Insolvency Law and Director Disqualifications

Rebecca Long Bailey Excerpts

Wednesday 14th June 2023 Westminster Hall

[Rebecca Long Bailey (Salford and Eccles) (Lab)]

I beg to move,

That this House has considered insolvency law and director disqualifications.

It is a pleasure to serve under your chairmanship, Ms Fovargue. Thank you for making time for this important debate.

Five years ago, Carillion collapsed in one of the biggest corporate scandals seen in recent years. Millions were racked up in debt, tens of thousands of workers lost their jobs and pensions, and thousands of supply chain businesses were put at risk, all because the auditors failed to hold Carillion’s board to account and a blind eye was turned to poor corporate behaviour. Five years on, have changes to the UK corporate governance regime been made to ensure that such a scandal cannot happen again? The answer, sadly, is not encouraging.

As the Unite the union has stated,

“In the end, four Carillion executives were fined £870,000 in total – a mere slap on the wrist given the hundreds of millions of pounds the company lost and the thousands of lives they ruined.”

Former BBC investigative journalist Bob Wylie, who wrote the Financial Times book of the year “Bandit Capitalism: Carillion and the Corruption of the British State”, summed up the present position perfectly when he said:

“The sad truth is they get away with it because they know they can.”

The most recent figures by the Insolvency Service for 2022-23 show that almost half of disqualifications were because of misuse or abuse of the bounce back loan scheme, rather than more robust action being taken against directors for unfit conduct prior to insolvency. I suggest that that is because the bar for disqualification for unfit conduct is very high and often difficult to prove, particularly where a director can claim to have relied on the advice of external advisers when making decisions. Further, the law surrounding whether directors have acted inappropriately in an insolvency situation, and specifically the point at which directors should begin to consult on redundancies and prioritise payments to creditors prior to insolvency, is ambiguous to say the least.

The Supreme Court recently affirmed that ambiguity in the case of BTI v. Sequana, noting that company directors are only required to begin prioritising creditors if it is probable that their company will plunge into insolvency. The problem is that no one knows what “probable” actually means. As the London Solicitors Litigation Association noted,

“the precise point in time at which the duty will be triggered and how to balance creditors’ interests with other competing interests of the business remains relatively elusive.”

It is that elusiveness that continues to allow some directors to act in a way that is detrimental to workers and other creditors.

The Bakers Food and Allied Workers Union highlights the cases of Dawnfresh Seafoods and Orchard House Foods, which it says

“raise significant concerns about the ability of business owners to abuse the process around administration and insolvency, leaving workers in the lurch and denying them the full value of their outstanding pay and redundancy monies owed—whilst Directors walk away with impunity, often with enormous levels of wealth intact.”

In the case of Dawnfresh, the union reports that the director allowed workers to carry on overtime shifts in full knowledge that he was about to bring in the receivers. He also took the opportunity before insolvency to rescue his own private art collection from company premises. The workers were left waiting for weeks without any source of income, obliged to depend on family and friends or use food banks in the resulting emergency, and they included one who was fighting leukaemia. A not dissimilar instance occurred at Orchard House Foods in Gateshead, with redundancy negotiations over the site’s closure seeing the company fail to pay workers ahead of the Christmas period.

Sadly, that practice does not just plague the food sector; it is increasingly evident across the wider economy. Thomas Cook, for example, also failed abjectly to consult over redundancies prior to insolvency, when it was known for some time that the company was in trouble. In a more recent case, journalists at Vice UK faced statutory redundancy terms, with many having to leave with almost nothing because the company filed for bankruptcy, while its recent global CEO was on an annual salary of $1.5 million. It is not just workers who lose out in these situations. Figures disclosed in response to written parliamentary questions tabled by my hon. Friend the Member for Ellesmere Port and Neston (Justin Madders) indicate that over the last two years alone statutory redundancy payments cost the taxpayer around £300 million.

If the law is not clear enough on the point at which creditors’ interests in an insolvency should be prioritised, what other mechanisms are there to sound the alarm?

[Jim Shannon (Strangford) (DUP)]

I commend the hon. Lady for securing this debate. I would like to be here for the whole debate, Ms Fovargue, but I have another event to attend at 3.30 pm. I apologise for not being here for the whole debate. Nevertheless, I would like to make a contribution.

There is another factor as well, which I would just like to outline for the record. Does the hon. Lady agree that in many situations the big businesses that she is referring to have the ability to use accountancy in their favour, by going insolvent and trading under different names, which too often has left those on the bottom of the ladder, such as suppliers and sole workers, with no option other than to swallow the pill and even go bankrupt themselves? Some of my constituents have experienced this. It is difficult to watch directors move on with impunity, while other people have to sell their homes to cover their costs. In other words, the small person at the bottom or the back of the queue always suffers and the big boy gets away.

[Rebecca Long Bailey]

I thank the hon. Member for his comments and I agree completely. There are huge issues surrounding the area of pre-pack administrations and the issue of phoenix companies, whereby directors are allowed to reappear in another form with the same kind of company structure with complete impunity. This certainly needs to be addressed by the Government.

Other mechanisms exist to sound the alarm on poor corporate governance. That is usually when the role of auditors should be key, but in recent years the unhealthy structure of the industry has been widely criticised, as well as the market dominance and conflicts of interest of the big accountancy firms. In this dysfunctional culture, firms must win and retain engagements from companies in order to generate revenue, but simultaneously they must objectively scrutinise the company reports of the very people they are trying to win business from. Indeed, the symptoms of this flawed culture are clear. The Financial Reporting Council has stated that 29% of the audits delivered by the seven biggest accounting firms fail to meet UK standards. It is abundantly clear that the UK corporate governance regime is in urgent need of reform

What actions have the Government taken so far? In his response to the debate, the Minster will no doubt refer to the Government’s White Paper on reforms to the UK corporate governance code, which the FRC is consulting upon as we speak. However, it is important to note that although the code is underpinned by listing rules that require premium-listed companies to “comply or explain” if they have not complied with a code provision, there is no strict legal requirement to comply with the code at all. It is merely a guidebook, and the lack of legal enforceability is clear. The Financial Times reported only last month that the FRC has reported falling levels of compliance since 2020, suggesting that boards are willing to risk avoiding the “comply or explain” requirements, particularly as the ultimate threat is simply to register dissatisfaction in a non-binding shareholder vote, or one that historically the company has a vanishingly small chance of losing.

Secondly, what is glaringly absent from the Government’s White Paper proposals so far is a statutory and enforceable Sarbanes-Oxley equivalent, which would make directors legally responsible for financial reporting governance. Instead, the White Paper opts for the fluffier “encouragement” of boards to include in their annual reports declarations about whether internal risk management and internal controls are effective or not. Similarly, the provisions that recommend that certain minimum clawback conditions or “trigger points” are included in directors’ remuneration arrangements are welcome in principle, but the reality is that these employment contracts are not publicly available so as to enable enforcement, and annual financial reports rarely provide comprehensive information.

Sadly, even the chief executive of the Institute of Chartered Accountants in England and Wales believes that the Government’s White Paper proposals on reform of the audit industry do not go far enough, stating:

“Taking these measures as a package with the draft audit reform Bill outlined, the government's approach has a half-hearted and lopsided feel to it… Lessons from Carillion and other recent company failures have been ignored, with little emphasis now on tightening internal controls and modernising corporate governance.”

A further five years on from Carillion, we are no closer to the creation of the Government’s long-promised audit, reporting and governance authority, or the passing of the Government’s promised audit reform Bill. When we can expect legislation on audit reform and the creation of ARGA?

Given these glaring deficiencies in the law, I will be grateful if the Minister considers some simple legislative changes that would provide much-needed clarity and protect workers, creditors, and the long-term health of companies. First, will he widen the scope of directors’ duties in section 172 of the Companies Act 2006, so that a duty is not owed solely to shareholders, as at present, but is owed to workers and other stakeholders as well? That must sit alongside a clear duty to prioritise the long-term welfare of a company, rather than simply the short-term maximisation of shareholder dividends.

Secondly, with regard to the duties of directors prior to insolvency, will the Government legislate to set clear definitions and parameters for when insolvency is deemed to be a “probable” event? That would provide much-needed clarity on when a duty to consult on redundancies is triggered, and when payments to workers and creditors need to be prioritised over shareholder dividend extraction.

Thirdly, will the Minister comment on why the Government proposals made in recent years to introduce workers on boards have been shelved? Will he commit to examine and develop policy in the light of the experience of other European jurisdictions, where direct representations of employees on both unitary and two-tier boards has actually helped to improve corporate performance and success, for the benefit of all stakeholders? Last, will he introduce clear Sarbanes-Oxley-equivalent legislation that would finally make directors legally responsible for financial reporting governance? If not, can he explain clearly the Government’s reasons for avoiding that in favour of more diluted and legally unenforceable guidance?

It is clear that the current UK corporate governance regime has become dysfunctional, ambiguous and unenforceable. Despite numerous scandals, it still has no room for the protection of employees and other stakeholders. I hope the Minister can reassure me today that things will change. Thank you for the opportunity to hold this debate, Ms Fovargue.

[Yvonne Fovargue (in the Chair)]

I call John McDonnell.

--- Later in debate ---

[Rebecca Long Bailey]

I thank everybody for taking part in the debate, which has been wide-ranging; a lot of interesting points were raised. I thank the Minister for his lengthy response. I welcome a lot of the comments he made, and I followed his work as a Back Bencher on this issue, so I know we are on the same page on many issues, but I am saddened that he did not go into the level of detail that many of the questions asked by myself and colleagues required.

The vast majority of directors do the right thing—we wholeheartedly agree on that point—but the problem is that when the minority do not and it goes seriously wrong, the Insolvency Service and the UK corporate governance code only work to a certain point, because the enforceability just is not there. I applaud the work of the Insolvency Service, but it can only examine conduct as determined under the current law. Take a situation where directors could have consulted on redundancies prior to an insolvency event but did not. The law is very weak and ambiguous on that, which is the point I was trying to make in my opening remarks.

As the Sequana case clearly shows, the point at which an insolvency becomes probable is not defined in law. There is a point in time when directors should be, on a sliding scale, prioritising the interests of creditors prior to a probable insolvency. Defining that is crucial to providing the protection that workers and creditors deserve in situations where some of the money they are owed could be paid back to them.

On the issue of Sarbanes-Oxley, the Minister said that there is a balance to be struck, and he implied that by introducing legal requirements on directors in the style of Sarbanes-Oxley, we would in some way restrict entrepreneurship. That has certainly not been the case in the United States. I was reading a Harvard law report this morning that suggested the opposite—that providing certainty to shareholders and investors would actually encourage future investment. Directors should be able to say, “Yes, all the financial statements we are making are 100% correct. We are categorically supportive of the work that our auditors have done, and we’re happy to provide those reports to our shareholders.” If they cannot do that, we have a serious problem with our UK corporate governance regime. I do not think it is unreasonable to expect directors to have that legal liability.

Finally, on the audit system, the Minister has not provided any clarity about when ARGA will be set up, when audit reforms will be forthcoming or how extensive they will be. We got a taster in the Queen’s Speech, but as I am sure he agrees, reforms need to go a lot further than what the Government have put forward, because issues arise time and again. If we look at the dysfunctionality of the audit industry, KPMG was fined £14 million for not auditing Carillion’s company accounts correctly, and that was not a one-off. Prem Sikka referred to the case of Silentnight, in which KPMG—again, in the pursuit of a coveted client—did a pre-pack administration and sold a company to that potential client at an undervalue. It was fined £13 million for its role in that. That shows the dysfunctionality and the unhealthy nature of the audit industry as a whole.

[John McDonnell]

I worked for Silentnight as a youngster, but one of the other issues is the distressing of assets by the accountancy firms, so that they can get sold on. We have seen case after case of that.

[Rebecca Long Bailey]

My right hon. Friend is 100% right. I hope the Minister will come back with plans for more detailed reforms of the audit industry in due course.

I will finish on the point about the three reports that my right hon. Friend the Member for Hayes and Harlington (John McDonnell) mentioned. Lord Sikka provided three incredibly detailed reports a few years ago: one on the reform of regulatory architecture, one on reform of the audit industry and one on reform of the UK corporate governance regime. He did that along with a whole team of accountants and industry experts. The points made in those reports are as valid today as they were then, and they are non-partisan. I hope the Minister will take time to read those reports when he is bored over the weekend, and will take some pointers from them that he can take forward in Government policy.

Question put and agreed to.

Resolved,

That this House has considered insolvency law and director disqualifications.