Proposals to increase claims against directors
We note with interest the Government's Discussion Paper, 'Transparency & Trust: Enhancing The Transparency of UK Company Ownership And Increasing Trust in UK Business'.
In the Paper, the Government proposes to (amongst other things):
•Allow a liquidator to sell or assign wrongful / fraudulent trading claims to a third party; and
•Give the courts powers to make compensatory awards at the time they make a director disqualification order.
These proposals are relevant to the length and breadth of the D&O market. Their purpose is to try to encourage civil claims being made against directors of failed companies, so creditors can be compensated.
Allowing a liquidator to sell or assign wrongful / fraudulent trading claims
These claims arise under the Insolvency Act 1986, in the case of wrongful trading where the directors have continued trading when they knew or ought to have known that the company was insolvent, and in the case of fraudulent trading where the directors have carried on the business with an intention to defraud creditors (or other persons).
The claims can only be brought by the liquidator, and only if the liquidator is put into funds by the company's creditors (or a CFA is utilised). The purpose of the claims is for the liquidator to obtain an order from the court that the directors make a personal contribution to the insolvent company’s assets. In the case of 'wrongful' but not 'fraudulent' trading, D&O policies will cover such awards. The policies will cover the defence costs, in either case.
Often creditors do not have the appetite or the financial backing to put the liquidator into funds, or only one creditor does but is discouraged from doing so because he will then be bearing all of the risk but will have to share the rewards with all the other creditors. Liquidators can utilise CFAs (although it is expected they will be prohibited from doing so in 2015) but wrongful and fraudulent trading claims tend to be difficult to prepare and bring, with the result law firms shy away from accepting them under a CFA. Claims with relatively good chances of success can therefore fall by the way side, because there is no one to pursue them.
Under the Government's proposal, a particular creditor (or another third party) can buy the claim, in return for all of the spoils. The Government's stated aim for the proposal is to increase the number of wrongful and fraudulent trading claims against directors. It anticipates that a "market in these [assigned] actions will develop". We agree this could well be the effect, but it is worth noting that under the current law liquidators can already assign other claims against directors (such as for breach of directors' duty) and yet this is rarely done. It is not immediately obvious why assignments of wrongful and fraudulent trading claims should be as prevalent as the Government expects.
Compensatory awards in disqualification proceedings
Disqualification proceedings (which are brought by the Insolvency Service in respect of insolvent companies) are comparatively rare – last year only 1031 directors were disqualified. However, these can be expected to increase significantly if the Insolvency Service can obtain compensation for those who have suffered losses as a result of the conduct leading to the disqualification.
The Government has invited comments on whether compensation should be awarded just to company creditors or if a wider class of persons should stand to benefit. If the Government decides shareholders can be compensated, the potential awards against directors could be very large indeed. Absent fraud, such awards will be covered under D&O policies.
This article first appeared in RPC’s Professional and Financial Risks Blog and has been reproduced with their permission. To view RPCs blog, click here.