Corporate Governance and Insolvency reforms
25 October 2018
The UK Government is implementing measures to strengthen corporate governance and insolvency laws. The aim is to increase accountability, improve creditor protection and promote company rescue. This note comments on a selection of the proposals which were published at the end of the summer.
Transparency and shareholder stewardship
There is to be increased transparency around complex group structures. Measures may include a requirement for groups to maintain an organogram documenting the structure and how corporate governance is promoted to increase accountability.
Institutional shareholders may enjoy greater stewardship, allowing escalation of concerns about company management. Shareholder stewardship is to be enhanced through the upcoming Stewardship Code and Shareholder Rights Directive (due to be implemented in June 2019).
The existing regime, based on a company’s distributable profits, is considered too complex and “backwards looking”. Disclosure requirements around available reserves and distributable profits are to be considered together with the merits of a solvency based system, which would require a formal declaration before dividends can be paid.
Sales of distressed subsidiaries
Where a company with a controlling interest in a financially distressed subsidiary sells its interest, directors of the holding company will be required to consider whether the sale is in the best interests of the subsidiary’s stakeholders. Should directors fail to give this due consideration, they may be exposed to disqualification. The measures will be limited to sales of large subsidiaries.
Value extraction schemes
The hurdle for preference claims will be lowered, making it easier to hold directors to account. The existing regime requires the office holder to prove that the company was insolvent at the time (or as a result) of the transaction. In future, if connected parties are involved, the insolvency requirement will be presumed. This would bring requirements in line with those for transactions at an undervalue claims.
A gap in legislation preventing misconduct by directors of dissolved companies from being investigated will be addressed. This will open the door to enforcement actions, allowing prosecution and compensation orders in appropriate cases. There will be no need to restore companies to the Register before action can be taken.
New moratorium and restructuring plan
A new moratorium regime will be introduced, modelled on that for administrations, and triggered by filing papers at court. Entry criteria will include one of prospective insolvency, with a requirement that the company will become insolvent unless action is taken. The company must have funds to carry on trading during the moratorium, meeting obligations as they fall due. An insolvency practitioner (“monitor”) will assess whether that remains the case. The moratorium is likely to last for an initial period of 28 days although extensions will be possible.
Also proposed is a new restructuring vehicle. This would include the ability to bind dissenting classes of creditors who vote against it whether they are secured or unsecured. This will be a standalone process, capable of being used in conjunction with the new moratorium. Proposals will pass through the court with creditors and shareholders voting.
Termination for insolvency
Clauses permitting the termination of a contract on the basis of a counterparty entering insolvency, or the new moratorium process, are to be invalid. This is to promote rescue and restructuring. It will not prevent termination on other grounds (e.g. non-payment or by notice). If continued supply will mean a supplier suffers undue financial hardship (i.e. its own insolvency), permission to terminate is likely to be granted upon application to the court. However, this is likely to be exceptional since suppliers will enjoy super priority for those debts incurred prospectively, once the counterparty has entered insolvency/the moratorium.
The incoming measures are intended to promote the UK as a place to invest and do business, with a view to improving already robust systems.
It will be interesting to see how widely the moratorium process is used, especially in light of the very limited take up of existing provisions in Schedule A1 of the Insolvency Act 1986. Further, whilst guidance is not explicit, it is presumed that suppliers will still be able to terminate contracts using common law rights of repudiation in appropriate cases, even if express contractual rights are invalidated. This is likely to see office holders being required to affirm contract terms promptly in relation to services or supplies they wish to keep, failing which termination for anticipatory breach or renunciation may follow. Suppliers and office holders alike should take legal advice promptly so that rights and obligations can be maintained or terminated as necessary.