Insolvency Law and Director Disqualifications

Yvonne Fovargue Excerpts

Wednesday 14th June 2023 Westminster Hall

[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.

[Yvonne Fovargue (in the Chair)]

I call John McDonnell.