The Department for Business, Energy and Industrial Strategy (BEIS) has published a consultation on insolvency and corporate governance.
The consultation is aimed primarily at improving corporate governance in firms that are in or approaching insolvency. However, it also puts forward proposals for improving the wider framework of corporate governance.
The key proposals from the consultation are set out below.
BEIS has requested responses by 11 June 2018.
Liability for parent company directors
BEIS is proposing to impose penalties for directors of a holding company who approve the sale of an insolvent subsidiary. The proposed penalties include disqualification and liability to pay compensation.
Holding company directors would be liable only if four conditions are all met. These are:
- The subsidiary was a large company and insolvent at the time of sale
- It enters into administration or liquidation within two years of the sale
- The interests of its creditors are adversely affected during that period
- The directors could not reasonably have believed that the sale would lead to a better outcome than placing the subsidiary into administration or liquidation
The consultation suggests that holding company directors would need to consider (among other things) the buyer’s ability to support the subsidiary’s business for up to two years going forward.
This proposal would significantly broaden the scope of penalties for directors. Currently, penalties can only be applied to directors of the insolvent company itself, and not those of its shareholders.
The Government will need to balance the merits of this proposal with the potential difficulties it raises. For example, the proposal would seem to by-pass a cardinal principle of company law, namely that shareholders are entitled to act in their own interests when it comes to their investment in a company.
Also, holding company directors would need to balance their duties to the holding company (and the interests of its stakeholders) with the interests of the subsidiary’s stakeholders. If there is a conflict, they might feel that the need to dispose of a failing asset and protect the holding company prevails.
The proposed reform potentially raises particular considerations for the private equity and venture capital sectors. Sponsors will be concerned to ensure that their own directors, and directors appointed to vehicles within an investment structure or “stack”, will not be at risk of incurring personal liability on the secondary sale of a failed investment (particularly those directors who are not appointed at the portfolio company level).
Finally, it is worth noting that the proposal would only impose liability on the directors of a holding company. It would not encompass a situation where an individual sells an insolvent company, nor would it attach liability to a holding company itself.
Numerous other points arise from this particular proposal and we await the Government’s next steps to see whether it evolves any further than its current embryonic state.
BEIS believes there is scope for shareholders and institutional investors to be more active in engaging with and stewarding companies.
The paper acknowledges that the Financial Reporting Council (FRC) is already consulting on changes to its Stewardship Code (as part of its larger consultation on the UK Corporate Governance Code). However, it asks for views on whether more can be done, as well as on concrete suggestions, such as:
- establishing an “expert stewardship oversight group” comprising the Investor Forum, company chairmen, company secretaries, asset owners and the FRC; and
- asking FTSE companies to commit to holding periodic “strategy and stewardship forum meetings” focussing on the company’s long-term strategic plans.
The Government is concerned about large companies paying dividends in the period immediately before they enter insolvency. More broadly, the paper raises the question of how and in what circumstances dividends are currently being declared and paid.
As a result, the paper is seeking views on whether the legal and technical framework for justifying and paying dividends should be reformed (and, if so, how) to make it clearer and more transparent to stakeholders.
In particular, the paper asks whether the current definition of “distributable profits” is fit for purpose.
As a matter of law, a company can pay a dividend only out of “profits available for the purpose”. The Companies Act 2006 defines these as accumulated, realised profits less accumulated, realised losses, but it provides no real guidance beyond this. Companies must look to their accountants to help them understand their level of profits and which profits are available to pay a dividend based on accepted accounting principles.
While adding clarity to the legislative framework would be useful, the Government will need to consider whether expanding the law in this area might intrude into the territory of accepted accounting regimes.
The paper notes that company directors often need to seek professional advice. It gives examples of accountants advising on the level of a company’s distributable profits, actuaries advising on pension-scheme deficits, and tax consultants advising on tax matters.
However, BEIS makes the point that, after obtaining advice, directors still need to make an evaluative judgment about whether to follow that advice and (if they choose to) how to apply it in practice.
In doing this, directors must comply with their duty under section 172 of the Companies Act 2006 to promote the company’s success. This may not mean following the advice wholesale. For example, they may feel they ought not to distribute all available profits and instead retain some to address business risks.
BEIS is worried directors may be following professional advice without full awareness of their duties. It is seeking views on whether this is likely to be the case and what can be done about it.
BEIS is also proposing the following:
- New powers to reverse the extraction of value from companies in financial difficulties through complex structures put in place by investors as part of a “rescue” attempt.
- New powers to investigate the conduct of directors of dissolved companies that do not go through formal insolvency proceedings.
- Stronger corporate governance and transparency measures to enable third parties to understand the complex group structures of organisations with which they do business.
- New measures to protect small and medium-sized enterprises (SMEs) in a supply chain where a large customer enters insolvency.