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Insolvency reforms threaten directors with greater liability

06 April 2018 by Jimmy Nicholls

Insolvency reforms threaten directors with greater liability - Read more

Recent corporate failures could prompt more scrutiny for directors who sell or close companies, and protect supplier payments

Alongside countless rounds of negotiations on the UK’s exit from the EU, the UK government is quietly pursuing an agenda of governance reforms to improve the business environment. The latest target is insolvency.

The collapse of corporate leviathans like the outsourcer Carillion and the retailer BHS has focused attention on several issues around company failure, and especially the conduct of directors in such situations.

According to the Department for Business, Energy and Industrial Strategy: ‘The vast majority of UK companies are run fairly and responsibly, but a small number of recent corporate governance failures have raised concerns that company directors can unfairly shield themselves from the effects of insolvency and – in the worst cases – profit from business failures while workers and small suppliers lose out.’

To combat misbehaviour, the government is proposing a number of reforms. The trick is to maintain balance, and protect what some see as a business advantage amid Brexit disruption.

Colin Haig, a restructuring partner at BDO, a professional services firm, said: ‘The fact is EU corporates often used the UK to restructure for good reason. We want to keep our flexibility because it gives us an edge. In insolvency there is certainty of loss to creditors.

‘At least in a share sale there is the possibility of creditors being kept whole. It is critical that there is calm consideration before changes are made.’

“The first reforms consider how directors are scrutinised when selling struggling firms and how former directors can be investigated”

Peter Swabey, policy and research director at ICSA, agreed: ‘Insolvency is an important part of the corporate landscape and the UK regime is well regarded internationally.

‘But that is no reason for complacency. In this, as in other areas of law and regulation, a balance must be struck between public expectation and legal practicality. As public expectation moves, so must the law evolve.

‘This is a well-targeted consultation, considering the need for reform in some specific areas and as such is to be welcomed.’

Director scrutiny

The first reforms consider how directors are scrutinised when selling struggling firms and how former directors can be investigated and, if appropriate, punished once a company has gone into insolvency.

Under the reforms, holding company directors could be penalised if selling a subsidiary caused harm to creditors or other stakeholders, ‘where that harm could have been reasonably foreseen at the time of the sale.’ Penalties could include ‘disqualification and personal liability’.

This will apply when the subsidiary being sold is insolvent, or would be if not guaranteed by related companies; enters administration or liquidation within two years of the sale; and the director ‘could not have reasonably believed that the sale’ would be better than putting the subsidiary into administration or liquidation directly.

The government also proposes powers that would let an insolvency office-holder apply to court to reverse transactions that ‘unfairly removed value from a company’ after it has been bought in an alleged rescue attempt. This would augment existing powers targeting simpler transactions.

The measures are a direct response to concerns over ‘asset stripping’, in which struggling companies are bought up and dismembered, with the parts sold for the buyer’s benefit.

The April 2016 collapse of BHS prompted accusations that Philip Green, its former owner, had sucked cash from the firm while disregarding its pension deficit. A year before its collapse, BHS had also been sold for £1 to a consortium led by Dominic Chappell.

Green has since pledged £363 million to the BHS pension scheme. In March, the Insolvency Service said it did not currently intend to bring disqualification proceedings against Green, although four other former directors of BHS, including Chappell, will be targeted in connection with the sale.

Contrasting the prominence of this story, BDO’s Haig said: ‘Sales of distressed subsidiaries via a share sale are not that common. Counterparties who regularly get involved in high risk situations build up an expertise. Ultimately they need to show a return on capital employed that is commensurate with risk.’

Haig was also sceptical about the proposal to make holding company directors more liable. ‘A holding company is a shareholder in much the same way as any other.

‘If you increase liability for holding company boards contemplating sales of controlling interests in subsidiaries, that could have the effect of generating more sales out of administration.’

Dissolved company probes

A further government proposal will look to ease authorities’ ability to investigate former directors of companies that have been dissolved. Under current rules, companies must apply to court for a company to be restored, with the process proving cumbersome, according to the government.

The plan is to extend current investigatory and enforcement powers to former directors of dissolved companies. This would allow such people to be investigated by the Insolvency Service more smoothly, opening the way to disqualification, compensation orders for former creditors, and prosecution for criminal conduct.

‘I would support an ability to investigate struck off companies without the expense of having to restore them to the register,’ Haig said.

“Responsible companies where have good company secretaries who are constantly bringing to directors’ attention what their duties are”

Similarly, the government wishes to impress on directors their duty to promote the success of their company under Section 172 of the Companies Act 2006.

Philippa Foster Back, director of the Institute of Business Ethics, agreed that directors might not be taking sufficient notice of their statutory duties.

‘There is a difference between the responsible companies where you have good company secretaries who are constantly bringing to directors’ attention what their duties are, and other firms,’ she said.

‘I have heard of one or two boards whose board packs every month or every meeting have section 172 stated there. A lot do not have that drawn to their attention. Once you get to the majority of companies, which are unlisted and smaller, I am unsure many directors have taken on board that section 172 actually exists.’

Haig backed clarification of directors’ role against that of professional advisors, saying: ‘You want directors to take professional advice. Generally they are more likely to do this and at an earlier stage than was the case, say, 10 years ago.

‘I think anything that makes it clearer to officers exactly what their responsibilities are is probably a good thing.’

Suppliers and shareholders

Under the banner of improving corporate governance before insolvency, the reform consultation is also looking at payments to suppliers, dividend payments, and the idea of shareholder stewardship.

Carillion’s collapse early this year prompted fears that many small suppliers were owed more than a billion pounds in back payments, with more than 1,000 job losses connected to the corporate failure.

The government has thus floated the idea of using project bank accounts, a kind of trust fund, to ensure that suppliers are paid in the event of a collapse.

‘I can see benefits to small suppliers, but it will potentially make it more difficult for large companies to avoid failure, because you are tying up scarce cash resources,’ said Haig.

‘If you exacerbate the shortage of cash flow by forcing companies to tie up money in trust accounts you could make businesses fail where they might otherwise have survived.’

As an alternative, Haig suggested that the government increase the ‘prescribed part’, money which is set aside for unsecured creditors, who take second priority to secured creditors in the event of insolvency. The prescribed part is currently capped at £600,000.

‘If it were calculated on a formulaic basis I do not see why there should be a cap at all,’ Haig said.

On dividend payments, the government is also asking whether it should update the legal and technical framework to improve transparency on directors’ decisions, following complaints of companies paying out large dividends before insolvency.

The Financial Reporting Council is also currently reviewing shareholder responsibilities under the Stewardship Code.

Jimmy Nicholls is deputy editor of Governance and Compliance

ICSA is seeking input into its response to the insolvency and corporate governance consultation. Those interested should contact Julie Bamford, head of policy (corporate), at jbamford@icsa.org.uk 

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