Section 17 - Levy to pay expenses of bodies concerned with accounting standards etc

91.     Section 17 gives the Secretary of State the power to make regulations imposing a levy for meeting the costs of any body to whom the Secretary of State has paid or is proposing to pay a grant under section 16. The aim of the power is to ensure that the body to whom a grant is made under section 16 - expected to be the FRC - will have security of funding; and it is anticipated that a levy would only be imposed if the currently voluntary funding arrangement was no longer viable.

92.     In determining the appropriate rate of the levy, the Secretary of State must take account of the level of the Government grant paid, or expected to be paid, under section 16 (subsection (5)). An amount payable by a person as a result of the levy will constitute a debt owed by that person to the FRC and be recoverable by the FRC as a debt (subsection (6)).

93.     It is anticipated that should a levy be necessary, it would be imposed on:

• listed companies; and

• the members of the Consultative Committee of Accountancy Bodies (ICAEW, ICAS, ACCA, ICAI, the Chartered Institute of Management Accountants, and the Chartered Institute of Public Finance and Accountancy).

These bodies already contribute to the funding of the FRC under the voluntary funding arrangement.

94.     The first regulations made in respect of the levy power - and any further regulations which change the persons or bodies by whom the levy is payable - will be subject to the affirmative resolution procedure of both Houses of Parliament (subsections (10) and (11)). Any other subsequent regulations will be subject to the negative resolution procedure (subsection (12)).

Section 18 - Exemption from liability

95.     Section 18 exempts a body receiving a grant under section 16, its subsidiary bodies and their members, officers and staff from liability in damages for things done or not done for the purposes of, or in connection with, the activities listed in section 16 (which is in effect a list of the FRC's regulatory functions). It supersedes two previous exemptions: that enjoyed by a body authorised to apply to the courts in respect of defective accounts (the FRRP) under s245C(6) of the Companies Act 1985; and that available to a body to which the Secretary of State delegates her functions under Part 2 of the Companies Act 1989 (expected to be the Professional Oversight Board for Accountancy of the FRC) under s48(3) of that Act. These two exemptions are therefore repealed.

96.     Subsection (1) provides that an exemption from liability in damages applies when a grant has been paid to a body under section 16, and that it applies to acts or omissions occurring during the period of 12 months following the payment.

97.     Subsection (3) provides for a body funded under section 16, its subsidiaries and their members, officers and staff to be exempt from liability in damages for things that they do or omit to do during the 12 month period since the grant was paid, for the purposes of, or in connection with, any of the activities listed in section 16(2). The exemption would not apply to any non-regulatory activities conducted by the regulator (for example, providing vocational training on a commercial basis or compiling a database of Non-Executive Directors).

98.     Subsection (4) sets out the circumstances when the exemption will not apply - that is to say, where the act or omission was in bad faith or where it was unlawful under section 6(1) of the Human Rights Act 1998.

Chapter 3: Directors' liabilities

99.     Sections 19 and 20 relax the prohibition on provision made by companies protecting directors and other company officers from liability. They form part of the Government's response to its consultation on director and auditor liability of December 2003.

Background

The nature of directors' potential liabilities

100.      Directors' general duties are owed to the company rather than to individual shareholders. It therefore falls to the company to take action for breach of duty (including the duty of care, skill and diligence): in practice this usually means the board of directors (in some cases a new board of directors) or the administrator or liquidator.

101.     Directors may also have liabilities to third parties e.g. in respect of a class action by a group of shareholders in the US, or criminal or regulatory penalties.

102. The prohibition on companies exempting their officers from, or indemnifying them against, liability in respect of any negligence, default, breach of duty or breach of trust in relation to the company dates back to the 1920s. It arose because individual company articles were beginning to relieve directors from the consequences of breach of their duties. This meant the shareholders were unable to obtain redress, especially as the courts then took a very relaxed approach to the directors' duty of care. Parliament therefore changed the law in 1928 so that these exemption clauses ceased to have any effect. The Companies Act 1989 relaxed the prohibition by providing that companies could purchase liability insurance for directors and pay their legal costs if they were successful in defence of legal proceedings.

The Department's consultation on directors' liability

103. The Department of Trade and Industry published a consultative document in December 2003 in response to business concerns that suitably qualified individuals may be deterred from accepting positions as company directors. The consultation exercise built on the work of the independent Company Law Review and of the subsequent review of the role and effectiveness of non-executive directors undertaken by Sir Derek Higgs.

104. The consultation identified two particular concerns:

• exposure to liabilities arising from legal action against directors by third parties. The sharp rise in the number of class actions by groups of shareholders in the US has made this a particular concern for directors of British companies with a US listing;

• the cost of lengthy Court proceedings. Companies are currently permitted to indemnify a director against the cost of defending legal proceedings, but only when judgment has been given in the director's favour or he has been acquitted.

105. The consultation provided strong evidence that these issues are affecting the recruitment and behaviour of directors. Sections 19 and 20 have therefore been included in the Act to address these concerns.

Summary

106. The new sections inserted by sections 19 and 20 replace the existing provisions on directors' liability (but not auditors' liability) in section 310 of the Companies Act 1985. Because of this, they begin by setting out the basic prohibition on companies exempting directors from, and indemnifying them against, liability to the company, but they also introduce two important relaxations of the prohibition:

• they permit, but do not require, companies to indemnify directors in respect of proceedings brought by third parties and applications for relief from liability (covering both legal costs and the financial costs of any adverse judgment except criminal penalties, penalties imposed by regulatory bodies such as the Financial Services Authority and the legal costs of unsuccessful criminal defences or applications for relief);

• they permit, but do not require, companies to pay directors' costs of defence proceedings as they are incurred, even if the action is brought by the company itself or is a derivative action. The director would still be liable to pay damages and to repay his defence costs to the company if his defence were unsuccessful.

Section 19 - Relaxation of prohibition on provisions protecting directors etc. from liability

107.      Section 19 does two things:

• it inserts into the Companies Act 1985 three new sections - 309A, 309B and 309C - which replace the previous provisions on directors' liability (but not auditors' liability) in section 310 of that Act;

• it disapplies section 310 from directors and other officers.

108. New section 309A begins by restating the core prohibition on companies exempting directors from, or indemnifying them against, liability. Many of the key elements are retained from the previous form of section 310 of the 1985 Act. In particular:

• a company is prohibited from exempting a director from, or indemnifying him against, any liability "in connection with any negligence, default, breach of duty or breach of trust by him in relation to the company";

• a company is permitted to purchase and maintain insurance against any such liability.

109. There are however some important changes from the previous form of section 310 of the Companies Act 1985. New section 309A:

• does not extend to liabilities of officers other than directors. It therefore permits companies to indemnify officers such as the company secretary;

• does not retain the words "by virtue of any rule of law", which are usually taken to refer to a rule of non-statutory law. As a result, the new provisions on directors' liability are not limited to non-statutory liabilities;

• prohibits indemnification of a director by an associated company as well as by his own company. "Associated company" is defined under new section 309A(6) as, in effect, a company in the same group. The prohibition on indemnification by an "associated company" is intended to prevent parent companies and subsidiaries from assuming liabilities in circumstances where the company itself would not be permitted to assume such liabilities. The intention is that the order commencing section 19 will provide that contracts which were permitted under former section 310 but are prohibited under new sections 309A and 309B will remain effective only if they were made before Royal Assent on 28 October 2004;

• permits indemnification by the company in respect of proceedings brought by third parties (such as class actions in the US) and applications for relief from liability. New section 309A(4) explains that the prohibition on indemnification does not apply to a "qualifying third party indemnity provision" ("QTPIP"). This is explained further in new section 309B.

110.      New section 309B explains that a QTPIP must satisfy three conditions:

Condition A is that the provision does not indemnify the director against a liability to the company or to any associated company;

Condition B is that the provision does not indemnify the director against payment of a criminal fine or a regulatory penalty (such as a fine imposed by the Financial Services Authority);

Condition C is that the provision does not indemnify the director against any liability incurred:

(a)     in defending any criminal proceedings in which he is convicted;

(b)     in defending any civil proceedings brought by the company, or an associated company, in which judgment is given against him;

(c)     in an unsuccessful application for relief from liability under the provisions for relief in the Companies Act.

111.      New section 309B(5), 309B(6) and 309B(7) explain when legal proceedings will be considered to have concluded in respect of Condition C.

112.      New section 309C requires the company to make two forms of disclosure about indemnification by the company or an associated company:

• if a QTPIP is in force for the benefit of one or more directors or was in force during the previous year, this must be disclosed by the company in the directors' report (and where the director is of one company but the QTPIP is provided by an associated company, in the directors' reports of both companies). Companies which choose not to indemnify directors will not have to make any disclosure;

• it applies section 318 of the Companies Act 1985 (under which directors' service contracts must be open to inspection by shareholders) so QTPIPs must be available for inspection by shareholders. This will permit shareholders to look at an indemnity provision in detail.

113.      Section 19 also amends section 310 of the Companies Act 1985 by removing the references to directors and officers of the company. Section 310 now applies only to auditors, with new sections 309A, 309B and 309C setting out the prohibition and related provisions in respect of directors. Other officers, such as the company secretary, are no longer covered.

Section 20 - Funding of director's expenditure on defending proceedings

114.     Sections 330-344 of the Companies Act 1985 place restrictions on a company's power to make loans or quasi-loans to directors, or to enter into certain types of credit transaction with a director. The prohibition prevents a company from indemnifying a director on an 'as incurred' basis even against his legal expenses.

115.     Section 20 therefore inserts a new section - section 337A - into these sections of the 1985 Act. New section 337A provides that a company is not prohibited from funding a director's expenditure in defending any civil or criminal proceedings provided that the director:

• repays any loan; or

• discharges any other liability to the company

if he is convicted in any criminal proceedings or judgment is given against him in any civil proceedings, or he is unsuccessful in an application for relief from liability under the provisions for relief in the Companies Act. Under new section 309B, however, a company may permit a director not to repay a loan if all the circumstances for a QTPIP (see paragraph 110 above) are satisfied (particularly in a case in which judgement is given against him in proceedings brought by a third party).

Chapter 4: Investigations

Summary and Background

116.     The Act makes a number of targeted amendments intended to strengthen the company investigations regime as part of the package designed to help ensure confidence in the UK corporate framework.

Powers to investigate

117.     The Secretary of State has a range of powers under companies legislation to investigate the affairs of a company and related matters. The vast majority of company investigations are carried out under section 447 of the Companies Act 1985. Members of DTI's Companies Investigations Branch (CIB) or other competent individuals can be authorised to require the production of documents and can require explanations of any document from the person who produces it or from any past or present officer or employee of the company. These are confidential fact-finding inquiries, but there is a disclosure regime which allows, for example, information to be passed to other regulators. Investigations under section 447 are carried out where, for example, there are grounds for suspicion of fraud, misfeasance, misconduct, conduct unfairly prejudicial to shareholders or of failure to supply shareholders with information they may reasonably expect.

Changes made by the Act

118.     The Act amends existing legislation in order to strengthen the current regime, without changing the basis for inspections or making any change of substance to the grounds for an investigation. Changes have been made to:

• give section 447 investigators a general power to require relevant information and strengthen their powers to require relevant documents (section 21);

• provide statutory immunity from liability for breach of confidence where people provide information to CIB voluntarily in certain circumstances (section 22);

• give inspectors and investigators a power to require entry to premises used for company business and a right to remain there for the purposes of the investigation (section 23);

• provide a more effective sanction for non-compliance with section 447 requirements and provide a sanction for non-compliance with the power to require entry to premises (section 24).

119.     The details of these changes and the circumstances in which the changes will apply are set out below.

Section 21 - Power to require documents and information

120.     This section replaces section 447 of the Companies Act 1985. That section contained the powers used to carry out the majority of company investigations. In almost all cases, investigations under section 447 are carried out by DTI investigators authorised for that purpose by the Secretary of State. An investigator's powers previously comprised:

• a power to require a company to produce documents specified by the investigator;

• where any other person appeared to be in possession of documents which the investigator could require the company to produce, a power to require that person to produce those documents;

• a power to copy or take extracts from documents produced;

• a power to require an explanation of documents produced from the person who produced them or from any past or present officer or employee of the company; and

• where a person did not produce specified documents as required, a power to require information from that person about their whereabouts.

121.     These powers were limited in ways which were capable of slowing down investigations and undermining investigators' ability to uncover the facts, particularly in cases where companies were prepared to do no more than comply strictly with their legal obligations, narrowly interpreted. First, there was no general power to require answers to questions unrelated to documents produced. Second, while it was clear that persons other than the company under investigation could be required to produce company documents in their possession and other documents held to the order of the company, the question of what other kinds of documents they could be required to produce was open to argument. The primary purpose of new section 447 is to remove these limitations.

122.     The previous section 447 also conferred document-gathering powers on the Secretary of State. The Secretary of State had powers to direct a company to produce documents, to require other persons to produce documents (where she could require the company to produce them), to copy or take extracts from documents produced, to require explanations of documents produced from certain persons and to ask about the whereabouts of documents which were not produced. These powers suffered from the same limitations as those affecting investigators, but the main purpose of new section 447 in this regard is only to give the Secretary of State a new, general power to require answers to questions from companies.

123.     Previous section 447 stated that the Secretary of State could exercise her powers (including her power to authorise the exercise of powers by an investigator) if she thought that there was "good reason" to do so. This restriction prevented the Secretary of State from acting on trivial, irrelevant or irrational grounds. As such, it added nothing to the restrictions which apply as a matter of general administrative law to the exercise of the Secretary of State's powers. As explained below, the "good reason" restriction has not been included in new section 447

124.     Section 452(2) prevented the powers in previous section 447 from being used to compel the production of documents which would be protected from disclosure in civil court proceedings on the grounds of legal professional privilege. Section 452(3) also provided a measure of protection for documents held by banks which relate to the affairs of their customers.

125.     Section 21 replaces previous section 447(2) to (7) and (9). (Section 447(1) had already been repealed.)

126.     New section 447(2) gives the Secretary of State the power to direct a company to produce documents or to provide information. Because of new section 447(1), the power can only be exercised for reasons relating to the company in question. The Secretary of State can either specify or describe the documents she wants. The Secretary of State's power to require documents under new section 447(2)(a) is narrower than her previous power to require documents under section 447 because it enables her to obtain documents only from the company concerned. But her general power to require information from a company under new section 447(2)(b) is new.

127.     New section 447(3) enables the Secretary of State to authorise a person to exercise certain investigatory powers (as previous section 447(3) did). Because of new section 447(1), the decision to authorise must relate to a company. Authorisation is, in effect, a decision to start an investigation of that company. For the first time a person authorised under section 447 is referred to as an "investigator", although this is not a change of substance. Investigators can still be appointed from the DTI's ranks or from outside. An investigator has the power to require the company under investigation, or any other person, to produce documents or provide information. The investigator can either specify or describe the documents he or she wants. These powers are wider than those previously available to investigators under section 447. The general power to require information from anyone is new. It subsumes the existing powers to ask where documents are which have not been produced and to require explanations of documents which have been produced. It also enables, for example, an investigator to require a person to explain his conduct, or give his opinion about something. The power to require the production of documents by persons other than the company is expressed in such a way as to make it clear that third parties can be required to produce any relevant document, not just documents in their possession which belong to the company under investigation or are held to the order of that company.

128.     The changes made to the powers of the Secretary of State and investigators do not lessen the protection which exists in relation to legal professional privilege and banking confidentiality. Section 452 of the Companies Act 1985 is amended by paragraph 21 of Schedule 2 so that, among other things, the protection which it provides is applied to the new powers to require information.

129.     References to "good reason" are omitted from new section 447, but this is not a change of substance to the grounds for use of the powers. The references have been omitted because (as explained above) they add nothing to the restrictions which apply as a matter of general administrative law. The Secretary of State will not be able to act under new section 447 on trivial, irrelevant or irrational grounds, just as she could not act on such grounds under previous section 447.

130.     New section 447(5) provides that a requirement to produce documents or provide information must be complied with at such time and place as the Secretary of State or investigator specifies. Among other things, this enables investigators to require specified documents to be handed over immediately.

131.     New section 447(6) provides that a lien on a document is not affected by the production of that document in compliance with a requirement imposed by the Secretary of State or an investigator. In this context a lien is, generally speaking, a legal right to keep possession of a document belonging to someone else until a claim is satisfied - for example, a claim for payment of professional fees. This subsection does not entitle a person to refuse to hand over a document to the Secretary of State or an investigator, but preserves the rights of (for example) the professional in question over those documents.

132.     New section 447(8) and (9) re-enact previous section 447(9). These subsections provide that the expression "document" in new section 447 includes information recorded in any form (for example, on paper or electronically). They also provide that, where information is recorded otherwise than in legible form (for example, electronically), the Secretary of State or an investigator can require a copy of it to be produced in legible form (for example in "hard copy") or in a form from which it can readily be produced in visible and legible form (for example, on a floppy disk).

133.     New section 447 does not re-enact previous section 447(6) and (7). So the offence of failing to comply with a requirement imposed under section 447 is repealed. To replace it, a new sanction is provided by section 24, which inserts new section 453C (failure to comply with certain requirements) into the Companies Act 1985.

134.     Previous section 447(8), (8A) and (8B) is re-enacted with modifications by new section 447A, inserted by paragraph 17 of Schedule 2.

Section 22 - Protection in relation to certain disclosures

135.     Statutory powers are not generally used by the DTI for enquiries carried out when vetting complaints about companies. The vetting process is non-statutory and its purpose is to establish whether a formal investigation (usually under section 447) is appropriate. The process therefore precedes the appointment of investigators with formal powers. A requirement to produce documents or provide information imposed by an investigator using such formal powers overrides any duty of confidence which might in other circumstances prevent the person in question from handing over the document or revealing the information. In the vetting situation, however, there are no statutory provisions guaranteeing immunity from legal liability to a person who, in breach of a contractual or other duty of confidence, provides information in response to an informal DTI enquiry.

136.     This is not necessarily to say that a person would not have a defence to a breach of confidence claim in such circumstances. However, the aim of this section is to remove the potential deterrent of having to argue such a defence so that individuals and businesses feel able to volunteer information in response to an informal DTI enquiry. This should give the DTI wider access to the sort of information which can help decisions to be made about whether or not to start formal investigations.

137.     The section inserts a new section 448A into the Companies Act 1985.

138.     New section 448A(1) provides immunity from legal liability for breach of confidence to any person who makes a "relevant disclosure".

139.     New section 448A(2) defines "relevant disclosure" for this purpose. A relevant disclosure is one which satisfies all of the five specified conditions in subsection (2). These are:

• that it is a disclosure which is not made in compliance with a requirement imposed under Part 14 of the Companies Act 1985. This makes it clear that the new statutory immunity relates to information which is volunteered, rather than information which is provided in response to the exercise of an investigation power under that Part;

• that the disclosure is of a kind which could be required by the exercise of a power under Part 14 of the 1985 Act - in other words that it is relevant to a matter which could be investigated under that Part and is not covered by the provisions of section 452 (as amended) relating to legal professional privilege;

• that the person making the disclosure does so in good faith and believes, on reasonable grounds, that the information he or she is disclosing is capable of helping the Secretary of State for the purposes of the exercise of her functions under Part 14. The "good faith" requirement will make sure that, for example, disclosures motivated by a desire to cause harm to a business competitor will not be protected;

• that the information disclosed is not more than is reasonably necessary for the purpose of assisting the Secretary of State in the exercise of her functions under Part 14. This will ensure that only disclosures which are proportionate will be protected;

• that it is not a disclosure of a kind described in subsection (3) or (4). The effect of this last condition is that there is no statutory immunity from liability for breach of confidence where:

     (i) the disclosure is in breach of a statutory duty of confidence (for example,      under the Data Protection Act 1998) (subsection (3));

(ii) the disclosure is made by a bank and involves revealing information about the affairs of a customer (subsection (4));

(iii) the disclosure is made by a lawyer and involves revealing information about a client (subsection (4)).

140.     Thus, for example, new section 448A will not make it easier for the DTI, when vetting complaints, to obtain information about companies' private banking transactions from their banks, because banks will still be exposed to the risk of having to defend breach of confidence claims if they reveal such information in those circumstances.

141.     The effect of new section 448A(5) is that reference to statutory duties of confidence includes duties contained in secondary legislation, in Acts of the Scottish Parliament and legislation made under such Acts and in legislation passed or made after new section 448A comes into force.