Insolvency consultation puts governance in the spotlight

We closed the first quarter of 2018 following a period of intense scrutiny on the restructuring and insolvency profession. The stress in the retail and dining sectors, the increase in CVAs and the various attendances of stakeholders in the profession before Select Committees has been the forerunner to two consultation papers.

On 20 March, the Department for Business, Energy and Industrial Strategy (BEIS) launched a consultation entitled ‘Insolvency and Corporate Governance’ and on 19 March, the Department for Work and Pensions launched a white paper on ‘Defined Benefits Pension Schemes’. The two papers raise similar issues in respect of the liabilities of directors of the insolvent entity’s parent in the context of insolvency of major companies like BHS and Carillion.

The BEIS Consultation Paper is wide-ranging in scope and highlights issues which could have far-reaching implications for directors, distressed investors and lenders.

The Consultation considers:

• Sales of a business in distress: the paper proposes potential changes to ensure directors of group companies are more accountable for losses occurring upon the sale of subsidiary/ies which enter an insolvency process within two years of the sale. The example given in the consultation is a (barely disguised) summary of the factual circumstances of BHS. The consultation proposes penalties for directors in circumstances where at the time of the sale the directors could not have reasonably believed that the sale would benefit creditors or employees;
• Reversal of value extraction schemes: this proposal is aimed at the distressed investment community and proposes that Insolvency Practitioners (IP) are given increased powers to investigate a company ‘rescued’ by investors which then becomes insolvent. The IP’s powers would extend to challenging excessive management fees, high interest rates and security taken;
• Investigations into the actions of directors of dissolved companies: this proposal explores extending the Insolvency Service’s investigative powers into the conduct of directors who dissolve companies with outstanding debts or where there are allegations of director misconduct. Whilst difficult to argue against, on a practical level it is challenging to understand how the Insolvency Service will find the additional resources to undertake such investigations;
• Strengthening Corporate Governance and pre-Insolvency situations: there are a range of proposals which are particularly aimed at looking at companies when they are in the zone of insolvency. The proposals focus on greater governance (record keeping), shareholder responsibilities (understanding the subsidiary’s long term strategy, corporate governance, risk management and executive remuneration), payment of dividends, use of professional advisors (in situations where directors do not independently examine the issues in accordance with their wider directors’ duties) and protection for the company’s supply chains. Of particular interest to the lending community is the suggestion in the report that the ‘prescribed part’ should be reconsidered either to remove the current cap entirely or to increase the proportion of floating charge realisations available for unsecured creditors, particularly in larger insolvencies.

With a response deadline of 11 June, it is apparent that there is a political will to react to the issues highlighted by cases such as Carillion and BHS and to hold those responsible for navigating major corporates more directly accountable.

As past experience has shown, extreme cases do not tend to make good law. It is incumbent on everyone to consider the balancing exercise between lax corporate governance on the one hand and the need for certainty, encouraging continued investment and attracting talent to the boardroom on the other.