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Business is inherently risky

28 June 2018 by Peter Swabey

Business is inherently risky

New insolvency rules could place businesses and entrepreneurial spirit in jeopardy

There have been three particularly interesting corporate governance developments this month: the publication by the government of the snappily titled Companies (Miscellaneous Reporting) Regulations 2018 on 11 June, about which you can read here; the publication by the Financial Reporting Council of the draft Wates Corporate Governance Principles for Large Private Companies; and our response to a wide-ranging government consultation document on Insolvency and Corporate Governance.

With regards to the latter consultation, our overall response was that it is far from proven recent instances of high-profile corporate failures have been due to weaknesses in the legal and regulatory environment.

It is far more likely corporate failures are due to the actions or inactions of individual directors. The responsibilities of directors to all stakeholders are clearly set out in current legislation and additional legislation will not lead to better behaviour and corporate responsibility. Robust enforcement of current regulations would send a clear signal that inappropriate behaviour will not be tolerated and individuals will be held to account.

Of course, if the Insolvency Service has identified some areas where it feels it needs additional powers, such as the ability to take action against the former directors of a dissolved company, we would support minor amendments to legislation or regulation to close such lacunae.

The most radical new proposal in our view was that directors of a parent company be held liable if a former subsidiary enters administration or liquidation within two years of that subsidiary company being sold.

Our concern is twofold: firstly, this strikes at the heart of entrepreneurial risk-taking; and, secondly, the risks the proposed liability would create for directors might lead them to prefer putting a business into insolvency, rather than selling it for potential turnaround.

It is the nature of entrepreneurial businesses that some succeed while others fail. That result is often down to decisions taken by the directors, but the ramifications of those decisions are not always immediately apparent. The suggested period of two years from the point in time when a business is sold is misaligned with the current basis of assessment of a business as a ‘going concern’, which looks forward for a period of 12 months. Once a business is sold, the previous owners no longer have any control over the company and cannot direct its operations. Management of the company is then entirely under the control of the new owners.

“It is the nature of entrepreneurial businesses that some succeed while others fail”

It is also impossible for directors to know what might be viewed in hindsight as something that ‘could have been reasonably foreseen at the time of the sale’ that ‘would have led to a better outcome for creditors’. The consultation document made it clear ‘the proposal does not require there be any causal link between the sale and the failure’. It will be established that ‘the director could not reasonably have believed that the sale was in the interests of creditors … by a worsening position followed by formal insolvency’.

This proposal would therefore create substantial risks to the directors of a company, by making them liable for the actions of the new owner(s) and new management. These are risks which they are unlikely to take. The result of this is potentially viable companies being wound up, rather than sold to new owners prepared to invest in the business and attempt to return it to profitability.

This outcome may very well be to the detriment of creditors, employees and other stakeholders. There is a long track record of successful turnaround investment and management in the UK which would be imperilled.

Alongside this work responding to consultations, the policy team has also been busy in the not-for-profit sectors. They have revised and updated 23 charity guidance notes and published six new ones. Four relate to board performance evaluation in charities, while the other two are joint guidance notes with the Sixth Form Colleges Association, covering ‘Managing conflicts of interest in sixth form colleges and 16–19 academies in England’ and ‘The role and duties of a company secretary in a 16–19 academy’. A further guidance note, on boardroom behaviours in charities, will be published at the ICSA Annual Conference on 10–11 July.

On 14 June, I spoke at the National Housing Federation Housing Governance conference – some 300 people assembled to discuss governance in the housing sector. It was great to meet so many keen and engaged governance professionals.

As always, I would be happy to receive any feedback or suggestions as to what the policy team can do or comments on the BEIS consultation at policy@icsa.org.uk.

Peter Swabey FCIS is policy and research director at icsa: the governance institute

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