The government is proposing a major overhaul of company law – but lawyers argue that the complexity of the reforms could end up doing more harm than good. Cameron Timmis reports

When former Secretary of State for Trade and Industry Margaret Beckett launched a review of UK company law, she said it was still largely based on ‘Victorian’ legal principles, ‘immensely complex’ and ‘seriously out of date’. The goal of the root-and-branch review, which was unveiled in 1998, was to develop a simple, flexible and modern legal framework that would keep Britain’s economy competitive and make life easier for the UK’s 14 million or so companies.


Finally, last year – four years after the Company Law Review published its report – that process culminated with the introduction of the Company Law Reform Bill in the House of Lords. Now, as the finer details of the Bill come under scrutiny for the first time in parliamentary committee, many business lawyers argue that the reforms could be more of a hindrance than a help to UK businesses.


Much of the Bill – a hefty 780 pages and 885 clauses – is welcomed by lawyers. Reforms that, for instance, would allow private companies to make shareholder decisions without having to convene a general meeting, and would not require them to hold an annual general meeting or have a company secretary (unless they choose to), would make running a small business ‘simpler and easier’, says Rita Dattani, a senior lawyer at City firm Norton Rose. Similarly, the proposed abolition of rules preventing companies from giving financial assistance for the acquisition of shares – a bugbear for many corporate lawyers – is widely applauded. Currently, the prohibition is overcome by structuring a deal using a lengthy process known as ‘whitewash procedure’. Abolishing the rule, says Ms Dattani, would save companies ‘time and money’.


But elsewhere in the Bill, lawyers are none too pleased. The greatest disquiet is over reforms to directors’ duties. ‘Ironically,’ says James Palmer, a partner at City firm Herbert Smith who chairs the City of London Law Society’s company law sub-committee, this is one area of company law where ‘we actually didn’t need much change’.


For the first time, the Bill would put in statutory form exactly what a director’s duties consist of. These duties are currently derived mainly from case law, which the government claims makes it hard for would-be directors to understand, or find out about.


The Law Society’s company law committee, which has been closely monitoring the progress of the Bill, has consistently opposed codification of directors’ duties. According to former chairwoman Vanessa Knapp, a partner at City-based law firm Freshfields Bruckhaus Deringer, a major disadvantage is the loss of flexibility. She explains: ‘If you rely on case law, that can be flexible and change as the environment changes… When you write something into an Act you crystallise it, and make it harder for judges to change in the future.’ As an alternative, says Ms Knapp, the committee had originally suggested the publication of a ‘Highway Code’ type booklet for new company directors that would list their key duties. After all, she says: ‘How many directors go and pore over Acts of Parliament?’


But now the Bill has been published – and the debate on codification effectively lost – lawyers’ concerns are focused on the specific wording of the statutory duties. Here, the devil is very much in the detail.


Of the clauses outlining statutory duties, by far the most controversial is section 156. This states that directors are under a duty to act in the way they consider ‘would be most likely to promote the success of the company for the benefit of the members as a whole’. However, under existing company law directors are under a duty to act in the ‘best interests’ of a company. Thus, lawyers argue, the Bill has unwittingly introduced a new duty – ‘to promote the success’ of a company.


‘Using the words “promote the success” of the company rather than “best interests” suggests something different is intended, otherwise why would you change the words,’ says Ms Dattani. ‘The concern is that everyone knows what “best interests” means, but we don’t know what “success” means.’


If, as many lawyers argue, section 156 does create a new duty for directors, this could have major repercussions. According to Ms Knapp, it was not what was intended by the Bill. ‘Originally, the plan was just to codify the existing law with some minor changes. The problem is that now we’ve seen the wording, we’re not convinced it’s relatively minor.’


Perhaps more controversial is section 156 (3). This states that in promoting the success of a company, a director must also ‘so far as reasonably practicable’ have regard to a number of factors, including ‘the likely consequences of any decision in the long term’; ‘the interests of the company’s employees’ and ‘the impact of the company’s operations on the community and the environment’.


This too appears to be a significant departure from the existing law, which says a company should be run exclusively for the benefit of its shareholders, without taking into account other interests. The fear now among business lawyers is that companies will have to spend a lot of time and resources examining the new factors before taking any decision – a considerable burden on smaller companies.


At least, say lawyers, the Bill does not go as far as many trade unions and environmental groups had hoped by making directors equally accountable to all stakeholders – a concept known as the ‘pluralism approach’. Richard Paton, a commercial partner at Hill Dickinson in Leeds, says: ‘Fortunately, that has fallen by the wayside. It would have put directors in an almost impossible position. They would have been open to being sued by all and sundry.’


But this debate may not be over. Environmental groups and trade unions are continuing to lobby vociferously on the issue, and have recently backed a parliamentary early day motion to have the wording of section 156 amended in their favour: ‘We are concerned that the wording is extremely weak and won’t lead to a change of behaviour,’ says Friends of the Earth corporate accountability campaigner Sarah-Jayne Clifton. ‘We would like a positive directors’ duty to take reasonable steps to minimise the social and environmental impact.’


Business lawyers are also worried about new provisions in the Bill relating to shareholders’ rights, specifically derivative claims, which enable shareholders to bring an action in the name of the company against directors. Currently, these are extremely rare as they require the claimant to prove directors have committed a ‘fraud on the minority’ – in practice this means something as serious as appropriating the assets of the company.


But under the new proposals (clause 239 of the Bill), derivative claims can be brought for negligence, default, breach of duty and breach of trust – far wider grounds than previously. According to Michelle de Kluyver, a litigation lawyer at City practice firm Allen & Overy, whose firm has been leading a campaign to amend this particular provision, this ‘massive lowering of the hurdle’ will make it ‘very easy’ for shareholders to commence claims. ‘They [shareholders] will simply have to make an allegation of negligence,’ she says.


As a check on potential abuse of this new power, the Bill also requires a shareholder to seek the consent of the court before proceeding with a derivative claim. But this too is criticised by Ms Kluyver, who says such decisions should be left to the discretion of the company board, not the courts. ‘We think a court should only be able to overturn a board’s decision if it is so unreasonable another board could not have made it.’


Mr Palmer also foresees more shareholder litigation as a result of derivative claims if the reform is implemented. ‘The government view is that courts will apply their discretion as in the past. My riposte is, “so why the hell change it in the first place?”.’


By introducing new – untested – duties on directors and extending shareholder rights, business lawyers claim the Bill will place an undue burden on companies, increasing the liability on directors at the same time as requiring them to scrutinise the wider impact of their decisions. Far from making UK companies more competitive – as the Bill intends – the proposed directors’ duties could make them less competitive, says Mr Paton.


With the Bill currently going through the House of Lords and still to go to the Commons – it is expected to be in force by next April or October – lawyers are still hopeful it will be possible to amend the legislation, even despite a robust stance by the government. The Law Society company law committee, whose members represent more than 30 law firms, is continuing to table amendments to the Bill.


Mr Palmer thinks these ongoing efforts are crucial: ‘It’s very important for all business lawyers... what we are trying to do is make sure we don’t screw anything up so people don’t stop using English companies.’


Cameron Timmis is a freelance journalist