Cracking down on governance during insolvency

The government has launched a consultation to improve governance processes of companies that go bankrupt – Tania Clench explains the HR implications

Introduced to shine a light on conduct within organisations from the top down, the launch of the government’s consultation around improving corporate governance and stakeholder outcomes in insolvency situations is likely to have been welcomed by many UK businesses. 

With several high-profile collapses bringing corporate governance to the fore in recent months, it is essential that individuals and businesses at risk of insolvency are aware of the proposals contained in the consultation and follow best practice when it comes to dealing with any resulting HR issues. 

The Government’s primary objective for launching its new consultation is to crack down on irresponsible behaviour of some UK directors and offer greater protection to employees throughout the insolvency and liquidation process.

For example, while there have been instances of individuals setting up companies only to run them into the ground and set up another, leaving a trail of destruction behind them, any investigation against them would be dependent on the business entering liquidation. Moreover, a general lack of resources means that even when a liquidator submits a director’s conduct report to the authority services, it is unlikely to be taken beyond the initial stages unless there is clear and serious evidence of misconduct. 

Key proposals

The key proposed legal changes outlined in the consultation report focus on four main areas. Firstly, it proposes potential changes to ensure directors responsible for the sale of an insolvent subsidiary of a corporate group protect the interests of the subsidiary’s shareholders, in particular by deterring reckless sales and ensuring fair outcomes when major companies get into difficulties. 

The second area proposes introducing new powers to enable the reversal of inappropriate extractions of value from companies in financial difficulties by ‘rescue investors’ if the company subsequently enters liquidation or administration.

Currently, where a company has been dissolved, there is the costly requirement of restoring it to the register before beginning any investigation into a director’s conduct. By removing this obstacle, the report’s proposed changes would also make it more financially viable to investigate where parties are unsure of what they are going to find, helping to protect the interests of employees. 

Finally, the consultation proposes changes around strengthening corporate governance in pre-insolvency situations, in particular those promoting the protection of suppliers through measures such as tighter documentation and timely payment. 

Key action points

It is important for businesses in insolvency situations to have a set of clear processes and procedures in place to protect the interests of the workforce and help to limit reputational damage.

As highlighted by recent collapses such as that of BHS, the most common HR issues are likely to arise around monies owed to employees made redundant, which may include outstanding salary and commission, accrued holiday pay, unpaid pension contributions and redundancy pay. 

When it comes to the rights of former employees, it is also vital to understand the distinction between those whose contracts are terminated during the first 14 days of the administration period (‘ordinary creditors’) and those made redundant after this period (‘preferential creditors’). Whereas ordinary creditors are in the last category to receive monies owed, preferential creditors stand a better chance of recouping any outstanding payments due to them. Moreover, while ordinary creditors are only entitled to outstanding wages and redundancy payments, preferential creditors may also be entitled to up to six weeks of accrued holiday pay and some occupational pension payments. 

While there is no ‘one size fits all’ solution to handling insolvency-related HR issues, a good rule of thumb is to maintain consistency and clear communication throughout the process. Insolvencies often have a profoundly negative impact on the livelihoods and families of employees and therefore it is the duty of office-holders to keep the workforce in the loop at every stage of proceedings. 

For employees or suppliers concerned that they may be at risk due to insolvency, keeping their eyes and ears open for red flags, for example, late payments, sudden structural changes or redundancies should help to make them aware of their situation and seek appropriate advice at the earliest possible opportunity. 

Recent headlines around the poor conduct of directors in insolvency situations are causing them to come under greater scrutiny. However, whether this consultation will have a significant impact on the treatment of employees remains to be seen. By taking steps to ensure a strong understanding of the proposals outlined in the report and adopting a conscientious approach to handling relevant HR issues, businesses can help the administration process run more smoothly while limiting damaging negative publicity. 

Tania Clench is a legal director in the recovery, restructuring and insolvency team at Shakespeare Martineau