Committee Reports > List of Committees > Joint > 1985 > Committee on the Secondary Legislation of the European Communities (4th Committee) > Report No. 20 - Fifth Company Law Directive

A. INTRODUCTION

Proposed Directive

1.The Joint Committee has examined the Commission’s amended proposal for a Fifth Directive on the structure of public limited companies which was published in August, 1983. The proposed Directive is one of a series of 10 dealing with company law, seven of which have already been adopted by the Council of Ministers and of which two have been implemented by Irish legislation (see Appendix 1).The legal basis for the proposal is Article 54 (3) (g) of the EEC Treaty which provides for the implementation of the right of establishment “by co-ordinating to the necessary extent the safeguards which, for the protection of the interests of members and others, are required by Member States of companies and firms within the meaning of the second paragraph with a view to making such safeguards equivalent throughout the Community”. “Companies or firms” are defined in Article 58 as “companies or firms constituted under civil or commercial law, including co-operative societies, and other legal persons governed by public or private law, save for those which are non-profit making”.

Background

2.Since the appearance of the proposed Fifth Directive in its original form in 1972 it has been the subject of controversy largely because of its proposal for worker participation in the decision-making structure of public companies. The revised version which appeared last year incorporates many of the suggestions of the European Parliament which adopted an opinion on the original proposal in May, 1982. The revised version has been under examination by a Council Working Group since December, 1983 and it is expected that the consideration at this level is likely to take some considerable time.

Examination by Joint Committee

3.The Joint Committee has had the revised draft Directive examined in detail by sub-Committees under the chairmanship of Senator Mary Robinson. The sub-Committees had the benefit of advice and submissions from the Federated Union of Employers, the Confederation of Irish Industry, the Consultative Committee of Accountancy Bodies - Ireland and the Irish Congress of Trade Unions as well as submissions from the Department of Industry, Trade, Commerce and Tourism and the Department of Labour.

The Committee wishes to express its thanks to those bodies who submitted material on the proposal and to acknowledge that the help given by them has proved invaluable. It also desires to record its appreciation of the work performed for it by Senator Robinson and her colleagues on the sub-Committees.

B. SCOPE OF PROPOSALS

Outline of Proposals

4.The draft Directive contains proposals for employee participation in the decision making structure of all public limited companies employing directly or through subsidiaries a minimum of 1000 employees. It contains a number of significant proposals dealing with the structure and functions of companies and other issues within the area of company law which would apply to all public limited companies. Prior to the enactment of the Companies (Amendment) Act, 1983, which required the re-registration of companies which wished to retain public limited status, there were about 340 public limited companies in this country and of these some 124 have re-registered under the 1983 Act.

Structure and Functions of Board

5.If the proposed Directive is adopted it will be necessary to enact national legislation so as to enable public limited companies to be organised on a two-tier basis with a management organ responsible for the running of the day-to-day affairs of the company under the supervision of a surervisory organ. The management organ would be appointed by the supervisory organ and if it had several members one would be designated as having special responsibility for personnel relations. The appointment of the supervisory organ would be made by the annual general meeting but where the company has more than 1000 employees there would be provision for employee representation. As an alternative to the two-tier system the proposed Directive would allow the national legislation to permit public companies to opt for organisation on a one-tier system with the controlling function being vested in a single administrative organ but under this system the distinction between supervisory and management functions would be maintained at board level. The administrative organ which would operate under the one-tier system would consist of executive and non-executive members, the former being appointed by the latter. In appropriate cases (i.e. where more than 1000 are employed) the one-tier system would also involve employee participation.

Employee participation

6.The proposed Directive would enable Member States to adopt one of the following options for employee participation in the supervision of the management of the company:-

(a)Election of a minimum of one-third and a maximum of one-half of the members of the supervisory organ in the two-tier system or the non-executive members of the administrative organ in the one-tier system, the remainder being appointed by the general meeting;

(b)In the two-tier system as an alternative to (a), co-option by the supervisory organ with a right in the general meeting, a shareholders’ committee or employees’ representatives to object to appointments on specified grounds and a right in an independent body to overrule such objections;

(c)As an alternative to representation on the supervisory organ or the administrative organ employees’ representatives to be given the right (i) to the same information as the members of the supervisory organ or the non-executive members receive, and to general information on the company’s affairs (ii) to be consulted on those major decisions in relation to which the supervisory organ or the non-executive members of the administrative organ have rights and (iii) if their advice is rejected to be informed of the reasons, or

(d)Employee participation to be regulated by collective agreements between the company and organisations representing the employees which would lead to at least the same rights for employees as the methods of participation described at (a), (b) and (c).

7.As already indicated the provisions relating to employee participation are to apply only to public limited companies employing 1000 or more employees. For the purpose of calculating the number of employees persons employed in a subsidiary undertaking are to be included. It appears, however, that employee participation would only be compulsory in respect of the parent company’s own employees but Member States would be permitted, if they chose to introduce measures, to include employees of subsidiaries in the scheme of participation applicable to the employees of the parent company, to relieve the subsidiaries (if there are public limited companies) from operating an employee participation scheme themselves. Member States would also be permitted not to apply the employee participation provisions to financial holding companies or to parent undertakings of international groups whose sole object is to co-ordinate management and finance.

8.Member States would also be permitted to derogate from the employee participation provisions with respect to companies whose sole or principal object is (a) political, religious humanitarian, scientific or artistic or (b) related to public information or expression of opinion.

Other Provisions

9.The proposed Directive also contains a number of significant provisions dealing with a wide range of conventional company law issues. Many of these provisions are at variance with or more stringent than existing Irish law and practice while others are less demanding. If adopted, the Directive will necessitate amendment of the Companies Acts, 1963 to 1983. The main elements of these provisions deal with the following:-

(i)liability of and proceedings against directors;

(ii)rights of minority shareholders;

(iii)calling, conduct and powers of general meeting;

(iv)legal reserves and appropriation of profits;

(v)functions and liability, appointment and dismissal of auditors.

C. STRUCTURE AND FUNCTIONS OF BOARD

Two-tier and one-tier structures

10.The two-tier structure is based on German practice and in the Commission Green Paper on “Employee Participation and Company Structure”, published in August, 1975 it is argued that it is the structure which offers the most satisfactory safeguards for shareholder and employee interests. While the revised draft Directive envisages companies having the option to adopt a one-tier system they would nevertheless be obliged to accept the formal division of management and supervisory functions which is the essential feature of the two-tier system.

11.The one-tier system operates in Ireland. The board of directors is appointed by and answerable to the shareholders in general meeting. Many companies entrust most functions to a management or executive committee of full-time directors with part-time directors confining themselves to supervisory functions, long-term policy and forward planning. Such companies are in a sense operating a division of functions but are so acting for practical considerations and not by compulsion of law.

12.The Federated Union of Employers and the Confederation of Irish Industry are opposed to the imposition of a two-tier system. Both consider that a two-tier board would lead to confusion and delay when the need is for flexibility and flair in adapting to changing circumstances. The Department of Industry, Trade, Commerce and Tourism does not see any particular merit in a two-tier structure or in the formal separation of functions in a one-tier system and considers that considerable changes would be required in current management functions by the mandatory imposition of either.

Views of the Joint Committee

13.The separation of management and supervisory functions is necessary in the Commission’s view to strengthen shareholder control of management and also to facilitate employee participation in the decision making process at company level. The Joint Committee is not satisfied that a formal separation of functions would have any particular advantages over the present system for this country as far as the management and control of companies are concerned. The question then arises whether such separation of functions would facilitate the introduction of employee participation in the decision making as such is considered desirable. The separation of supervisory from management functions might open the door to participation by employees in the former and the Committee notes that “not surprisingly, the development of participation in relation to decision making bodies is most advanced in countries where the dualist system operates” according to the Discussion Paper on Worker Participation ⁽¹⁾ published by the Department of Labour in March, 1980. The case for the separation of functions therefore seems to the Committee to depend on the view taken of the draft Directive’s proposals for employee participation.

D. EMPLOYEE PARTICIPATION

Worker Directors or Works Council

14.The proposed Directive envisages that representatives of the employees of public limited companies with 1000 employees or more would fill at least one-third of the non-executive director posts under both the two-tier and one-tier system. In that capacity they would participate in the appointment and the supervision of the management organ or the executive directors as the case may be. Alternatively employee representation could be secured under a body such as a Works Council representing the employees with a right to regular information and consultation on the administration, situation, progress and prospects of the company, its competitive position, credit situation and investment plans as well as to the information available to the supervisory organ or non-executive directors as the case may be. While the Works Council’s functions would be consultative only it would be entitled to be informed of the reasons when its opinion was not adopted in case of certain specified decisions. The proposed Directive would also allow employee participation to be regulated by collective agreements which would at least secure the same rights for employees as those already described.

15.In its Green Paper of 1975 the Commission pointed out that company laws of the traditional pattern did not contain provisions involving employees in the decision-making of companies “because they were based on economic and social policies which saw the employees’ relationship with companies as essentially contractual”. In the Commission’s view “in so far as economic and social policies come to regard the company as an enterprise in which labour and capital combine in their own and society’s interests, then the laws relating to companies will sooner or later have to reflect this change of underlying philosophy and include provisions expressly dealing with relationships between providers of capital, the management and the employees”. As the laws of several Member States already reflect the “change of underlying philosophy” by providing for employee participation, the Commission argues that “to make no provision for the matter at European level would be to fail in a significant degree to ensure that the laws of Member States provide for equivalent safeguards and obligations”.

16.The Confederation of Irish Industry and the Federated Union of Employers have both expressed to the Joint Committee their opposition to the proposals relating to employee participation. The Confederation believes that there is a basic misconception in seeing a board of directors as a supervisory body rather than a body with responsibility for strategic policy initiation as well as control. In its view even if a representative body had no power of veto it would have the capacity for causing undesirable delays and unless the shareholders retained the right to dismiss directors an inappropriate board structure would be the result. The Federated Union of Employers considers that the adoption of these proposals would lessen the prospects of investment and damage the potential for employment. In its view the thinking behind the proposals reflects the system of industrial relations in the Federal Republic of Germany and the Netherlands and are wholly inappropriate where trade unions have the freedom under the law which they enjoy in Ireland.

17.The Irish Congress of Trade Unions supported the proposed Directive in its original form. While the present modified version does not go quite as far as it would like Congress is prepared to give it its general support.

18.The Department of Industry, Trade, Commerce and Tourism has also expressed its opposition. The Department believes that the legislative imposition of rigid worker participation structures would discourage investment from abroad and stifle investment at home. It considers that if EEC companies were subject to restrictions from which their competitors were free their competitiveness would be affected. The present unemployment problem might well be exacerbated if companies were tempted to reduce staff to avoid the application of the worker participation provisions, or to break up or re-structure groups towards that end. In this connection the Joint Committee notes that any such tendency could be counteracted by the State availing of its option to reduce the threshold of 1000 employees. The Departemnt considers that worker participation in Irish public companies should be allowed to develop on a voluntary basis.

Irish legislation

19.The Worker Participation (State Enterprises) Act, 1977 prescribes procedures whereby one-third of the board of seven commercial-type State companies are elected by employees. The Act has been implemented in the case of the seven companies in question and the Joint Committee understands that the Government has approved the extension of the Act to a further six companies and for alterations in the participatory structures.⁽¹⁾

Views of the Joint Committee

20.In the opinion of the Joint Committee the employees have interests in the functioning of companies which can be as substantial as those of the shareholders. They are likely to be affected by the decisions taken by the boards of their companies in varying and sometimes vital respects. If proposals are mooted for commercial reasons which may prove inimical to the interests of employees it is not unreasonable that the employees whose livelihood is dependent on the company should be consulted and have the opportunity of influencing decisions or at least be put in the position where they can appreciate the considerations leading to the decisions taken. In the Committee’s view there is a strong case in principle for some participation by employees in the decision-making process of the companies which employ them.

21.The Confederation of Irish Industry has expressed the opinion that “the unitary board structure containing representatives elected by shareholders and employees would tend to promote conflict rather than consensus in the board room”. Presumably therefore the Confederation would not expect worker participation to have any beneficial effect on labour relations. A more optimistic view was taken by the then Minister for Labour in 1980. In the foreword to his Department’s Discussion Paper on Worker Participation of March, 1980(1) the Minister expressed the belief “that workers’ involvement will help to reduce the tensions which very often lead to industrial strife”. The Joint Committee is of the opinion that it would be too much to expect that worker participation would have the effect of eliminating all avoidable confrontation. However, in the longer term the Committee would expect that acceptance generally of the rights of employees to influence the decisions of companies would have a beneficial effect on labour relations. As far as this country is concerned the Committee believes that it would be easier to convert employers to that point of view if the operation of the Worker Participation (State Enterprises) Act, 1977 were seen to be producing beneficial results in the labour relations field in the public sector.

22.While it would obviously be preferable if a mutually acceptable system of employee participation in the management of companies could evolve through the purely voluntary efforts of both sides of industry the Joint Committee is sceptical of the prospects of much being achieved in the absence of legislation. Moreover it accepts that the best prospects of securing general acceptance of the concept of employee participation lie in the adoption of uniform measures in the Community. Accordingly it acknowledges the importance of proceeding in this area by way of a Council Directive and broadly speaking it would accept the proposals of the draft Directive as providing a legislative framework within which both sides of industry would be encouraged to find agreement. In particular the Committee considers that the proposed separation of management and supervisory functions at board level and the one and two tier structures should be available as options because it believes that a formal division of functions should be conducive to employee participation.

23.The Joint Committee, however, accepts that due regard must be paid to the objections voiced by the employers’ organisations in this country. Accordingly it believes that any Directive adopted must allow for the maximum flexibility in its implementation by the Member States. The Committee considers that several years ought to be allowed for the incorporation of the Directive provisions into national law so that within that period both sides of industry could work towards agreement within the options allowed.

24.The Joint Committee has made a separate report on the draft Directive on procedures for informing and consulting employees which has become known as the Vredeling Directive. That Directive would apply to a wider range of undertakings than are affected by the draft Directive which is the subject of this report. Nevertheless there are circumstances in which both Directives, if adopted, would apply and as there are provisions in these proposals which overlap it is important in the Committee’s view to avoid introducing overlapping procedures which could prove unnecessarily costly and confusing. In particular this applies to provisions dealing with the type of information to be supplied to employees’ representatives, the withholding of secret information and the obligations to consult.

E. OTHER PROVISIONS

Directors’ Liability

25.The draft Directive proposed that directors would be jointly and severally liable for “all damage sustained by the company as a result of breaches of the law or of the memorandum or articles of association or of other wrongful acts”. This would involve a change of the law in Ireland where at present a director is not the agent of his fellow directors and consequently is not by virtue of his office liable for the wrongful act of another director. Under the proposed Directive a director could “Exonerate himself if he proves that no fault is attributable to him personally”.

26.The Joint Committee presumes that the purpose of this provision is to avoid the need to determine which director or directors are responsible for the damage sustained by the company. Its effect would be to shift the onus of proof on to a director to prove his innocence rather than requiring proof of his responsibility for the damage suffered as at present. The Committee is not in favour of this change as it believes that it could unfairly pose considerable difficulties for the innocent director.

27.The draft Directive would prohibit executive directors from carrying on activities in another undertaking, whether remunerated or not, without authorisation. The Joint Committee does not object to this proposal but it considers that there should be no restriction on such directors participating in the activities of charitable or voluntary organisations. Any authorisation given would have to be disclosed to the general meeting. While this requirement would go beyond the provisions of the Companies Act, 1963 the Joint Committee has been informed by the Consultative Committee of Accountancy Bodies - Ireland (CCAB-I) that it is in line with current “best practice” and it agrees with the Committee that disclosure should be on an on-going annual basis.

Minority Shareholders

28.Minority shareholders holding 5% of the share capital or shares of a nominal value of 100,000 ECU (IR£72,000 approx.) would, under the proposed Directive, be enabled to have an action brought on behalf and in the name of a public company to enforce the liability of the executive directors though if this right were exercised unreasonably they might be made liable for costs. Under the rule in Foss v Harbottle which applies in this country and which is designed to discourage litigation it is for the company itself and not individual shareholders to sue a wrongdoer as a result of whose unlawful act the company suffers loss. By way of exception to the rule a shareholder is permitted to bring a derivative suit in the name of the company against those who control the company where the latter commits a fraud on the company and fraud in this context is given a wide connotation. The Directive’s proposals in this regard would not appear to be subject to any such restriction. The Joint Committee doubts the merit of encouraging further litigation in the field of company law and considers that if the Directive’s proposal is adopted in its present form the proposed right of action should be made subject to the prior consent of the Court.

29.The draft Directive would allow minority shareholders (as defined above) to requisition a general meeting whereas current Irish law confers that right on the holders of not less than 10% of the paid up capital. While the Joint Committee has no strong views on this aspect it considers that in another respect current Irish law is to be preferred to that proposed in the draft Directive and should be retained. If the directors fail to convene a requisitioned meeting within the specified period section 132(3) of the Companies Act, 1963 permits the requisitionists to do so themselves whereas Article 23(2) of the draft Directive would require an application to court.

30.The CCAB-I has drawn the attention of the Joint Committee to Article 34 of the draft Directive which it considers to be based on the Commission’s perception of a need to protect minority interests. The Article seeks to prevent a shareholder from voting on certain issues where there is a conflict of interest between the company and the shareholder personally.

The Joint Committee would have thought that the Article was intended to apply to shareholders who were directors, employees or persons against whom the company had contractual rights. The CCAB-I has pointed out that the Article is to apply even when its application results in voting being confined to a minority of shareholders and this could lead to severe practical difficulties in group situations. The CCAB-I has in mind a parent company holding 70-80% of the share capital being unable to prevent the removal of a director whom it had originally nominated or being unable to use its voting rights to prevent a contract going to a third party “although it could have been fulfilled by an affiliated company either on an ‘arms length’ basis or on a basis, when considered in the group context, satisfactory to both the subsidiary and the affiliated company”. The Committee accepts the need for reviewing this Article to accommodate the situation of companies forming a group.

General Meeting

31.The draft Directive contains detailed provisions relating to the general meeting of a public company including convening, requisitioning, notice, agenda, attendance, proxies, voting, resolutions, alteration of memorandum of association and minutes. In the main these do not raise points of principle and indeed the Joint Committee would question the need for absolute uniform rules on many of these matters throughout the Community. It finds it surprising, therefore, that Article 42 provides that, without prejudice to rights acquired by third parties in good faith, resolutions of a general meeting shall be void or voidable if the company does not comply with the draft Directive’s requirements relating to the calling of meetings, distribution of documents, treatment of shareholders and conduct of meetings. No distinction is drawn between degrees of non-compliance and in the Committee’s opinion it is unduly harsh to void all resolutions passed at a general meeting because of a minor irregularity. The Committee recommends that Article 42 be amended to allow for minor and accidental omissions and to permit a court to decline an application for the voidance of a resolution if it considers it just and equitable to do so.

Legal Reserve and Appropriation of Profits

32.The draft Directive would require 5% of any profit for the financial year (reduced by any losses brought forward) to be appropriated to a legal reserve until that reserve amounted to 10% of the subscribed capital. The Joint Committee agrees with CCAB-I that it is not easy to see what benefit to creditors and shareholders would be provided by this provision in view of the fact that the Companies (Amendment) Act, 1983, which implements the Second Directive on Company Law (77/91),⁽¹⁾ obliges public companies to have a minimum paid up capital and restricts the distribution which may be made by all limited companies and by public limited companies in particular. Indeed the Joint Committee considers that provision might well have a detrimental effect if by restricting dividends it hampered a public company raising additional capital during the initial period of its existence. Moreover any additional security for creditors provided by such a reserve could be offset by an overvaluation of the company’s other assets.

Auditors

33.The draft Directive contains provisions relating to auditors and their work and dealing with their functions and liabilities, independence, appointment, remuneration, report, dismissal and civil liability. The CCAB-I has given the Joint Committee the benefit of its advice on a number of these provisions to which it now wishes to refer.

34.In the interests of ensuring the independence of auditors the draft Directive provides that (i) the audit of the accounts of a public limited company may not be carried out by persons who are, or were during the preceding three years, members of the staff or the board(s) of the company or by firms to which such former members are attached, (ii) persons who or whose firms had audited the accounts may not become members of the staff or the board(s) within three years of the cessation of their auditing duties and (iii) auditors should be appointed for a specified period of not less than three and not more than six years and be eligible for re-appointment.

35.The Joint Committee disagrees with the proposal that accountancy firms should be prohibited from auditing the accounts of a public company because a person, who was a director or employee of the company within the stated period, is a member of or a partner in the firm. In the Committee’s opinion the present practice suffices whereby the former officer or employee is barred personally from taking part in the audit.

36.The Joint Committee agrees with the CCAB-I that the proposed restriction for a three year period on former auditors, their partners or managers of their firms becoming members of the board(s) or staff of public companies is not justified. In the Committee’s view this provision could prove damaging to public companies by depriving them of a common source of senior commercial management.

37.The CCAB-I does not consider that the appointment of auditors for a fixed period of up to six years would ensure their independence. The Joint Committee has no reason to believe that there is any dissatisfaction with the provisions of section 160 of the Companies Act, 1963 providing for the appointment of auditors annually and section 161 providing for the appointment of an auditor other than the retiring auditor.

38.The draft Directive provides that the annual accounts shall be adopted by the general meeting of the company though it would permit national laws to provide that the accounts of companies organised according to the two tier system be approved by the management and supervisory organs where they are in agreement. The adoption of the accounts by the general meeting is apparently intended to relieve the directors of personal liability in relation to accounts so adopted. The CCAB-I has suggested that shareholders be required formally to “approve of” the accounts. At present in this country shareholders do not have the option of rejecting the accounts which logically they should be given if they are asked to approve of the accounts and the Joint Committee would not favour the present practice being changed.

39.The CCAB-I has objected to a proposal in the draft Directive that the auditor’s report should contain “observations concerning any infringements of the law” on the grounds that such observations would be outside the professional competence of accountants. The Joint Committee accepts that this objection is soundly based. The CCAB-I has also objected to a proposal that the auditor could “withhold” an opinion on whether the annual accounts give a true and fair view of the company’s assets, liabilities, financial position and profit or loss with the consequence that any resolution adopting the accounts in such circumstances would have to be treated as void or voidable. The CCAB-I considers that an auditor should be entitled to express an adverse opinion on the accounts or to indicate his inability to expresss any opinion but points out that inability to express an opinion might arise because of significant uncertaintities extending over several accounting periods which might be incapable of clarification by either the auditor or the company and that in the latter circumstances it could cause serious problems for the company if the accounts could not be adopted. The Joint Committee considers that there is merit in this objection.

40.The Fifth Company Law Directive has been on the stocks for a protracted period at this stage. The social partners are polarised on many of its central proposals. The Joint Committee, as it did in relation to the Vredeling Directive, urges further meaningful dialogue between the opposing interests in this debate, in order to seek a broadly based consensus.

3 September, 1985.

(1) Prl. 8803

(1) See Appendix 2. Page 26

(1) Prl. 8803

(1) See Appendix 1