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A bridge too far?

Provided by Insolvency News

While the Insolvency Service is making the most of resources to crack down on misbehaviour by company directors, the government must manage its own expectations if it is to call for more drastic action to be taken under the current funding model, says Fred Crawley

Suggestions by business secretary Vince Cable at the end of the third quarter of 2013 that greater measures must be taken to deal with “dodgy directors” prompted the response that, with the Insolvency Service’s current funding mechanism, there is enough of a challenge keeping disqualification levels proportionate to levels of corporate failure – let alone cracking down further.

Alastair Lomax, director of the restructuring team at law firm Pinsent Masons, commented that the number of directors disqualified had fallen 30%, from 1,333 to 920, between 2010-11 and 2012-13. At the same time, he argued, levels of liquidation had remained high, averaging in excess of 4,000 per quarter over the past three years.

Certainly, there is no argument over the fact that the Insolvency Service has seen a decrease in resourcing. Its most recent annual report confirms that case work has fallen 58% since 2010, with the value of asset realisations from formal insolvencies down 54%, representing a £7.4m decrease. Over the same period, operating costs were reduced by 34% and employee numbers reduced by around 33%.

Nevertheless, the service’s chief executive Graham Horne contends that to infer a decrease in efficacy in action against directors by comparing disqualification rates against liquidation figures is potentially misleading, due to the timing of investigation and disqualification procedures in the insolvency process.

“The number of insolvencies has been broadly flat for the last three years,” says Horne. “It is important to note that there is a two to three year lag between insolvencies and disqualifications and therefore the two figures should not be compared year on year.

“The Insolvency Service acknowledges that investigation and enforcement outputs dipped in 2010 but have returned to targeted levels. This is primarily attributable to the high degree of change within the agency as overall employee numbers reduced. However, overall numbers of employees in this part of the agency have been maintained.”

On the subject of funding, Horne insists that actions taken in 2010 to change fee structures are already having the desired effect. Nevertheless, he says, there is a “difficult but important balance to strike” between the service’s debtor, creditor and taxpayer funding sources, and as such it has embarked on a “project to establish the most flexible and sustainable funding model.”

Turf war
One proposed improvement to the current regime that has sparked discussion in the industry – and one which returns to Cable’s demands for more “dodgy” director disqualifications – is the idea of giving the service the ability to seek compensation from rogue directors, with the monies recovered going to creditors.

This, says Lomax, could trigger “a turf-war with liquidators who have traditionally been tasked with prosecuting compensatory claims against directors, so as to return money to creditors before handing details to the Insolvency Service to deal with disqualification”.

Lomax continues: “Of course, liquidators are plagued by similar funding issues; companies are often so heavily indebted to their lenders that there are rarely any sufficient free assets available for a liquidator even to investigate misconduct claims, let alone prosecute them.”

Commenting on the impact of proposals to the status quo for liquidators and creditors, a spokesman for the Insolvency Service commented: “The proposals to allow courts to make compensation orders and to enable liquidators to assign causes of action are intended to increase the likelihood of creditors being compensated where they have suffered from director misconduct.

“Compensation orders will complement the landscape by allowing a court to make a compensatory order against a director it has disqualified if, for whatever reason, the liquidator has not obtained compensation from the director using existing remedies.”

Lack of work
To Lomax, the key issue for the Insolvency Service is “a lack of case-work and the funding that it generates” rather than any lack of fitness for purpose in the range of legal powers available. But what suggestions are there for mitigating this shortfall without causing a conflict of interest with either liquidators or creditors?

Nick Pike, also a partner at Pinsent Masons, thinks the simplest solution would be to further increase the filing fees and other administration costs leveed by the service as case work passes through the court system. He feels there is more than enough potential in increasing these fees to cover more work for the Insolvency Service.

Some in the industry, however, feel there may be more creative solutions. Robert Smailes, consultant at Shipleys LLP, proposes an option which would not only see a more robust funding model for the service, but also deal with the reputational issue surrounding pre-packaged administrations.

Smailes suggests that, in any pre-pack sale, it be made compulsory for a company to exit into liquidation within a year of entering administration. At this point, he says, the administrator would be released and the official receiver would take control – and handle any further income received or actions required.

As well as its effect on the pre-pack climate, Smailes feels this system would mean a much bigger case load for the service – and a better quality of case, too. Further light may be shed on this topic when the results of an independent review of pre-packs, led by Teresa Graham, former deputy chair of the government’s Better Regulation Commission, are reported in the spring.

Until then, and until the service makes public its own plans for adapting its funding model to a changing landscape, it seems that the government should curb its ambitions for a crackdown on director misbehaviour.