending the range of companies that are exempt from the statutory audit. The full findings of the survey are attached to this submission for information. In summary, however, the main findings are as follows:
• 82% of companies see the information contained in audited accounts as being useful to banks and the Inland Revenue.
• 64% of companies and 53% of banks agree that the audit provides the most authoritative check of a company’s performance.
• 79% of companies and 71% of banks agree that being subject to audit instils discipline into a company’s record keeping.
• 93% of companies and 94% of banks agree that banks are more willing to lend to companies if they can produce audited accounts.
• 60% of companies favour an increase in the audit turnover threshold to £500,000 (while 28% oppose any increase). 41% of banks would favour an increase to that level, while 53% are opposed. An increase to £750,000 would be supported by only 30% of companies and 6% of banks.
2.17 The findings of the survey suggest that the external audit is regarded by the great majority of business people and banks as a cost-effective exercise that adds value and credibility to a company in the conduct of its business and in its dealings with its stakeholders. They confirm our view that the independent audit should not be seen as a routine compliance procedure or even as a legal concession to the public interest but a practically beneficial business process. Given that one of the core aims of the review is to promote competitiveness, we therefore urge that any moves to extend the range of exempt companies should be treated with caution.
3.Chapter 6: High level accounting issues
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3.1 The information that companies publish in their annual accounts and related statements constitutes the prime source of data for stakeholders and the general public as to how effectively and responsibly the company is operating. The publication by all companies of information that is sufficient to meet the needs of stakeholders should, therefore, be confirmed as an essential feature of company law. We are conscious of the adverse effects on stakeholders, particularly creditors, in those jurisdictions where public filing requirements are either non-existent or not enforced.
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3.2 The consultative document discusses the present ‘hybrid’ arrangements for determining accounting and reporting rules, whereby the law sets a framework of disclosure and the accounting profession supplements it through the issue of guidance largely on measurement issues, and suggests that they are not ideal. In our view, they have proved effective, particularly since the re-structuring of the standard-setting process following the Dearing Report, and should be retained.
3.3 The advantage of the current system is that technical guidance on new issues can be considered and issued far more quickly than can statutory rules. It is accepted that guidance from the accountancy profession constitutes an integral element of the overriding legal requirement for accounts to give a true and fair view: accordingly, the current arrangements allow the law to be kept up to date and responsive to new developments. The establishment, as part of the standard-setting regime, of the Financial Reporting Review Panel (FRRP) means that the statutory reporting framework is supported by an effective monitoring and enforcement mechanism. We believe that, at a technical level, the combined work of the standard-setting bodies has proved successful. Their work has been helped by the fact that there is effectively statutory backing for their output. We believe, therefore, that the current dual system has benefits for both the law and the accountancy profession and deserves to be retained.
3.4 The consultative document mentions the argument that the accounting profession’s emphasis on historic cost and tangible assets no longer meets the needs of today’s economy. If this particular argument is valid, then it would appear to indicate a failing of accounting standards rather than a defect in the law, one which the standard-setting machinery should be capable of rectifying in the first instance. We do, however agree strongly with the suggestion made in the consultative document concerning the possibility of legislating for the production of a cash flow statement. In our view, the focus of the law should be on setting minimum disclosure standards. Given the importance of cash flow in business, it would be appropriate for the law to reflect this by requiring all companies, including small companies but exempting wholly-owned subsidiaries, to produce a cash flow statement as part of their statutory accounts, on the same level as the balance sheet and profit and loss account.
International accounting standards
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3.5 In the view of growing support for accounting harmonisation and the increasing globalisation of business and commerce, it is logical for the review to consider the relative status of national and international accounting standards (IAS). We do not believe it is defensible to deny listed companies the right to follow international standards. Although there are differences in accounting treatment between UK and Ireland GAAP and IAS, these differences are likely, in due course, to diminish. We therefore favour the law allowing, but not requiring, the use of IAS. In the interests of comparability, however, there would need to be a requirement for companies which opted for IAS to add a reconciliation statement, as is currently provided by UK companies with US listings.
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3.6 We agree with the suggestion that the directors’ report has developed in an incoherent fashion, having been regarded as a convenient hook on which to hang new disclosure measures. While we do not dispute the value of the information that is currently included in the directors’ report, it would indeed be appropriate for the review it’s nature and purpose.
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3.7 ACCA strongly believes in the value of the independent audit, the core legal purpose of which is to make sure that a company is complying with its statutory responsibilities to maintain accurate financial records and to prepare annual accounts that give a true and fair view. This alone is, an essential public interest function which it is right that the law provides for. What the audit process does indirectly, however, is to exert legitimate pressure on a company’s management to make sure that its internal financial management is effective and correct and that it accounts for its activities properly and makes full disclosure of all relevant matters. Without the involvement of the auditor and the audit process, the pressure on company management to operate legally, efficiently and correctly is significantly reduced.
3.8 The audit profession is fully aware of the difficulties, some of which are identified in the consultative document, that it faces in explaining the virtues of the audit. The profession has already acted to try to resolve them. ACCA supports, in principle, moves to extend the role of auditors so as to enhance the practical usefulness of the audit to companies and their shareholders. We would therefore encourage the review to consider ways in which the scope of the audit and the responsibilities of the auditor might be so extended. Any proposals in this direction cannot however be considered in isolation from the concerns that the audit profession has over the issue of professional liability. It has become increasingly difficult in recent years for large audit firms to obtain adequate and affordable insurance cover. This is due largely to the increasing tendency of plaintiffs when suing companies for financial loss to join the company’s auditor in their actions, on the basis that auditors, through their indemnity insurance, have ‘deep pockets’. This tendency has been responsible for forcing up the price and restricting the availability of insurance cover. ACCA and the other audit bodies have argued in favour of a system of proportional liability under which auditors can be held financially liable up to the level of their actual responsibility for the loss that the plaintiff has been caused. We view such a system as fair and reasonable. We appreciate that this is an ancillary issue to the reform of company law as it affects the audit report but we mention it here since it is an issue that is relevant to any consideration of the expansion of auditor duties.
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3.9 As indicated earlier, we agree that the implications of developments in information technology are of great significance to company law. The Companies Act should be brought up to date so as to reflect developments in technology with the aim of, inter alia, making published company information more useful.
Responses to specific questions
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Our responses to specific questions posed in the consultative document are as follows:
Q1 (a) Although it will be useful to have an accessible statutory presentation of the duties of directors, we do not believe that there is a case for any material change in the law relating to the scope of directors’ responsibilities. The substance of the present statutory and non-statutory rules should remain intact, although these should be rationalised and re-presented on the conclusion of the work currently being undertaken by the Law Commission. If the Commission’s proposals to develop authoritative non-statutory guidance for directors are pursued, that would appear to be a suitable vehicle for a discussion of the range of matters that directors should consider when assessing what are the best interests of the company in any particular situation.
Q1 (b) It would be helpful if a revised Companies Act could include, as an Appendix, references to the statutory provisions which are applied to company directors by other statutes.
Q3 We agree that s309 of the Act is currently misleading, particularly to the extent that it is presented in the Act as a duty to employees and should be removed pending clarification as under our response to Q1(a).
Q5 We do not favour the introduction of any new obligation for directors to have regard to unspecified wider social or ethical objectives at the expense of the interests of members. Directors should retain their power of discretion to commit their company to any activity they believe is in its best interests (with appropriate safeguards being provided for members to challenge directors’ decisions). The law as it stands already implicitly allows companies to spend company funds for charitable and even political purposes, provided always that the directors are able to satisfy themselves that such expenditure will be in some way beneficial to the company. It would be useful for the revised Act to spell out this discretionary power.
Q6 (a) ACCA favours the introduction of legal requirements to extend the scope of statutory reporting to areas that have identifiable public interest implications. Statutory requirements to report on particular matters not only provide potentially helpful information to users of a company’s accounts but also act as an encouragement to companies to compare their performance with industry benchmarks and, thereby, to seek to improve their own performance in the area concerned.
We believe that a broad consensus has now developed among Government, the business community and the professions with respect to the wider social importance of how a business impacts on the environment. This consensus is mirrored in other developed countries. It is also the case that individual companies are recognising the benefits, for their own internal management and their own marketing, of devising comprehensive strategies for identifying and responding to environmental risks. We believe, therefore, that the introduction of reasonable environmental disclosure requirements in the Companies Act would be in the public interest. Statutory recognition of environment-related activity also has the potential to assist individual companies to take appropriate and effective action in this area in their own operational interests.
The Companies Act should contain a requirement for all companies with over 250 employees to publish, as part of their annual report, a brief environmental review. The law should provide that the review covers the following issues:
• Identification of the board member, if any, who has responsibility for environmental issues
• A statement of what the directors see as the main environmental risks facing the company, and how the company is responding to them
• A statement by the directors giving their opinion as to the effectiveness of the company’s environmental management system.
• A general statement that there are no undisclosed environmental liabilities and that existing environmental remediation provisions (if any) are adequate
• A cross-reference to any more detailed environmental communications (separate reports, web sites etc)
Q7 If directors genuinely feel that to take action on behalf of their company to thwart a take-over bid would be in the best interests of their company, as they see them, we believe they should be free to do so. Should shareholders be dissatisfied at the directors’ actions in any particular case, they can always seek the directors’ removal.
Q8 The basic scope of company law must apply to all companies regardless of size. This is because all companies share a similar legal status and character, which involves protection of their members from the unmet financial commitments of their company, a protection which has the potential to cause loss to creditors, employees and the state. The basic law should therefore be applied uniformly to all companies. It should, however, be flexible as regards the detailed application of particular rules. It should be prepared to acknowledge the different ownership structures of small, closely-held companies on the one hand and large, public companies on the other and accept, for example, that the detailed prescription of internal administrative rules is not necessary for the former type of company. As regards reporting on their activities to the outside world, allowance should be made for the extent of disclosure that is likely to be reasonable and useful for prospective readers of that information. We envisage, for example, that the disclosure of new ‘stakeholder information’, which we address in response to Q6 above, should be only applied only to public companies.
Q9 We agree that the needs of small and closely-held companies warrant special attention during the review project.
Q10 We do not agree with the steering group’s quick dismissal of the merits of restricting access to limited liability. We suspect that some at least of the pressure which has been exerted on Government to reduce small company compliance burdens in recent years has derived from the fact that many limited companies are so small or under-resourced that they do not have the capacity to cope with the administrative requirements which the law imposes, and therefore claim that they are being overwhelmed by unnecessary red tape. It can also be pointed out that the pressure to reform s459 of the Companies Act, currently being acted upon, has been caused, in large measure, by the high number of family or partnership-based companies whose directors fall out and subsequently enter into prolonged and expensive legal actions. It seems inconsistent for company status to be so easily and cheaply available when directors’ duties are so onerous and when directors and their companies are capable of causing so much financial damage to those with whom they deal.
If there were a material entry test, either a minimum capital figure or some form of bond, this would, we believe, serve as a practically useful preparatory measure, which would cause proprietors of small businesses in particular to think seriously about whether they need to be incorporated, about the responsibilities which they as directors would assume and also about the financial commitment which they would have to make. It would also serve to complement any new official efforts to raise awareness among company directors of the nature and importance of their responsibilities.
The fact remains that the UK is one of only two member states of the EU that do not impose minimum capital tests on limited companies. We believe that the review should examine the proper place of the limited company in the context of the range of business formats that is or could be made available. Our view is that company status should be made available only to businesses that are prepared and able to satisfy a minimum capital test: alternative formats should be made available for businesses that are not prepared or able to do this. Once a company has satisfied the entry test, legal compliance obligations should be kept to a minimum consistent with the overriding requirement to ensure that companies do not abuse their legal privilege. We believe that restricting access to corporate status has the potential to serve two purposes. First, it could help to improve standards of governance and second, it would provide a bedrock source of funds for creditors in the event of the company’s insolvency.
Q11 The current Companies Act accounting exemptions for SMEs require wholesale revision. Abbreviated accounts filed with the Registrar are not conspicuously popular with the companies they are intended to appeal to, they do not provide any cost savings to companies, and small company accounts in particular offer very little useful information or protection. As far as the last point is concerned, continuation of the provision to file abbreviated accounts would appear to be at odds with the concerns, being expressed by the steering group and by the Government alike, to safeguard ‘stakeholder’ interests. The inconsistency would become all the more glaring if the DTI’s current proposal to raise significantly the exemption thresholds was brought into effect.
For the above reasons, we would favour the abolition of abbreviated accounts. Our preference would be for all small companies to be required to file with the Registrar their ‘full’, statutory accounts. This would involve no additional cost and would give readers, whether customers, suppliers or members of the public, a fuller picture of the company’s financial standing. It would at the same time be useful for the review to consider the feasibility of combining the accounts and the annual return into a single document, the preparation and submission of which could perhaps be prompted, as the return currently is, by a shuttle document from Companies House.
As an alternative to the abolition of abbreviated accounts which would retain for small companies a measure of commercial confidentiality while at the same time providing readers with a meaningful financial statement, we believe that the suggestion for the filing of a certificate of solvency has some attraction. Whatever form of filed statement is decided on, however, the question of filing deadlines has to be looked at. The current permitted deadline of ten months from the accounting year end means that information on file may be of little practical usefulness to a user, especially if the accounts are ‘abbreviated’. The declaration of solvency would be particularly vulnerable to obsolescence if it were filed ten months after the date to which it was made. We would favour a substantial reduction in the current ten-month filing deadline for private companies.
Q12 We favour the so-called ‘integrated’ approach, as outlined in the consultative document.
Q14 We would favour, in principle, the adoption of an ‘opt-out’ on formation, a special ‘Table A’ for small close companies and a more widely drawn elective regime.
Q15 (a) We have no objection to the combination of the memorandum and articles of association into a single constitutional document.
Q15 (b) Yes
Q15 (c) Yes
Q16 The current rules on company and business names are not wholly satisfactory as they stand.
We appreciate that the sheer number of companies on the register makes it difficult for the Registrar to operate meaningful controls on the use by companies of particular names. However, if there are to be rules to the effect that companies should not be able to adopt names that are too like those of companies already on the register, then those rules should be capable of being applied more strongly. At present, the Registrar will only consider taking action under s28 of the Act if a proposed or already adopted name is practically identical to an existing name, rather than on the basis that a proposed new name is so similar as to cause confusion or otherwise to suggest an association. The result is that in many cases, both within group structures and outside them, too-like names are capable of causing difficulties to third parties.
It is also the case that, even if a company is barred under the Act from adopting a particular corporate name, it may still be able to conduct business using that name as its trading name. While, technically, corporate names and non-corporate names are entirely separate matters, this is not how the position is likely to be seen by the general public and by many customers and suppliers. A company that is faced with a rival business using a trading name that is identical or very similar to its own has the option of taking action for passing off, although this can be difficult, time-consuming and expensive. As a means of addressing this issue, we suggest the re-introduction of an overall register of business names, covering both corporate and non-corporate names.
Q17 The reforms of the ultra vires rule introduced by the Companies Act 1989 have not successfully resolved the uncertain position regarding company objects and powers. Since the ultra vires rule has been abolished for dealings with third parties, we do not see any reason why companies should not have, in their relations with third parties, all the powers of a legal person.
Q18 We agree that express objects clauses are not needed. Companies should, however, be permitted to impose in their constitutions explicit restrictions on the carrying out of certain activities.
Q21 Yes.
Q22 Yes.
Q23 We do not see why the Companies Act should address this point. The principles of agency law would apply to the situation described.
Q24 We believe that a simple statement to the effect that the public company concerned had all the powers of a legal person would be sufficient to satisfy the terms of the Second Directive.
Q25 If the foregoing changes were made to the objects clause and the ultra vires rule, the minority protection clause would need to be abolished too.
Q26 We believe that all companies, including private companies, should be required to have a minimum level of capital, which should be maintained. This minimum figure need not be linked to the nominal value of a company’s shares, and could be set at a specific level. The minimum capital sum would be available to a company’s creditors in the event of the company’s insolvency.
Q27 We support the proposal for approving capital reductions as set out in paragraph 5.4.7. Any reduction would only be permissible down to the minimum statutory level of capital.
Q28 We do not see that there should necessarily be a requirement for companies to obtain court approval for reductions of capital.
Q29 Yes.
Q30 We agree that private companies should be generally empowered to provide financial assistance to their companies with regard to share purchases, subject to approval by disinterested shareholders and a solvency certificate. The suggestion to impose a de minimis provision and other tests appear to be unnecessarily restrictive.
Q31 Subject to shareholder approval, we do not see why a similar regime should not apply to public companies.
Q32 Yes.
Q34 We believe that, in the event of no par shares being introduced, existing shares should be deemed to be of no par value with consequential effects on the balance sheet.
Q35 There should be a single reserve for share capital equal to the net proceeds of the shares in issue.
Q50 We agree with the proposals in the consultative document to legitimise the use of new forms of communications technology in the conduct of company affairs.
Appendix: Initiatives in environmental reporting – a summary
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| Date | Organisation(s) | Recommendations |
| 1989 | UN ISAR | Environmental disclosures |
| in the annual report and | ||
| accounts | ||
| 1992 | Public Environmental Reporting Initiative (PERI) | The PERI guidelines on public environmental reporting |
| 1995 | UNEP/Sustainability | 50 core elements of environmental reporting |
| 1996 | UK Government’s Advisory Committee on Business & the Environment (ACBE) | Guidelines on Best Practice environmental reporting for the financial sector |
| 1997 | DG XV (EU) | Interpretative communication on best practice disclosures in the annual accounts |
| 1998 | UN/ISAR | Environmental reporting through the annual report and accounts: a checklist |
| 1998 | DETR | Support for UK companies with over 250 employees to publish an environmental report |
| 1999 | DETR | Paper on publication by companies of a Greenhouse Gas indicator |
| 1999 | Global Reporting Initiative (GRI) | Sustainability reporting guidelines |
1999: DG XV still consulting, via research projects and the EC Accounting Advisory Forum, on the merit of enhanced environmental disclosures through the annual report and accounts.
1999: OECD draft guidelines on corporate governance extending beyond financial controls; similarly, the UK Turnbull Committee.