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Clauses issued for comment by the Department of Trade and Industry (DTI)

Comments from ACCA
September 2005

 

ACCA (the Association of Chartered Certified Accountants) is pleased to set out, on the following pages, its comments on the draft clauses of the above Bill, issued for comment on 19 July 2005. Our comments in this paper focus on:

1. the substance of those new provisions being incorporated into legislation for the first time
   and
2. the wording of new or re-drafted clauses.

We do not comment on those provisions which are wholly or substantially drawn from existing legislation.

The key points arising for ACCA from the draft clauses are as follows.

• Compulsory electronic filing must not move ahead of companies’ ability to cope with that medium.
  
• Without a more active involvement on the part of Companies House in the monitoring of information it receives, the new offence of knowingly or recklessly to deliver a document or make a statement that is misleading, false or deceptive in a material particular may have only nominal effect.
  
• We agree that the disclosure of the terms of the auditor’s contract with the company would be best dealt with via an addition to the Combined Code.
  
• Limitation liability agreements should be subject to approval, in advance, by the client company’s shareholders and there should be no undue influence placed on either side to enter into the contract.
  
• Limitation agreements should not be able to specify a maximum amount to which an auditor would be liable – to do so would be contrary to the principle behind proportionate liability. We recommend that the wording be changed so as to avoid giving the impression that fixed liability ‘caps’ will be permissible under the new rules.
  
• The draft clause on liability limitation agreements needs to be re-framed so as to provide two options – (i) to enable shareholders to approve the principal terms of the agreement, and to authorise the directors to finalise the agreement, and (ii) to enable shareholders to approve a whole agreement which has been negotiated between the company and the auditors by the company’s directors. To remove any doubt about the capacity of the latter to negotiate the agreement, there should be a positive provision to the effect that companies may enter into limitation liability agreements.
  
• The text currently provides simply that a limitation liability agreement may be approved by means of the company passing a ‘resolution’. This implies that only a simple majority of members would be needed to authorise the PL contract. We suggest that a more substantial vote in favour, ie a special resolution, would be appropriate in this case, since the agreement would have major implications for the economic rights of the company and its shareholders.
  

PART L – THE REGISTRAR OF COMPANIES

L10 Power to require delivery of statutory information by electronic means

Under L10, the Registrar of Companies could be given the power via regulations to require statutory documents to be delivered by electronic means. Any regulations to be made under this power need to take into account that the great majority of the 1.8 million companies on the register are still small private companies and many of these may not yet have access to on-line filing facilities. Compulsory electronic filing must not move ahead of companies’ ability to cope with that medium. There must be adequate consultation with companies and interested parties before rules on compulsory e-filing are introduced for particular classes of documents.

L13 Defective delivery

Sub-clause (1) sets out the conditions which must be fulfilled in order for a document to be considered properly delivered. These include requirements concerning the contents of the document and its authentication. The following sub-clause then says that the Registrar may accept and register a document which does not comply with those requirements. While the clause makes clear that acceptance in these circumstances does not affect the potential liability of the filer for any compliance failure, acceptance of a defective document still has implications for the integrity of the information held on file. There is currently a growing concern within the accountancy profession and the business community generally about the posting of information on Companies House records which is not properly authenticated. We consider that every opportunity should be taken to take steps to improve levels of security surrounding the posting of company information. One of these steps should be to improve the degree of control exerted over the authentication of documents. If the Registrar makes a genuine mistake over whether or not a document is authenticated, that is one thing. But we would oppose giving a positive power to the Registrar to accept for registration documents which have not been properly authenticated.

L14 Informal correction of documents

This clause would allow the Registrar to amend documents filed with it, but not yet accepted for posting, on instructions given by the company to the Registrar (following an enquiry initiated by the Registrar). The Registrar would be entitled to use this power in respect of documents which were ‘incomplete or internally inconsistent’.

We support this proposed power. We suggest, however, that the new process not be referred to as ‘informal’ correction – any amendment of statutory documents made by the Registrar will be on the basis of express instructions and formal authorisation given by the company concerned.

L15 Voluntary replacement of documents previously delivered

We query the need for this provision. If a document does not meet the criteria for proper delivery, then it should not be accepted by the Registrar in the first place, and the filing company should be informed accordingly. When the company proceeds to file a corrected document, then this will be the first time that that particular document will have been properly delivered and accepted for filing. Therefore, there should be no question in this context of the company filing a ‘replacement’ document. This being said, we can accept that there should be a provision, exercisable in accordance with clause L32 (Registrar’s notice to resolve inconsistency on the Register), for replacement documents to be filed where information in them is subsequently considered by the Registrar to be inconsistent or incorrect.

L34 Rectification of the Register under court order

We support this provision, which will allow the Registrar to remove from the Register material which the court has declared to be invalid, which appears to have been done without the authority of the company, which is factually inaccurate, or is forged.

L37 Documents relating to Welsh companies

Sub-clause (3) refers to a document having been properly delivered to the Registrar without a certified translation into English. In such a case the document would not have been ‘properly delivered’.

L38 Documents drawn up in other languages

We query the need to allow companies to file documents in languages other than English (apart from Welsh), albeit with a certified translation. Where companies do this, third parties should at least be entitled to rely on the filed English translation of the document. Accordingly, in L40, the clause should say that third parties should be able to rely on the translation unless the company shows that the third party had knowledge of and understood the original. We appreciate that ‘knowledge’ is the term used in the revised First Directive relating to this matter, but would argue that knowledge must involve awareness of the contents of a document and not simply its existence.

L47 General false statement offence

We welcome the proposal to make it an offence knowingly or recklessly to deliver a document or make a statement that is misleading, false or deceptive in a material particular. But for this provision to make a serious difference, Companies House needs to have the resources to enable it to carry out meaningful checks of the information which it receives and files: without a more active involvement on the part of Companies House in the monitoring of information it receives, the new offence may be of only nominal effect.

 

PART M – COMPANY NAMES

M15 Name not to be the same as another in the index

Clause M16 states that the Registrar must not register a company with a name which is the same as another appearing in the index of company names. While we agree with the re-statement of this provision, we suggest it would be more appropriately positioned within clause M1 (Prohibited names). We also note that Northern Ireland corporate bodies are expressly referred to as forming part of the index of names, implying that there are to be UK-wide rules to prohibit duplication of corporate names. We welcome this.

M19 Objection to company name

We welcome the proposed new procedure for companies to object to the adoption by other companies of names which suggest a connection between them. In our view, this is an appropriate issue for statute law to deal with. In the same way as has become the case with domain names, we have seen a trend for companies to seek to appropriate the goodwill of established companies via the adoption of very similar names. With the number of companies on the Register approaching two million, the problems associated with similar names are likely to continue. Further, the problems associated with the successful prosecution of passing-off actions mean that it is not satisfactory to leave such disputes to be resolved solely by means of litigation through the civil courts. We therefore agree that the proposal is desirable in order to preserve the integrity of the Register.

PART N – POLITICAL DONATIONS

N2–N4 Definitions

The proposed definitions covering political donations appear to cover only donations relating to political parties and candidates or in respect of referenda.
It is conceivable that companies could avoid any requirement to seek authorisation by making payments to special trusts or other front organisations set up by or associated with formal political parties. The definitions should therefore be broad enough to encompass such devices.

N5 Authorisation

Sub-clause (5) says that any political donation that is paid before it is approved by members is incapable of subsequent ratification by the members. While prior approval of expenditure will in most cases be preferable, it is not clear that there needs to be an express, and unusual in company law, insistence that ratification by members in this matter is not possible. If members are prepared to back their directors and approve a donation, it should be possible for them to do this. The directors will know that, should the members refuse to give retrospective approval, they will have to repay to the company the money spent.

N10 Enforcement of directors’ liabilities

The proposal gives rise to the question of how the company’s shareholders are to acquire information about unauthorised donations which may have been paid. Under recent changes to the law, directors have to be fully forthcoming to their auditors about their transactions and to divulge all material information to the auditors (which should include any appropriate admissions concerning the failure to obtain shareholders’ authorisation). The auditors would separately consider making an appropriate disclosure in their audit report on the failure of directors to obtain any necessary shareholder approval for particular expenditure.

But since 2004, all small companies have been exempt from the statutory audit. For exempt owner-managed companies, therefore, the recovery provisions may not be effectual, since owners will not be motivated to take action to recover company funds from themselves, and they will be aware that there will be no independent check on whether the statutory rules are being kept to. Where an exempt company has minority shareholders, the absence of any external monitoring of whether the directors have followed the rules on authorisation could mean that they will be unaware of whether or not political donations have been paid. There are, therefore, practical obstacles to the achievement of the Bill’s aims in the case of unaudited companies.

In terms of the means of contesting any unauthorised donations, an ‘authorised group’ of members, comprising 50 members in number or 5% of members, would have the right to bring proceedings to enforce directors’ liabilities in respect of unauthorised political payments.

Given that any single member would have the right to bring the new statutory derivative action, it is not clear why such a threshold would need to be applied to actions in respect of unauthorised donations. Derivative actions will be able to be brought under the new provisions in respect of, inter alia, ‘any actual or proposed act or breach’ - such circumstances could easily, on the face of it, encompass failure to obtain authorisation for a political donation. We suggest, therefore, that the procedure for contesting unauthorised disclosures could be dealt with in the new rules governing statutory derivative actions.

 

PART O - DERIVATIVE ACTIONS

O1 Definition

Sub-clause (1) should make clear that derivative actions can be brought against directors in the plural, and not just single directors as is suggested in this passage.

O4 Whether permission to be given

Sub-clause (4) says that the court should refuse to allow a derivative action to continue if it is satisfied that, inter alia, a person who was acting in accordance with the directors’ duty to promote the success of the company for the benefit of its members would not seek to continue it (as set out in clause B3 of the Bill).

Disallowing a derivative action by cross-reference to clause B3 would restrict the circumstances in which such actions could be brought. O1 already states that derivative actions could be brought in respect of any actual or proposed acts or omissions, implying that compliance failures could come within the scope of the action. But clause B3 is essentially of an operational character, and so not obviously comparable with considerations of compliance.

The cross-reference also appears uncomfortable, since it seeks to judge shareholders’ actions by the standards expected of directors. Since derivative actions will only ever be brought by non-director minority shareholders, this basis for assessing shareholder motives is not sound.

 

PART Q - AUDITORS

Q12 The reporting accountant

Sub-clause 12(3) says that an individual or firm may be appointed as a reporting accountant. There needs to be confirmation, as there is in the Companies Act 1989 with respect to the appointment of auditors, that a firm may be a corporate body or an unincorporated body.

Q22 Accounts meeting

The definition of ‘accounts meeting’ of a public company should refer to a ‘general meeting’ at which accounts are laid. Q27, which deals with the format of the auditor’s report, already refers to accounts which have been laid before a ‘general meeting’. There should at least be consistency between the terms used.

Q25 Disclosure of terms of contract

Q25 provides that regulations may be made to require the disclosure of the terms of the auditor’s contract with the company. We understand that the Government has invited the Financial Reporting Council (FRC) to incorporate provisions on this matter into the Combined Code. We agree that the disclosure concerned would be best dealt with in that way rather than through legislation.

Q40 Criminal offences

The intention of sub-clauses (3)(b) and (c) is presumably to extend liability for the new criminal offence of knowingly or recklessly causing misleading etc. elements to be included in an audit report to qualified associates of the lead auditor. The wording, however, is flawed, since it reads as if the offence would extend to employees as well as qualified audit personnel. The wording should make clear that the individuals caught by the provision should be those who are both employees, etc. and qualified auditors. Since ‘partners’ are expressly covered in the clause, members of limited liability partnerships (LLPs) need also to be covered.

Q55 & 56 Auditors’ resignation statements

Clause Q55 requires that a resigning auditor must inform the ‘appropriate authority’ (which in most cases will be his recognised supervisory body (RSB) of his resignation. He must also file with the authority the statement regarding ‘relevant circumstances’ which is to accompany the notice of resignation. Clause Q56 additionally requires that the resignation notification and the statement of relevant circumstances must be sent to the ‘accounting authorities’ (which will be both the DTI and the Financial Reporting Review Panel (FRRP)).

We agree that it could be useful to the DTI and the FRRP to be informed wherever auditors deliver a statement under Q52(1), ie where they set out reasons connected with their resignation which they feel need to be brought to the attention of members or creditors. But we do not see that any useful purpose would be served by the systematic filing with them of either resignation notices or statements which merely state that there are no circumstances which should be brought to the attention of members or creditors - these are likely to make up the great majority of Q52 statements.

Q57 Casual vacancies

Clause Q57 says that during a casual vacancy in the office of auditor, any surviving or continuing auditor or auditors may continue to act. A ‘casual vacancy’ is usually understood to mean a situation where no auditor is in office, for whatever reason. Accordingly, it does not seem logical to refer to continuing or surviving auditors in this context. In any case, unless the company, or as the case may be directors, have exercised their powers to appoint auditors, there is no ‘continuing’ auditor.

Q58 & 59 Members’ right to require website publication of audit concerns

The proposal in this clause, which presumably is related to the European Commission’s current proposal on the matter, would give members of quoted companies a right to require their company to publish a statement on a relevant matter, which would be a matter ‘relating to’ the audit of the company’s accounts (including the auditor’s report and the conduct of the audit) or any circumstances connected with an auditor of the company ceasing to hold office, which the members propose to raise at the next ‘accounts meeting’ of the company.

If the emphasis on the link with the audit is to be retained in this provision, it needs to be clarified as to whether the proposed right is to be restricted to matters which are directly related to the audit process itself or, additionally, to matters which are the subject of the audit, i.e. the form and content of the accounts themselves. If the intention is to cover the accounts as well as the audit, and there would appear to be no good reason why this should not be so, then it would be better if the clause were re-worded expressly to cover the accounts.

We would also query the time which is to be made available for members to take advantage of their new right. In future, companies will only have to give 15 days’ notice of the general meeting at which the annual accounts are to be laid. The accounts will invariably be circulated to members at the same time as the notice. In those situations where a members’ statement is ‘related’ to the annual accounts and the audit of them, the members will have only a minimal window of opportunity to react. During that 15-day period, members would have to receive and review the accounts, consider the form of any statement they might wish to make, accumulate the necessary threshold of support and then communicate the agreed statement to the company. The company will then have to post the statement on to its website, which might take another day or more to go ‘live’. If the members’ statement were to have the presumably intended effect of conveying relevant information to members prior to their attendance at the general meeting, all these steps would need to be completed well within the 15-day notice period (NB the company would also have to place the statement on its website within three days of receiving it). This is not likely to be enough in most cases for members to be able to exploit the new opportunity open to them.

Under clause Q59, all quoted companies would be required to include in their meeting notices a reference to ‘the possibility of a statement being placed on the company website in pursuance of section Q58.’ We suggest that this reference should be framed in terms of ‘any valid members’ statements received under section Q58 shall be placed on the company’s website prior to the meeting.’

Incidentally, the reference to posting members’ statement on a website assumes that the companies affected will all have websites. We assume in turn that the new Bill will contain a basic requirement for quoted companies to have websites.

Q64 & Q65 Liability limitation agreements

ACCA supports the rationale behind the proposed ‘liability limitation agreements’. Although they are not expressly referred to as being proportionate liability (PL) arrangements, the intent of Q66 is clearly to apply the principle of proportionate liability to them. As we have said on previous occasions on this issue, we believe that the principle of PL is a reasonable one to apply to the liability of an auditor to his client company, provided that the limitation is formally approved by the shareholders in advance of the engagement. PL will not have the effect of absolving a negligent auditor of liability in respect of his negligence, it will only mean that, where a limitation agreement applies, the auditor will only be held financially responsible for his share of the responsibility for the shareholders’ loss. An auditor who is partly responsible for the loss will be partly liable to claimants, but an auditor who is found to be solely responsible for the loss will remain, as is the case now, wholly liable to claimants. The main caveat we would place on the new type of agreement is that it must be subject to approval, in advance, by the client company’s shareholders and that there should be no undue influence placed on either side to enter into the contract.

Our specific comments on the drafting of this clause are set out below.

1. Duration of PL contracts
   
   Sub-clause (1) suggests that a liability limitation agreement could have effect for any period specified in the agreement. This could effectively extend the period of the PL contract indefinitely or until further notice. We consider that, if proportionate liability is to be applied to the external audit on a contractual basis as opposed to as a general rule of law, then it should as a rule only apply in respect of one audit engagement at a time. Otherwise, large numbers of shareholders could be bound by an agreement entered into before they joined the company. We recommend that, in all cases where the auditor is appointed on an annual basis, the PL contract should also be entered into on an annual basis.
   
   
2. Approval of PL resolutions
   
   Q65 provides simply that a limitation liability agreement may be approved by means of the company passing a ‘resolution’. This implies that only a simple majority of members would be needed to authorise the PL contract. We suggest that a more substantial vote in favour, i.e. a special resolution, would be appropriate in this case, since the agreement would have major implications for the economic rights of the company. Even with the approval of a special resolution the possibility should not be discounted that a dissatisfied minority of members could argue that their interests have been subject to unfair prejudice.
   
   
3. Content of liability agreements
   
   Q64 and Q66 both refer to liability limitation agreements having the effect of limiting the ‘amount’ of liability owed by the auditor to the client company. It was not our understanding that limitation agreements would be able to specify a maximum amount to which an auditor would be liable – to do so would be contrary to the principle behind proportionate liability. We recommend that the wording be changed so as to avoid giving the impression that fixed liability ‘caps’ will be permissible under the new rules.
   
   
4. Means of approval of liability agreements
   
   Under Q65, there would be three means by which a limitation liability agreement would be approved:
   
   a) by the company resolving, before it enters into the agreement, to waive the need for approval
   b) by the company resolving, before it enters into the agreement, to approve the agreement’s principal terms (explained in Q65(3)
   c) by the company resolving, after it has entered into the agreement, to approve the agreement.
   
   Regarding a), we do not believe it would be appropriate, or possible, for the company’s members to approve a limitation liability agreement by means of waiving the need for approval of it. Approval via waiver would imply that a general limitation rule would apply to the particular audit engagement. This would not be the case - in the absence of a valid contract between the company and its auditor, the general principles of the law on negligence would apply to the auditor’s liability. It is also not possible for a party to enter into a contract by merely waiving its responsibility to approve that contract. We believe, therefore, that some positive action on the part of the company should be required.
   
   On b), we agree that it would be acceptable for the shareholders to be authorised to approve the principal terms of a limitation agreement, and to leave the directors to finalise its terms with the auditors. But it will be recalled that directors only have powers which are delegated to them by the company - there is currently no power for a company or its directors to agree to reduce shareholders’ rights of redress against their company’s auditor. So we suggest that the company’s members, when passing their resolution, should also be required expressly to authorise the directors to enter into the agreement on the company’s behalf.
   
   Method c) suggests that the company would pass a resolution approving the full terms of the agreement ‘after it enters into the agreement’. We query the logic of this. The wording appears to suggest that the agreement is to be approved twice, once by the directors and then by the company’s members. But directors do not currently have the authority to commit the company on this matter in the first place, so the company could not ‘enter into‘ the contract prior to its being presented to the members. Hence the shareholders will only be able to authorise an agreement which has been negotiated by the directors. In any case, we believe that the legislation should reflect the principle that a PL contract should be approved before an audit engagement starts.

We suggest, therefore, that clause Q64 needs to be re-framed so as to provide two options – i) to enable shareholders to approve the principal terms of the agreement, and to authorise the directors to finalise the agreement, and ii) to enable shareholders to approve a whole agreement which has been negotiated between the company and the auditors by the company’s directors. To remove any doubt about the capacity of the latter to negotiate the agreement, there should be a positive provision in Q64 to the effect that companies may enter into limitation liability agreements.

Q69 Termination of liability limitation agreement

We do not consider that, once properly authorised with respect to a specified period, an agreement should be capable of being overturned by a company’s members. We accept that sub-clause (3) would ensure that any act or omission occurring before the date of termination would not be affected. But the audit fee for the whole engagement will have been calculated in the light of any limitation agreement, and the auditor’s insurance premium will also have been determined with the agreement in mind. As with any other contract, once properly entered into, a limitation agreement should be allowed to run its course, in this case for the duration of the auditor’s appointment. If there is to be a statutory opt-out provision at all, it should apply in respect of exceptional circumstances only, such as where members have given their approval to the agreement on the basis of misleading or incomplete information provided to them by the directors.

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