Corporate governance reforms – the story so far

22 October 2018

Following a number of recent high profile insolvencies, the Government announced plans in the spring to reform the corporate governance framework, aimed at reducing the risk of poor governance or stewardship leading to major corporate insolvencies.

At the end of August, revised corporate governance proposals were published alongside the Government’s revised corporate insolvency proposals (first consulted on in 2016). R3’s post on the corporate insolvency proposals can be read here.

While the corporate insolvency proposals look like they are ‘legislation ready’ (‘when parliamentary time permits’), indications are that the corporate governance proposals require a bit more work. For the most part, clear plans for legislation are limited, and, instead, there are promises of further consultation and work with stakeholders.

R3 called for the Government to make substantial changes to its corporate governance proposals when they were first published, warning that they could have a significantly negative impact on business rescue and investment. The Government has listened to these concerns, and has responded by making a number of changes to the proposals. R3 is discussing the revised proposals with members, and will be feeding those views back to the Government before the end of the year.

The proposals of direct relevance to R3 members include measures to:

• Disqualify directors of parent companies who sold a financially distressed subsidiary which became insolvent within 12 months of the sale;
• Review insolvency practitioner powers to undo a transaction, or a series of transactions, which ‘unfairly’ strip value from a company; and
• Extend the director disqualification framework to cover dissolved companies.

Other measures (not discussed below) include:

• Increasing the “prescribed part” from £600,000 to approximately £800,000 (in line with inflation);
• Strengthening access to training and guidance for directors of their legal duties; and
• Improving transparency of group structures.

Sanctions for directors who sell subsidiaries which become insolvent

The original proposals would have made directors financially liable for creditor losses, if a distressed subsidiary they had sold entered liquidation or administration within two years of its sale, and if the “director could not have reasonably believed that the sale would lead to a better outcome for the creditors than placing it into liquidation”.

R3 raised serious concerns that this proposal would act as a significant deterrent to business rescue, sales and investment. The Government’s proposed reforms have been revised and limited in line with R3’s and other stakeholders’ recommendations.

Under the revised proposals, directors will not be held financially liable for creditor losses in the event of a sold subsidiary’s insolvency, but they may face sanction under the existing director disqualification regime if it is found that they did not give “due consideration” to the interest of stakeholders at the time of the sale. The timeframe for any action against the director of subsidiary being sold and entering into administration or liquidation has also been reduced from two years to one.

Despite the changes, it’s still not clear what benefit this measure would have, and there is still a risk that the threat of disqualification may persuade directors to close down struggling subsidiaries rather seek to rescue them. As an alternative to this proposal, the Government should review existing office holder powers to address wrongful trading and misfeasance.

Review of insolvency practitioner powers to tackle ‘value extraction’

The Government said that it had concerns that recent insolvency cases had featured value being extracted from a company ahead of insolvency for the benefit of investors, but to the detriment of creditors. The Government’s response was to consider granting the profession new powers to allow an insolvency practitioner to apply to court to reverse a transaction, or to review existing antecedent recovery powers to assist in tackling such behaviour. R3 raised concerns that the powers would have a negative impact on business rescue and investment – and would not solve the significant practical problems insolvency practitioners face when seeking to use their existing powers. Instead, R3 called on the Government to review and update the existing insolvency practitioner ‘tool-kit’. Many of these existing powers could achieve the Government’s objectives – without the downsides – but they need to be usable first.

Following significant criticism of this measure from R3 and other stakeholders, the Government has amended its proposals to review the existing powers of insolvency practitioners (with the help of the profession), rather than creating new stand-alone powers. The Government will also work with stakeholders to look at how the extortionate credit transaction provision might work more effectively where creditors are ‘unfairly disadvantaged’.

Extending the director disqualification framework to cover dissolved companies.

In response to concerns that unscrupulous directors were using dissolutions to avoid the scrutiny of an insolvency procedure, the Government has proposed that the director disqualification framework be extended to cover dissolved companies, too.

The proposed measure would allow the Secretary of State to disqualify directors of dissolved companies, where the dissolved company is connected to a live or insolvent company investigation, or where a complaint has been made regarding the directors’ conduct. The measures would allow a director of a dissolved company to be investigated without restoring the company. Directors could be subject to investigation and disqualification in instances where companies have been repeatedly dissolved to avoid paying liabilities.

The measure is welcome, as long as adequate resource can be provided by the Government for it. R3 also recommends making the process of restoring companies easier, and raising the penalties for wrongly dissolving a company.