Hannah Thornley was appointed as a specialist legal adviser to the Work and Pensions and Business Select Committees for the BHS inquiry in 2016 and for the Carillion inquiry in 2018. Here she reviews what has happened post-BHS, what happened at Carillion and discusses the different areas of insolvency and corporate governance law in the consultation on which the Government seeks the views of different stakeholders by 11 June 2018
The failure of BHS in 2016 seemed to catch the nation’s collective attention. Therefore the Work and Pensions Select Committee and the Business Innovation and Skills Committee, now the Business, Energy and Industrial Strategy Committee (“the Committees”) chose to investigate BHS because the failure encapsulated many of the Committees’ ongoing concerns about the regulatory and cultural framework in which business operates, including the ethics of business behaviour, the governance of private companies, the balance of risk and reward, mergers and acquisitions practices, the governance and regulation of workplace pension schemes, and the sustainability of defined benefit pensions.
The collapse of Carillion in January 2018 was unexpected as it simply seemed too big to fail. However, the government were ultimately unprepared to bail it out as it was a private company. At the end, there was so little cash left in the company that none of the insolvency practitioners at the big four accountancy firms were prepared to accept appointments as administrators and the company was put into compulsory liquidation with special managers appointed. Therefore, it will in any event end up costing the taxpayer many millions of pounds.
After the collapse of BHS in 2016 and the collapse of Carillion in 2018 amongst others, the Government has been looking at ways to tighten up the laws which allow the winners in these massive collapses to retain big pay-outs and which leave the losers with worthless shares, claims, jobs or pensions. However, the Government also wishes to retain the competitiveness of the UK market. After the collapse of Carillion, on 20 March 2018, the Government issued a consultation on insolvency and corporate governance, seeking the views of a number of stakeholders on the proposals, including amongst others, a vast majority of those who read this Digest, such as: insolvency professionals (both legal professionals and insolvency practitioners); business representative bodies; professional bodies and members of the public.
The collapse of BHS
Sir Philip Green owned BHS privately through a holding company within a complex corporate structure for 15 years before he sold it to Dominic Chappell (a former bankrupt) through his company, Retail Acquisitions Limited, for £1 in March 2015, having taken out substantial monies in dividends. The BHS report found that Mr Chappell had very little credibility.
Having been stripped of its assets, BHS then entered into administration on Monday 25 April 2016 leading to the loss of 11,000 jobs and a pension deficit estimated at £571m.
A report on the collapse of BHS was published on 25 July 2016.
The BHS report noted that breach of duty, wrongful trading and disqualification in the public interest may all apply regarding the former and current directors of BHS.
Eventually, Sir Philip Green paid over £363m in cash to help rescue the BHS pension scheme. Eventually, Sir Philip Green paid over £363m in cash to help rescue the BHS pension scheme.
On 27 March 2018, the Insolvency Service confirmed the outcome of its investigation into the directors of BHS. A spokesperson for the Insolvency Service said: “We can confirm the Insolvency Service has written to Dominic Chappell and three other former directors of BHS and connected companies informing them that we intend to bring proceedings to have them disqualified from running or controlling companies for periods up to 15 years. We can also confirm that we have written to Sir Philip Green, also a former director of BHS, informing him that we do not currently intend to bring disqualification proceedings against him. As this matter may now be tested in the Court it is not appropriate to comment further. The intention to bring disqualification proceedings follows an investigation by the Insolvency Service, an executive agency of the Department for Business, Energy and Industrial Strategy. Leading counsel has confirmed all our findings”.
Carillion was the second largest construction firm in the UK in 2017. It was a public company with a complex group of subsidiaries. This was mainly due to acquisitions of rival companies over the past 10 years or so. However, with those acquisitions came additional pension schemes that were in deficit, to add to the Carillion deficit.
As at the sign off and publication of its March 2016 accounts on 2 March 2017, Carillion appeared to be perfectly healthy. However, it was said by the directors of the company that problems began to arise between March and June 2017 which led to the profit warning in July 2017. On 10 July 2017, Carillion suddenly announced that they would be including a provision for £845m against at least 18 contracts in their interim financial results. The share price fell from 192p on Friday 7 July 2017 to just 57p by Wednesday 12 July 2017 (a 70% fall). The share price never recovered, falling further to 14p by the time the company sought a winding up order. When further interim results were released in September 2017, £200m was added to the provision which BHS and Carillion completely wiped out the company’s equity and left it with net liabilities of £405m.
The company sought to negotiate with the Government for assistance, which was ultimately not forthcoming. Clearly it was not considered “too big to fail”. Carillion went into compulsory liquidation on 15 January 2018. The estimated pension deficit at the time of the liquidation was £2.6bn. Debt had also risen from £689m in 2016 to £961m in 2017.
In the evidence sessions before the Committees, MPs were particularly critical of the directors and the auditors of Carillion. A report on the Carillion collapse was published on 16 May 2018.
As a result of both the BHS and Carillion collapses, the Government has been motivated to suggest ways in which the current law might be improved in order to catch the worst offenders when the big firms go bust.
The government is already working to implement reforms to improve the corporate governance regime in relation to executive pay, strengthening the employee and stakeholder voice in the boardroom, and corporate governance in large privately held businesses.
As noted above, on 20 March 2018, the Department for Business, Energy and Industrial Strategy issued a consultation paper entitled: “Insolvency and Corporate Governance”. The aim of the consultation paper is to deliver: “a strong business environment…by seeking views on new proposals to improve the governance of companies when they are in or approaching insolvency”. It is recognised that the insolvency regime is an important part of the UK’s business regime, but that it must be continually improved.
The consultation looks at:
- Sales of businesses in distress;
- Reversal of value extraction schemes;
- Investigation into the actions of directors of dissolved companies; and
- Strengthening corporate governance in pre-insolvency situations, including:
- Group structures;
- Shareholder Responsibilities;
- Payment of Dividends;
- Directors’ duties and the role of professional advisors; and
- Protection for company supply chains in the event of insolvency.
Each of these areas in the consultation are reviewed and commented upon in the following paragraphs
Sales of Businesses in Distress
This section of the consultation seeks views on whether directors of a parent company should be held to account and penalised where the sale of an insolvent subsidiary causes harm to creditors, where this was foreseeable at the time of sale. This section arises as a result of the scenario that occurred in BHS, where Sir Philip Green through his Taveta Group sold BHS (the subsidiary) to Dominic Chappell for £1 through Mr Chappell’s vehicle Retail Acquisitions Limited, which had no real funding or capital to rescue or improve the position of BHS and its huge pension deficit. There is currently no requirement for a holding or parent company (or its directors) to do any due diligence regarding the purchaser of a subsidiary. The proposal in this section is that directors of holding companies should be held to account if they conduct a sale which harms the interests of the subsidiary’s stakeholders, such as employees or creditors, where that harm could have been reasonably foreseen at the time of the sale and the subsidiary enters administration or liquidation within two years of the completion of the sale. In line with the current law the appropriate penalties might include disqualification and/or personal liability.
Reversal of Value Extraction Schemes
This section of the consultation seeks views on whether new powers should be introduced in addition to those that already exist to undo a transaction, or a series of transactions, which unfairly strips value from a company. The Government wishes to provide ways of undoing transactions which unfairly strip value from an ailing company. The concern is that where an ailing company has been “rescued” by investors, they then extract value to return at least part of their investment quickly and to lessen their potential loss should the company fail. These arrangements could take the form of management fees or excessive interest on loans (as happened with Retail Acquisitions and its failed “rescue” of BHS). The proposal in this section is that alongside the current antecedent transaction powers, new powers might be introduced which allow an officeholder to apply to reverse a transaction or series of transactions which are considered to have unfairly removed value from a company in the approach to insolvency.
Investigation into the Actions of Directors of Dissolved Companies
This section of the consultation explores the Government’s proposal to extend existing investigative powers into the conduct of directors to cover directors of dissolved companies. This section is not a reflection of findings relating to BHS or indeed the circumstances of the Carillion collapse. There are a number of ways in which a company can enter into dissolution. There are approximately 400,000 company dissolutions annually. Complaints are regularly received from the public about alleged wrongdoing by directors of companies after they have been dissolved and often in relation to successive company failures. There is also evidence that points to a recurring theme of directors using dissolution to avoid debts, including tax, civil penalties and employment tribunal awards or other judgments. The current legislative framework does not provide for the investigation of the conduct of directors where their company has been dissolved. Also, as there is no officeholder’s report in the case of a dissolved company, the trigger for investigation will be complaints from members of the public, a creditor or other government department, or in relation to an existing investigation. The proposal in this section is that the Secretary of State be given the power to: (i) require information to allow investigation of former directors of a dissolved company; (ii) seek disqualification of such directors; (iii) seek orders for financial compensation for creditors; (iv) seek prosecution where there is evidence of criminal conduct.
Strengthening Corporate Governance in Pre-insolvency Situations
This section of the report in the main reflects the Government’s response to the collapse of Carillion
1. Group structures
It is important that as companies grow, their group structures remain effectively managed and governed. Groups should have clear records regarding identity of directors and ownership of assets. This was found wanting in respect of Carillion. In this section it is proposed that stronger corporate governance and transparency measures are required, such as large companies and their subsidiaries disclosing their corporate governance arrangements.
2. Shareholder Responsibilities
A large corporate failure can give rise to questions about whether shareholders, particularly large institutional shareholders, should have been more alert to the warning signs, more engaged with long term company strategies and done more to challenge boards to take timely remedial action. Although there has been some progress in investor engagement in recent years, recent corporate failures like Carillion demonstrate that institutional investors should be more actively engaged. The proposal in this section is that shareholders should be challenging directors on management and mitigation of risks as well as ensuring executive remuneration policies align the interests of the directors with the interests of the company. An update of the Stewardship Code may assist with strengthening the quality of investor engagement.
3. Payment of Dividends
In this section the appropriateness of payment of dividends in certain situations is considered, especially where a company is approaching insolvency and/or has high debts and a large pension deficit as with Carillion. The law on the payment of dividends is well-established and is set out in the Companies Act 2006 and the relevant accounting rules. However, examples of large companies like Carillion continuing to pay out large dividends in the period immediately before their insolvency raises questions about whether reform is needed. The proposal in this section is that there may need to be changes to the legal, governance and technical framework within which companies determine dividend payments.
4. Directors’ Duties and the Role of Professional Advisors
In this section the Government is interested in views on whether some directors are commissioning and using professional advice without a proper awareness of their duties as directors, and in particular the requirement to apply an independent mind.
5. Protection for Company Supply Chains in the Event of Insolvency
Small and medium-sized companies in the supply chain were one of the main losers in relation to the Carillion collapse where 120-day payment terms had often been enforced on those smaller suppliers. In this section views are sought as to whether more should be done to help protect payments to suppliers, particularly smaller firms, in the event of insolvency of a customer and whether there would be any wider consequences of such protection