UK: Protecting Companies In Challenging Markets

Last Updated: 2 October 2009
Article by Jonathan Edgelow

In the current financial climate directors' must be particularly aware of their responsibilities to their company and its employees and the circumstances in which their actions may be open to challenge. This article seeks to highlight the key duties that directors must consider when taking action to restructure their company or defend against takeover action.

Directors' Statutory Duties

  • To act within their powers.
  • To act in the best long term interests of the company (including its shareholders) – an insolvent company's directors will owe this duty to the company's creditors.
  • To exercise independent judgement and reasonable care, skill and diligence – more experienced directors will be subject to a higher level of expectation.
  • To avoid, and declare, any actual or potential conflict of interests – subject to the company's articles, conflicts may be waived if approved by the shareholders.
  • Not to accept benefits from third parties if it is likely that a conflict will arise.


Directors of UK companies are subject to a set of statutory duties which, although established by case law for many years, have been set out in statute for the first time in the Companies Act 2006. A director can be held personally liable for any losses caused to the company as a result of any breach of these duties. In addition, offending transactions can be unwound and the director can be disqualified from acting as a director of a UK company. The directors' actions will be especially scruntinised by shareholders, creditors and any appointed administrator when the company is in financial difficulty. The circumstances in which the directors' actions may be challenged and ultimately unwound include:

  • Transaction at an Undervalue – this occurs when the consideration received by a company in a transaction is significantly less than the consideration provided by it. Any such transactions that have occurred in the two year period before a company becomes insolvent may be unwound by the court. A transaction at an undervalue may be a 'transaction defrauding creditors' if it has been entered into with the intention of putting assets beyond the reach of or otherwise prejudicing creditors (there is no requirement to show fraud). There are no special time limits for unwinding transactions defrauding creditors, so general limitation rules apply.
  • Preference – a 'preference' occurs when a company repays, or renegotiates the terms of a contract with, one of its creditors and does not provide the same accommodation to its other creditors. Any preference provided to any person in the six month period before a company becomes insolvent may be unwound by the court. The period is extended to two years where the person is connected with the company (other than an employee).
  • Wrongful Trading – directors who believe, or should have believed, that their company cannot avoid becoming insolvent have a duty to take every step to minimise the potential loss to the company's creditors. The court can order any director who has failed in this duty to make a contribution to the company's assets for distribution to the creditors.

There are additional rules that apply to companies whose shares are listed on the London markets (including the Main Market and AIM). In particular, it is a criminal offence for directors to make misleading statements, or to conceal material facts, which may create a false or misleading impression of the state of the company.

Such behaviour may also constitute the civil offence of 'market abuse'. The directors of a company in financial difficulty must consider disclosing this information to the public at the earliest opportunity. A failure to do so can lead to significant penalties being imposed on the directors, including an unlimited fine, public censure and, in the most serious cases, imprisonment.

In order to avoid incurring any personal liability for a breach of statutory duties or as a result of any transactions being unwound, the directors are advised to seek professional advice. The directors must consider the circumstances surrounding each decision that they are taking and be sure that it is in the best long term interests of the company. The directors must also fully document each decision in a board minute to defend against any future challenge to their actions.

Directors' Compensation

There are no limitations set out by law on the amount of remuneration that a director may receive from a company. However, when setting their pay the directors will need to ensure that they are acting in the interests of the company. Directors' service contracts that last for a period of more than two years must first be approved by the shareholders.

Corporate governance rules state that companies whose shares are listed on a UK market should form a remuneration committee to determine executive pay. The committee should consist entirely of independent non-executive directors. The committee is expected to ensure that executive pay is fair to both the directors and the company and reflects market practice. The committee should be able to seek external advice where required.

The Government has recently been exerting pressure on struggling companies, notably banks, to limit, and even claw back, bonuses paid to their directors. It is possible that new legislation will be proposed that could grant shareholders increased powers to regulate directors' pay. The Financial Services Authority ('FSA') has published a draft code of practice seeking to ensure that executive pay at those companies that it regulates is in line with good risk management practices. The draft code does not attempt to limit the quantum of any remuneration.

Shadow Directors

A shadow director is any person in accordance with whose direction or instructions the directors of a company are accustomed to act (other than professional advisers and parent companies).

A substantial shareholder providing instructions to the board who does not meet the definition of a 'parent company' is likely to be deemed a shadow director. Influence needs only to be exercised over a significant area, and not the whole, of the company's business.

A 'de facto' director is a person who assumes the role of a director of a company even though that person has not been properly appointed. Both shadow and 'de facto' directors are subject to many of the duties, and penalties for breach of duty, that apply to formerly appointed directors.


There are a number of steps that a company that is experiencing financial difficulty may take in order to seek to turn around its business or protect against unwanted takeover offers.

Terminating Contractual Relationships

The company may wish to renegotiate its contracts in order to achieve a better deal. Termination clauses can usually only be invoked where one party is in breach of the terms, or on the giving of a certain amount of notice. In particular, a company may wish to review the terms of any facility agreement that it has entered into with a lender. If the company is in danger of breaching any of the financial covenants then it may need to renegotiate the agreement.

A company seeking to terminate a contract with a contractual party that it suspects may be in difficulty should review any material adverse change clauses contained in the contract. Such clauses are commonly found in share or business purchase agreements providing for a separate signing and completion. However, it is very difficult to enforce these clauses in the context of an offer for a listed public company. Material adverse change clauses are also found in facility agreements and may enable a lender to terminate the relevant facility. Such clauses have rarely been considered by the UK courts.

There are other events, such as the triggering of a change of control clause or an 'insolvency event', that may also cause a contract to terminate. A company that is in financial difficulty can seek to leverage the threat of its own insolvency in order to force its contractors to renegotiate their contracts.

Permitted Defensive Action

  • Convince shareholders that the offer undervalues the target and its future prospects – where the bidder is offering its own shares as consideration the board may also wish to examine the bidder's financial strength.
  • Publish written statements from key shareholders who do not wish to accept the offer – where the Code applies the statements will need to be approved by the authorities.
  • Encourage a competing offer from a third party (called a 'white knight') – in doing so the directors will be accepting that a takeover is inevitable.
  • Encourage a third party (called a 'white squire') to acquire a block of shares large enough to prevent the original offer from succeeding.
  • Where an offer is subject to competition clearance, seek to demonstrate that the takeover would have an anticompetitive effect on the market.

Listed Companies: Defending a Takeover Offer

The City Code on Takeovers and Mergers (the 'Code') applies to all offers for companies admitted to the Main Market and AIM which have their registered office in the UK, the Channel Islands or the Isle of Man and (in the case of companies admitted to AIM) are considered to have their place of central management and control in one of these jurisdictions. It may also apply to certain other companies incorporated in these jurisdictions.

The board of a listed company is prevented by the Code from taking defensive action that would frustrate an imminent bid unless its shareholders have approved the action by ordinary resolution. This prohibition extends to issuing new shares, issuing any options or similar securities and/or disposing of any material assets or paying an unscheduled dividend. There are significant sanctions for breaching this rule. Case law has also suggested that such actions may be a breach of the directors' duty to act within their powers. However, the board can take some steps to defend against an unwanted offer, set out in the box opposite.

Public companies may wish to structure their business in such a way as to deter any future bid (for example, including change of control clauses in key contracts or granting weighted voting or subscription rights). Such practices, referred to as 'poison pills', are difficult to enforce in the UK. Any attempt to adopt a 'poison pill' when an offer for the company is imminent is likely to be prevented by the Code rules on frustrating action. In addition both the Listing Authority and representative bodies of the main UK institutional shareholders (such as the Association of British Insurers and National Association of Pension Funds) have resisted the types of weighted share structures adopted in the US.

In taking any of the above steps the directors of a UK incorporated target must ensure that they are acting in the best interests of the target, otherwise they will be in breach of their company law duties. Any information that is released in defence of an offer must be accurate and properly verified. Private companies, or unlisted public companies, may wish to restrict third party offers by including share transfer restrictions in their articles or a shareholders' agreement.

Raising New Capital

Companies can also protect themselves by offering new shares for sale to their shareholders. Shareholders are incentivised to accept the shares as, if they do not, their shareholding in the company will be diluted. Companies whose shares are admitted to trading on a UK market will often use this method to raise capital (most of the large UK banks have done so during 2009) by offering the shares at a discount to their market price. Caution should be exercised where the capital is being raised to help the company resist a takeover offer as this may be a breach of the directors' duties.

If the value of the net assets of a UK public company falls to below half of the value of the company's called-up share capital then the directors must, within twenty-eight days of becoming aware of this fact, convene a general meeting to discuss the situation with the shareholders. It is a criminal offence to fail to comply with this requirement.


It may be necessary for a company to reduce its workforce. In the UK this will involve a formal redundancy process. Redundancy arises where an employee's dismissal is wholly or mainly attributable to the fact that:

  • the employer has ceased or intends to cease to carry on the business for the purposes of which the employee was employed (business closure) or at the place where the employee was employed (workplace closure); or
  • the business no longer requires, or is expected to no longer require, employees to carry out work of a particular kind, or at the place where the employee was employed to work (reduced requirement for employees).

Redundancy Payment

An employee with two years continuous employment who is dismissed by reason of redundancy is entitled to a statutory payment. The payment is calculated using a formula based on the employee's age, length of service and week's pay. The figure for the week's pay is subject to a statutory limit (currently £350 per week). Some employers give enhanced redundancy pay on top of the statutory minimum.

Employees may have an express contractual right to an enhanced redundancy payment where their employment contract or a contractual scheme sets this out. Alternatively they may have an implied contractual right to it (for example, where the employer's past regular practice has been to make such payments).

Trade Unions and Collective Bargaining

English law states that a strike, and almost every other type of industrial action, is a breach of the employee's contract of employment. A Trade Union that induces its members to breach their contract terms may be guilty of an offence and liable to pay damages to the employer. However, a Trade Union may have an immunity from liability if the industrial action that it organises is done so lawfully.

For the industrial action to be lawful it must be taken in connection with a trade dispute and the correct procedure (including a secret ballot of members) must have been followed. The main power of a Trade Union is its ability to undertake 'collective bargaining' on behalf of its members. 'Collective bargaining' is an agreed method between the Trade Union and the employer of negotiating certain key employment rights (such as pay, hours and holiday entitlements) and redundancy proposals.

Collective Consultation

A 'collective redundancy' arises where an employer proposes to dismiss as redundant twenty or more employees at one establishment in a period of ninety days or less. In this context any dismissal for a reason that is not connected with the individual worker concerned will be held to be a redundancy. This commonly arises where the employer proposes to change employees' terms and conditions of employment by dismissing and offering to re-engage on new terms.

In a collective redundancy situation, the employer has a duty to inform and consult appropriate employee representatives (failing which protective awards of ninety days' pay in respect of each employee can be made) and also to notify the Secretary of State. Where the employees are members of a Trade Union the appropriate representatives will be those of the Trade Union, otherwise they will be representatives elected by the affected employees.

Ensuring a Fair Dismissal

  • Give as much advance warning of the impending redundancy (in practice two weeks is often given) as is reasonably practicable in the circumstances.
  • Identify the correct pool for selection for redundancy and apply objective criteria to the pool.
  • Consult with the affected employees (and, where there is a collective redundancy, with their appropriate representatives).
  • Offer suitable alternative vacancies to the affected employees.

Redundancy and Unfair Dismissal

A genuine redundancy is a potentially fair reason for dismissal. However, if the employer does not follow a fair procedure, the dismissal is likely to be unfair. This would entitle the employee to a basic award (which equates to the usual redundancy payment) and a compensatory award the amount of which is determined by the tribunal. Except in certain limited circumstances, the compensatory award is subject to a statutory maximum, currently £66,200.

In order to ensure that the redundancy is a fair dismissal the employer needs to act reasonably at all times in dismissing the employee and follow a fair procedure. There is no set procedure to follow – it will vary according to the circumstances of each case.


If the directors believe that the company's insolvency cannot be avoided then they must ensure that they do not commit the offence of wrongful trading (see above). Usually in these circumstances the directors will immediately place the company into administration.


A company may be placed in administration by (amongst others): (i) a secured creditor, usually a lender; (ii) an unsecured creditor; or (iii) the company itself or its directors. An insolvency practitioner (called an 'administrator') will be appointed to manage the company's affairs in place of its directors. The main purposes for which a company may go into administration are:

  • to rescue the company (as opposed to the business that the company carries on) so that it can continue trading as a going concern;
  • to achieve a better result for the company's creditors as a whole than would be likely if the company were immediately put into liquidation; or
  • to sell the company's assets to make a distribution to the company's secured or preferential creditors.

Administration is often preferable to liquidation as it allows a company to continue trading during the process. Without consent, a creditor may not bring or continue legal proceedings or enforce its security against the company or its assets while the company is in administration. If the company successfully repays in full, or negotiates a compromise with, its creditors then the administration must end and the company can continue to trade normally. However, administration usually results in the sale of the company's business or assets, leaving debts behind in the company's shell, followed by its liquidation or dissolution.

Although the directors of a company in administration remain in their position, their powers are limited. A director cannot exercise any management power without the administrator's express consent but directors remain liable for filing accounts during this period. A director acting in breach of this rule will not bind the company and may incur personal liability. Assuming that the company is not ultimately liquidated or dissolved, the directors will regain their powers once the administration process is completed.

A simple administration usually completes within twelve to eighteen months, although a complex administration can last for a number of years. Under an increasingly common process (known as a 'pre-pack' administration) a company may agree a sale of its business before it goes into administration, which is then completed immediately on the appointment of the administrator. This process attracts some controversy – unsecured creditors often may not know that the process is to occur and there is limited opportunity to ensure that the best price is realised for the assets. However, 'pre-pack' administrations enable a company to transfer its business with minimum disruption to customers and suppliers, and the costs of the process are usually less.

Distressed Sales

Distressed sales usually occur when a company has entered into a formal insolvency process. An insolvency practitioner will advertise the sale to generate interest and thereby achieve the best price, unless it is a 'pre-pack' sale that will be effected on the practitioner's appointment. The insolvency practitioner will not disclose information which may damage the value of the business until he is happy that any inquiry is made in good faith and/or a confidentiality agreement has been signed.

Insolvency practitioners will typically exclude all personal liability as part of a sale of a company or business and will not give representations or warranties. The buyer will also have limited time to carry out a due diligence exercise as the longer the process continues, the more damage is likely to be done to the target's long term prospects. The buyer will reflect these factors in its price.

Other Remedies for Secured Creditors

  • Administrative Receivership – This process enables a secured creditor to appoint an administrative receiver to sell the assets of a company that are the subject of the creditor's security. However, there are very limited circumstances in which this process can be used – in most cases administration will be the appropriate remedy.
  • Liquidation (compulsory and creditors' voluntary liquidation) – Liquidation is a terminal procedure allowing the liquidator to realise assets of the company for the benefit of creditors and investigate suspect transactions and conduct.
  • Voluntary Arrangements – The company may negotiate an agreement with its creditors. The agreement will be supervised by an insolvency practitioner and will require the approval of a certain percentage of the company's shareholders and creditors. It can be used together with, or instead of, administration proceedings.

Insolvency and Forum Shopping

Increasingly corporate groups will contain companies based in a number of different jurisdictions. The EC Insolvency Regulation has established common rules, applicable to all EU Member States (except Denmark), to deal with conflicts of law issues on cross-border insolvencies.

The UK has also adopted the UNCITRAL model rules on cross-border insolvency. These enable non-UK insolvency proceedings to be recognised by the English courts if the debtor has a place of business or assets in the UK. This recognition prevents UK creditors from taking certain action to recover any affected assets. Non-UK creditors may be able to start or participate in UK insolvency proceedings. These rules do not apply to certain credit institutions or insurance companies. The provisions of the EC Insolvency Regulation will take precedence if there is any conflict with these rules.

Protection of Banking Sector

  • A facility to make Tier 1 capital (the core capital that a bank is required to have to absorb any losses it incurs while remaining able to pay creditors and depositors) available to UK banks and building societies.
  • A scheme to issue a full or partial credit guarantee of certain eligible triple-A rated securities backed by residential mortgages over properties in the UK.
  • An insurance scheme seeking to remove uncertainty surrounding the value of banks' past investments by which the Government agrees to meet a certain percentage of the losses above an agreed figure associated with an agreed pool of assets. The Royal Bank of Scotland group and the Lloyds Banking Group have reached agreement with the Government to participate in this scheme.
  • The formation of a new Council for Financial Stability, consisting of representatives of the FSA, Bank of England and the Treasury. The Council will report regularly on any risks to financial stability. It is intended that the Council will have certain powers to combat these risks, although the extent of those powers is yet to be determined.



The Banking (Special Provisions) Act 2008 enabled the Government, until 20 February 2009 and in limited circumstances, to make an order to nationalise the shares or assets of UK banks. Under this Act two banks, Northern Rock and Bradford & Bingley, were nationalised and part of the respective businesses of Kaupthing Singer & Friedlander and Heritable (both UK-based subsidiaries of Icelandic banks) were transferred to a third party.

Regulation of the Banking Sector

The Banking Act 2009 strengthens depositor protection and provides new mechanisms for dealing with banks in financial difficulty. Powers under this Act were used to transfer part of the business of the Dunfermline Building Society to the Nationwide Building Society in order to protect depositors and safeguard financial stability. The box opposite describes certain other schemes established by the UK Government to protect the banking sector.

These schemes are only available for a limited time and are subject to a number of conditions and eligibility criteria. In particular the Government has sought to ensure that participants in the schemes agree to increase the amount of lending they provide to homeowners and businesses.


In general investors based outside the UK are free to invest in UK companies. Authorisations from regulatory bodies are usually only required where a transaction is of a significant size and will have an impact on the competitiveness of the market or where the transaction involves shares that are, or are to be, traded on a UK market. Mergers in certain industries (such as the press, national defence, and utilities) may be referred for further investigation. The UK Government has expressed its intention to avoid the introduction of protectionist measures to combat the financial crisis.

Other Specific Measures

In addition to lowering interest rates, engaging in 'quantitative easing' (whereby the bank spending newly created money to buy government and corporate bonds), and the car scrapping scheme, the Government has introduced the following measures:

  • Short Selling – short selling occurs where a seller agrees to sell listed securities it does not own on a future date. The seller will hope that the market value of the securities will fall enabling it to buy them for less than its agreed sale price. It is thought that certain short sellers commit the offence of market abuse by starting rumours designed to reduce the value of companies in which they hold short positions. In 2008 the FSA introduced measures to prohibit short selling and also required the disclosure of all short positions. These measures have since been lifted. However, the FSA has reserved the right to enforce temporary bans on short selling in the future and is proposing a permanent disclosure requirement relating to significant short positions.
  • Tax changes – from April 2010 any amounts that an individual earns over £150,000 will be subject to income tax at a rate of 50% (currently the top rate of 40% is charged on income over £37,400). The Government is also making changes to ensure that companies issuing certain types of share (for example, banks issuing shares that give a right to a dividend that is conditional on the payment of the dividend not causing a breach of the bank's capital requirements) can continue to claim group relief.
  • Competition Law – mergers that will, or may be expected to, result in a substantial lessening of competition are usually referred to the Competition Commission for investigation. The Secretary of State has limited powers to veto or approve a merger in matters of exceptional public interest (for example, national security). The relevant legislation has recently been amended to permit the Secretary of State to ensure that mergers which are deemed important to the maintenance of the UK's financial system can take place without reference to the Competition Commission, notwithstanding that there may be competition issues. This legislation was used in the merger between Lloyds TSB Group and HBoS plc.

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.

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