Are new laws that will make directors of holding companies accountable for the sale of distressed subsidiaries a charter for zombies?

black crow and a pigeon standing on a slab of concrete surrounded by water

I’ve written before about the extent to which English courts have been prepared to lift the corporate veil and hold a parent company responsible for the acts and defaults of another company in the same group. In the Chandler case, the Court of Appeal allowed an employee of an insolvent subsidiary to receive workers compensation after he’d contracted asbestosis and had no other recourse. Now the government is proposing to introduce legislation to extend the responsibilities of the directors of parent companies to consider the future viability of a subsidiary after sale. This follows a number of high profile cases in which a purchaser of an enterprise which has subsequently failed was found to have had no sound basis for the belief that they could return the company to profitability.

The new law

The proposals are to be found in the same consultation which I mentioned in my previous blog, A new U.K. Corporate Governance Code will require directors to look beyond shareholders’ interests.This would represent an important extension of existing company and insolvency law, which is designed to address the conduct of the failed company’s directors and to attack certain transactions which have unfairly harmed creditors, but does not readily allow for the conduct or actions of directors of the selling company to be criticized. On the contrary, English common law doesn’t impose a duty of care on sellers of a company to that company’s employees or future creditors. This would change under the government’s proposal that:

“…. holding company directors should be held to account if they conduct a sale which harms the interests of the subsidiary’s stakeholders, such as its employees or creditors, where that harm could have been reasonably foreseen at the time of the sale.”

The sanctions proposed for breach of the new law would be a power granted to liquidators and administrators to “…apply to court for an order that the director contribute a sum that the court thinks fit towards the subsidiary’s creditors and that the director should also be liable to be disqualified where appropriate.” These are fairly formidable weapons not dissimilar to those available in the context of a wrongful trading case.

Safeguards against hindsight

The critical words here are of course “which could have been reasonably foreseen.” There would be considerable temptation on regulators and courts to apply hindsight in circumstances where the company has (perhaps spectacularly) collapsed despite all hopes, promises and expectations at the time of sale. The government, recognizing this danger, proposes the following safeguards be built into the new law:

  • At the time of the sale, the group subsidiary must either be insolvent, or insolvent but for guarantees provided by other companies or directors in its group;
  • The subsidiary enters into administration or liquidation within two years of the completion of the sale;
  • The interests of its creditors must have been adversely affected between the date of the sale and the liquidation or administration; and
  • At the time they made the decision to sell the company, the director could not have reasonably believed the sale would lead to a better outcome for those creditors than placing it into administration or liquidation.

A charter for zombies?

Leaving aside the other conditions, the key period here is 24 months after the completion of the sale. Provided the sold subsidiary can survive that long, directors of the selling company would be able to escape liability altogether. One can perhaps imagine that unscrupulous sellers might try to find ways to keep companies afloat in this limbo period specifically to escape liability. After all, the concept of zombie companies (needs subscription) is not a new one.

On the other hand, sellers who act in good faith and the genuine, albeit mistaken, belief that the company might have a viable future could be vulnerable to personal liability due to unforeseen circumstances. It’s noticeable that the government’s proposals do not require there to be any causal link between the sale and the failure, and would even consider that it is “…enough that the director could not reasonably have believed that the sale was in the interests of creditors, and this has been borne out by a worsening position followed by formal insolvency.”

If you are left with the uneasy feeling, despite the proposed safeguards, that if these new laws are introduced they could turn out to be a blunt instrument used to hold directors to account after the event, you’re not alone.

About Francis Kean

Francis is an Executive Director in Willis Towers Watson's FINEX Global, where he specializes in insurance for Dir…
Categories: Claim & Risk Control, Directors & Officers, Insurance and Risk Management, Risk Culture | Tags: , , , , , ,

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