On 20 March 2018 the government published a consultation document on proposed measures designed to improve corporate governance when companies are in or approaching insolvency.
The document seeks views on a range of issues including,
- enhanced corporate governance and transparency measures in relation to complex group structures
- shareholder responsibility
- the legal and technical framework within which distributable profits are determined for dividend purposes
- directors’ awareness of their duties with regard to seeking and relying upon professional advice, and
- measures to protect payment of SME supply chain creditors.
The consultation document notes that the UK has a leading international reputation for being a dependable place to do business and that the insolvency regime is well regarded internationally. However, it states that the government recognises that the regime must be continually improved to ensure that it delivers the best outcomes for all stakeholders now and in the future. Therefore, it proposes the introduction of new powers for insolvency office holders and the Secretary of State and seeks views of stakeholders on these proposed measures.
It is clear that in drafting some of the proposed new measures the government had in mind one or two recent high profile corporate failures and is keen to ensure that in future action can be taken in the interests of creditors where currently there are perceived loopholes.
Sales of Businesses in Distress
Directors must act in the best interests of the company but when a company becomes insolvent the directors must act in the best interests of the company’s creditors. Any failure to do so leaves the directors open to claims for, amongst others, misfeasance, wrongful and fraudulent trading. However, currently, where a parent or holding company sells an insolvent subsidiary which subsequently enters a formal insolvency process, there is no recourse against the directors of the parent company even though the insolvency of the subsidiary was entirely foreseeable once the support of the parent was removed. There are clear parallels here with the insolvency of BHS following its sale to Dominic Chappell.
The government is proposing that the directors of the parent company should be liable to contribute to the assets of the insolvent subsidiary in the following circumstances,
- At the time of the sale the subsidiary was insolvent or insolvent but for guarantees of other group companies or directors,
- The subsidiary enters liquidation or administration within two years of the sale,
- The interests of creditors were adversely affected between the date of sale and the commencement of the formal insolvency process,
- At the date of the sale, the directors of the parent company could not have reasonably believed that the sale would lead to a better outcome for creditors than placing the subsidiary into administration or liquidation.
Where these criteria are met, it is proposed that the administrator or liquidator of the subsidiary should be entitled to apply to the court for an order that the directors of the parent contribute to the assets of the subsidiary.
I have no doubt that had such provisions been in force a couple of years ago, the administrators of BHS would have taken a very close look at Philip Green and there would have been considerable interest amongst third party litigation funders to fund such a claim, given the known assets of Mr Green.
Value Extraction Schemes
These proposals are intended to supplement the existing powers vested in insolvency office holders to challenge transactions amounting to preferences, transactions at undervalue, extortionate credit transactions and certain floating charges. As such any new measures will be in addition to and not in place of the existing legislation.
The government is concerned that the existing legislation does not provide a mechanism for dealing with a situation where is company has been “rescued” by investors who then seek to extract value quickly to lessen their potential losses should the company subsequently fail. Examples of the conduct that the government is concerned about include charging management fees, excessive interest on loans, taking security over company property, excessive remuneration and the sale/leaseback of assets. The challenge with implementing any new measures along these lines will be not to discourage genuine rescue attempts which the government welcomes. As such it is proposed that the new measures will only apply in cases where,
- The company received new investment,
- Had value extracted by way of a transaction or series of transactions designed to benefit the investor without adding value to the company, and
- The company subsequently enters liquidation or administration.
It is proposed that the power to challenge the extraction scheme will vest in the insolvency office holder who will be able to challenge schemes in the period of two years prior to the commencement of insolvency and thereby enable a fairer distribution of company assets if the company fails and where otherwise, ordinary creditors are disadvantaged more than is “commercially reasonable”.
Interestingly, it is proposed that there will be no requirement to show that the company was insolvent at the time of the extraction scheme or that it became so as a consequence. Instead, the proposed test is whether the scheme unfairly puts the investor in a better position than other creditors in a subsequent formal insolvency than would otherwise have been the case.
Such claims are likely to be attractive to a third party funder given that one of the required conditions is that the investor has extracted value and is therefore likely to have the means to satisfy a judgment or settle the claim.
Currently the Secretary of State has power to investigate the conduct of directors of live companies and companies that have entered a formal insolvency process. However, there is a perceived loophole in respect of directors of companies which have been dissolved or struck off. It is believed that in some cases directors cause or allow their companies to be struck off in order to avoid being held accountable for their actions.
It is therefore proposed that the Secretary of State be given powers to,
- require directors of dissolved companies to provide information,
- seek a disqualification order against a former director of a dissolved company,
- seek an order requiring the former director to compensate creditors,
- prosecute criminal conduct.
If granted, these powers are to be exercised at the discretion of the Secretary of State provided there is sufficient evidence of wrongdoing and it is in the public interest for action to be taken.
It remains to be seen whether the Secretary of State will be given the human and financial resources with which to apply these proposed new powers. There would seem to be no reason in principle why a third party funder should not be brought in to fund compensation claims. Such claims are regularly funded in insolvency cases and the stated purpose of the proposals is to bring the provisions applying to dissolved companies in line with those applying to insolvent companies.
The government invites views on the above measures by 11 June 2018.