October brings major changes to insolvency law – What do directors and D&O insurers need to know?

Introduction:

Wide ranging changes to insolvency law will come into force on 1 October 2015 that will have repercussions for insolvency practitioners, directors and D&O insurers alike. One of the more significant - and controversial - changes allows office holders in insolvency proceedings to assign claims deriving from those proceedings to third parties. The implications of this are potentially far reaching and are discussed below.

New powers of assignment

On 1 October, a number of provisions in the Small Business Enterprise and Employment Act 2015 and the Deregulation Act 2015 will come into force. In particular administrators will be placed on an equal footing with liquidators insofar as they will be permitted to bring proceedings against directors for wrongful trading and fraudulent trading. However, the legislation goes a step further. From 1 October administrators and liquidators will have the power to assign claims to third parties that were previously only capable of being brought by the office holders themselves. Wrongful trading and fraudulent trading as well as transactions at an undervalue and preferences will all be treated as an asset in the insolvency estate to be assigned and sold.

There was much debate within the insolvency industry as the Small Business Enterprise and Employment Bill passed through Parliament, as many feared claims will be assigned to unconnected parties and companies whose sole purpose is pursuing litigation against directors. Such parties are likely to be better resourced than many office holders (whose ability to pursue litigation is often restricted by the level of assets in the estate) and more aggressive in pursuing claims. They would also not be bound by traditional considerations of office holders such as whether bringing the claim can be justified in the interests of creditors.

D&O insurance policies commonly cover claims brought by administrators and liquidators against previous directors of insolvent companies, as well as providing for the advancement of defence costs in relation to those claims. The defence costs cover is usually subject to a clawback if there is a finding of fraud or dishonesty on the part of the directors. We would expect such claims to continue to be covered if bought and pursued by an unconnected party.

Although some D&O policies contain Insured v Insured (“IVI”) exclusions these commonly write conventional insolvency claims back into the cover by exception. IVI exclusions also apply to claims brought in the name of the company whereas it is understood that third party purchasers of office holders’ claims will be able to sue in their own name as assignees, which would prevent the IVI exclusion from applying at all. Insurers will need to review their wordings in the light of this.

Where D&O Insurers exclude from cover claims “arising out of insolvency” they will need to consider carefully whether the language used is wide enough to cover unconnected party claims acquired under the new provisions.

Disqualification and compensation orders – an additional liability for directors

A number of changes are also being introduced to the directors’ disqualification regime. The period for applying for a disqualification order will be extended from two years to three, but more troubling for directors will be the new power for the court to make compensation orders against directors. For conduct occurring post- 1 October 2015, the court, on the application of the Secretary of State, may order a director to pay compensation to a creditor or creditors who have suffered loss as a result of the misconduct leading to the disqualification.

Alternatively the Secretary of State may accept an undertaking to pay compensation without applying to court. As failure to pay any monies owed to HMRC is one of the subject points of the test for disqualification, directors may find themselves personally liable to HMRC despite the company’s limited liability status.

These developments are also of significance to D&O Insurers. Because the new orders are (as they suggest) “compensatory”, rather than penal, in nature, they should, in principle, be recoverable under most common D&O policy definitions of “Loss”, along with any reasonable costs of defence, subject to clawback in the event of a finding of fraud or dishonesty.

Again, Insurers will need to decide whether they wish to include this new class of claim, either in whole or in part, within D&O covers. Any review would need to consider whether any exclusion in respect of HMRC or other tax liabilities is wide enough to cover compensation orders.

For more information on these issues please contact one of the key contacts.