In its search to deliver a strong business environment by strengthening the corporate governance of the companies in the country, the British government has put out a document, Insolvency and Corporate Governance, to consultation, wishing to gain insights from different viewpoints regarding insolvency risk in companies due to weak governance. It asks for feedback on how to reinforce the accountability of members of the board in decision making with respect to insolvencies.

The consultation is about establishing an open and fair business environment that can attract investors, while stopping the actions of a few companies from undermining the reputation of British business generally.

The consultation period finished on June 11. Below, we analyze the main considerations of the process.

Liability and disciplinary proceedings for the sale of insolvent subsidiaries

When a holding company sells off an insolvent subsidiary, British law does not demand that it take into account the viability of the business after the divestment takes place. Thus, if the subsidiary sold collapses, even if the divestment has been a contributing factor in its failure, neither the holding company nor its directors are liable for the negative consequences.

The proposal put forward argues that the success or failure of a company not only impacts its owners, but also its employees, suppliers and clients, and even the industry in which it operates. Thus, to ensure that these stakeholders are not unfairly prejudiced, the report proposes that the directors of the holding group be liable for decisions that could cause them harm.

It also suggests that directors could be subject to penalties for the resolutions they have adopted. This must be done proportionally, limiting their responsibility to cases in which they have acted irrationally or when the damage caused to stakeholders from the sale could have been foreseen.

The proposal mentions that there does not need to be a causal link between the sale and the failure. It would be sufficient for the director not to have reasonably believed that the disposal of the subsidiary was in the interests of its creditors and other stakeholders, and for this to have been confirmed by the worsening of the situation, followed by formal insolvency proceedings.

New powers to ensure equity

The document cites the case of companies rescued through complex schemes carried out by investors that simply extracted value from them to get a quick payback on their investment and reduce their potential loss once the company was declared insolvent. Such value extraction scheme can unfairly benefit some parties while putting creditors in a worse situation than they would have been should the company have continued business as usual until becoming formally insolvent.

The British government is aware that the current laws do not suitably legislate such situations in order to ensure equitative schemes for all the parties impacted by the insolvency. It thus wants to ensure that creditors and other stakeholders receive fair treatment in insolvency situations, providing suitable tools to be able to reverse complex value extraction schemes applied to the company before it became insolvent.

Thus, its proposal tries to define what new powers could be established in order to go to court to apply for the reversion of schemes that have unfairly extracted value from a potentially insolvent company and thereby harmed its stakeholders during a specific lookback period.

Winding up companies

The current British legal system permits the supervision of the director’s activity and conduct in both active and/or insolvent companies, but not companies that have been dissolved. Thus, the government proposes an expansion of its oversight powers regarding the governing bodies of dissolved companies, to avoid their members benefiting from the dissolution without being held accountable for subsequent events.

Corporate governance in pre-insolvency situations

• Group structures. The document includes the idea that corporate groups should have a sound system of corporate governance with stronger transparency measures to ensure effective oversight and control of the corporate groups with complex structures.
• Shareholder responsibilities. It considers that shareholders play a relevant role in the long-term success of companies. It therefore proposes that their engagement with the investee companies be extended beyond simply voting at general meetings, and that shareholders, particularly large institutional shareholders, should be involved in strengthening the good governance of companies and ensure that they are being responsibly managed. It also suggests that a specific group be established to supervise the stewardship of the companies, reviewing failures and scandals and making recommendations based on the lessons learned and ensuring that they are enforced. It also suggests periodic meetings and forums to establish long-term strategy plans.

• Payment of dividends. Given the large number of companies that continue to pay out substantial dividends to shareholders even when teetering on the brink of insolvency, the government suggests a reform to the legal and governance framework to strengthen transparency and accountability among directors responsible for decisions about shareholder payout.

• Directors’ duties and the roles of professional advisers. Directors have an indelegable duty to promote the long-term success of their company, pursuant to article 172 of the Companies Act 2006. They may request support from experts in order to make informed decisions. However, they must be aware that only they, and not their advisers, are responsible for the decisions taken and for issuing an independent value judgement, under the provisions of the act.

Other issues

The document concludes with a proposal to the interested public to assess whether the proposals made foster sufficiently high standards, asking them to make suggestions regarding any other issue or submitting ideas to be considered in order to enhance the corporate governance framework in the UK.