Challenging markets – the risks to directors of energy companies in financial difficulty

Posted: 18/10/2021

The coronavirus pandemic posed a significant challenge to the financial health of businesses across the UK. A sector additionally at the mercy of the markets following the easing of lockdown restrictions is the energy industry, with the wholesale price of natural gas (measured on a pence per therm basis) having risen dramatically from around 50p/therm in January 2021 to over 200p/therm during the first few weeks of October 2021. These market pressures are compounded by the constraints of the price cap in the domestic supply of gas and electricity, which means suppliers are unable to adjust their prices to match their costs and thus find themselves in a loss-making position.

Some larger energy suppliers were able to effectively hedge against price fluctuations by entering into long term futures contracts for the supply of gas at fixed prices, allowing them to weather the storm. Many small and medium energy suppliers, however, have sadly fallen into Ofgem’s ‘Supplier of Last Resort’ (SoLR) process and have subsequently entered into administration or liquidation.

The decisions of the company’s directors will be scrutinised carefully once in insolvency to see whether they could have acted differently in order to reduce any potential losses to creditors. While the collapse of those suppliers will have happened fairly quickly, the advice taken by directors and decisions made in the period beforehand will be critical. Those directors who acted cautiously, took advice early, and recorded decisions through regular board minutes, can take some comfort in being able to rely upon that conduct to defend themselves from personal liability. There are many more companies, however, which continue to be affected, including those commercial consumers of gas and electricity not shielded by the price cap, who are facing financial difficulty. It is vital that specialist advice is taken early to ensure that decisions made are in the interests of creditors as soon as a risk of insolvency becomes apparent. Energy sector insolvencies involve unique elements – it is therefore important to obtain advice from advisers with experience of the industry.

When should directors be worried and seek advice?

In short: when a business is on, or nearing, the bread line, meaning the business cannot pay its creditors in the usual way, its liabilities are greater than its assets, or creditors take steps to enforce a debt due by the company. The exact moment in time this is triggered is hard to pinpoint, but the safest course of action is to seek advice when there are any signs of this being likely. The key to protection is speed; directors cannot protect themselves after the event.

What are directors at risk of?

The main potential claims against directors will be brought following administration or liquidation. The claims are usually brought by the liquidator or administrator but can be assigned to third parties.

Wrongful Trading s.214 and 246ZB Insolvency Act 1986

The claim:

• Wrongful trading occurs where a company has gone into insolvent liquidation or administration, and at some time beforehand, the directors knew or ought to have known that there was no reasonable prospect of the company avoiding the insolvency; and
• they failed to take every step after that with a view to minimising potential losses to the company’s creditors.
• A defence may be available if directors can demonstrate they took those steps possible to minimise losses.
• The court will look at the knowledge, skill and experience that could reasonably be expected of a person carrying out that function (an objective test) and the knowledge, skill and experience that the individual actually possesses (the subjective test). A higher standard is applied to professionals such as accountants.

The penalty:

• If found liable, the court can order the individual to contribute to the debts or liabilities of the company. This is usually calculated with reference to the amount that the net assets were depleted by the individual’s actions (or lack of). This is especially important in the current context where losses are likely to be high.
  

Misfeasance s.212 Insolvency Act 1986

The claim:

• In broad terms, misfeasance is a claim triggered by a breach of the duties held by directors listed in sections 171-177 of the Companies Act 2006, and is a very wide claim. It is usually brought together with a claim for wrongful or fraudulent trading, unless you can demonstrate that you acted reasonably and honestly and it would be fair to excuse you from liability.
• It does not require a positive act and failing to act may be used as evidence against directors.
• It can be brought against a wide range of defendants including former directors and anyone involved in the management of the company’s affairs – you can be at risk even if you are not a formal director.

The penalty:

• If found liable for misfeasance the defendant can be ordered to:
• repay any misappropriated money or property to the company, with interest; and/or
• compensate the company by way of contribution to the company's assets.

Fraudulent Trading s.213 and s.246ZA Insolvency Act 1986 and s.993 Companies Act 2006

The claims:

• Fraudulent trading is a criminal offence and carries criminal sanctions.
• In addition, it is also a civil claim under s.213 if the business of the company was found to have been carried on with the intent to defraud creditors, defraud creditors of any other person or business, or for any other fraudulent purpose.
• It does require an element of dishonesty, unlike wrongful trading, and there is no defence available

The penalty:

• If found liable, the individual must compensate for the loss caused by the fraud, and the court’s powers here are wide.

Director disqualification

• Administrators and liquidators must report to the Insolvency Service on the conduct of all directors who have held office in the 3 years preceding the insolvency. A negative report can lead to the individual being disqualified as a director, and the conduct which can lead to a negative report is very wide.
• If a disqualification order is made, that individual can be disqualified from being a director of, or being involved in any way with the promotion, formation, or management of a company without the Court’s permission for up to 15 years.

What action can directors take now to mitigate the risk?

• Identify the level of risk and, as a board, formulate a strategy for approaching the problem.
• Hold and minute regular board meetings and do so with professional assistance; board minutes form a primary way of demonstrating that you considered and assessed all risks and decisions in the correct way and acted diligently and reasonably in doing so. Their correct formation is crucial.
• Seek advice: insolvency lawyers and insolvency practitioners with experience in energy insolvencies can guide you as to what steps you need to take, both procedurally and practically, to protect your position as a director.

This article does not constitute legal advice and cannot be relied upon as such. Should you wish to obtain advice based on specific facts and circumstances you can contact Penningtons Manches Cooper LLP.

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