Corporate failures – can the UK’s financial regulator lead the charge? – Paul Brehony, Abdulali Jiwaji and Johnny Shearman

By Paul Brehony & Abdulali Jiwaji

Partners Paul Brehony and Abdulali Jiwaji and Professional Support Lawyer Johnny Shearman examine the conflict between the UK’s financial regulatory regime and its insolvency legislation, following the news that the FCA is planning to take action against Carillion and some of its former directors.

This article was first published in Global Restructuring Review, 11 December 2020, and can be found here.

With news that a number of UK companies are on the brink of collapse, it is timely that the Financial Conduct Authority (FCA) has set out its plans to take action against the construction and facilities giant, Carillion, and some of its former directors following the company’s liquidation in January 2018.

Carillion was one of the UK government’s biggest contractors but it failed under a burden of approximately £7 billion of debt after the government refused to bail it out.

Last month, the UK regulator issued warning notices to a number of Carillion’s former executive directors as well as the company itself for alleged market abuse between 2016 and 2017. The FCA alleges specific breaches of the Market Abuse Regulation (MAR), the Listing Rules and Premium Listing Principles. The FCA claims that numerous misleading and inaccurate market announcements were made by the company during this time. The statements were misleadingly positive about Carillion’s financial performance generally and in relation to the UK construction business. The information purportedly gave false signals as to the value of the company’s shares.

Those directors hit with warning notices have been singled out for failing to act with integrity and labelled as reckless by the regulator for failing to ensure Carillion’s announcements were reasonably accurate.

Conflict between the regulatory regime and insolvency framework

The issuance of these warning notices has understandably attracted notable publicity in terms of regulatory scrutiny in the aftermath of a significant corporate failure.  At the same time, this development illustrates that there was, and continues to be, an important balancing act between the regulatory regime and insolvency framework in play which deserves some focus. That balancing act was played out before the High Court culminating in a judgment which was handed down in August of this year (FCA v Carillion PLC (in Liquidation) [2020] EWHC 2146 (Ch)).

As regulator, the FCA’s role, understandably, includes protecting against market abuse. Its powers include imposing restrictions and large financial penalties on those it regulates. When deciding to take action against a business, the Regulatory Decisions Committee (RDC) first decides whether to issue a warning notice which sets out the alleged acts and, if it then proceeds with the action, to issue a decision notice specifying the outcome and any monetary penalty. However, when Carillion entered liquidation, it benefitted from a liquidation stay pursuant to section 130(2) Insolvency Act 1986 (IA 1986). This stay protects an insolvent estate for the benefit of the company’s creditors by preventing any “action or proceeding” being continued or commenced against the company or its property. An exception to such a stay can be made where permission is obtained from the court.

When the FCA initially considered issuing a warning notice against Carillion, the Official Receiver cautioned the FCA stating that the regulator would require permission from the court to proceed. This was on the basis that the warning notice would contravene the stay in place as it would constitute an action or proceeding under section 130(2) IA 1986. Proceeding with caution, the FCA sought a declaration from the court to confirm whether a warning notice would fall within the scope of the Insolvency Act and, if so, permission to issue the notice.

The decision of the High Court was unambiguous. It concluded that it is unarguable that the underlying purpose of section 130(2) applies even where the FCA intends to issue a warning notice. A liquidator must be afforded time to investigate the position before being able to respond to a warning notice or to permit the company to continue to make representations to FCA.

As the High Court noted, it would be surprising to find that this particular statutory role of the FCA, acting as a body required to ensure markets function well and with integrity, would not be subject to the control of the insolvency court for a company in liquidation. The role requires the FCA to hold and determine quasi-legal proceedings. This process and type of decision, the court concluded, should therefore be subject to the provisions of section 130(2) when it is a process and decision which directly and specifically concerns an insolvent company. This is because the decision may affect creditors and impact the conduct and operation of the liquidation, its cost and expense and any distribution (for example, if the FCA becomes a creditor through the sanction of a penalty or otherwise).

Having established that the stay prevented the FCA from issuing the warning notices without the court’s permission, the court proceeded to determine whether it would grant leave for the FCA to proceed. When making this decision in the context of liquidation stay, the court must apply a test of what is right and fair according to the circumstances of the case (Cosco Bulk Carrier Co Ltd v Armada Shipping SA TX Pan Ocean Ltd [2011] EWHC 216 (CH)). In this instance, permission was given, as this was held to be in the public interest, but with conditions attached. In particular, while the FCA can issue (and subsequently has issued) the warning notices, the regulator is required to seek further permission from the court should it wish to impose a financial penalty. At this stage, the FCA has indicated that it only intends to publicly censure Carillion, but there is scope for that position to change.

Striking the right balance

Understandably, the FCA was concerned that the High Court’s decision could affect many other actions taken by it. In its submission to the court, the regulator noted that the issuance of a warning notice applies to a wide range of its regulatory processes (over two hundred were cited) but that this was the first time this issue had come before the court. The FCA’s concern centred on the public interest and importance of ensuring that it is capable of fulfilling its statutory duties. However, on the other hand, the liquidation of a company needs to be carried out efficiently in order for realisations to be distributed to creditors.

As noted in the judgment, a clear tension exists between the two statutory regimes. On this occasion, balance was achieved by the court’s decision to grant the FCA leave to pursue regulatory actions, albeit ruling out a financial penalty without further permission from the court.

While this is the first time the FCA has had to grapple with an insolvency stay, other regulatory bodies have done so already. In Re Frankice (Golders Green) Ltd (In Administration) [2010] EWHC 1299 (Ch), it was held that the Gambling Commission’s regulatory processes were caught by the comparable administration stay under paragraph 43(6) of Schedule B1 IA 1986.

It is likely, therefore, that the courts would adopt a similar position were the FCA taking action in respect of an entity caught by an administration stay – because the courts have already decided that there is no material difference between a stay under section 130(2) and paragraph 43(6) of Schedule B1 IA 1986 (Harms Offshore Aht “Taurus” GmbH& Co KG v Bloom & Ors [2009] EWCA Civ 632). However, notably, there is a difference between the provisions when deciding to grant leave. The primary concern of an administration stay is to achieve the purpose of the administration. Whereas, for the purposes of a liquidation stay, the court will apply a test of what is right and fair. Conceivably, this leaves room for the court to strike a different balance when determining whether permission should be granted for the FCA to pursue a regulatory action against a company in administration.

Enforcement and litigation risk

Inevitably seeking leave to proceed against a company where there is an insolvency stay in place will become part of the FCA’s processes going forward. However, as the Carillion case demonstrates, directors of distressed companies will not be insulated from action by virtue of the insolvency process. While the FCA has indicated that it will not impose a financial penalty on Carillion, which negates any need for it to go before the court again, it has been ambiguous as to whether it would pursue financial penalties against the former directors.

The FCA has signposted its intention to target misconduct by directors and senior managers of regulated firms, but enforcement activity in this area has been relatively light in recent years.  There is an example of action taken last year by the FCA to fine the CEO and Finance Director of Cathay International Holdings Limited £214,300 and £40,200 respectively for being knowingly concerned in the company’s breaches of the Listing Rules.  This might be seen as part and parcel of the FCA’s focus on instances of market misconduct.  The bigger issue for the FCA is whether it can be seen to be effective in cases involving corporate governance failings and larger corporate collapses, when there is an insolvency overlay.  Questions are already being asked of the FCA in this regard with Dame Elizabeth Gloster recently handing over to the FCA the findings of her independent investigation into its handling of the collapse of London Capital & Finance Plc. Any further steps taken by the FCA in relation to Carilllion will be telling of the regulator’s capacity and appetite to become embroiled with the insolvency regime.

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