It’s a long established principal of English law that when a company starts to struggle financially, its directors are required to pay more attention to the interests of the creditors than they might have before then and that the worse the financial problems become, the more they should prioritise the interests of the creditors over those of its parent company. If the company’s directors fail to do so, they can be forced to contribute personally to the company’s assets where they have caused the company to trade wrongfully or fraudulently, or have carried out any misfeasance, preference, transaction at an undervalue or breach of duty.
The UK government is currently talking about bringing in some new laws which could see parent company directors of larger companies disqualified where its English subsidiary goes into liquidation or administration within a year of any sale. In addition, the parent company directors could be forced to contribute personally towards the company’s assets under a compensation order. The law is part of the government’s initiative to improve the standards of stewardship of larger companies in the UK. Here’s a link to the proposal. If you’re a parent company director, it’s worthwhile reading the document.
So when is to become law?
It’s not yet clear when this will become law, as it depends on parliamentary time (which is taken up with other stuff right now), nor is it clear what the final law will look like. A proposed 2 year period of sale has already been reduced to one, will the law be further watered down in the cold light of day?
Does it apply to all subsidiaries?
No, it only applies to medium sized companies and above. Quite what that will mean remains to be seen.
Is there a defence?
The proposal is that parent company directors will not be liable if at the time of sale they believed, and had reasonable grounds for doing so, that the sale would bring about no worse an outcome for the subsidiary’s stakeholders than a liquidation or administration would do. This means employing professionals to prepare a comparison of outcomes at the appropriate time.
What impact is it having right now?
I’m guessing here, but even though the law is not yet in place, I’m wondering if the proposals might be currently leading to:
- Sales of struggling subsidiaries to third parties being brought forward, with more favourable terms being offered to the buyer now than might potentially be on offer later on.
- An increase in administrations initiated by private equity investors in order to avoid being caught by the law later.
And later on, once it’s in place I expect to see some delay in agreed disposals as advisors prepare statements comparing the outcome with liquidation and administration.
Do I expect any more difficulties?
- Firstly, and this is one of the main points of the legislation, parent company directors often face a conflict between their duties to the parent, the parent’s stakeholders and the subsidiaries’ stakeholders/creditors. Quite where the prime duties lie remains to be seen, especially where the affairs of the group are complex, for example involving pension fund issues.
- The potential to be made personally liable if the parent sells the subsidiary might encourage directors to push the subsidiary into administration as the first option – while this may protect the parent directors, administration could potentially destroy more value for stakeholders than a sale. We may see even more administrations, we may see more calls on the Pension Protection Fund. The law of unintended consequences!
- This in turn could see more pre-packs as struggling subsidiaries with a business worth saving are forced into administration, arguably unnecessarily.
- Exactly what does a parent director have to get prepared to demonstrate they have a reasonable belief that the outcome of a sale was no worse than administration / liquidation? I can see these reports being very complicated because it must be assumed they will be tested in court. Right now there is no guidance. Will detailed guidance come from the government or will it be left to the various governing bodies to prepare it? How do the different outcomes for different stakeholders – suppliers, customers, HMRC, employees, Pension Protection Fund – fit together in all this?
- What can the government do to ensure that non-UK based parent company directors are held to account as much as UK based parent company directors?
The UK wants to be seen as the place to do business because its standards of stewardship are high, but it also wants to encourage foreign investors to come in and invest heavily without being afraid that they might lose their shirt. Right now, there’s little detail in the proposals in what is a hugely complex area of business, it will be interesting to see if the powers that be manage to find the right balance when drafting the legislation and guidance.