Loose regulation allows insolvency to be “weaponised”, MP says as APPG report casts shadow over industry

Loose regulation allows insolvency to be “weaponised”, MP says as APPG report casts shadow over industry

Parliamentary report seeks to eradicate conflict of interest in "Wild West" insolvency industry

Loose regulation allows insolvency to be “weaponised”, MP says as APPG report casts shadow over industry

A weak regulatory system and a lack of accountability enable the insolvency industry to be “weaponised” by banks for financial gain, according to Kevin Hollinrake MP, co-chair of the All-Party Parliamentary Group (APPG) for Fair Business Banking.

Hollinrake’s warnings follow the APPG’s release of a report earlier today denouncing deeply-rooted failings within the insolvency industry and calling for a quick regulatory clampdown on the sector’s “Wild West” practices.

“There are too many examples where there’s an ability for the powers that insolvency practitioners (IPs) have to be abused – what we’re not seeing is robust regulation of those practitioners,” Hollinrake told Accountancy Age on Tuesday.

“We’ve seen that insolvency can almost be weaponised, rather than what it should be – which is an incredibly important part of a healthy free-market society.”

The foundational argument of the APPG report, which draws on evidence from a nine-month investigation into the sector, is that IPs’ ability to seize and sell assets are often abused by banks or secured creditors, who strike secretive deals with IPs in order to profit from a company’s financial distress.

Around that central dynamic, the report says “evidence of intimidation, deception, dishonesty and even misappropriation of assets, all involving IPs supposedly performing their court-appointed functions” had been found.

One such example cited by the APPG is the “grave misconduct” of KPMG in advising the recent sale of bed manufacturer Silentnight to US private equity firm HIG Capital.

The findings adjudged the Big Four accounting firm to have helped force the company’s insolvency in order for it to be acquired without its £100m pension liabilities in tow. In August this year, KPMG was fined a near-record £13m for its involvement.

The report also extensively references the scandal surrounding HBOS Reading, which emerged in 2016. Lyndon Scourfield and Mark Dobson, both directors in HBOS’ impaired assets division, were found to have abused their positions of power at the bank, using insolvency practitioners to misappropriate sums of money in excess of £1bn.

“Critically, at the heart of this is a closeness between the banks and the large accountancy firms,” says Toby Starr, partner at law firm Humphries Kerstetter, which assisted in producing the APPG’s report.

“There are secretive discussions that are likely to have been going on for months before any official insolvency takes place – and by that point, there is very often a pre-agreed plan in place between the bank and the insolvency practitioner.

“It’s inevitable that in a competitive market, if there are lucrative jobs to be won, you look to the person most likely to secure the next job.”

Mismatch between legislative framework and market incentives

Starr also highlights the Enterprise Act of 2002 as a key reference point in this scenario, arguing that while the provisions were intended to enhance efficiency and increase accountability in corporate rescue proceedings, insolvency professionals continue to act above this legislation.

“The Act led people to expect a particular approach – that there would be a focus on rescue culture.

“There was an expectation that jobs would be protected and that there will be a long-term approach to businesses in financial difficulty – but on the other hand there’s what’s happened on the ground.”

This is echoed by Alan Tilley, president of the European Association for Certified Turnaround Professionals, who notes that insolvency professionals actively shirked their responsibility to preserve businesses as going concern.

“They totally abandoned that – they don’t do that anymore. I’m not privy to what their discussions are, but they’re clearly in favour of doing what the banks want.

“So, viable businesses that could be turned around are going prematurely into insolvency with a loss of value and a loss of jobs. And the bottom line is that it’s extremely lucrative.”

Tilley’s view is also reflected in the APPG’s report, which points out that, under the UK Insolvency Act, the “Objective One” of any administration should be, wherever possible, to rescue a business as a going concern.

Instead, the report states that a “defining characteristic of the insolvency industry that emerged from our work is how far IPs have departed from the core principles of the Insolvency Act, that rescuing a business should be the primary goal of their work […] Pretty much no administrations achieve Objective One.”

Tilley also laments the new moratorium introduced by the Corporate Insolvency and Governance Act of 2020 (CIGA). Crucially, the Act stipulates that the moratorium supervisor must be an insolvency practitioner.

“This is just perpetuating the very conflict that has caused the problem to occur,” he says.

“What we are lobbying for is for turnaround professionals to be recognised as suitably qualified to handle the moratorium.”

APPG’s five policy recommendations

Having detailed its guiding premise and the findings of the APPG investigation, the report concludes by outlining five recommendations that are designed to tackle and remedy the issues in the insolvency industry.

Firstly, it suggests measures to eradicate conflict of interest within the insolvency process – most notably, forbidding IPs to be appointed in a scenario where they have personally been involved with the “interested party” within the previous two years – a measure that would “introduce true independence,” the paper says.

The report, however, goes further to suggest that a wider ban covering entire firms, rather than just individuals, would be preferable in the future.

“There is no doubt that this would better protect conflicts of interest. We consider that a ban on this wider basis should be a longer-term aim.”

The second recommendation proposes the introduction of a single regulator with an ombudsman – a suggestion originally put forward during an Insolvency Service call for evidence in 2019. This would replace the existing recognised professional bodies (RPBs), which also oversee the accounting and audit professions.

“We see the attraction of introducing a single regulator for reasons of consistency and confidence,” the report says, adding that the addition of an ombudsman would “assist in the swift, low-cost resolution of certain disputes”.

The report also recommends placing the Insolvency Code of Ethics on statutory footing, allowing its enforcement to be punitive and consequential.

“It has no force of law and no teeth without sanction, which is currently effectively absent,” the report says. There should be “provision for reliance on breaches by shareholders and cred­itors”, it adds.

The report’s fourth recommendation proposes a centralised database recording the outcomes of administrations. The rationale behind the proposal is that, since the Enterprise Act’s aim of enhancing efficiency in corporate rescue proceedings, there has been no proper assessment of its effectiveness due to a lack of documentation.

“Impact assessments are common in other areas of public policy,” the report says. “In the years since the Enterprise Act, no proper assessment of the effectiveness of the statutory objective of rescue has been possible.”

On this point, Hollinrake adds: “That’s one of the things the industry could do tomorrow.”

Finally, the report details five other ‘rule changes’ designed to support the other four recommendations.

These measures include barring legislative administrators from discussing or pre-agreeing strategies with appointing creditors, and removing banks’ veto powers, which currently grant the lender the right to choose an IP.

The report also suggests putting the obligation for an IP to seek solvent rescue is put on statutory footing, as well as extending new evaluator process to cover asset sales over £5m.

Moreover, the government should re-consider extending the CIGA moratorium to financial contracts and imposing a statutory charge or levy over 5 percent of an insolvent company’s assets, the report says

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