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THE UNEXPLORED CONTRACT AND INSOLVENCY LAW DIMENSIONS OF HEDLEY BYRNE V HELLER
- David Campbell, David Milman
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- The Cambridge Law Journal / Volume 82 / Issue 1 / March 2023
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- 26 April 2023, pp. 58-82
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It has been argued in previous work that Hedley Byrne v Heller addressed no actual mischief. In the case itself, the defendant's credit reference about Easipower Ltd. was neither a misstatement nor negligently given, and in general the indemnification of reliance on negligent statements is far better regulated by contract than it can possibly be by negligent misstatement. This paper expands on the significance of contract relative to tort in Hedley Byrne, but mainly argues that the mischief perceived by the claimant was caused by the operation of the statutory regime regulating Easipower's insolvency. This makes regarding Hedley Byrne as a necessary response to “the privity of contract fallacy” even more implausible.
PART II - The Context of Corporate Insolvency Law: Financial and Institutional
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Acknowledgements
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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8 - Receivers and their Role
- from PART III - The Quest for Turnaround
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
A first legally structured insolvency procedure with some potential for rescue is receivership. This chapter will look at receivership as a process as well as an institution. The laws, procedures and actors involved in receivership will be examined and the benchmarks of efficiency, expertise, accountability and fairness will be employed in asking whether receivership plays an acceptable role in insolvency as a whole. The part played by receivers in rescues will be a focus here, but attention will also be paid to ongoing corporate operations and the impact of receivership on these.
It might be objected that administrative receivership has largely been abolished and so does not need to be examined here – that the Enterprise Act 2002 took away the floating charge holder's right to appoint an administrative receiver and, in doing so, largely replaced receivership with administration. It is true that the 2002 Act restricted the use of administrative receivership, but receivership is not dead yet. Creditors with ‘qualifying’ floating charges that were created before the 2002 Act, or those with charges which, though created after that date, fall within one of the specified exceptions may still appoint administrative receivers. ‘Ordinary’ or non-administrative receivers, moreover, can still be appointed by the courts and debenture holders. Receivership also has potential usage beyond the confines of insolvency law. It is, accordingly, necessary to consider the operation of receivership and the reasons for its curtailment. This discussion is best commenced by outlining the development of receivership, the procedures that are adopted in receivership and the duties and obligations that form the legal framework for receivership.
The Development of Receivership
Receivership is a long-established method by which secured creditors can enforce their security. There have traditionally been two types of receiver in English law: the receiver appointed by the court and the receiver appointed by a debenture holder under the terms of the debenture deed. The ‘administrative receiver’ was an institution introduced by the Insolvency Act 1986 and is covered by a distinct statutory regime. The receiver is thus a person appointed to take possession of property that is the subject of a charge and he or she is authorised to deal with it primarily for the benefit of the holder of the charge.
11 - Company Arrangements
- from PART III - The Quest for Turnaround
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
This chapter looks at the statutory arrangements that companies may voluntarily enter into so as to deal with troubles or adapt to changes in market conditions. The two main procedures for effecting voluntary arrangements either within or outside administration or liquidation are schemes of arrangement under section 895 of the Companies Act 2006 and Company Voluntary Arrangements (CVAs), as provided for in Part I and Schedule A1 of the Insolvency Act 1986.
Before looking at these two methods, it should be emphasised that informal arrangements made contractually can, as noted in chapter 7, provide very useful ways of attempting rescues before there is need to resort to the formalities of section 895 or CVA provisions. Informal steps, moreover, may be taken confidentially and, in the international context, may provide a useful way of negotiating between different insolvency systems. Such contractual steps, however, possess a number of weaknesses. They are only binding on contracting parties and cannot tie dissenting parties to an agreement. They offer no form of moratorium to shield the company from its creditors and, even if approved by meetings of creditors and members, offer no protection from the enforcement of claims. Informal procedures may also lend themselves to domination by large secured creditors in a way unmatched by CVAs and section 895 processes.
Schemes of Arrangement under the Companies Act 2006 Sections 895–901
The roots of the scheme of arrangement lie in Victorian legislation but, as set out in the Companies Act 2006, the process allows a ‘compromise or arrangement’ to be agreed between a company and ‘its creditors, or any class of them’. An arrangement here may include a reorganisation of share capital by the consolidation of shares of different classes or by the division of shares into different classes. Such schemes are commonly used to effect compromises and moratoria with creditors, or to restructure debts, and schemes with policy holder creditors of insurance companies have also been common. They are also used in takeover and merger transactions and in reorganisations of rights allocated to classes of shares or debt, often where the articles or instruments constituting the capital are inadequate.
Introduction to the Third Edition
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
Eight years have elapsed since the previous edition of this work. During that period a number of landmark events have occurred.
The global financial crisis has impacted on the commercial environment and has produced some spectacular corporate insolvencies across the globe. Lehman Brothers led the roll-call of casualties in September 2008 when it entered US Chapter 11 bankruptcy and triggered a tidal wave of insolvencies in its local subsidiaries across the globe. A dramatic increase in UK corporate insolvencies might have been expected in the wake of that global economic downturn. That has not happened. The statistics indicate a fall by a third between 2008 and 2015, with corporate insolvencies in England and Wales declining steadily from 21,811 to 14,600.
What explains this lack of business failures, particularly when the number of registered companies continues to rise? Firstly, many of the weaker businesses may have gone to the wall just prior to the 2008 crash. Secondly, many distressed businesses may have been saved through creative use of informal rescue schemes, cost-cutting measures and mergers. Many other firms have simply downsized rather than collapsed. It is also clear that secured creditors (particularly banks) have, on occasions, been reluctant to foreclose on struggling debtor clients because their assets were not worth realising during depressed economic times. The rise of the ‘zombie’ company, drip-fed with small amounts of funding but barely surviving as a viable business entity, has been noted. That dynamic might change if the economy picks up significantly. There are also hints that some small companies are being ‘abandoned’ by their owners without undertaking formal insolvency procedures – but there is no hard data on this phenomenon.
The overall number of corporate insolvencies may have declined steadily since 2008, but there have been significant variations in resort to different procedures. Thus, there were 4,822 administrations embarked upon in 2008, but this figure had fallen to 1,406 in 2015, which is a drop far more dramatic than that experienced with insolvencies. There were 587 Company Voluntary Arrangements (CVAs) in 2008, but this number also fell in 2015 (to 357). The decline has been most marked for receiverships, which reduced from 867 in 2008 to a position, at the time of writing, in which there are only single-figure incidences. That particular decline was predictable as the effect of the Enterprise Act 2002 reforms began to kick in.
Frontmatter
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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14 - The pari passu Principle
- from PART IV - Gathering and Distributing the Assets
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
The pari passu principle is often said to constitute a fundamental rule of corporate insolvency law. It holds that, in a winding up, unsecured creditors shall share rateably in those assets of the insolvent company that are available for residual distribution. In what might be called the ‘strong’ version of pari passu, ‘rateably’ means that unsecured creditors, as a whole, are paid pro rata to the extent of their pre-insolvency claims. This contrasts with the ‘weak’ version of pari passu in which such creditors share rateably within the particular ranking that they are given on insolvency by the law – a system of ranking that draws distinctions between different classes of unsecured creditors (for example, preferred employees and ordinary unsecured creditors).
This chapter and the one following consider whether the pari passu principle (hereafter discussed and referred to in its strong version unless otherwise stated) operates in an efficient and fair manner and whether there is a case for approaching post-insolvency distribution in a different way. Issues of accountability and expertise will not be addressed since pari passu is a substantive rule governing the distribution of goods and little is to be gained by asking whether a principle is, in itself, accountable or expert. Whether insolvency principles are administered accountably and expertly are matters dealt with in other chapters.
As noted in chapter 13, creditors are free, prior to winding up, to pursue whatever enforcement measures are open to them: for example, repossession of goods or judgment execution. Indeed, the race goes to the swiftest. Liquidation puts an end to the race as the liquidator is responsible for the orderly realisation of assets for the benefit of all unsecured creditors and for distributing the net proceeds pari passu. The pari passu principle, however, can only apply to unencumbered assets of the insolvent company that are available for distribution. If a company holds property as a bailee or trustee, that property is not part of the common pool for distribution. Similarly, goods possessed by the company under a contract of sale that reserves title to the seller until completion of payment do not form part of the pool.
19 - Conclusion
- from PART V - The Impact of Corporate Insolvency
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
In some ways, corporate insolvency law has come a long way since the Cork Report. Numerous statutes, court decisions, administrative reforms and changes in professional practice have sought to develop the regulatory landscape so as to remedy deficiencies and secure newly appreciated needs. In the new millennium, the UK Government has shown a renewed desire to attune insolvency laws to the requirements of enterprise while, at the same time, avoiding abuses and injustices. These changes have given the UK a high position in terms of world corporate insolvency law rankings. In other ways, however, corporate insolvency law can be seen, to date, as an area marked by missed opportunities and modest achievements. It has, first, failed to develop as an organised, consistent and purposeful body of rules and processes. This has been a legal sector in which Cork's prescriptions were cherry-picked and where, subsequently, particular issues have been dealt with piecemeal by both legislators and judges. Corporate insolvency law has, secondly, been developed without close coordination with relevant legal sectors and processes. It has not been linked sufficiently tightly with company law – in spite of its relevance to the ongoing needs of healthy companies – nor has it been tied in with an analysis of the arrangements for providing finances for companies that are found in the UK. As was made clear in chapter 3, corporate insolvency law is faced with a pattern of corporate funding that is dictated very largely by the legal frameworks that govern the provision of credit, notably those relating to security and quasi-security. To design insolvency law without looking at those arrangements is to cut the cloth without measuring the client.
A third deficiency is that this has been an area of law that has developed without a consistent guiding philosophy. As was stressed in chapter 12, different procedures have been developed on the basis of inconsistent assumptions not only about the values and objectives that are properly to be pursued, but also about the potential and roles of the different actors that are involved in insolvency processes. Directors and employees are central figures in corporate insolvency law and processes, but the law is based on notions of directorial roles and employee rights that are multiple, inconsistent and competing. This has led to a host of confusions, uncertainties, inefficiencies, unfairnesses and misplaced accountabilities.
15 - Bypassing pari passu
- from PART IV - Gathering and Distributing the Assets
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
The main potential bases for supporting pari passu as a principle of corporate insolvency law are that it provides an efficient and a fair ground rule for allocating the residual insolvency estate. As was seen in the last chapter, however, exceptions to pari passu produce a principle that is unduly complex and uncertain. This chapter considers the extent to which pari passu can be bypassed and a central issue will be whether bypassing is so easily and frequently practised that the value of pari passu is undermined. Here, therefore, we return to the second of the two key problems that corporate insolvency law faces in this area: how a company's insolvent estate is to be constructed.
As a preliminary point, it should be emphasised that the law does not readily countenance contracting out of collective arrangements for dealing with the insolvency estate. It was noted in chapter 14 that parties may be allowed by the courts to enter into contracts in a manner that worsens their status in the distribution of an insolvent company's estate. What the courts will not do is allow creditors to ‘contract with [their] debtor [to] enjoy some advantage in a bankruptcy or winding up which is denied to other creditors’. The House of Lords made it clear in the British Eagle case that this would be contrary to public policy whether or not the contractual provision was expressed to take effect only on insolvency. Effect would not be given to a contractual arrangement that attempted to avoid collectivity by purporting to allow certain creditors to opt out of pari passu distribution of the residual estate to their advantage. British Eagle was a member of an International Air Transport Association (IATA) clearing house scheme in which moneys due from airlines to each other would be netted out each month. When British Eagle went into liquidation it owed money to a number of airlines but it had a claim against Air France, which the liquidator sought to recover.
18 - Cross-Border Insolvency
- from PART V - The Impact of Corporate Insolvency
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
Many modern corporate collapses give rise to private international law issues. This is a natural consequence of the processes of globalisation and the rise of transnational capital markets. Indeed, as the modern corporate enterprise exploits the group structure to an increasing extent, it will often be the case that some of the members of the group will be incorporated in different countries, and many ‘group assets’ will be located in a number of legal jurisdictions. Creditors of a single debtor will be spread across a range of different legal jurisdictions. How does a modern system of corporate insolvency law seek to cope with this reality?
English law has a long record of dealing with this problem, but in a typically ad hoc fashion. Globalisation was never only a twentieth-century phenomenon for businesses operating in the British Empire. That said, this challenge of cross-border insolvency is an increasingly complex topic and requires a full monograph to do itself justice. Fortunately, such dedicated texts exist. The purpose of this chapter is to apply the framework of analysis used throughout this book in looking at the increasingly complex issues posed by cross-border insolvencies. This provides a basis for arguing that the processes of cross-border insolvency law can be enhanced by the promotion of the central aspects of a good insolvency process that are the focus of this volume.
Cross-Border Insolvency: Current Mechanisms Operating in English Law
Common Law
The common law has always had an eye towards resolving the problems of crossborder insolvency. The early authorities deal with cases of personal insolvency, but as the limited liability company rose to prominence from the mid-nineteenth century onwards, it became necessary to address the peculiar issues generated by it. There has never been a problem in allowing foreign creditors to prove for the debts due to them in an English liquidation; though this rule does have qualifications.
Dedication
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Table of Statutes and Other Instruments
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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7 - Informal Rescue
- from PART III - The Quest for Turnaround
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
For most troubled companies, entering into formal insolvency procedures is a course of last resort only to be pursued when informal strategies have been exhausted. Informal procedures, as noted in chapter 6, will often prove more attractive than formal steps and stakeholders will hope that informality may avoid the negative consequences that are often the result of commencing an Insolvency Act process.1 Those consequences may include: the precipitation of contractual breaches across financing arrangements; liquidations of collateral;2 rating agency devaluations; shocks to market confidence; reductions in employee morale; and reputational harms to brands and directors as individuals. Informal processes are likely to offer more flexibility than statutory arrangements and they will be more amenable to the early and proactive involvement of major creditors. They also offer a less confrontational forum for ‘marketplace’ negotiations than many a formal procedure.
It is understandable, accordingly, that informal strategies of various forms are of increasing importance to companies and their advisers. Different modes of informal action are reviewed in this chapter but, before looking at particular approaches, it is worth considering the different parties that may be interested in an informal rescue and the stages of events that commonly lead up to the selection of an informal rescue strategy.
Who Rescues?
When a company encounters problems it has long been the paradigm that informal rescue processes are started when its major creditor, the bank, becomes concerned and starts to take action – either by making enquiries of the directors or by taking a more hands-on approach to overseeing managerial performance. It was noted above, indeed, that the banks have recently taken the ‘rescue culture’ to heart and many of them have established teams of specialists that are dedicated to the provision of turnaround services to debtor companies.4 As discussed in chapter 3, however, the last decade has seen radical changes in the credit market and the arrival of new actors with fresh interests in troubled companies.
1 - The Roots of Corporate Insolvency Law
- from PART I - Agendas and Objectives
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
In a society that facilitates the use of credit by companies there is a degree of risk that those who are owed money by a firm will suffer because the firm has become unable to pay its debts on the due date. If a number of creditors were owed money and all pursued the rights and remedies available to them (for example, contractual rights; rights to enforce security interests; rights to set off the debt against other obligations; proceedings for delivery, foreclosure or sale) a chaotic race to protect interests would take place and this might produce inefficiencies and unfairness. Huge costs would be incurred in pursuing individual creditors’ claims competitively and (since in an insolvency there are insufficient assets to go round) those creditors who enforced their claim with most vigour and expertise would be paid but naïve latecomers would not.
A main aim of insolvency law is to replace this free-for-all with a legal regime in which creditors’ rights and remedies are suspended and a process established for the orderly collection and realisation of the debtors’ assets and the fair distribution of these according to creditors’ claims. Part of the drama of insolvency law flows, accordingly, from its potentially having to unpack and reassemble what were seemingly concrete and clear legal rights.
Corporate insolvency law, with which this book is concerned, is now a quite separate body of law from personal bankruptcy law although these have shared historical roots. Those roots should be noted, since the shape of modern corporate insolvency law is as much a product of past history and accidents of development as of design.
Development and Structure
The earliest insolvency laws in England and Wales were concerned with individual insolvency (bankruptcy) and date back to medieval times. Early common law offered no collective procedure for administering an insolvent's estate but a creditor could seize either the body of a debtor or his effects – but not both. Creditors, moreover, had to act individually, there being no machinery for sharing expenses. When the person of the debtor was seized, detention in person at the creditor's pleasure was provided for. Insolvency was thus seen as an offence little less criminal than a felony.
17 - Employees in Distress
- from PART V - The Impact of Corporate Insolvency
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
The insolvency of a company may prove traumatic for employees, especially those who have invested years of effort and skill in the enterprise. A range of outcomes for employees may be triggered by insolvency, and the law, in some respects, seeks to minimise the negative consequences of insolvency for employees. Insolvency law, however, has other interests to look to, notably those of creditors and possibly those of shareholders and the state. Issues of fairness come to the fore, as do considerations of rescue and the design of rules that allow efficient transfers of enterprises.
This chapter begins by outlining how the law treats employees in an insolvency. It then moves to a now familiar set of issues by asking four questions. Do insolvency laws relating to employees lead to efficient rescue processes and corporate operations? Do these laws make best use of employee expertise? Are employees given an appropriate voice within the schemes of accountability that operate in insolvency? Does the law allocate rights to employees that are fair? A further, more general issue is then discussed: whether insolvency law's conception of the employee evidences a coherent and appropriate philosophy.
A preliminary issue, however, has to be dealt with: the scope of the term ‘employee’ for the purpose of insolvency protections. A starting point here is that, in order to claim priority as an employee, a person must be employed under a contract of service with the company rather than, say, operate as an independent contractor. The courts, moreover, will consider a number of factors in assessing whether a person is an employee or not, factors that include: whether the person is under the control of another or an integral part of another organisation; whether they are in business on their own account; and the economic reality of the relationship with the alleged employer. As for the status of a director, it appears that a non-executive director who acts on his own account cannot be a company employee but that an executive director may be.
10 - Pre-Packaged Administrations
- from PART III - The Quest for Turnaround
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
In chapter 6 it was argued that, over recent years, responses to corporate troubles have increasingly tended to be made before any final crisis precipitates formal action. One form of anticipatory action is the pre-packaged administration. This is a device that has been encountered on the UK insolvency scene since the mid-1980s, but which has grown in use more recently. It is a device that some commentators herald as a freshly effective mechanism for furthering rescue objectives and others see as a means by which powerful players can bypass carefully constructed statutory protections. In many senses, it represents the public face of ‘rescue’ and has therefore attracted considerable attention in the media and political arenas. It has also attracted the interest of distressed firms across the EU which have been happy to relocate to the UK jurisdiction to exploit its potential as a restructuring tool.
The ‘pre-pack’ is a process in which a troubled company and its creditors conclude an agreement in advance of statutory administration procedures. This has the effect of establishing a deal in advance of the appointment of an administrator and it allows statutory procedures to be implemented at maximum speed. The danger most commonly pointed to is that such speedy implementations of faits accomplis will tend to ride roughshod over the procedural and substantive interests of less powerful creditors.
This chapter looks at the development of the pre-pack, identifies the issues raised by this device, and considers how insolvency law might respond to the burgeoning popularity of such agreements. A particular concern will be whether the advent of the pre-pack calls for a rethinking of current approaches to the protection of those interests that are affected by corporate troubles. Frisby has argued that the pre-pack represents one area of insolvency practice where established principles and commercial practice do not converge, thereby creating a challenge for policy-makers and the legal system.
List of Abbreviations
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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5 - Insolvency Practitioners and Turnaround Professionals
- from PART II - The Context of Corporate Insolvency Law: Financial and Institutional
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
Corporate insolvency processes are not mere bodies of rules: they are elaborate procedures in which legal and administrative, formal and informal rules, policies and practices are put into effect by different actors. Those actors, in turn, have cultural, institutional, disciplinary and professional backgrounds which influence their work. They also operate under the influence of a variety of economic, career and other incentives and are subject to a host of constraints ranging from legal duties and professional obligations to client and own-firm expectations. The Cork Report, in an oft-quoted statement, urged that the success of any insolvency system is very largely dependent upon those who administer it, and socio-legal scholars have emphasised how insolvency law is not applied in a mechanical way but is manoeuvred around or manipulated by means of administrative structures ‘designed and imposed by dominant actors’.
This chapter looks at how insolvency law and turnaround processes are made operational by those actors who dominate such procedures: the insolvency practitioners (IPs) and turnaround professionals (TPs). In accordance with the discussion in chapter 2, it will be asked whether present practitioner and professional regimes can be supported as efficient, expert, fair and accountable. This will demand examinations of both the ways that these actors carry out their tasks and the ways that they are regulated.
Insolvency Practitioners
In the post-millennium era there has been a shift in the role of the IP in relation to troubled companies. This can be described as a move in direction from ‘undertaker to renovator’. Before the Enterprise Act 2002 and the rise of the ‘rescue culture’, the IP's contribution was focused on overseeing the orderly distribution of a company's assets to creditors. The modern role demands that the IP spend more time acting as restructuring advisor and manager. Changes in the loan market have further encouraged such a shift in roles. Corporate credit is now obtained routinely from a variety of sources rather than a ‘single bank relationship’, and actors such as the buyers of secondary debt often look to IPs, not to enforce debts formally, but to advise and assist in structuring deals.
16 - Directors in Troubled Times
- from PART V - The Impact of Corporate Insolvency
- Vanessa Finch, London School of Economics and Political Science, David Milman, Lancaster University
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Summary
The rules and processes that make up insolvency law operate as a set of incentives and constraints that influence how company directors behave at times of both good and bad corporate fortune. This chapter considers how those incentives and constraints operate and examines the assumptions and philosophies that underpin the role of the company director in insolvency law. The analysis offered here continues the approach set out in chapter 2 and asks whether current insolvency law deals with directors in a manner that renders directors appropriately accountable, makes the best use of directorial expertise, fosters efficiently produced outcomes and is consistent with the fair treatment of directors and parties affected by directorial behaviour. For the purposes of clarity of exposition, the issue of accountability will be considered first, since this involves a mapping out of the broad array of influences and constraints that insolvency law applies to directors – a mapping exercise that should provide a useful background to the discussions of expertise, efficiency and fairness that follow. As a preliminary matter, it is necessary to explore the meaning of ‘director’. In English law, whether a person is a director or not depends upon function and not formal designation. A de jure director is a properly appointed director. A de facto director performs the functional role of director, but without having being formally appointed as such. A shadow director is a person who exercises real influence over a majority of board members without any appointment to the board. The issue of who might be regarded as a de facto director was reviewed in HMRC v. Holland (Re Paycheck Services Ltd), when the Supreme Court emphasised that a director of Company A, which itself is a corporate director of Company B, does not automatically become a de facto director of Company B. For many of the matters discussed below, it matters little which category of director a particular individual falls into. Increasingly, liability is common. This trend is confirmed by section 89 of the Small Business, Enterprise and Employment Act 2015.