What do record number of insolvencies mean for D&O insurers?

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What do record number of insolvencies mean for D&O insurers?

Published 29 marzo 2022

Company insolvencies have recently hit a record high and are on an upward trend in the aftermath of the COVID-19 pandemic. This means that we are likely to see an increase in claims against directors, especially in light of new legislation that expands the government’s powers of investigation.

Record high insolvencies

It was widely predicted, by insolvency experts and others, that the end of the government’s furlough scheme on 30 September 2021 would lead to a sharp rise in company insolvencies, particularly when banks started to ask for repayment of loans made during the pandemic that were backed by government guarantees.

These predictions proved accurate. In January 2022, the Insolvency Service revealed that in the fourth quarter of 2021 there had been 4,175 Creditors Voluntary Liquidations (“CVLs”), where the directors of a company choose to place the company into liquidation without a formal court order. This was the highest quarterly number of insolvencies since records began in 1960. Indeed, the overall number of company insolvencies between October and December in 2021 was almost a fifth higher than in the previous quarter, and 51% higher than in the same quarter in 2020.

Impact of COVID-19 pandemic

As the government noted, the record number of insolvencies coincided with “the phasing out of measures put in place to support businesses during the coronavirus pandemic”.

Importantly, the Insolvency Service confirmed in December that an estimated 9,733 companies in England, Wales and Scotland that entered insolvency between 1 May 2020 and 31 October 2021 had taken out a Bounce Back Loan facility. This is high on the government’s agenda, as it raises the question of how support has been spent and whether directors have always acted appropriately in taking Bounce Back Loans and other COVID-related support packages.

Importance of director roles in insolvencies

Directors are under a duty to act in the best interests of the company. However, once they form the view that the company is in financial difficulties or is irredeemably insolvent, their duty switches to act in the best interests of the company's creditors. Failure to comply with this duty can expose directors to the risk of personal liability.

When a company enters into administration or liquidation, the insolvency practitioner dealing with this process will investigate how directors have acted in the period leading up to the company’s insolvency. Claims are made under the Insolvency Act 1986 and can include wrongful trading, misfeasance and fraudulent trading. In each case, it can result in directors being personally liable to creditors or the company for loss caused by any improper conduct.

Directors’ disqualification

The most common ground for disqualification of directors is where a director’s conduct in the run-up to insolvency is deemed to render him or her unfit to act as a director in future. The process of disqualifying a director is governed by the Company Directors Disqualification Act 1986 (“CDDA”). Under CCDA, a director can be disqualified for between 2 to 15 years, and the current average ban is just over 6 years.

In the last few years, the government’s calls for tougher sanctions on errant directors has provoked an upward trend in the number of directors being disqualified. This trend is likely to continue, not least because the government has now closed a loophole in CDDA, such that it will also now apply to directors of companies that have been dissolved.

Dissolution is a cheaper, quicker and easier way of winding up a company when compared with liquidation. Until recently, it also allowed the directors to avoid a government investigation into their conduct under CDDA. However, thanks to the Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Act 2021, which received Royal Assent on 15 December 2021, the government’s powers of investigation and disqualification of directors under CDDA are extended to directors of dissolved companies. The new Act also provides that a court order for compensation can be made against a disqualified director whose conduct has caused loss to creditors of a dissolved company.

Conclusion

The combination of record numbers of insolvencies, increased powers to investigate directors of dissolved companies and political will for directors to be held liable is likely to result in a significant increase in claims against directors, whether under the Insolvency Act or the new Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Act. This underlines the importance of directors acquiring Directors’ and Officers’ (“D&O”) insurance to protect them against the risk of exposure. Depending on the type of cover provided, a D&O policy may respond to cover the director’s costs of dealing with an insolvency-related investigation.

Authors

Graham Briggs

Graham Briggs

Bristol

+44(0)117 918 2712

Matthew Butler

Matthew Butler

Bristol

+44(0)117 366 2837

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