Trying to lighten the twilight zone: Insolvency and corporate governance proposals
23 / 04 / 2018
On 20 March 2018 the UK Department for Business, Energy and Industrial Strategy published a consultation seeking views on proposals to improve the governance of companies when they are in or approaching insolvency.
This consultation comes after several papers and reports seeking to ensure that laws regarding directors’ duties remain up to date and relevant. Directors already have enhanced duties in relation to trading whilst insolvent if they knew or ought to have known at some point before the company became insolvent, that there was no reasonable prospect of avoiding liquidation. However, the government aims to keep these duties relevant particularly in light of recent high profile failures such as Carillion.
The main proposals are to:
- enable directors of a parent company to be held to account and penalised where the sale of an insolvent subsidiary causes harm to creditors (where the harm was foreseeable at the time of the sale);
- augment the existing powers to unwind a transaction, or a series of transactions, which unfairly strip value from a company;
- extend existing investigative powers of the Insolvency Service into the conduct of directors to include investigation of directors of dissolved companies (not just those in administration or liquidation); and
- strengthen corporate governance in pre-insolvency situations through:
- promoting more engaged stewardship of UK companies by their investors;
- strengthening existing investor initiative to hold companies to account;
- ensuring that lessons are learned from large company failings and controversies;
- reforming the frameworks within which companies determine dividend payments;
- ensuring directors are fully aware of their duties;
- protecting payments to SMEs in the supply chain;
- reviewing (perhaps with a view to increasing) the £600,000 cap on the “prescribed part” (which is the maximum amount that is earmarked for unsecured creditors in an insolvency, even where a lender has a floating charge over all the assets of a company); and
- ensuring commitment to high standards of governance whilst maintaining low burdens.
The overall objective of the review is the strengthening of directors’ duties in the period leading up to a company’s insolvency. Directors can already be held personally liable to compensate creditors of a company for loss suffered as a result of their conduct and decisions, and the government’s proposals seem to have the aim of enhancing the scope of these measures.
It is suggested that enhanced duties on directors will result in the “clawback” powers of insolvency practitioners being widened, including the power to reach parent companies and already dissolved companies (along with altogether new powers which may be unveiled during the next phase of the legislation).
Most of these changes are well intentioned but currently lack real clarity. However, even without any changes, directors (and general counsel assisting them) of companies that are insolvent or face financial difficulty face a very challenging path to navigate.
There are some key but simple guidelines to assist in these circumstances to avoid criticism by a subsequently appointed liquidator (usually challenging the directors for trading whilst insolvent or negligent decision making):
- Follow best practice at directors’ meetings. This may involve calling regular, full board meetings and reporting decisions in full in the company’s minutes.
- Always have up-to-date financial information. Do not wait for an event to sound the alarm that the company is in financial difficulty and be careful to monitor compliance with financial covenants in agreements with lenders or other stakeholders.
- Take As soon as the directors know or fear that there is no reasonable prospect of avoiding insolvency, this must be raised with the board and independent advice taken from an insolvency practitioner.
- Resign as a director? This is not generally looked on well by the courts and should only be considered as an option if, despite your best efforts, you have failed to persuade the majority of the board that there is no reasonable prospect of the company avoiding insolvency or they continue to fail to recognise the issue.
It is very difficult to chart a way through difficult financial times but these simple guidelines are the types of issues that the court will consider if action is subsequently commenced against directors. Hindsight is a wonderful thing (and the courts recognise this) but directors (often with the guidance of general counsel) have to make the best decision they can in all the circumstances. Often there is no right or wrong answer, just a judgment call. The above guidelines are the bare minimum parameters within which directors should operate if they find themselves in the twilight zone.