Insolvency Law and Director Disqualifications
(1 year, 6 months ago)
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Rebecca Long Bailey (Salford and Eccles) (Lab)
I beg to move,
That this House has considered insolvency law and director disqualifications.
It is a pleasure to serve under your chairmanship, Ms Fovargue. Thank you for making time for this important debate.
Five years ago, Carillion collapsed in one of the biggest corporate scandals seen in recent years. Millions were racked up in debt, tens of thousands of workers lost their jobs and pensions, and thousands of supply chain businesses were put at risk, all because the auditors failed to hold Carillion’s board to account and a blind eye was turned to poor corporate behaviour. Five years on, have changes to the UK corporate governance regime been made to ensure that such a scandal cannot happen again? The answer, sadly, is not encouraging.
As the Unite the union has stated,
“In the end, four Carillion executives were fined £870,000 in total – a mere slap on the wrist given the hundreds of millions of pounds the company lost and the thousands of lives they ruined.”
Former BBC investigative journalist Bob Wylie, who wrote the Financial Times book of the year “Bandit Capitalism: Carillion and the Corruption of the British State”, summed up the present position perfectly when he said:
“The sad truth is they get away with it because they know they can.”
The most recent figures by the Insolvency Service for 2022-23 show that almost half of disqualifications were because of misuse or abuse of the bounce back loan scheme, rather than more robust action being taken against directors for unfit conduct prior to insolvency. I suggest that that is because the bar for disqualification for unfit conduct is very high and often difficult to prove, particularly where a director can claim to have relied on the advice of external advisers when making decisions. Further, the law surrounding whether directors have acted inappropriately in an insolvency situation, and specifically the point at which directors should begin to consult on redundancies and prioritise payments to creditors prior to insolvency, is ambiguous to say the least.
The Supreme Court recently affirmed that ambiguity in the case of BTI v. Sequana, noting that company directors are only required to begin prioritising creditors if it is probable that their company will plunge into insolvency. The problem is that no one knows what “probable” actually means. As the London Solicitors Litigation Association noted,
“the precise point in time at which the duty will be triggered and how to balance creditors’ interests with other competing interests of the business remains relatively elusive.”
It is that elusiveness that continues to allow some directors to act in a way that is detrimental to workers and other creditors.
The Bakers Food and Allied Workers Union highlights the cases of Dawnfresh Seafoods and Orchard House Foods, which it says
“raise significant concerns about the ability of business owners to abuse the process around administration and insolvency, leaving workers in the lurch and denying them the full value of their outstanding pay and redundancy monies owed—whilst Directors walk away with impunity, often with enormous levels of wealth intact.”
In the case of Dawnfresh, the union reports that the director allowed workers to carry on overtime shifts in full knowledge that he was about to bring in the receivers. He also took the opportunity before insolvency to rescue his own private art collection from company premises. The workers were left waiting for weeks without any source of income, obliged to depend on family and friends or use food banks in the resulting emergency, and they included one who was fighting leukaemia. A not dissimilar instance occurred at Orchard House Foods in Gateshead, with redundancy negotiations over the site’s closure seeing the company fail to pay workers ahead of the Christmas period.
Sadly, that practice does not just plague the food sector; it is increasingly evident across the wider economy. Thomas Cook, for example, also failed abjectly to consult over redundancies prior to insolvency, when it was known for some time that the company was in trouble. In a more recent case, journalists at Vice UK faced statutory redundancy terms, with many having to leave with almost nothing because the company filed for bankruptcy, while its recent global CEO was on an annual salary of $1.5 million. It is not just workers who lose out in these situations. Figures disclosed in response to written parliamentary questions tabled by my hon. Friend the Member for Ellesmere Port and Neston (Justin Madders) indicate that over the last two years alone statutory redundancy payments cost the taxpayer around £300 million.
If the law is not clear enough on the point at which creditors’ interests in an insolvency should be prioritised, what other mechanisms are there to sound the alarm?
Jim Shannon (Strangford) (DUP)
I commend the hon. Lady for securing this debate. I would like to be here for the whole debate, Ms Fovargue, but I have another event to attend at 3.30 pm. I apologise for not being here for the whole debate. Nevertheless, I would like to make a contribution.
There is another factor as well, which I would just like to outline for the record. Does the hon. Lady agree that in many situations the big businesses that she is referring to have the ability to use accountancy in their favour, by going insolvent and trading under different names, which too often has left those on the bottom of the ladder, such as suppliers and sole workers, with no option other than to swallow the pill and even go bankrupt themselves? Some of my constituents have experienced this. It is difficult to watch directors move on with impunity, while other people have to sell their homes to cover their costs. In other words, the small person at the bottom or the back of the queue always suffers and the big boy gets away.
Rebecca Long Bailey
I thank the hon. Member for his comments and I agree completely. There are huge issues surrounding the area of pre-pack administrations and the issue of phoenix companies, whereby directors are allowed to reappear in another form with the same kind of company structure with complete impunity. This certainly needs to be addressed by the Government.
Other mechanisms exist to sound the alarm on poor corporate governance. That is usually when the role of auditors should be key, but in recent years the unhealthy structure of the industry has been widely criticised, as well as the market dominance and conflicts of interest of the big accountancy firms. In this dysfunctional culture, firms must win and retain engagements from companies in order to generate revenue, but simultaneously they must objectively scrutinise the company reports of the very people they are trying to win business from. Indeed, the symptoms of this flawed culture are clear. The Financial Reporting Council has stated that 29% of the audits delivered by the seven biggest accounting firms fail to meet UK standards. It is abundantly clear that the UK corporate governance regime is in urgent need of reform
What actions have the Government taken so far? In his response to the debate, the Minster will no doubt refer to the Government’s White Paper on reforms to the UK corporate governance code, which the FRC is consulting upon as we speak. However, it is important to note that although the code is underpinned by listing rules that require premium-listed companies to “comply or explain” if they have not complied with a code provision, there is no strict legal requirement to comply with the code at all. It is merely a guidebook, and the lack of legal enforceability is clear. The Financial Times reported only last month that the FRC has reported falling levels of compliance since 2020, suggesting that boards are willing to risk avoiding the “comply or explain” requirements, particularly as the ultimate threat is simply to register dissatisfaction in a non-binding shareholder vote, or one that historically the company has a vanishingly small chance of losing.
Secondly, what is glaringly absent from the Government’s White Paper proposals so far is a statutory and enforceable Sarbanes-Oxley equivalent, which would make directors legally responsible for financial reporting governance. Instead, the White Paper opts for the fluffier “encouragement” of boards to include in their annual reports declarations about whether internal risk management and internal controls are effective or not. Similarly, the provisions that recommend that certain minimum clawback conditions or “trigger points” are included in directors’ remuneration arrangements are welcome in principle, but the reality is that these employment contracts are not publicly available so as to enable enforcement, and annual financial reports rarely provide comprehensive information.
Sadly, even the chief executive of the Institute of Chartered Accountants in England and Wales believes that the Government’s White Paper proposals on reform of the audit industry do not go far enough, stating:
“Taking these measures as a package with the draft audit reform Bill outlined, the government's approach has a half-hearted and lopsided feel to it… Lessons from Carillion and other recent company failures have been ignored, with little emphasis now on tightening internal controls and modernising corporate governance.”
A further five years on from Carillion, we are no closer to the creation of the Government’s long-promised audit, reporting and governance authority, or the passing of the Government’s promised audit reform Bill. When we can expect legislation on audit reform and the creation of ARGA?
Given these glaring deficiencies in the law, I will be grateful if the Minister considers some simple legislative changes that would provide much-needed clarity and protect workers, creditors, and the long-term health of companies. First, will he widen the scope of directors’ duties in section 172 of the Companies Act 2006, so that a duty is not owed solely to shareholders, as at present, but is owed to workers and other stakeholders as well? That must sit alongside a clear duty to prioritise the long-term welfare of a company, rather than simply the short-term maximisation of shareholder dividends.
Secondly, with regard to the duties of directors prior to insolvency, will the Government legislate to set clear definitions and parameters for when insolvency is deemed to be a “probable” event? That would provide much-needed clarity on when a duty to consult on redundancies is triggered, and when payments to workers and creditors need to be prioritised over shareholder dividend extraction.
Thirdly, will the Minister comment on why the Government proposals made in recent years to introduce workers on boards have been shelved? Will he commit to examine and develop policy in the light of the experience of other European jurisdictions, where direct representations of employees on both unitary and two-tier boards has actually helped to improve corporate performance and success, for the benefit of all stakeholders? Last, will he introduce clear Sarbanes-Oxley-equivalent legislation that would finally make directors legally responsible for financial reporting governance? If not, can he explain clearly the Government’s reasons for avoiding that in favour of more diluted and legally unenforceable guidance?
It is clear that the current UK corporate governance regime has become dysfunctional, ambiguous and unenforceable. Despite numerous scandals, it still has no room for the protection of employees and other stakeholders. I hope the Minister can reassure me today that things will change. Thank you for the opportunity to hold this debate, Ms Fovargue.
John McDonnell (Hayes and Harlington) (Lab)
Thank you, Ms Fovargue—I always find the pronunciation difficult. That is my fault, not that of the spelling. I do not have a lot to say, other than to compliment my hon. Friend the Member for Salford and Eccles (Rebecca Long Bailey) on her speech. To be frank, I am here to listen to the Minister’s report on progress to date.
I believe that in 2018-19, my hon. Friend was involved in work with Lord Prem Sikka on the development of a report on regulatory structures and standards overall. Having identified that my hon. Friend had obtained this debate, I looked back to her work with Prem Sikka on that regulatory regime. To be frank, I am looking forward to the Minister’s response, because it seems not an awful lot has moved on.
That report came out of Carillion and a number of other cases. The hon. Member for Strangford (Jim Shannon) made the point that a number of companies went into insolvency and left behind large-scale debts, large numbers of workers laid off and contracts not fulfilled. In Liverpool, the collapse of Carillion meant that a hospital would not be built in the required timescale, causing considerable distress at the time.
Prem Sikka produced a comprehensive report. So that people are aware of Prem Sikka’s background, he is a professor of accountancy. He became an adviser to Select Committees and Government about 30 years ago and went on to advise on the appalling Bank of Credit and Commerce International banking scandal. He demonstrated his expertise and as a result was regularly called to advise Select Committees when different issues arose. He then set up a group of lawyers and accountants to examine and explore corporate abuse. They published a book about 10 years ago, if I remember rightly, and I brought together his group to take advice on where we went from here. That is how the connection was made. When Carillion happened and we desperately needed someone to advise us—he was already advising Select Committees—he came on to advise us.
What was startling about Prem Sikka’s report was his description of a maze of regulatory bodies—the chaos of the regulatory bodies. They all had a particular role to play, but none of them played the role effectively, and those who had committed what I think were economic and financial crimes during that period walked away without any loss to themselves. The report identified extraordinary and bizarre issues. Among the financial sector regulators, he identified 41—I think he gave up after No. 41—different agencies involved in financial regulation, which bizarrely included the Faculty Office of the Archbishop of Canterbury, which had a notarial professional role.
All of those bodies failed to address the real issue, which was inadequate supervision and accountability in the operation of the individual companies, particularly with regard to insolvency, where the audit companies seemed to be asleep at the wheel, particularly with regard to Carillion. The audit companies consistently produced audits that could be described as not just inaccurate, but almost deceptive in the way that they portrayed the state of the company, which allowed it to keep operating and employing contractors and so on while knowing that there was an issue. Prem Sikka went on to look at the role of the audit companies in advising companies and selling them products on tax avoidance as well. That is why he argued that there needed to be a reform of audit, possibly introducing a form of public audit into the sector.
On the insolvency role, Prem Sikka has consistently argued that there are no supervisory committees for the companies, as there are in the German economic system, where representatives supervise the decision making of companies. There are representatives in the workforce, as well as the recipients of particular services, or the consumers. Because we had no supervisory committees, companies became reckless in their endeavours. We had almost a moral hazard developing because a large number of the companies were often able to walk away from the liabilities that they had incurred.
One issue that Prem Sikka raised in his report was the offloading of pensions. We saw that with Carillion and elsewhere, when pensions were offloaded on to the public and the taxpayer had to step in to protect the rights of the workers who held pensions with those companies. Yet again, no one seemed to be held liable for the way in which they had either deliberately or recklessly put the companies into a situation where they were offloading their responsibilities.
I am particularly critical of the Financial Conduct Authority. I have said this publicly in debates before. I was critical of the FCA during the period in which Andrew Bailey was its chief executive. Before he was appointed Governor of the Bank of England, I urged the Chancellor of the Exchequer to delay his appointment because we were awaiting a number of reports of scandals with regard to investment bodies that should have been properly investigated by the FCA. What was generally identified, by not just me but other commentators, was that the FCA under his directorship was consistently asleep at the wheel on a number of individual instances.
Going back to Prem’s report, what he was identifying was a huge panoply of regulators, all of which seemed to be failing. Secondly, a large number of them were subject to corporate capture by the very sectors that they were meant to be regulating. As the hon. Member for Strangford said, the small people lost out badly as a result of that. They always lost out, and the people responsible often gained. As yet, I have not seen radical proposals from the Government to address that.
Prem Sikka did two reports. One was on the regulatory architecture of the financial sector overall, and the other was on audit. He put forward the establishment of an overall business commission, which brought together the various regulatory bodies under one structure. That included supervisory committees that would enable all stakeholders to be involved in the development of regulatory rules and the implementation of regulation much more effectively. That would at least be more open and transparent than the existing system.
I hope that the Minister will tell us, but I cannot see what has changed between now and back in 2018-19 when Carillion and other scandals were happening. I fear that those vulnerabilities still exist because we have not seen the radical reform that is needed. We need to integrate the whole process of regulation and to make it more independent, open and transparent. I hope the Minister will tell us that is the direction of Government.
We have had reports on this particular issue for a long time; I think the Cooke report was in the 1960s. It brought forward proposals but never really established independent regulation and handed it back to the industry itself. There has been a long history of corporate capture when it comes to financial regulation over successive Governments; I am not particularly blaming this one. The basic questions asked by my hon. Friend the Member for Salford and Eccles could provide us with more clarity on the Government’s sense of direction on some of these issues.
I feel there needs to be a sense of urgency about action. I understand why the Government want to consult thoroughly, but consultation is beginning to result in delay as far as I can see. Vulnerabilities still exist; we will be back here again, maybe in six or 12 months’ time, with yet another scandal, asking why action was not taken and why redress was not available to people who suffered as a result.
Richard Thomson (Gordon) (SNP)
It is a pleasure to serve under your chairmanship, Ms Fovargue. I congratulate the hon. Member for Salford and Eccles (Rebecca Long Bailey) on securing the debate. Given its title, it could have gone in many directions, but I think we are coalescing around a theme.
Directors clearly have important duties to their companies and their shareholders, whether in good times or bad. They have legal duties, including the duty to promote the success of the company for the benefit of the shareholders. However, when a company is in financial difficulty and there is a risk of insolvency, another set of responsibilities kick in. There is a duty to creditors to minimise losses.
As each speaker has highlighted, the regime appears to be letting far too many people down, and it is often those who can afford to lose out the least who end up losing out the most. Our view is quite simple. The UK Government must ensure robust supervision. Proper deterrents should be in place to ensure that those responsible in cases of negligence, or where economic crime has been committed, can be held to account.
The organisation openDemocracy estimates that fraud costs the UK about £290 billion a year in total and, in recent years, high-profile corporate scandals such as those at British Home Stores and Carillion raised serious questions about the level and quality of corporate governance in the UK and about the ability of those charged with supervising that governance to spot the obvious danger signs. In particular—I think it bears repetition—the collapse of Carillion in 2018 led to the loss of thousands of jobs and delay to many hundreds of infrastructure projects, while the directors walked away with their pay and bonuses intact. Those who had worked for them were left to suffer without.
Jim Shannon
Not only that, but a number of small companies suffered. People with their own businesses had to sell their properties and businesses, because they honoured the debt while others did not.
Richard Thomson
The hon. Member makes an extremely powerful point, which gets to the heart of the issue: those responsible for the waves of financial chaos that result from a corporate failure are not the ones who pay the price. Often, those who can afford to lose the least end up losing the most, whether that is their homes or their livelihoods. In 2020, two years on from the collapse, the assistant general secretary of the trade union Unite said that the UK’s accounting and audit system was clearly “not fit for purpose” and accused the Government of failing, even then, to demand reforms, because of their “many friends” among the major accountancy firms.
While the recent launch of the Financial Reporting Council consultation on its proposed changes to the UK corporate governance code was welcome, serious questions need to be asked about why that has taken so long so far. Frankly, the Government must get a move on with the reforms to ensure that they lead to a prompt, substantive and enforceable change of the landscape, so that the culture of corporate backscratching —if I may put it that way—that led to the Carillion collapse is left as a dim, distant and not-too-pleasant memory.
Robust deterrents are also required to ensure that where criminality is involved, those responsible—whether they are company owners or directors—and enablers are caught and receive proportionate sanctions for their actions. Culpable directors, senior managers and other enablers of economic crime need to face proportionate sanction, and the rules on anti-money laundering supervision need to be applied consistently.
John McDonnell
The hon. Member mentions criminality. I am flicking through Prem Sikka’s report, and I forgot to mention the section on Companies House. Previously, in the exposure of Magnolia Fundaction UK, an Italian fraudster who was one of the directors had registered himself—hardly fraudulently—as the “chicken thief”, with his occupation as “fraudster”, while another officer gave his address as the “Street of the 40 Thieves” in the town of “Ali Babba”. The issues at Companies House need to be addressed. I am interested to hear how much that will be addressed by the Minister.
Richard Thomson
I thank the right hon. Member for highlighting a particularly egregious example of hiding in plain sight. I will come on to mention some of the reforms that need to take place at Companies House.
To go back to the anti-money laundering supervision, there are clearly some significant holes in the AML framework, as well as a pretty patchwork approach to supervision, which varies significantly across companies and sectors. The non-governmental organisation Spotlight on Corruption noted that some 22 industry bodies oversee anti-money laundering compliance across the legal and accountancy sectors, which seems far too many to be doing the job effectively. With 22 supervisory organisations, a few gaps are bound to creep in somewhere.
In 2021, the Office for Professional Body Anti-Money Laundering Supervision, or OPBAS, found that only 15% of supervisors were effective in using predictable and proportionate supervisory action. OPBAS also found that only 19% had implemented an effective, risk-based approach to supervision, so the system is clearly not working. In the UK, an estimated £88 billion of dirty money is cleaned by criminals every year, compared with £54.5 billion in France and £51.3 billion in Germany. I know money launderers are consistently evolving their practice and that pace needs to be kept, but trying to supervise it across 22 bodies with those low levels of effective frameworks in place does not seem to be making the best impact possible on that trade and the other criminal activities that it promotes. Putting adequate resources into tackling economic crime not only pays for itself, it provides additional resources for public spending and reduces criminality across a broad spectrum of activities.
On Companies House specifically, Transparency International recently found that 14% of all LLPs incorporated show money laundering red flags. The Economic Crime and Corporate Transparency Bill had the opportunity to be a strong first line of defence in tackling that at the earliest opportunity, but unfortunately it did not provide the scale of reforms needed to ensure that the registrar could effectively tackle economic crime. Low registration fees in the UK and the quick turnaround clearly do not lend themselves to robust scrutiny by the registrar, as we heard in the example given by the right hon. Member for Hayes and Harlington (John McDonnell). It is exemplified by the inclusion of a warning at the top of the Companies House website that states that it does not
“verify the accuracy of the information”
filed. Well, it seems to me that that is something it very much should be doing.
The SNP tabled amendments to the Economic Crime and Corporate Transparency Bill that would have introduced more stringent requirements for company directors, including one to limit the number of directorships that an individual could hold. We put forward amendments for directors in breach of duties, which would prevent directors who failed to comply with their tax obligations from being able to receive public funds, except for the purpose of paying staff. We were vocal on the issue of phoenixing, where directors of companies that go insolvent then open up a new company that is effectively the same as the one that went under.
We are used to amendments to Bills falling flat on their face. That seems to be the fate of Opposition parties who table amendments, whether they are the third party or the official Opposition, but it was particularly disappointing that nothing to pick those ideas up was reflected in what came through in the Bill, because ensuring that information is correct at that early point would ultimately help to prevent companies from engaging in money laundering, other forms of economic crime and other dubious activities or from evading their corporate governance responsibilities, which causes the damage we have heard about. With adequate resourcing, that is a task that Companies House is more than capable of fulfilling.
To draw my remarks to a close, we need robust supervision of directors and proper deterrents in place against negligence and malfeasance. We need further reform and increased resourcing for Companies House. Above all, we need to create a culture of honesty, transparency and compliance, which in good times and especially in bad is as fair and beneficial to all as it is possible to be. I very much look forward to what the Minister has to say about those points when he takes to his feet.
Seema Malhotra (Feltham and Heston) (Lab/Co-op)
It is a pleasure to serve under your chairship, Ms Fovargue. I also congratulate my hon. Friend the Member for Salford and Eccles (Rebecca Long Bailey) on securing the debate and on her excellent opening speech. I thank my right hon. Friend the Member for Hayes and Harlington (John McDonnell) and the hon. Member for Gordon (Richard Thomson) for their important contributions on the chaos of regulatory bodies, and what really came through was the ongoing lack of a culture of challenge, and the links to the Economic Crime and Corporate Transparency Bill, which—I will speak to this later—we were keen for the Government to move much further on to tackle some of the weak areas, particularly phoenixing.
It is worth referencing that rising insolvencies, if we are talking about insolvency law and director disqualifications, also show an environment in which businesses are being hit hard. Many businesses are under strain due to the way in which they have been hit by the cost of doing business crisis, the supply chain crisis, the cost of living crisis, late payments and rising inflation and interest rates, with a Government that many businesses tell me is not on their side.
Monthly insolvencies hit record levels earlier this year in February and March. In March, there were almost 2,500 insolvencies, setting new records. However, alongside companies and directors who find themselves subject to insolvency despite their best efforts to survive, we know that there are business owners who abuse the process around administration and insolvency, with poor governance and stripping of assets. They incur high levels of debt and then dissolve the company, leaving workers and creditors in the lurch, and even denying workers the value of their outstanding pay and redundancy.
I thank the Bakers, Food and Allied Workers Union for its briefing and the caterers of Dawnfresh Foods and Orchard House Foods, which my hon. Friend the Member for Salford and Eccles also spoke about.
John McDonnell
We have had several representations from the bakers union over a period of time. It looks as though it is a sector where the strategy of insolvency has been used consistently. I wonder whether there could be a specific examination by the Government of this particular sector, because over the past eight or nine years we have had a pattern of behaviour, and it is one that is becoming almost endemic in the baking industry.
Seema Malhotra
I thank my right hon. Friend for his contribution. I agree with putting that question to the Minister and asking for a specific response.
The other issue is that rogue directors are able to walk away with seeming impunity. Some Government steps have been brought forward, and they have been important, but clearly they have not been enough—certainly not for the scale of the challenge. Recent public cases have highlighted the need for urgent action, but where steps have been taken by the Government there seems to be a lack of will to really grasp the challenges. I make reference to insolvency powers and audit and corporate governance reform here.
As one example, in 2021, clauses 2 and 3 of the Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Act 2021 introduced powers to enable the Insolvency Service to investigate directors of dissolved companies—measures that were first proposed in 2018. The Government’s main policy objectives were, first, to ensure that public concerns that rogue directors who abuse a company and insolvency law can be investigated and held accountable and, secondly, to provide a deterrent for company directors who may use the dissolution of the company to evade their responsibility to repay bounce back loans. Since the Bill became an Act, data showed to the Insolvency Service has focused mainly on the second policy objective, a point made effectively by my right hon. Friend the Member for Hayes and Harlington. In December ’21, the Insolvency Service gained powers to disqualify directors of dissolved companies, and, since 2022-23, just 25 directors of dissolved companies have been disqualified.
Many of the issues being talked about today were laid bare for all to see during the Carillion collapse in early 2018. Carillion had ostensibly been financially healthy. Its collapse saw more than 3,000 jobs lost, 450 public sector projects, including hospitals, schools and prisons, plunged into crisis and a company in billions of pounds of debt. In Hounslow, our leisure services were affected, and saved only by the council stepping in. Approximately 11,000 employees lost their jobs at British Home Stores, with a pension deficit of £571 million. These issues not only affect those close to the cases but cost the taxpayer, too. The National Audit Office reported that the Carillion affair cost the taxpayer at least £148 million, including £65 million in redundancy payments. Since the Government promised action on reforming corporate governance in the wake of the Carillion collapse, it took until May 2022 for a White Paper to emerge, and only in the past few weeks has the Financial Reporting Council issued its own consultation in response to the White Paper.
Let me say a few words on audit and corporate governance reform. This is an important policy space, in which reforms need to be robust for red flags to be seen early. An annual audit is a statutory requirement for listed and large companies. The purpose is to provide assurance to shareholders that financial statements give a true and fair view of a company. Good audit protects not just shareholders, but employees, pension holders, suppliers, customers and the wider community. At the broadest level, it serves the public interest by underpinning transparency and integrity in business.
Reform of the audit sector is clearly necessary and long overdue. The scandals we have heard about have damaged the reputation of the audit sector and the professionals who work in it. The Financial Reporting Council’s finding in December 2020 that over 80% of audits reviewed in the previous two years required improvement indicates the scale of the challenge. It also raised the issue of the importance of a challenge culture. Despite some improvements, there is still huge urgency, and it seems that the Government are dragging their feet. We are still waiting for legislation. The accounting and audit professions, the business community and the trade unions are all clear that change must come, and that the new audit, reporting and governance authority, which will step in when directors breach their duties, must be put on a clear statutory footing and given new powers that can only be conferred through legislation. I would be grateful for the Minister’s response to questions about plans for reform of section 172 of the Companies Act 2006 and directors’ duties.
I have some final remarks on the effectiveness of insolvency law and the director disqualification framework. R3 members note that for many years, regardless of the number of insolvency appointments and the number of reports submitted highlighting director behaviours that could warrant disqualification, broadly the same number of directors seem to have been disqualified each year, though there was a notable drop post pandemic. Are those numbers driven by resourcing constraints in the Insolvency Service, rather than assessment of director conduct?
Secondly, the annual enforcement statistics published this year indicate that there have been no disqualifications for phoenixing or insolvent trading. I would be grateful for the Minister’s view on enabling greater use of section 216 of the Insolvency Act 1986, so that it can be applied not only to companies in liquidation, but also to those that enter insolvent administration or are dissolved while the balance sheet is insolvent. That would accord with the Government’s recent extension of the director disqualification regime to dissolved companies.
During the recent passage through the Commons of the Economic Crime and Corporate Transparency Bill, we tabled amendments that would have improved the insolvency regime, including by tackling the practice of phoenixing, but the Government voted against them all. I hope that we can come back to some of those measures.
There is not just a failure to take this issue seriously, but a broader pattern of failing working people, who are so often left in the lurch. For too long, our economy has been ravaged by dire productivity, insecurity and stagnant pay. Government and business need to work together on a proper, pro-business, pro-worker, long-term plan for industry and the economy. Labour is committed to creating jobs that provide security, treat workers fairly and pay a decent wage through our new deal for working people—the biggest upgrade to workers’ rights in a generation. I would welcome assurances from the Minister that there will be progress on audit and corporate governance reform, and a further strengthening of the insolvency and director disqualification regime—two vital tools for keeping enterprise, employment and the economy protected from rogue directors, and for preventing the huge scandals that we have seen from ever happening again.
The Parliamentary Under-Secretary of State for Business and Trade (Kevin Hollinrake)
It is a pleasure to serve under your chairmanship, Ms Fovargue. I add my grateful thanks to the hon. Member for Salford and Eccles (Rebecca Long Bailey) for bringing forward this important debate. Members may know that I spoke out on this subject a lot from the Back Benches, and my appetite for change in this area—when parliamentary time allows—remains the same.
There is no doubt that the Government absolutely believe in strong corporate governance and an effective insolvency regime. The hon. Lady rightly referred to the demise of Carillion. Years have passed since that happened, but it is very important that we do not forget the lesson learned from the impact that had on all stakeholders, including employees and small and medium-sized enterprises in the supply chain.
I have great sympathy for those affected when companies declare themselves insolvent or go through insolvency in any circumstances, including the SMEs in those companies’ supply chain. The hon. Lady referred to the case in her constituency of Orchard House Foods; the redundancy protection service stepped in rapidly after the insolvency to make sure that people were properly compensated. Nevertheless, it was a worrying time for many people. Clearly, it would not be appropriate to talk about any ongoing investigations, but it is important that the Insolvency Service follows through on these matters and ensures that proper procedure is followed.
Given the comments made in the debate, it is important to say that most directors and businesses are bona fide and do the right thing. Of course we are concerned when companies go into insolvency, for all the reasons that have been outlined in the debate. The hon. Member for Strangford (Jim Shannon), who is no longer in his place, commented on cases in his constituency. Such cases have immense knock-on effects for stakeholders in our constituencies. Indeed, this is one of the issues on which I get the most letters from colleagues.
We must consider any changes we make to the regime in the light of the fact that most directors and businesses do the right thing. It is important to recognise that our economic system is not a zero-failure system. Failure is part of the process, and unfortunately many bona fide businesses that seek to do the right thing and invest their hard-earned money enter insolvency—in many cases through no fault of their own. We need a regime that reflects that context.
I think that most people accept that the FRC has significantly improved its oversight of the sector in recent years, particularly under the stewardship of Jon Thompson. There have been significant improvements. The right hon. Member for Hayes and Harlington (John McDonnell) referred to the regulator as being asleep at the wheel. That may have been a fair accusation years ago, but it is probably inappropriate now. However, when parliamentary time allows, it is right to replace the regulator with a new one—the audit, reporting and governance authority.
The hon. Member for Salford and Eccles referred to the US’s Sarbanes-Oxley system. Should we adopt that kind of system? We believe that there is a balance to be struck. We do not want anything that would be counter-productive to our economic system, in which competition is ultimately the best outcome for consumers. High competition drives down prices for consumers and drives up service. It is therefore important that we do not move to a system of a new generation of professional directors. It is important that our system is entrepreneurial, encourages investment, and encourages people to start up and expand businesses. We are, however, planning new corporate governance rules, which I will talk about in a second.
A number of hon. Members asked whether we will reform the Companies Act 2006 duties. The Act already requires all company directors to have regard to employee, consumer, environmental and other interests while pursuing the success of the company. Since 2019, large companies have been required to report annually on how those wider interests have been taken into account in boardroom decision making. I think the hon. Member for Feltham and Heston (Seema Malhotra) made a point about reform of those duties. It is important that we parliamentarians are cognisant of the burden on businesses; I applaud her for referring to that. Many businesses are under significant pressure right now from a number of angles, and it is important that we do not add to the burdens on them.
The right hon. Member for Hayes and Harlington raised the issue highlighted by Baron Sikka. I have worked very closely with Baron Sikka on economic crime and money laundering, and on the fact that there are 41 regulators in the financial system. It is important that we have straightforward corporate governance reform, so that we can hold people to account on their duties under the Companies Act 2006 and other requirements.
The Government response in May 2022 to our consultation on the “Restoring trust in audit and governance” White Paper confirmed plans to require very large companies to provide targeted new annual reporting on their management of risk and certain other matters. The new reporting will apply to UK-listed and private companies with more than 750 employees and an annual turnover of more than £750 million. Crucially, it will consist of four new statements in those companies’ annual reports: a resilience statement setting out how the company is managing significant risks over the short, medium and long term; confirmation that the company has sufficient realised profits to pay out any proposed dividends, and a statement about the company’s approach to profit distribution; a statement on the directors’ actions to prevent or detect material fraud; and an audit and assurance policy setting out how the company is assuring the quality of non-financial information that largely lies outside the statutory audit.
The new reporting requirement responds to concerns identified followed the sudden collapse of Carillion and other very large companies. Shareholders and other stakeholders need more information to understand the steps being taken by directors to ensure the future prospects of the company. We are developing secondary legislation, which we hope to lay before Parliament soon, to implement those new measures.
I often spoke about insolvency reform from the Back Benches; indeed, I co-authored a report called “Resolving Insolvency” on behalf of the all-party group on fair business banking. That relates to a point raised by the hon. Members for Feltham, and for Strangford, about insolvency reform. The Insolvency Service primarily investigates company directors and corporate misbehaviour. That includes investigating trading companies, and taking court action to wind them up when they have been acting against the public interest—for example, when there is evidence of fraud or corporate abuse. About 150 companies are investigated each year for that reason. The Insolvency Service also works collaboratively with other enforcement agencies to ensure the public are protected.
The bulk of the Insolvency Service’s enforcement work relates to investigating the conduct of directors of companies that are subject to formal insolvency, such as liquidation or administration. If an investigation finds evidence of misconduct by a company’s directors, the Insolvency Service may bring disqualification proceedings where that is in the public interest. Disqualification can be for a period of up to 15 years, and breach of a disqualification order is a criminal offence. Disqualification is therefore a significant interference with a person’s rights, and the courts take it very seriously. High standards of evidence are required. If a disqualification order is made, in certain circumstances there is the option to seek a compensation order against the disqualified director, who is personally required to pay back the losses they caused.
Having said that, we can go further on insolvency reform. It is the Government’s intention, when parliamentary time allows, to move towards a system of regulation with a single independent regulator, and away from the recognised professional bodies that we see today. I am very keen to take that forward when parliamentary time allows.
The hon. Member for Gordon (Richard Thomson) spoke about money laundering, the number of supervisors who act in that space, and the need to streamline that regime. His Majesty’s Treasury is looking at that, and is due to report on how we do that more effectively. I do not recognise his comments about the changes we are making as a consequence of the Economic Crime and Corporate Transparency Bill. That is the most significant change to Companies House in 170 years, and I look forward to the Scottish Government introducing a legislative consent motion so that Bill is fully effected in Scotland. Some of the hon. Gentleman’s comments, such as those on verification , were about the situation today, rather than the situation as it will be. We are all on the same page on the need to replace the dumb register with a database with integrity. That is one of the registrar’s four main objectives.
On fees, we are keen to make sure that it is quick, easy and affordable to start up a company in this country, but we recognise that fees need to increase to make sure that Companies House, and potentially the Insolvency Service, have the resources to do their work. We will therefore bring forward plans to make sure that those resources are there, through increases to the incorporation fee and the annual fees for registration.
On the hon. Member for Gordon’s points about directors’ limits, we do not feel that is a key issue. Setting an arbitrary limit on the number of directorships would not be the right way forward. I was the Minister responsible for taking the Economic Crime and Corporate Transparency Bill through the House, and if I remember rightly, the SNP suggested a limit of 20 directorships. I had more than 20 directorships at any one time in my past business life, so that limit would have restricted me from making some investments in the economy that created jobs and raised taxes. I do not think those kinds of arbitrary limits are right; instead, we see the regime working on the basis of red flags. If a high number of directorships is connected with other potential issues, we expect the registrar to investigate.
The hon. Member for Gordon raised an important point about phoenixing. That has certainly been of concern to many hon. Members, and we are keen to act on it. We have made significant changes around phoenixing. Individuals who have acted as a director of an insolvent company at any time in the preceding 12 months are prevented from forming, managing or promoting any business, including a company with the same name as, or a similar name to, the liquidated company for a period of five years from the date of insolvency. There are both criminal and civil penalties for a breach of that restriction, including director disqualification proceedings.
The Government strengthened the law in that area in 2021 by introducing changes to the disqualification regime to make sure that directors cannot avoid investigations by simply dissolving their companies. That point was also made by the hon. Member for Feltham and Heston. Twenty-five directors have been disqualified under that legislation. None of those disqualifications would have happened without the Government’s legislation in that area. We want to make sure that legislation goes further, and more investigations are ongoing. I will not specify the numbers, but it is fair to say that when the IS looks for cases of phoenixing, that is not the only misconduct identified. Often, those cases are dealt with as more serious offences that it is more important to prosecute. The hon. Lady gave a figure of 25, but that does not reflect some of the detriment and misconduct that we have identified.
We absolutely think there is a case for reform, and we are determined to take reforms forward quickly, as soon as parliamentary time allows. We also want to make sure that the UK is the best place in the world to do business, and that we do not interfere with people’s ability to start up and scale their business; however, we also want to maintain proper fiduciary responsibilities and have a system that properly oversees the conduct of directors. We will bring forward the legislation that strikes that balance as soon as parliamentary time allows.
Rebecca Long Bailey
I thank everybody for taking part in the debate, which has been wide-ranging; a lot of interesting points were raised. I thank the Minister for his lengthy response. I welcome a lot of the comments he made, and I followed his work as a Back Bencher on this issue, so I know we are on the same page on many issues, but I am saddened that he did not go into the level of detail that many of the questions asked by myself and colleagues required.
The vast majority of directors do the right thing—we wholeheartedly agree on that point—but the problem is that when the minority do not and it goes seriously wrong, the Insolvency Service and the UK corporate governance code only work to a certain point, because the enforceability just is not there. I applaud the work of the Insolvency Service, but it can only examine conduct as determined under the current law. Take a situation where directors could have consulted on redundancies prior to an insolvency event but did not. The law is very weak and ambiguous on that, which is the point I was trying to make in my opening remarks.
As the Sequana case clearly shows, the point at which an insolvency becomes probable is not defined in law. There is a point in time when directors should be, on a sliding scale, prioritising the interests of creditors prior to a probable insolvency. Defining that is crucial to providing the protection that workers and creditors deserve in situations where some of the money they are owed could be paid back to them.
On the issue of Sarbanes-Oxley, the Minister said that there is a balance to be struck, and he implied that by introducing legal requirements on directors in the style of Sarbanes-Oxley, we would in some way restrict entrepreneurship. That has certainly not been the case in the United States. I was reading a Harvard law report this morning that suggested the opposite—that providing certainty to shareholders and investors would actually encourage future investment. Directors should be able to say, “Yes, all the financial statements we are making are 100% correct. We are categorically supportive of the work that our auditors have done, and we’re happy to provide those reports to our shareholders.” If they cannot do that, we have a serious problem with our UK corporate governance regime. I do not think it is unreasonable to expect directors to have that legal liability.
Finally, on the audit system, the Minister has not provided any clarity about when ARGA will be set up, when audit reforms will be forthcoming or how extensive they will be. We got a taster in the Queen’s Speech, but as I am sure he agrees, reforms need to go a lot further than what the Government have put forward, because issues arise time and again. If we look at the dysfunctionality of the audit industry, KPMG was fined £14 million for not auditing Carillion’s company accounts correctly, and that was not a one-off. Prem Sikka referred to the case of Silentnight, in which KPMG—again, in the pursuit of a coveted client—did a pre-pack administration and sold a company to that potential client at an undervalue. It was fined £13 million for its role in that. That shows the dysfunctionality and the unhealthy nature of the audit industry as a whole.
John McDonnell
I worked for Silentnight as a youngster, but one of the other issues is the distressing of assets by the accountancy firms, so that they can get sold on. We have seen case after case of that.
Rebecca Long Bailey
My right hon. Friend is 100% right. I hope the Minister will come back with plans for more detailed reforms of the audit industry in due course.
I will finish on the point about the three reports that my right hon. Friend the Member for Hayes and Harlington (John McDonnell) mentioned. Lord Sikka provided three incredibly detailed reports a few years ago: one on the reform of regulatory architecture, one on reform of the audit industry and one on reform of the UK corporate governance regime. He did that along with a whole team of accountants and industry experts. The points made in those reports are as valid today as they were then, and they are non-partisan. I hope the Minister will take time to read those reports when he is bored over the weekend, and will take some pointers from them that he can take forward in Government policy.
Question put and agreed to.
Resolved,
That this House has considered insolvency law and director disqualifications.