Insurers and directors should take stock now and  prepare for Government proposals to enhance  corporate transparency and accountability. The  proposals aim to create, amongst other things, a  beneficial ownership central registry as well as  prevent use of the form and status of directorships  to further mischief or misconduct. 

The Government is also clamping  down on director misconduct and  disqualified directors will face tougher  penalties. This will be achieved  primarily by making amendments  to the determination of directors’  unfitness under the Company Directors  Disqualification Act 1986 (CDDA),  by removing barriers to improve  information sharing between regulatory  bodies and insolvency bodies, and by  placing greater personal responsibility  for misconduct upon directors. 

On 21 April 2014, the Government  published its response to the  Department for Business, Innovation  and Skills’ paper, “Transparency &  Trust: Enhancing the Transparency of UK  Company Ownership and Increasing Trust  in UK Businesses” (the paper). In this  article we consider the impact the  proposals may have on:

  • Corporate directorships used in  Employer’s Occupation pension  schemes
  • Whether increasing personal  director accountability and creditors’  rights will lead to an in increase in  claims against directors
  • D&O insurers and policy wordings

Corporate transparency

Part A of the paper deals with  enhancing corporate transparency;  we consider the proposed changes to  the role of corporate directors; ‘front’  directors and shadow directors.

Corporate directors 

UK companies will be prohibited from  appointing corporate directors, subject  to specific exemptions. 

The exemptions will apply to  companies considered to have a  low risk of financial crime and high  standards of corporate governance  or regulatory oversight. For example,  group structures including large listed  and private companies, Open-Ended  Investment Companies and charities.  The Government has welcomed views  as to whether the exemption should  extend to LLPs. 

The abolition of corporate directors is  said to represent a significant change  of approach to corporate governance.  However, under section 155 of the  Companies Act 2006, companies  (including LLPs) are already required  to appoint at least one director who is  a natural person. In the UK, only 2% of  companies and LLPs have a corporate director. Therefore the majority of companies will not be  affected by this proposal.

One sector which will be affected by the changes is the  pensions sector. It is a common practice for an employer to  establish a subsidiary company to act as corporate trustee  for its occupational pension scheme. Making changes  at director level is easier to document than changes in  trustees and the individuals benefit from the protection the  corporate veil brings for directors, whereas trustees can be  personally liable for their actions. Since the Pensions Act  2004 there has been an increase in professional independent  trustees being appointed as a corporate director of these  trust companies. This brings a further advantage as the  professional independent trustee might then be represented  by the person with the most appropriate expertise – for  example actuarial or investment – at a trustee meeting.  The Government’s exemptions do not extend to corporate  trustees of pension schemes, but it is difficult to see why  that should not be the case. There is an extensive regulatory  regime for pensions following the Pensions Acts 1995 and  2004. In addition, the Pensions Regulator keeps a register of  independent trustees – who have to meet certain criteria to  be on the register – and it would not be difficult to allow an  exemption where the corporate director is on the register. 

“Front” directors 

The term “front” director refers to registered but  irresponsible directors who engage in unacceptable  behaviours and seek to obscure control thereby facilitating  criminal activity. The Government suggested introducing  a register of front directors and those who control them,  making it a criminal offence for a director to take steps to  divest their powers. The proposal received little support.  Respondents to the paper pointed out that directors who  acted as a front for any wrongdoing were likely to be  breaching their general statutory duties. Furthermore, it  is common business practice for companies to “nominate”  a director for their role by another party and act properly.  The consensus is that this arrangement should continue.  Consequently, the proposal was abandoned in favour  of director registration with Companies House coupled  with an increased awareness of directors’ duties and of  directors’ liabilities. 

The Government is also considering measures to increase  accountability of shadow directors who control appointed  directors and whether to extend the directors’ general  statutory duties to such shadow directors.

Making directors more accountable

Part B of the response paper focuses on making directors  more accountable for failure to fulfil their duties. 

Notably, the Government did not take forward plans to  introduce a new primary duty on banking directors to  promote the financial stability of their companies over  the interests of shareholders. It considered that directors’  duties already explicitly require directors to have regard to a  range of matters in the long term, and these were applicable  to directors in all sectors. In addition the proposed  introduction of a senior persons’ regime, which will affect  directors and other key staff in banks, has already been  legislated for in the Financial Services (Banking Reform) Act  2013, with likely implementation in 2015. 

Director disqualification

Schedule 1 of the CDDA sets out the matters which a  court must take into account when determining whether  a director is unfit. This schedule is viewed as outdated and  there is a gap between what the law says and what the  courts take into consideration in practice. It will therefore  be amended to incorporate a wider and more generic set of  factors that the court must take into account including the  materiality of the conduct, culpability of the individual and  the impact of the individual’s behaviour. The new factors  will include misfeasance, breaches of duty, legislation or  sector regulation by an individual as a director, applying  both domestically and internationally

It is intended that a director’s overseas misconduct will be  relevant in disqualification proceedings. This makes sense  in today’s globalised economy. The Secretary of State will  have the power to disqualify an individual from acting as a  director in the UK upon conviction of a criminal offence in  connection with the promotion, formation or management  of a company overseas. Such action could be taken  preventatively against persons who may pose a risk in the  future and prior to that individual acting as a director in  the UK. 

D&O Insurers may also wish to consider whether further  information on directors’ history both in the UK and  internationally is required upon renewal of the policy.

A further change is that courts should also factor in the  “wider social impact” and “vulnerable creditors” when deciding  the director’s conduct. These are not defined terms but the  intention is to extend protection to those who suffer loss  indirectly as a result of the misconduct. Arguably, the concept  of wider social impact introduces a broad discretionary  element. However, section 172(1) (b) – (e) Companies Act  2006 (which sets out directors’ duties) already includes the  requirement that directors consider the impact of their  operations on the community and environment. 

Furthermore, the court (or Insolvency Service on  behalf of the Secretary of State) may also factor into its  considerations any previous director positions held in  insolvent companies and the relevant director’s track  record in running these companies, including former  disqualifications. Directors will be able to present evidence  to show that the insolvency was not on account of the unfit  conduct of the director. 

Breaking down the barriers between sector  regulators

Although the Government stopped short of giving sector  regulators powers to disqualify directors through their own  processes, such powers will remain with the Insolvency  Service, it is committed to improving the integration of sector  regulatory regimes and the director disqualification regime.

The Government proposes to better integrate sector  regulation by removing the legislative barriers to  investigative material that can be provided by regulators  or others for use by the Insolvency Service to pursue the  disqualification of a director. In addition, the time limit for  commencing disqualification proceedings will be increased  from two to three years from the earliest insolvency act.  The extension of time for bringing disqualification  proceedings against directors could result in more director  disqualifications. On the other hand, it may have the  opposite effect by reducing the Insolvency Service from  protectively, and perhaps unnecessarily, issuing proceedings  within the current two year time frame. Furthermore, the  impact of the proposals on the scope of the disqualification  regime may in practice be minimal given that many of the  intended changes simply serve to bring the law up to date  with the practice of the courts.

Key sector regulators, including the FCA and Prudential  Regulation Authority will work alongside the Insolvency  Service to ensure there is joint planning and participation. 

Compensating creditors

The Government is concerned that the current  disqualification regime does not adequately protect and  benefit those who have suffered loss as a result of the  misconduct. It has therefore proposed that creditors should  have greater powers to bring claims on their own behalf.

Office holders, such as liquidators and administrators, are  presently permitted under the Insolvency Act 1986 to bring  actions on behalf of creditors for wrongful and fraudulent  trading, preferences and transactions at undervalue. It is  rare for such actions to be brought and the cause of action  is not currently assignable. This is set to change and it  will be possible to assign the above causes of actions to  creditors in order to encourage the use of claims taken  against directors to benefit creditors. Administrators  will also be afforded the same rights as liquidators to  commence fraudulent trading and wrongful trading  actions (thereby bypassing and saving the costs of first  placing the company into insolvent liquidation).

Whilst these proposed changes should enhance the ability  of creditors to seek redress against unscrupulous directors,  the inherent costs and risks in bringing such claims will  remain. Furthermore, creditors will not be able to utilise  the detailed investigative powers of administrators and  liquidators under the Insolvency Act 1986 prior to issuing  any proceedings. Notwithstanding this, there will be certain  instances where it is attractive for both the office holder  and creditors to agree to an assignment of claims. Office  holders will have to consider the terms of any assignment  and whether to accept a lump sum for the assignment or a  percentage of the fruits of litigation.

It is therefore difficult to accurately predict whether the  ability to assign the above noted actions to creditors will  result in more actions being taken against directors. One of  the issues creditors will face that has already been touched  upon is the cost and risk of bringing such claims. The Jackson  reforms have been a double edged sword with regard to the  availability of funding arrangements. Whilst lawyers are  now allowed to enter into contingency fee agreements, so  called Damages Based Agreements (DBAs), there are widely  held concerns around their workability based on the current  regulations governing DBAs. It is hoped these regulations will  be amended soon to improve take up as the Government has  recognised there is an issue. Insolvency related proceedings  backed by Conditional Fee Agreements (CFAs) and After the  Event insurance (ATE) were also exempted from the move to  abolish recoverability of CFA success fees and ATE insurance  premiums – a process which transfers the majority of the  risk and cost of litigation to the defendant, if it loses the  case. These exemptions will apply until April 2015 although  the associations that represent insolvency practitioners  are continuing to lobby the government for a permanent  exemption. The exemptions also only apply to insolvency  related proceedings brought by liquidators, administrators  and trustees in bankruptcy. This potentially places creditors  outside this privileged position and may mean their only  potential funding option is a currently unworkable DBA. If this  remains the case it is likely that only cases involving wealthy,  motivated creditors will find assignment of actions attractive.

Directors will be held financially accountable to creditors  in circumstances where their actions have caused loss.  The Secretary of State will have the power to apply to  the court for a compensatory order to be made against a  disqualified director, where that director’s actions have  caused identifiable loss either to specific creditors or  creditors generally. The Secretary of State may accept a  compensation undertaking from a director against whom  disqualification proceedings have been, or propose to be  brought against, where the director offers an acceptable  compensation settlement instead of going to court. The  courts and Insolvency Service will have discretion to make  the compensation award to a particular creditor, or group or  class of creditors, or the creditors as a whole. This discretion  may increase the risk that compensation is received by the  creditors with the loudest voices.

Once the specific language of the  enacting legislation is known, existing  conduct exclusions in policies may  need to be reviewed to ensure they  are sufficient to address (either by  way of exclusion or inclusion), both  the making of Compensation Orders  against a director or any voluntary  director compensation undertaking.

Conclusion

Many of the proposed changes will  require primary and secondary  legislation. In the Queen’s Speech  earlier this month reference was made  to the Small Business, Enterprise and  Employment Bill (the Bill) intended to  introduce the proposals noted above.  The Bill will be published on 16 June  2014, so may just be in time to start  its journey through the House of  Commons, which only recesses for the  summer on 22 July 2014 (re-opening in  September). The Government would  like this Bill to be agreed before the  next General Election on 7 May 2015. D&O insurers should use this time  to assess how the proposals will  impact them.