Issues for directors of listed companies in financial difficulty
Pursuant to section 172(1) of the CA2006 a director must act in the way he considers, in good faith, would be most likely to promote the success of the relevant company for the benefit of its members as a whole.
Section 172(3) provides that the duty imposed by section 172(1) has effect “subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company”. Cases have since determined that where the insolvency of a company is probable, the directors owe a duty to act in the best interests of creditors. This is perhaps best articulated in the following statement of Street CJ in Kinsela & Anor v Russell Kinsela Pty Ltd (in liquidation)  4 NSWLR 722:
...“in a solvent company the proprietary interests of the shareholders entitle them as a general body to be regarded as the company when questions of the duty of directors arise... But where a company is insolvent the interests of the creditors intrude. They become prospectively entitled, through the mechanism of liquidation, to displace the power of the shareholders and directors to deal with the company’s assets.”
Liability for a failure to maintain this duty is enshrined in section 212 of the IA1986, whereby a liquidator may bring an action for misfeasance against directors who have breached their duty to creditors. Directors must also take steps to avoid liability under various other provisions of the IA1986. The most obvious is an action under section 214 for “wrongful trading”, whereby a director of a company who knew, or should have known, that the company had no reasonable prospect of avoiding insolvent liquidation (likely to be a point in time after duties have shifted to creditors) must take all steps with a view to minimising losses to creditors.
A successful challenge can have severe consequences for the director concerned, ranging from an adverse “D report” in relation to his conduct to personal liability for any losses caused to creditors as a consequence of a failure to take such steps in those circumstances.
Relationship between directors’ duties and reporting obligations
It is clear that directors of companies where insolvency is probable must be primarily concerned with the impact which their decisions may have on creditors.
However, there is something of a conflict between such concerns and the obligations of the directors to make announcements to the markets for the benefit of current and prospective shareholders.
Companies admitted to trading on EU regulated markets, multilateral trading facilities or organised trading facilities (referred to in the legislation as “issuers”) must comply with the EU Market Abuse Regulation (MAR). Pursuant to Article 17(1) of MAR:
“An issuer shall inform the public (typically by a stock market notification) as soon as possible of inside information which directly concerns that issuer...”
“Inside information” is, broadly, information, which:
- is of a precise nature;
- has not been made public;
- relates directly or indirectly to the issuer or its shares; and
- would, if it were made public, be likely to have a significant effect on the price of its shares.
The third part of the test is predicated on the “reasonable investor” test, which MAR defines as follows:
...“information which a reasonable investor would be likely to use as part of the basis for his or her investment decision” (MAR Article 17(4)).
Recital 49 of MAR explains that,
“The public disclosure of inside information by an issuer is essential to avoid insider dealing and ensure that investors are not mislead”.
The disclosure regime addresses wider issues than the relationships between an issuer and its shareholders and creditors. It instead exists to ensure that there is a “level playing field” so that investors do not sell or purchase securities in circumstances where there is material information about which they do not know that would affect their investment decision. It is not difficult to think of circumstances that would rapidly lead to a general loss of confidence in capital markets if the regime did not exist.
It is therefore no surprise that the disclosure regime does not contain a general carve-out for announcements which would breach directors’ duties. The regime does, however, allow disclosure to be delayed in certain circumstances. MAR Article 17(4) provides that:
“An issuer may, on its own responsibility, delay disclosure to the public of inside information, such as not to prejudice its legitimate interest provided that all of the following conditions are met:
- immediate disclosure is likely to prejudice the legitimate interests of the issuer;
- delay of disclosure is not likely to mislead the public; and
- the issuer is able to ensure the confidentiality of that information.”
The principal application of avoiding prejudicing “legitimate interests” is to negotiations. Paragraph 5(1)(8)(a) of MAR guidelines on delay in the disclosure of inside information published by the European Securities and Markets Authority (the ESMA Guidelines) makes clear that there could be a legitimate interest where:
“the financial viability of the issuer is in grave and imminent danger, although not within the scope of the applicable insolvency law, and immediate public disclosure would seriously prejudice the interests of existing and potential shareholders by jeopardising the conclusion of the negotiations designed to ensure the financial recovery of the issuer.”
The FCA has stated in paragraph 2.5.4 of its Disclosure Guidance and Transparency Rules that,
“In the FCA’s opinion, paragraph 5(1)(8)(a) of the (ESMA Guidelines) does not envisage that an issuer will:
- delay public disclosure of the fact that it is in financial difficulty or of its worsening financial condition and is limited to the factor substance of the negotiations to deal with such a situation; or
- delay disclosure of inside information on the basis that its position in subsequent negotiations to deal with the situation will be jeopardised by the disclosure of its financial condition.”
Of particular concern will be the potential erosion to the value of the company’s business and assets that an announcement would be likely to cause, as well as alerting the market that the company may soon enter an insolvency process. Dealings with suppliers will become almost impossible, employee morale will plummet and debtor collections will become far more difficult. Shareholders may be therefore left with shares whose value falls significantly, notwithstanding the fact that the company is in negotiations with its creditors about providing additional funding. That notwithstanding, the disclosure regime is very clear. The company’s financial difficulty must be announced to the market immediately (although it can delay the announcement of its negotiations with its creditors). In other words, general duties to shareholders and creditors are overridden by specific rules around the importance of maintaining confidence in the capital markets. However, directors will also be careful to avoid making an announcement later than necessary, and being accused of misleading the market by doing so.
The FCA is granted extensive powers for breaches of MAR. It could issue significant fines, which in itself could be harmful to the interests of creditors, from a directors’ duties perspective. It is also authorised to suspend, prohibit, order injunctions, bring criminal prosecutions or take other action to prevent market abuse and make a public announcement when it begins disciplinary action against a firm or individual and publish details of warning notices.
Although directors’ duties change when a company is in financial difficulty, a listed company’s disclosure obligations do not, and there is therefore a tension between the competing interests of creditors against the regulatory requirement for transparency. It is difficult to see, from a public policy perspective, a scenario where a court would hold that directors were in breach of their duties to act in creditors’ interests as a result of having procured that the issuer comply with specific legal and regulatory obligations, but this must be very carefully managed.
Directors of listed companies will, therefore, wish to avoid liability towards the FCA as well as under the provisions of the IA1986 set out above and should, therefore:
- take legal advice;
- ensure relevant creditors are aware of the company’s disclosure obligations, and the possible consequences of an early/late announcement;
- have the wording for any possible announcement prepared and ready to be issued at short notice;
- minute decisions and keep records of discussions with lenders and advice received as well as discussions of whether to announce or not and have a full audit trail supporting those decisions; and
- take advice from the sponsor (full list)/NOMAD (AIM) on the application of MAR/AIM Rules.
In situations where creditors are themselves regulated by the FCA, and required under regulation to conduct business with integrity, with due skill, care and diligence and to observe proper standards of market conduct, there ought to be a common interest from a compliance perspective. However, again, dialogue to ensure that disclosure obligations are properly understood will be vital.