An update on Directors and Officers liabilities, May 2015

Briefing

21 May 2015

7 MIN READ

1 AUTHOR

In this Briefing: Overview of new Senior Managers Regime for financial institutions; What are the new director compensation orders that the Small Business, Enterprise and Employment Act 2015 will introduce into the Company Disqualification Act 1986?

Overview of new Senior Managers Regime for financial institutions

Background

The Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) are proposing changes to the regulatory regime for senior bankers in the UK in order to “make individual responsibility in banking a reality” in the words of the report of the Parliamentary Commission on Banking Standards whose recommendations formed the basis of the new regime. This included:

The statutory and regulatory framework in place had been inadequate. It did not clearly provide for individual accountability and consequently public trust was lost in the banking system and its regulation. Initially, the Parliamentary Commission on Banking Standards recommended making amendments to the Financial Services and Markets Act 2000. This was effected through the Financial Services (Banking Reform) Act 2013 which introduced structural reform of the banking industry and measures aiming to increase the capacity of banks to absorb losses. The new Senior Managers Regime is the next step in the new regime.

In July 2014, the PRA and FCA published joint consultation paper CP14/14, which proposed the following changes:

This Briefing focuses on the SMR.

The proposals apply to UK-incorporated banks and investment banks. HM Treasury may also expand the scope of the regime to non-UK-incorporated banks and investment banks.

SMR – principal changes

Current status

As stated above, the FCA and PRA issued their consultation paper CP14/14 in July 2014. They stated that they would consider feedback on responses received to this paper.

On 16 March 2015, the FCA and PRA published consultation paper CP15/9, in which they set out their policy intentions as a result of the feedback received.

HM Treasury has announced that the new regime will need to come into force by 7 March 2016. The FCA and PRA therefore plan to publish final rules in either the late spring or summer of 2015.

In the meantime, the FCA invites firms to provide comments on its proposals by 16 June 2015 using their online response form at http://www.fca.org.uk/your-fca/documents/consultation-papers/cp15-09-response-form.

Insurers’ response

What does this then mean for D&O insurers?

What are the new director compensation orders that the Small Business, Enterprise and Employment Act 2015 will introduce into the Company Disqualification Act 1986?

A “compensation order” is an order requiring the person against whom it is made to pay an amount to the Secretary of State for the benefit of creditor(s) or a class of creditor(s) as a contribution to the assets of company (amended section 15B(a) of the CDDA 1986).

The Secretary of State can apply for the compensation order within 2 years of a disqualification order being made against a director (amended section 15A(5) of the CDDA 1986).

Factors to be taken into account in determining the amount to be paid under a compensation order are:

Alternatively, the Secretary of State may accept a “compensation undertaking” from the relevant director instead of applying for a compensation order (amended section 15A(2) of the CDDA 1986). A “compensation undertaking” is an undertaking to pay an amount specified in the undertaking to the Secretary of State for the benefit of a creditor or class of creditors as a contribution to the assets of the relevant company (amended section 15B(2) of the CDDA 1986).

Comparison with the Insolvency Act 1986

Prima facie, the compensation orders introduced by the 2015 Act appear remarkably similar to sections 212 to 214 of the Insolvency Act 1986 (IA 1986), which allow liquidators to apply to the court for an order that directors contribute to the assets of the insolvent company:

The principal difference between the IA 1986 and 2015 Act is that the 2015 Act does not specify that any “wrongful” or “fraudulent” activities are required in order for the application for compensation to be made. It merely requires a person subject to a disqualification order to have caused loss to creditors. Therefore, conduct might warrant disqualification and give rise to a claim for a compensation order under the 2015 Act, even though it might not reach the threshold of sections 213 or 214 in the IA 1986. For instance, disqualification for failure to maintain proper books and records.

However, in practice, it is difficult to imagine many situations where the Secretary of State would apply for a compensation order without an element of wrongful or fraudulent trading having been committed by directors.

The new Insolvency Rules are expected to come into force in April 2016. It is possible that the director compensation orders will be incorporated into these Rules given their similarity to the provisions of the current IA 1986.

What is the potential impact of the new director compensation orders upon D&O insurance?

There is some uncertainty as to coverage of D&O insurance if a director is subject to a compensation order made under the 2015 Act. However, in general terms it may be assumed that:

For more information, please contact John Barlow, Partner, on +44 (0)20 7264 8188, or john.barlow@hfw.com, or your usual contact at HFW.

Footnote

The 2015 Act states that “the conditions are that –
(a) the person is subject to a disqualification order or disqualification undertaking under this Act, and
(b) conduct for which the person is subject to the order or undertaking has caused loss to one or more creditors of an insolvent company of which the person has at any time been a director.”