Since the pandemic, during which insolvency rates were low due to government measures, there has been a considerable rise in insolvencies in the UK and many other jurisdictions. High interest rates have significantly increased the cost of borrowing and many companies are saddled with mountains of debt that was taken out in better times and which are now difficult to repay. In addition, high inflation and energy costs, lower consumer confidence and volatile supply chains have all contributed to making the last few years very difficult for businesses.
Insolvency specialists[1] estimate that more than 47,000 businesses are near collapse in the UK at the start of 2024 and, according to the 2023 statistics released by the Insolvency Service, the number of registered company insolvencies for 2023 was 25,158, the highest annual number since 1993 and Q4 2023 saw the highest quarterly insolvency numbers since Q4 2008 (during the global financial crisis).
This upward trend is reflected in many other jurisdictions, including the US, Australia and the EU.
Despite these reports, concern about insolvency does not feature in the top seven risks of our D&O survey and only features as a number six concern for the smallest companies (<$50m) (though when viewing the data historically, concern has risen from 45% of respondents considering it to be an extremely important risk in 2022 to 59% in 2023).
“Areas with higher level of activity in 2023 appear to be Retail and Private Equity owned companies where due diligence process was either rushed or when leverage buy outs took place. Additionally, although not a trend, there has been a handful of examples of chapter 11 related D&O claims for UK domiciled companies with 100% UK exposure, with the chapter 11 filling being triggered by US bondholders.”
D&O Underwriter
Whilst it might be true that SMEs are quicker to fail and in greater numbers, larger companies are not impervious to the risk of failing or the considerable consequences that could follow for D&Os. In addition, when such companies do fail, there are significant ramifications, as was seen when Carillion collapsed. Further, there is evidence that there has been an uptick in larger companies failing. For example, Cornerstone research[2] shows that “In 1H 2023, 72 large companies filed for bankruptcy, already surpassing the total number of bankruptcies filed in 2022 and more than three times the number of bankruptcies in 1H 2022…there were [also] 16 mega bankruptcies (those filed by companies with over $1 billion in reported assets) in 1H 2023, matching the full-year total for 2022 and higher than the 2005-2022 half-year average of 11.”
Insolvency-related claims are a large source of claims against directors in many jurisdictions, including the UK, but the risk of claims has increased as insolvencies have rocketed. Further, during difficult economic times, there is a higher risk of fraudulent, dishonest or wrongful actions – this could all lead to more actions against D&Os for breaches of insolvency legislation and their duties to the company, in addition to disqualification proceedings and orders for compensation.
Claims arising from the twilight zone – the time when insolvency is a very real possibility but before the company is officially insolvent – are common in most jurisdictions. In the UK, insolvency practitioners are obliged to examine the decision-making of directors in the time leading up to the insolvency and an investigation into directors' conduct and the company's affairs happens in every case, with resulting civil claims (for example, for wrongful trading, fraudulent trading, misfeasance or breach of fiduciary duty) being common.
In 2023, there were a range of cases against D&Os arising out of insolvency events, which clarified some important points that are worth bearing in mind:
In the UK, Insolvency Practitioners must submit reports to the Secretary of State on the conduct of every director (including shadow directors) who acted in that capacity in the three years prior to insolvency, regardless of their conduct. These reports are then considered by the Insolvency Service and, where the conduct suggests that they may be unfit to be concerned in the management of a company, investigation, enforcement and disqualification may follow.
Statistics show that the Insolvency Service has intensified its actions against unfit directors, especially those who misused COVID-19 loans (583 of the 850 director disqualifications in the last year included an allegation relating to COVID-19 financial support scheme abuse) and the average disqualification period has increased to over eight years, up from five years ten months in 2021-22. Directors who seek to dissolve companies to evade debts are also being sanctioned in greater numbers following the new powers bestowed by the Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Act 2021. In addition, the Insolvency Service has a high criminal conviction rate and recently succeeded in obtaining its first court compensation order (for £50,000) against a director for his abuse of the Bounce Back Loan scheme.
Insolvency risk is high and, given the current climate, it is more important than ever that directors of all companies are cognisant of the risk and are operating adequate risk management strategies to prevent insolvency or mitigate the consequences. This includes regular review of profitability, debt and capitalisation figures and prudent decision-making in the ‘insolvency zone’, bearing in mind the range of duties directors have to the company, its shareholders and creditors.
“Recent bank failures have highlighted the importance of key risks such as liquidity and interest rate and concentration risk, giving rise to regulatory attention. The failures underscore the problems that liquidity vulnerabilities and maturity mismatches can pose for the financial system.”
Adam Warner | Financial Institutions Underwriter, Beazley
