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Insolvency and corporate governance – group structures

James Eldridge

On 26 August 2018, the Government issued its response to its consultation on insolvency and corporate governance. Here’s a summary of the key themes, their effects and tips on how you can prepare for the future.

The key themes of the Government’s response include action to strengthen the UK’s corporate governance framework to reduce the likelihood of large corporate failures, to improve the insolvency framework in cases of major failure, and to increase protections for creditors and achieve a fairer balance in insolvencies.

Transparency of groups structures
In the response, the government stated its intention to strengthen transparency requirements around group structures to ensure that, as structures become more complex, they remain effectively managed and governed such that groups have clear records on the entirety of their structure and it is clear to third parties which company within a group structure they are contracting with and which company owns particular assets.

The government has suggested that it will consider the following actions in this regard:
•    working with the Financial Reporting Council to set stronger expectations that directors will keep complex group structures under review;
•    considering whether further measures regarding transparency around group structures would be proportionate, business-friendly and beneficial. This could include introducing a requirement for corporate groups of significant size to provide an organogram of their corporate structures;
•    considering whether the process for dissolving redundant companies and streamlining group structures could be simplified.  

The Government has also indicated that it will consider strengthening the UK’s existing dividend regime to provide additional protection to creditors and will extend the existing investigation regime under the Company Director Disqualification Act 1986 to include directors of dissolved companies which have not been through an insolvency process.  

What’s the effect of these proposed actions?
It’s clear that enhancing transparency requirements around group structures is an area where the Government will take action to strengthen the UK’s corporate governance framework. For groups with complex legal entity structures, this may require significant work to comply with any new rules such as:

•    preparing an organogram of the group structure;
•    mapping the group’s operational structure onto its legal entity structure, including contracts and other assets and liabilities;
•    ensuring the appropriate corporate governance controls are in place for group companies so that directors are focused on their accountability within the structure.  

Simplification of group structures
Some responses to the consultation suggested that the simplification of group structures can be complex and costly, and the Government has suggested that it will consider whether the process for dissolving redundant companies and streamlining group structures could be simplified. In my view, this may not be compatible with the Government’s aim of increasing protections for creditors.  

The simplification of corporate structures is currently undertaken using processes such as voluntary striking off, members’ voluntary liquidation and, less frequently, European cross-border mergers or court-approved scheme of arrangements. Each of these processes has inbuilt protections for creditors such as criminal penalties for failure of directors to notify interested parties such as  contingent creditors when striking off, a requirement for the liquidator to seek out creditors in a liquidation and the involvement of the Court in European cross-border mergers and schemes of arrangement.  

It may be that any changes to legislation to make simplification of structures more straightforward such as implementing an out of Court merger process would mean that liabilities and other obligations to counterparties and creditors could be moved to a different group company without the agreement of the creditor which is at odds with existing UK legal principles such as maintenance of capital and privity of contract.  

What should my group be doing to prepare for future developments?
In my experience, a corporate simplification project can be completed cost-effectively and efficiently using the current processes available in the UK if the project is well planned, properly advised and economies of scale are maximised. When assessing a typical group structure, we usually find that around nine out of ten companies are capable of elimination with very few issues arising that cannot be resolved.

Generally, corporate simplification projects become costly and time consuming due to a combination of factors including a lack of buy-in from stakeholders at the group, a lack of senior sponsorship, a lack of momentum in the project, a failure to obtain specialist advice to resolve issues arising or kicking off the project too close to critical deadlines. Where a project is well planned, cost savings will routinely offset the costs of the project within 12 months.

Next steps
Moore’ specialist Corporate Simplification team would be pleased to meet you free-of- charge to discuss your legal entity’s structure.