Insurers and directors should take stock now and prepare for Government proposals to enhance corporate transparency and accountability. The proposals aim to create, amongst other things, a beneficial ownership central registry as well as prevent use of the form and status of directorships to further mischief or misconduct.

The Government is also clamping down on director misconduct and disqualified directors will face tougher penalties. This will be achieved primarily by making amendments to the determination of directors' unfitness under the Company Directors Disqualification Act 1986 (CDDA), by removing barriers to improve information sharing between regulatory bodies and insolvency bodies, and by placing greater personal responsibility for misconduct upon directors.

On 21 April 2014, the Government published its response to the Department for Business, Innovation and Skills' paper, "Transparency & Trust: Enhancing the Transparency of UK Company Ownership and Increasing Trust in UK Businesses" (the paper). In this article we consider the impact the proposals may have on:

  • Corporate directorships used in Employer's Occupation pension schemes
  • Whether increasing personal director accountability and creditors' rights will lead to an in increase in claims against directors
  • D&O insurers and policy wordings

Corporate transparency

Part A of the paper deals with enhancing corporate transparency; we consider the proposed changes to the role of corporate directors; 'front' directors and shadow directors.

Corporate directors

UK companies will be prohibited from appointing corporate directors, subject to specific exemptions.

The exemptions will apply to companies considered to have a low risk of financial crime and high standards of corporate governance or regulatory oversight. For example, group structures including large listed and private companies, Open-Ended Investment Companies and charities. The Government has welcomed views as to whether the exemption should extend to LLPs.

The abolition of corporate directors is said to represent a significant change of approach to corporate governance. However, under section 155 of the Companies Act 2006, companies (including LLPs) are already required to appoint at least one director who is a natural person. In the UK, only 2% of companies and LLPs have a corporate director. Therefore the majority of companies will not be affected by this proposal.

One sector which will be affected by the changes is the pensions sector. It is a common practice for an employer to establish a subsidiary company to act as corporate trustee for its occupational pension scheme. Making changes at director level is easier to document than changes in trustees and the individuals benefit from the protection the corporate veil brings for directors, whereas trustees can be personally liable for their actions. Since the Pensions Act 2004 there has been an increase in professional independent trustees being appointed as a corporate director of these trust companies. This brings a further advantage as the professional independent trustee might then be represented by the person with the most appropriate expertise – for example actuarial or investment – at a trustee meeting. The Government's exemptions do not extend to corporate trustees of pension schemes, but it is difficult to see why that should not be the case. There is an extensive regulatory regime for pensions following the Pensions Acts 1995 and 2004. In addition, the Pensions Regulator keeps a register of independent trustees – who have to meet certain criteria to be on the register – and it would not be difficult to allow an exemption where the corporate director is on the register.

"Front" directors

The term "front" director refers to registered but irresponsible directors who engage in unacceptable behaviours and seek to obscure control thereby facilitating criminal activity. The Government suggested introducing a register of front directors and those who control them, making it a criminal offence for a director to take steps to divest their powers. The proposal received little support. Respondents to the paper pointed out that directors who acted as a front for any wrongdoing were likely to be breaching their general statutory duties. Furthermore, it is common business practice for companies to "nominate" a director for their role by another party and act properly. The consensus is that this arrangement should continue. Consequently, the proposal was abandoned in favour of director registration with Companies House coupled with an increased awareness of directors' duties and of directors' liabilities.

The Government is also considering measures to increase accountability of shadow directors who control appointed directors and whether to extend the directors' general statutory duties to such shadow directors.

Making directors more accountable

Part B of the response paper focuses on making directors more accountable for failure to fulfil their duties.

Notably, the Government did not take forward plans to introduce a new primary duty on banking directors to promote the financial stability of their companies over the interests of shareholders. It considered that directors' duties already explicitly require directors to have regard to a range of matters in the long term, and these were applicable to directors in all sectors. In addition the proposed introduction of a senior persons' regime, which will affect directors and other key staff in banks, has already been legislated for in the Financial Services (Banking Reform) Act 2013, with likely implementation in 2015.

Director disqualification

Schedule 1 of the CDDA sets out the matters which a court must take into account when determining whether a director is unfit. This schedule is viewed as outdated and there is a gap between what the law says and what the courts take into consideration in practice. It will therefore be amended to incorporate a wider and more generic set of factors that the court must take into account including the materiality of the conduct, culpability of the individual and the impact of the individual's behaviour. The new factors will include misfeasance, breaches of duty, legislation or sector regulation by an individual as a director, applying both domestically and internationally.

It is intended that a director's overseas misconduct will be relevant in disqualification proceedings. This makes sense in today's globalised economy. The Secretary of State will have the power to disqualify an individual from acting as a director in the UK upon conviction of a criminal offence in connection with the promotion, formation or management of a company overseas. Such action could be taken preventatively against persons who may pose a risk in the future and prior to that individual acting as a director in the UK.

D&O Insurers may also wish to consider whether further information on directors' history both in the UK and internationally is required upon renewal of the policy.

A further change is that courts should also factor in the "wider social impact" and "vulnerable creditors" when deciding the director's conduct. These are not defined terms but the intention is to extend protection to those who suffer loss indirectly as a result of the misconduct. Arguably, the concept of wider social impact introduces a broad discretionary element. However, section 172(1) (b) – (e) Companies Act 2006 (which sets out directors' duties) already includes the requirement that directors consider the impact of their operations on the community and environment.

Furthermore, the court (or Insolvency Service on behalf of the Secretary of State) may also factor into its considerations any previous director positions held in insolvent companies and the relevant director's track record in running these companies, including former disqualifications. Directors will be able to present evidence to show that the insolvency was not on account of the unfit conduct of the director.

Breaking down the barriers between sector regulators

Although the Government stopped short of giving sector regulators powers to disqualify directors through their own processes, such powers will remain with the Insolvency Service, it is committed to improving the integration of sector regulatory regimes and the director disqualification regime.

The Government proposes to better integrate sector regulation by removing the legislative barriers to investigative material that can be provided by regulators or others for use by the Insolvency Service to pursue the disqualification of a director. In addition, the time limit for commencing disqualification proceedings will be increased from two to three years from the earliest insolvency act.

The extension of time for bringing disqualification proceedings against directors could result in more director disqualifications. On the other hand, it may have the opposite effect by reducing the Insolvency Service from protectively, and perhaps unnecessarily, issuing proceedings within the current two year time frame. Furthermore, the impact of the proposals on the scope of the disqualification regime may in practice be minimal given that many of the intended changes simply serve to bring the law up to date with the practice of the courts.

Key sector regulators, including the FCA and Prudential Regulation Authority will work alongside the Insolvency Service to ensure there is joint planning and participation.

Compensating creditors

The Government is concerned that the current disqualification regime does not adequately protect and benefit those who have suffered loss as a result of the misconduct. It has therefore proposed that creditors should have greater powers to bring claims on their own behalf.

Office holders, such as liquidators and administrators, are presently permitted under the Insolvency Act 1986 to bring actions on behalf of creditors for wrongful and fraudulent trading, preferences and transactions at undervalue. It is rare for such actions to be brought and the cause of action is not currently assignable. This is set to change and it will be possible to assign the above causes of actions to creditors in order to encourage the use of claims taken against directors to benefit creditors. Administrators will also be afforded the same rights as liquidators to commence fraudulent trading and wrongful trading actions (thereby bypassing and saving the costs of first placing the company into insolvent liquidation).

Whilst these proposed changes should enhance the ability of creditors to seek redress against unscrupulous directors, the inherent costs and risks in bringing such claims will remain. Furthermore, creditors will not be able to utilise the detailed investigative powers of administrators and liquidators under the Insolvency Act 1986 prior to issuing any proceedings. Notwithstanding this, there will be certain instances where it is attractive for both the office holder and creditors to agree to an assignment of claims. Office holders will have to consider the terms of any assignment and whether to accept a lump sum for the assignment or a percentage of the fruits of litigation.

It is therefore difficult to accurately predict whether the ability to assign the above noted actions to creditors will result in more actions being taken against directors. One of the issues creditors will face that has already been touched upon is the cost and risk of bringing such claims. The Jackson reforms have been a double edged sword with regard to the availability of funding arrangements. Whilst lawyers are now allowed to enter into contingency fee agreements, so called Damages Based Agreements (DBAs), there are widely held concerns around their workability based on the current regulations governing DBAs. It is hoped these regulations will be amended soon to improve take up as the Government has recognised there is an issue. Insolvency related proceedings backed by Conditional Fee Agreements (CFAs) and After the Event insurance (ATE) were also exempted from the move to abolish recoverability of CFA success fees and ATE insurance premiums – a process which transfers the majority of the risk and cost of litigation to the defendant, if it loses the case. These exemptions will apply until April 2015 although the associations that represent insolvency practitioners are continuing to lobby the government for a permanent exemption. The exemptions also only apply to insolvency related proceedings brought by liquidators, administrators and trustees in bankruptcy. This potentially places creditors outside this privileged position and may mean their only potential funding option is a currently unworkable DBA. If this remains the case it is likely that only cases involving wealthy, motivated creditors will find assignment of actions attractive.

Directors will be held financially accountable to creditors in circumstances where their actions have caused loss. The Secretary of State will have the power to apply to the court for a compensatory order to be made against a disqualified director, where that director's actions have caused identifiable loss either to specific creditors or creditors generally. The Secretary of State may accept a compensation undertaking from a director against whom disqualification proceedings have been, or propose to be brought against, where the director offers an acceptable compensation settlement instead of going to court. The courts and Insolvency Service will have discretion to make the compensation award to a particular creditor, or group or class of creditors, or the creditors as a whole. This discretion may increase the risk that compensation is received by the creditors with the loudest voices.

Once the specific language of the enacting legislation is known, existing conduct exclusions in policies may need to be reviewed to ensure they are sufficient to address (either by way of exclusion or inclusion), both the making of Compensation Orders against a director or any voluntary director compensation undertaking.

Conclusion

Many of the proposed changes will require primary and secondary legislation. In the Queen's Speech earlier this month reference was made to the Small Business, Enterprise and Employment Bill (the Bill) intended to introduce the proposals noted above. The Bill will be published on 16 June 2014, so may just be in time to start its journey through the House of Commons, which only recesses for the summer on 22 July 2014 (re-opening in September). The Government would like this Bill to be agreed before the next General Election on 7 May 2015.

D&O insurers should use this time to assess how the proposals will impact them.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.