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Directors under pressure: It’s a crime…or is it?

18 July, 2018Keith Pond

bird-drinking-from-a-milk-jug“Poor management” is often a key reason given for the insolvency and failure of businesses (e.g. Ooghe & DePrijcker, 2008).  Even where lack of cash flow or collapse of a market are cited, the managers of the business are tarnished by the commission or omission of decisions.  Poor governance (especially of larger firms where boards of directors, representing owners, are separate from the operational management of the business) can also facilitate poor management decisions or omissions:

  • Managers not seeing or acting in a changing environment such as the rise of internet retailing (Toys R Us?)

  • Managers not changing the inflation defying £1 price point (Poundland?)

  • Managers taking on an acquisition or project that focuses vital attention away from the core business (Carillion?)

    in smaller companies, too, governance issues can arise.For example the agreement and payment of an improper dividend.
Of course, managers are not omnipotent but they can be supported by objective Boards, perhaps by Non-Executive Directors (NEDs) and by governance structures that question risky plans and actions.  Smaller firms, where the dichotomy of ownership and control is less apparent, often lack this objectivity and may rely more heavily on their bank for this boon.

But what sort of responsibility do NEDs, often suggested or provided by banks, and bankers, themselves, hold?  For some time banks wondered if the law (Companies Act 2006) would consider them to be “shadow directors”, especially where SMEs were used to receiving and acting on instructions from banks contained in loan agreements and facility letters or even through informal discussions with relationship managers.  The FCA notes actions within its 2018 report on RBS that reflected this fear.

In his excellent book on the governance of Distressed firms, Professor David Milman (2013) calms banking fears.

“Professionals acting solely within their professional capacity are not thereby deemed to be shadow directors.” (CA, 2006, s.251(2))

NED's Role

For the individuals acting as NEDs, the position is less clear.  The law does not distinguish between specialist directors (e.g. Finance Director) and NEDs but it can be questioned whether a NED could realistically challenge the “executive” counterparts effectively.

Of more immediate and scurrilous interest, however, is the distinction between wrongful trading (a disqualification issue for directors) and fraudulent trading (a criminal matter).

Fraudulent vs. wrongful trading can be exemplified as: asset stripping vs. misplaced optimism – and it may be the banker who can aid the prosecution by giving evidence as to the state of mind of the director(s) as this appears to be the wafer dividing the two concepts.

Did the director intend to defraud?  Or were the same actions able to be interpreted as wishful thinking that the market would pick up or that sunny days were just around the corner?

The objective judgement of a liquidator is often used to determine the status of the action.  For example, taking on new credit at a time that a “rational director” knew or should have known that there was no expectation of being able to repay it – is that fraudulent or wrongful?

Fraudulent Trading

Selling an asset at a value well below its market price at a time when the company is technically insolvent can also be interpreted as “fraudulent”, especially when the asset is sold to a new company in the stewardship of the same directors (See my blog on Phoenixism).

Statistics from the courts show that successful fraudulent trading prosecutions are very rare.  Evidence can be well hidden, funding to investigate limited and that all important “intention” most tricky to prove.

References

FCA, (2018), A report on an independent review of Royal Bank of Scotland Group’s treatment of small and medium sized enterprise customers referred to the Global Restructuring Group.  Available at: https://www.fca.org.uk/publication/corporate/final-summary-independent-review-rbs-grg.pdf

Ooghe, H., and De Prijcker, S. (2008), Failure processes and causes of company bankruptcy: a typology, Management Decision, Vol. 46(2) pp. 223 - 242

Milman, D. (2013) Governance of Distressed firms, Edward Elgar, Cheltenham, ISBN: 9781781000182