An overview of the Government's proposals to improve corporate governance in firms in or approaching insolvency.
On 20 March 2018, the Government published a consultation paper with proposals to improve the corporate governance of firms in or approaching insolvency, some of which appear to stem from lessons learnt following the failure of BHS and Carillion.
The main issues on which the Government is seeking views are:
- Sales of businesses in distress - whether to make the directors of a parent/holding company liable where the sale of an insolvent subsidiary causes harm to the subsidiary’s creditors and this was foreseeable at the time of the sale.
- Reversal of value extraction schemes - new powers to allow an administrator or liquidator to apply to court to reverse a transaction (or series of transactions) that has unfairly removed value from a company.
- Directors of dissolved companies - whether to extend existing investigative powers into the conduct of directors to cover directors of dissolved companies.
- Strengthening corporate governance in pre-insolvency situations - various ways to strengthen corporate governance in pre-insolvency situations including:
- Group structures - whether stronger corporate governance and transparency measures are needed for the oversight and control of complex group structures.
- Shareholder responsibilities - what more could be done through a revised Stewardship Code or other means to promote more engaged stewardship of UK companies by their investors, including the active monitoring of risk.
- Payment of dividends - whether reforms are required to the legal, governance and technical framework within which companies determine dividend payments. If so, what reforms should be considered and how should they be targeted so as not to discourage investment.
- Directors’ duties - whether there are perceptions that some directors may not be fully aware of their duties about commissioning and using professional advice.
- Companies in the supply chain - whether the Government should consider new options to protect payments to SMEs in a supply chain in the event of the insolvency of a large customer.
Sales of businesses in distress
Where the directors of an insolvent company are considering a sale of the company or business, they must act in the best interests of its creditors. But, the directors of a holding/parent company, which is likely to have initiated the sale, cannot be held liable for the sale of that insolvent subsidiary, even if it is damaging to the subsidiary's creditors and stakeholders.
There is also no requirement in law for a seller to consider the future viability of a business after its sale, for example, to review a purchaser's credentials and proposals, and no duty of care on the part of a seller towards the company's employees or future creditors. If a company that was sold subsequently fails, even if the sale contributed to that failure, or if the purchaser is found to have had no viable way to return the business to profitability, the seller cannot be held accountable for the consequences of the decision to sell the business.
The proposal is that directors of a parent company should be held accountable where the sale of an insolvent subsidiary (or solvent only as a result of support from the group) causes harm to creditors and this was foreseeable at the time of the sale, unless the directors reasonably believed that the sale was in the creditors’ best interests. This should apply if:
- the subsidiary enters into administration or liquidation within two years of completion of the sale
- the interests of its creditors are adversely affected between the date of the sale and the liquidation or administration, and
- when they made the decision to sell the company, the directors could not have reasonably believed that the sale would lead to a better outcome for those creditors than placing it into administration or liquidation.
Only directors of a holding company incorporated in the UK would be caught.
Reversal of value extraction schemes
The proposal is for new powers to allow an administrator or liquidator to apply to a court to reverse a transaction (or series of transactions) that has unfairly removed value from a company. Arrangements to extract value could take the form of management fees; excessive interest on loans; charges being granted over company property; excessive director pay or other payments or sale and leaseback of assets.
These new powers would apply only where the company:
- had received a new investment
- had value extracted in a transaction or series of transactions designed to benefit that investor or those connected to it, without adding value to the company, and
- subsequently enters liquidation/administration within two years.
The value extraction scheme must have unfairly put the beneficiary in a better position than other creditors in a subsequent formal insolvency (liquidation/administration) than would otherwise have been the case.
Directors of dissolved companies
Current legislation does not allow the conduct of directors whose companies have been dissolved to be investigated (or for them to be removed from the company register) unless the company entered an insolvency procedure before the company was dissolved or the company is restored to the register. Restoration to the register is usually impractical where there is not already strong evidence of misconduct and could undermine the integrity of the register if firms which have ceased operations are routinely resurrected to the register.
The Government is therefore considering whether the Secretary of State should have the power to:
- require any person to provide such information as may be reasonably requested to allow the Insolvency Service to investigate the conduct and actions of former directors of a dissolved company
- seek an order disqualifying a former director from being a director of any other company
- seek an order that the former director financially compensates creditor(s), where the director's actions caused identifiable losses, and
- seek a prosecution where there is evidence of criminal conduct.
Strengthening corporate governance in pre-insolvency situations
The Government is considering the following:
- Group structures - whether stronger corporate governance and transparency measures are required in relation to the oversight and control of complex group structures.
- Shareholder responsibilities - what more could be done through a revised Stewardship Code or other means to promote more engaged stewardship of UK companies by their investors, including the active monitoring of risk. Whether existing investor initiatives to hold companies to account could be strengthened (such as through developing the role of the Investor Forum). Whether better arrangements should be made to ensure that lessons are learned from large company failings and controversies, for example by establishing an expert "stewardship oversight group" which could review significant corporate failings and scandals, make recommendations, and ensure that lessons are applied throughout the investment chain.
These would be in addition to the measures in the amendments to the EU Shareholder Rights Directive to strengthen engagement and increase transparency amongst institutional investment, asset management and proxy advisers; the FRC’s proposed amendments to the UK Stewardship Code; and the Government’s commitment to introduce a new statutory requirement on all large companies to report each year how directors are fulfilling their section 172 Companies Act 2006 duty.
- Payment of Dividends - the Government has no plans to interfere with decisions about dividend payments as these are matters for directors and shareholders. But, examples of large companies continuing to pay out large dividends in the period immediately before their insolvency raise questions about whether reform is needed.
It is therefore considering whether reforms are required to the legal, governance and technical framework within which companies determine dividend payments. Issues to be considered are whether the definition of "distributable profits" remains fit for purpose; whether there is sufficient transparency and accountability to shareholders and other stakeholders for decisions taken by companies on how to allocate capital as between, for example, the competing demands of investment in R&D, returns to shareholders, pay and benefits for employees, making the business more sustainable and contributions to pension funds.
Responses to the consultation are by 11 June 2018.
This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.