In March 2018, the Department for Business, Energy and Industrial Strategy (BEIS) published a consultation on proposed reforms to the UK’s insolvency and corporate governance landscape. That consultation included certain significant proposals, including extending liability to the directors of holding companies that sell insolvent subsidiaries. You can read more in our Corporate Law Update for the week ending 23 March 2018.

Following feedback, BEIS has now published its response to the consultation. The key points coming out of the response are as follows.

Liability for directors of holding companies

In its consultation, BEIS had proposed that directors of holding companies could incur personal liability if their holding company sells an insolvent subsidiary, that subsidiary enters liquidation or administration within a “look-back period” of two years beginning with the date of the sale, and the directors could not reasonably have believed that the sale would lead to a better outcome than placing the subsidiary into administration or liquidation.

This was the most significant, and arguably controversial, of the original proposals. We noted previously that this reform raises particular considerations for the private equity and venture capital sectors, where directors appointed by sponsors, who often will not be directors at the “operational” level, could be at risk of incurring personal liability on the secondary sale of a failed investment.

Despite some significant opposition to this proposal, the Government intends to implement it. BEIS says it recognises the “valid concerns of respondents”. It is therefore proposing to introduce measures designed to enable directors to remain confident that a sale will not expose them to liability if they had a “reasonable belief at the time of the sale that the sale would likely deliver a no worse outcome” for the subsidiary’s stakeholders than formal insolvency proceedings.

However, it is not clear how this differs in substance from the original consultation proposal. Indeed, the response states that the Government will “ensure that legislation is properly targeted to bring into scope directors who had no reasonable belief that the subsidiary’s stakeholders would be no worse off as a result of the sale than if the subsidiary entered into administration or liquidation”. This essentially mirrors the wording of the original consultation.

BEIS has, however, confirmed certain changes to its original proposal that will provide some comfort to directors of holding companies:

  • The Government will not be introducing a new ability for administrators and liquidators to bring personal actions against holding company directors.
  • BEIS will produce a non-exhaustive list of matters that a court must take into account when deciding whether a holding company director was acting reasonably on the sale of an insolvent subsidiary, so giving holding company directors guidance as to what actions they should take.
  • The original “look-back” period of two years will be reduced to 12 months.

Dividends

Feedback to the consultation revealed that the UK’s regime for declaring and paying dividends is “complex” and “too backwards-looking”. The Government will explore the case for a comprehensive review of the UK dividend regime with professional groups, including the Law Society and the Institute of Chartered Accountants in England and Wales (ICAEW).

As part of this, the Government will consider introducing a new requirement for companies to disclose their distributable profits in their audited accounts. At present, companies are required by law and accounting standards to state their accumulated profits or losses at financial year-end, but this figure does not always tally with a company’s “distributable profits”.

The Government will also consider whether the current regime, under which dividends can be paid only if a company has distributable profits, should instead be based on a “solvency test”, so that a company could pay a dividend provided it would remain solvent and able to pay its creditors. This would bring the regime closer to the procedure under which a company can reduce its capital out of court.

Finally, BEIS is concerned that companies are consistently paying interim dividends, rather than final dividends, so as to avoid obtaining shareholder approval. It intends to ask the Investment Association to assess how prevalent this practice is and, if necessary, will legislate to require at least one shareholder vote on dividends each year.

Capital allocation

BEIS believes that companies should be disclosing more clearly how they allocate capital resources between shareholders, investment and R&D, rewards for employees, defined-benefit pension schemes and other demands.

If investor pressure and the forthcoming duty to publish a section 172 statement do not bring improvements, the Government will consider legislating to require companies to disclose their capital allocation decisions. This will include measures to scrutinise dividend payments where the company has a pension scheme deficit.

Other items

  • Directors’ duties. The Government is going to bring forward proposals to give directors greater access to training and guidance on their duties. It will also consider introducing a requirement for mandatory training for directors of large companies.
  • Board evaluations. The Government will ask ICSA: The Governance Institute to convene a representative group to explore ways to improve the quality and effectiveness of board evaluations.
  • Group transparency. The Government will consider requiring corporate groups of a “significant size” to provide a group structure chart (or “organogram”) and an explanation of how corporate governance is maintained within the group. The response does not say how these would be published, but feedback suggests they could be included in the group’s annual report. There is naturally an overlap here with existing and forthcoming requirements to comply with or explain against a corporate governance code.
  • Redundant companies. The Government will consider streamlining the process for dissolving redundant companies. At the moment, this can be a tedious, time-consuming and sometimes costly process involving striking dormant companies off, winding them up in a voluntary liquidation, or (where possible) pursuing a court process (such as a cross-border merger) that results in their automatic dissolution.
  • Investor stewardship. BEIS recognises the need for investors to take a greater role. It notes that the position should improve with the introduction of the revised FRC Stewardship Code, the revised EU Shareholder Rights Directive and (if implemented) proposals by the Department for Work and Pensions to require pension trustees to set out their stewardship policies. Alongside this, the Government will work with investors, regulators and other interested parties to examine how investment mandates can make explicit reference to stewardship and to ensure institutional investors can escalate any concerns about a company or its directors.
  • Directors of dissolved companies. The Government intends to press ahead with changes to extend the current director disqualification regime to directors of dissolved companies, so that action can be taken against a director of a dissolved company without having to restore the company to the register first.