best available settlement.25 It will be seen below that such co-ordination challenges have a dramatic effect on the potential of certain strategies for effecting turnarounds and rescues – such as the London Approach.26

The stages of informal rescue

Assessing the prospects

There are seldom clearly identifiable times in corporate life when rescue steps are required. As noted in chapter 4, the financial state of a company can be thought of as a portrait painted by accountants or company directors, a picture that may reflect a variety of ‘calculative technologies’, disciplinary perspectives and even sets of negotiations.27 Different actors, moreover, may play key roles in setting up rescues. As suggested, it is traditionally a firm’s bank that initiates turnaround steps.28 In the modern world of complex debt, however, the scenario may be quite different. The earliest signs of trouble may become apparent first to the hedge funds, investment banks and others who are swiftest to notice that a company’s high-yield debt has started to trade at below par; or that the rating agencies have downgraded the relevant paper; or that the credit insurers have tightened supply lines.29 The market may then develop its own momentum as the company’s own ‘relationship’ bank may start to sell its senior debt, the credit market loses confidence, and unfriendly buyers start to purchase controlling positions in the debt structure.

A firm’s own directors may also institute actions.30 They may call in firms of accountants to act as company doctors or specialist corporate

25See G. Tett, ‘GUS Saga Shows the Tide is Turning’, Financial Times, 15 November 2006, and A. Sakoui, ‘The Delicate Task of Restructuring Lehman Begins’, Financial Times, 27 October 2008.

26See pp. 311–14 below.

Accountants and the Social Construction of Markets (Routledge, London, 1995).

28R3’s Ninth Survey of Business Recovery in the UK reported in 2001 that when insolvency professionals were brought into a firm to carry out turnaround work such a step was instigated by a secured lender in 60 per cent of cases. See also R. Bingham, ‘Poacher Turned Gamekeeper’ (2003) Recovery (Winter) 27 (stating that it is usually the banks that call in interim turnaround executives).

29See A. Wollaston, ‘The Growing Importance of Debt in European Corporate Transactions’ (2005) 18 Insolvency Intelligence 145–9.

30On the difficulties that directors may encounter in dealing with the credit derivatives market see ibid.

troubleshooters may be consulted. Directors have been said to be responsible for appointing turnaround IPs in a fifth of cases.31 There are particular dangers to be borne in mind by directors when rescue measures are under consideration. They must look to their potential legal liabilities and must act consistently with their obligations. These are reviewed in chapter 16 but will be noted in outline here.32

The first of four main areas of concern is the director’s potential liability for wrongful trading under section 214 of the Insolvency Act 1986, which requires directors to monitor the financial position of the company and when they conclude, or should conclude, that there is no reasonable prospect of their company avoiding insolvent liquidation they must take every step which a reasonably diligent person would take to minimise potential loss to the company’s creditors. If, after a company has entered insolvent liquidation, a court considers a director has failed to discharge such a duty, it may require the director to make such contributions to the company’s assets as it thinks fit.33 What matters for such purposes is not the actual knowledge of the director but the knowledge that might reasonably be expected of a person carrying out the director’s particular functions in the company. In the rescue context, directors must consider the prospects of avoiding insolvent liquidation and, if they are unsure of the position, must take heed of their duties to minimise potential losses to creditors and, when necessary, must cease trading and commence suitable insolvency procedures. A special concern of directors will, accordingly, be whether any agreed arrangement will allow debts to be paid as they fall due and whether projected cash flows and incomes will allow rescheduled loan payments to be met.

Under the Insolvency Act 1986, liability for wrongful trading (under section 214) applies not merely to directors but also to shadow directors, who are defined in section 251 as persons ‘in accordance with whose directions or instructions the directors of the company are accustomed

31R3, Ninth Survey (2001).

32See N. Segal, ‘Rehabilitation and Approaches other than Formal Insolvency Procedures’ in R. Cranston (ed.), Banks and Remedies (Oxford University Press, Oxford, 1992) p. 133.

33See Insolvency Act 1986 s. 214(1). Such jurisdiction was deemed to be primarily compensatory in Re Produce Marketing Consortium Ltd [1989] 5 BCC 569; compare the discussion in ch. 16 below.

to act’.34 A stakeholder may be treated as a shadow director if they exercise ‘real influence’ over the board35 and in the case of Becker36 emphasis was placed on proving that the de jure directors followed a consistent pattern of compliance with the instructions of the putative shadow.

When a bank exercises ‘intensive care’ over a distressed company it accordingly runs risks. It may be deemed a shadow director if, at a time of threatening insolvency, it gives ‘directions or instructions’ to the client company, as distinct from giving professional advice or merely imposing conditions for making or continuing a loan.37 There is evidence, however, that some judges may sympathise with the bank’s good intentions. Thus, in Re PFTZM Ltd, Jourdain v. Paul38 Judge Baker QC stated that a bank was unlikely to be treated as a shadow director, even where it exercised a considerable degree of control over the management of the company, when its actions were motivated by a desire to protect its position. Milman has cautioned, however, that such comments were obiter dicta and that ‘this is a questionable proposition in that it appears

to confuse objective conduct with the subjective motivation behind such actions’.39

Nor is the position of the independent consultant to a troubled company one that precludes uncertainty.40 A professional adviser acting strictly in that capacity is exempt from categorisation as a shadow

34Based on the definition in the Companies Act 2006 s. 251. Shadow directors will not merely be liable for wrongful trading, they could also be subject to a number of provisions, notably those requiring disclosure or controlling certain types of transaction: see Companies Act 2006 ss. 187(1)–(4), 188(7), 223(1), 230; Insolvency Act 1986 ss. 206 (3), 214(7). (This section builds on V. Finch, ‘The Recasting of Insolvency Law’ (2005) 68 MLR 713.) See also ch. 16 below.

35See Secretary of State for Trade and Industry v. Deverell [2001] Ch 340, [2000] 2 BCLC 133. See D. Milman, ‘A Fresh Light on Shadow Directors’ [2000] Ins. Law. 171; J. Payne,

‘Casting Light into the Shadows: Secretary of State for Trade and Industry v. Deverell ’

(2001) 22 Co. Law. 90; S. Griffin, [2003] 54 NILQ 43. See also Re Hydrodan (Corby) Ltd [1994] BCC 161.

36Secretary of State for Trade and Industry v. Becker [2003] 1 BCLC 555. See S. Griffin,

‘Evidence Justifying a Person’s Capacity as Either a De Facto or Shadow Director:

Secretary of State for Trade and Industry v. Becker’ [2003] Ins. Law. 127.

37See Re A Company (No. 005009 of 1987), ex p. Copp [1988] 4 BCC 424.

38[1995] BCC 280.

39D. Milman, ‘Strategies for Regulating Managerial Performance in the Twilight Zone’ [2004] JBL 493, 495–6.

40See P. Godfrey, ‘The Turnaround Practitioner – Advisor or Director?’ (2002) 18 IL&P 3.

director41 but it is clear from Re Tasbian Ltd (No. 3)42 that a company doctor or management consultant may in certain circumstances be deemed a shadow director. In that decision, the Court of Appeal held that there was an arguable case sufficient to go to trial, that an accountant, brought in to advise a troubled company as a consultant and company doctor, was a shadow director, having allegedly gone further than merely acting as a watchdog or adviser.

Such legal questions, nevertheless, do not constitute insuperable impediments to a new focus on preventative measures. The courts have yet to hold a bank to be a shadow director for exercising ‘intensive care’. It would be a mistake, moreover, to confuse the timing of, say, a bank’s intervention in the management of a company with the intensity and breadth of that intervention. Provided that bank monitoring, scrutiny and advice do not constitute directions or instructions that the directors follow in a consistent pattern, the lenders will not be liable as shadow directors. It is arguable, furthermore, that the courts might well see themselves as having no especially strong reasons for holding banks to account as shadow directors when lenders exercise ‘intensive care’.43 The purpose of the Insolvency Act 1986 section 214 wrongful trading provision is primarily to stop directors from continuing to trade during troubled times so that unjustifiable risks are run at the creditors’ expense.44 There is, accordingly, little cause to hold the major lender to account if the funds at risk were largely their own and if there is evidence that rescue attempts were for the benefit of creditors as a whole. There is a case, perhaps, for holding banks liable under section 214 when there is evidence that the bank’s actions as a shadow director prejudiced the interests of other creditors – for example, unsecured creditors.45 Should

41Companies Act 2006 s. 251(2); Insolvency Act 1986 s. 251: ‘a person is not deemed a shadow director by reason only that the directors act on advice given by him in a professional capacity’ (the wording is the same in both sections).

42[1992] BCC 358. See O. Drennan (1993) 8 IL&P 176 for comment; and Milman, ‘Strategies’, p. 496.

43On reasons for deeming a party to be a shadow director and the link with mischiefs see Deverell where Morritt LJ stated that the definition of a shadow director was to be construed in a normal way to give effect to the parliamentary intention ascertainable from the mischief to be dealt with and the words used: [2000] 2 BCLC 133, 144–5.

44See Cork Report, ch. 44; V. Finch, ‘Directors’ Duties: Insolvency and the Unsecured Creditor’ in A. Clarke (ed.), Current Issues in Insolvency Law (Stevens, London, 1991).

45The bank may, for instance, be found to have brought undue pressure on the directors to cease certain operations where continuing those activities would have improved returns to unsecured creditors without significantly increasing risks to the bank. It is to be expected that the courts would not be quick to hold banks liable as shadow directors

the courts endorse such reasoning, the legal constraints on ex ante approaches to insolvency risk management may not prove daunting in most cases since the bank will often be the main creditor and potential liabilities will be relatively small.

It should also be borne in mind that even if it does act as a shadow director, the bank will only be liable for wrongful trading under the Insolvency Act 1986 section 214(2)(b) if it continues to act as a shadow director after it knew, or ought to have concluded, that there was no reasonable prospect that the company would avoid going into insolvent liquidation.46 Few banks, it is to be expected, will continue to put resources into intensive care after the point when liquidation has become inevitable.

A second area of directors’ concern will be their potential liability for fraudulent trading under section 213 of the Insolvency Act 1986. Directors, under this provision, may be liable to make contributions to the company’s assets where it appears, in the case of the winding up of the company, that any business has been carried on with intent to defraud creditors or for any fraudulent purpose. Criminal liability may also be involved.47 Fraudulent trading will thus be engaged in when a director obtains credit for the company when he knows that there is no good reason for thinking that funds will be available for repayment when due or shortly thereafter.48

A third area of relevant directorial worry relates to the general fiduciary duty of a director to act bona fide in the interests of the company, a duty that requires consideration of the interests of creditors as well as shareholders.49 Where rescue arrangements are under discussion,

where doing so would chill the provision of rescue funding by creating expectations of liability or uncertainties for banks. There is some evidence that when companies are in ‘intensive care’ the banks tend to reduce their exposure to the debtors with the effect that, in 25 per cent of failures, the trade creditors would tend to be more exposed: see J. Franks and O. Sussman, ‘The Cycle of Corporate Distress, Rescue and Dissolution: A Study of Small and Medium Size UK Companies’, IFA Working Paper 306 (2000) pp. 16–19.

46On the time at which a party ‘knew or ought to have concluded’ etc., see Re Continental Assurance Co. of London plc [2001] All ER 229, [2001] BPIR 733; Liquidator of Marini Ltd v. Dickenson: sub nom. Marini Ltd, Re [2004] BCC 172 (Ch). See further ch. 16 below.

47Companies Act 2006 s. 993; R v. Grantham [1984] 2 WLR 815; Morphitis v. Bernasconi [2003] Ch 552.

48R v. Grantham [1984] 2 WLR 815.

49Liquidators of West Mercia Safety Wear Ltd v. Dodd [1988] 4 BCC 30. See further ch. 16 below; Finch, ‘Directors’ Duties: Insolvency and the Unsecured Creditor’; Finch, ‘Directors’ Duties Towards Creditors’ (1989) 10 Co. Law. 23; Finch, ‘Creditors’ Interests and Directors’ Obligations’ in S. Sheikh and W. Rees (eds.), Corporate Governance and Corporate Control (Cavendish, London, 1995). See also Companies Act 2006 s. 172(3).