Insolvency Oracle

Developments in UK insolvency by Michelle Butler

The Small Business, Enterprise and Employment Bill: Part 1 – Directors

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IMGP0277 This “Small” Bill will have a big impact on IPs. Not only does it include the widely-publicised reserve powers to ban pre-packs and appoint a single insolvency regulator, but it will result in a completely new D-reporting process and will relegate physical creditors’ meetings to something that only creditors can request. The Bill contains many other smaller items that will require significant overhauling of templates and checklists… far more than the 7 hours estimated in the Impact Assessment!

The Bill’s government webpage is at http://goo.gl/VwKvPe and I have sketched out (to help myself get an overview) the clauses that will impact IPs here: Insol relevant provisions Jul-14

In this first post, I cover the key changes to reporting on directors and actions arising from directors’ misconduct. My next post will deal with the changes to the IP regulation regime, pre-packs, and the numerous technical changes to the Act.

D-Reporting

I know that R3 spins this as a success – the move from burdensome paper reports to something far speedier online – but I have to say that I am more sceptical about the advantages of this process for IPs.

The Impact Assessment (“IA”) describes the present problem as delayed reporting because “the IP must be satisfied that there is evidence of unfit conduct… The proposed design of the new form would require the IP to highlight (at an earlier stage) information or behaviour which may indicate unfit conduct as opposed to providing a significant amount of justification and evidence at that stage.” The Bill sets the timescale for submitting a report to within three months of appointment – the rationale, it says, being that “the SoS would be able to better consider behaviour identified by the IP” at this earlier stage [why?] and “the quality of information should improve due to the return being submitted with greater proximity to events” [really?] – although I thought it was charming that, in the same breath, the Bill is providing the Service with an extra year in which to commence disqualification proceedings.

Personally, I expect that this change will result in a greater number of ‘clean’ reports, as IPs will have less knowledge of past events at three months than at six months. However, as IPs will be “under an ongoing obligation to report any new information that he/she considers should have been included in the return”, I cannot see that this will result in less, or even the same amount of, work for IPs in the long run. The forms themselves might also require more work, as “there are also other pieces of information not currently requested which R3 states that IPs could usefully provide”.

The IA estimates only one hour for IPs (nothing for other staff) to familiarise themselves with the new process and one hour per director in completing the new return where misconduct is indicated, which I can see, depending on the final form of the return, would be a reduction over the present demand, although the IA has provided no time costs in relation to providing additional information to the SoS after a return has been submitted.

One sentence that really got my goat was: “Analysis undertaken on a sample of 250 cases where D1 reports were submitted but not proceeded with indicated that a significant percentage of them should not have been submitted”. Should not have been submitted?! What can the government mean? Are IPs failing to meet their statutory obligations?

I am reminded of a question raised by the House of Commons BIS Select Committee when it interviewed Richard Judge and Graham Horne in 2012 about the apparent disparity between the number of D1s filed – around 5,000 per year – and the number of disqualifications. I remember Dr Judge stating that this meant there were “5,000 indications of misconduct… there are people that are innocent in that” and Mr Horne chipping in quickly to clarify that IPs are required by statute to report directors who, by analogy, drove at 31 mph in a 30 mph zone; technically, the conduct might be reportable, but of course not all such directors will be pursued to disqualification. Although switching to a system in which IPs simply provide the facts and leave the SoS to decide whether the director’s behaviour merits action may avoid future discomfort in answering such questions, it seems to me that nothing here changes the statutory obligation for IPs to waste time reporting on the 31 mph drivers.

Compensation Awards

The IA gives us a clear hint at what has driven this measure. It states that “a frequent complaint in Ministerial correspondence from creditors is that although disqualification can prevent a director acting as a director in future, it provides no compensation to those who have suffered from their misconduct”. What types of cases might attract compensation awards? The IA states that “it is reasonable to believe that compensation could be sought from, at least those cases where there has been an identifiable loss to creditors, for example: misapplication of assets, transactions to the detriment, criminal matters and accounting records” – that’s quite a list! The IA continues: “it is also reasonable to assume that whatever the allegation, the SoS will also seek compensation for those cases where there are a lot of unsecured creditors or ‘vulnerable’ members of the public who have lost out”.

However, the IA presents a confusing picture as to how the government envisages the process of seeking compensation awards against disqualified directors working – in tandem? – with the activities currently carried on by office holders in challenging antecedent transactions. For example, the IA states: “the option of the SoS seeking a compensation order or agreeing a compensation undertaking from a miscreant director will enable greater financial redress for creditors, where the office holder (IP) has not taken any of the available actions him/herself or it is considered that further action in addition to that taken by the IP is merited”. Fair enough, as the IA points out, this may be because the office holder has insufficient funds to pursue the case (although I am irritated by the comment that an IP might feel “they don’t have the specialist expertise to bring a claim”). But, I wonder, will this exacerbate the difficulties in reaching settlements with directors who, notwithstanding any settlement agreed with the IP, could then be pursued by the SoS? At least the IA recognises that there are likely to be fewer disqualification undertakings under the future regime, as directors are less likely to give in without a fight.

Do you wonder whether this could result in the SoS and IP fighting between themselves as to who might chase after the director’s finite pot first? The IA states that IPs “should be able to proceed with any action they deem appropriate before the SoS”. Well, that’s alright then.

The Bill also indicates that compensation may be awarded to a particular creditor or creditors, a class or classes of creditors, or it may form a contribution by the director to the assets of the company. However, the IA states “the compensation award will be awarded direct to creditors” (although it makes no provision for the Service’s costs in collecting the monies from the director, adjudicating on creditors’ claims, or paying a distribution). This quote appears in the context of “free-riding amongst liquidators”! It seems that some consultation responses suggested that office holders might not pursue claims themselves, but they might sit back, wait for the Service to do the work, and then pop up to collect the funds and take a fee. The IA does nothing to counter this libellous title and simply states that, because the award is direct to creditors, they “do not think the risk of ‘free-riding’ is high” and “no evidence exists on the likely number of cases of free-riding by liquidators”. Come on, Insolvency Service, we expect better of you than that!

I am also puzzled by the repeated references to improving gateways so that the SoS and IPs might share information better, for example, “to better enable successful recovery actions to be taken forward by the office holder”. As far as I can tell, the gates only swing one way (unless there is something in the OR’s handover) and will continue to do so; there are no proposals in the Bill to help IPs have greater access to information, although the IA suggests that things may change “through updating internal guidance used by Insolvency Service staff”.

I was also puzzled at the IA highlighting a “risk” that “this will result in compensation orders being made for the benefit of HMRC as they are the major unsecured creditor in the majority of insolvencies”. Personally, I don’t see that a bit of recompense to the public purse is a bad thing. Instead of the IA pointing to the Bill’s reference to factors that the court/SoS would consider – the amount of loss, nature of misconduct, and any recompense already paid – it answered this by referring to the fact that the court/SoS could determine that compensation be awarded to a particular creditor or class or group of creditors “taking into account what is equitable in all the circumstances”. Could the prospect of deviating from the pari passu rule, especially if HMRC might not get a look-in at all, result in some creditors calling for office holders to resist taking action and leaving it to the SoS?

Power to assign certain rights of action to third parties

The apparent “problem” that the government is seeking to fix is the lack of court applications as regards wrongful and fraudulent trading (which are both extended under the Bill to Administrators), transactions at undervalue etc. However, the IA acknowledges that “a lot” of claims are settled out of court (they have heard upwards of 90%) and it reports that the other principal reasons for lack of court actions given in the consultation responses were the targets’ lack of assets and the high evidential bar necessary, so the government acknowledges itself in the IA that the Bill’s provisions are unlikely to result in many more cases going to court.

The IA does not mention the issue for an IP who agrees to share in the proceeds of any action assigned to a third party: won’t the risk of an adverse costs order deter IPs from entering into some assignments? The IA points out a risk “of speculative or opportunistic claims being brought against directors who may be ill placed to defend themselves. However, this risk should be small as we expect insolvency professionals to have regard to existing professional and ethical standards in judging when to assign causes of action.” But in the next paragraph the IA refers to the IP’s duty to maximise returns to creditors: could an IP really be justified in turning away third parties offering to pay for rights of action, if it represented a good deal for creditors?

The IA appears more thoughtful in relation to the justification for IPs selling to a third party, who after all is looking to make a profit from the action: they feel that IPs may be justified as the third party’s greater appetite for risk and economies of scale in taking the action forward compensate for the discount on the action suffered by the estate. The IA also makes the sensible point that simply opening the way for third parties may improve IPs’ negotiating position in pursuing claims directly from directors.

My part 2 on the Bill will follow in a week or so (once I’ve done some real work!)

(UPDATE 25/09/14: I read an excellent blog on the subject of the director provisions of the Bill from Neil Davies & Partners – http://goo.gl/uYp3RU.  I was particularly intrigued by the observations on the complications that could arise from the provision to empower the SoS to pursue compensation orders.)

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