D&O insurance considerations as UK insolvency claims rise

Directors and officers insolvency claims are increasing in the UK amid economic uncertainty. Marsh provides insight on why insolvency risk is rising and key actions directors can take.

Directors and officers (D&O) insolvency claims are increasing in the UK amid economic uncertainty brought about by Brexit, the pandemic, and the end of government COVID-19 support schemes.

Marsh claims data shows insolvency notifications at the end of H1 2021 reached the same level as for all of 2019 and more than half the levels reported at year-end 2020. 

Insolvency risk for boards

Directors and officers can face personal liability for wrongful trading following the insolvent liquidation of a company.

Under The Insolvency Act 1986, there is accountability if they fail to cease trading in a situation where they “knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation,” unless they “took every step with a view to minimising the potential loss to the company’s creditors.”

A decision to keep trading will not always result in liability. In the case of Nicholson v Fielding (2017), the court held that “wrongful trading cannot be addressed by looking at the company’s business in an economic vacuum. It was operating in a market directly affected by the global financial shock.”

Directors were able to demonstrate an ongoing detailed consideration of the company’s position, consistent with evidence that they “were constantly monitoring and discussing the situation. They were doing so backed by exemplary management accounts” and “were taking tough decisions.”

This conclusion demonstrates what the courts are looking for from directors — that they will consider the external factors a company and its directors are facing, and that a certain amount of subjectivity will be applied.

Why is insolvency risk rising?

Where economic uncertainty and risk of downturn exist, insolvency risk usually follows. Both Brexit and COVID-19 have led to economic uncertainty in the UK. While Brexit has created regulatory and trade challenges, the pandemic triggered unprecedented wholesale shutdown of some industries and completely changed how others operated.

At the start of the pandemic, when a number of industries were shut down by necessity, the government announced that wrongful trading would be suspended for an initial period of three months which was then extended until 30 June 2021. A business rescue moratorium was also put in place to prevent creditors taking enforcement action. Other measures to help struggling companies included the furlough scheme. A peak of nine million workers were on furlough in May 2020.  

Now these interventions have ended, insolvencies are expected to rise. The UK Government’s monthly insolvency statistics, via The Insolvency Service, do not record whether an insolvency is directly related to the pandemic or other specific triggers, and so it is therefore not possible to assess any direct effect of COVID-19 on the number of insolvencies. That said, the numbers provide an indication of what can be expected.

For example, the number of registered company insolvencies in England and Wales in November 2021 was 1,674:

  • 88% higher than the number registered in the same month in the previous year (891 in November 2020), and
  • 11% higher than the number registered two years previously (pre-pandemic; 1,509 in November 2019).

Litigation funders

Another insolvency-related risk for companies and directors is the rise of litigation funders in the UK. In situations where a lack of funds would otherwise stifle a claim, or where individuals or companies do not want to risk their own funds, a litigation funder can step in to provide a “fighting fund” for the law suit, in exchange for a share of the damages where a claim is successful.

The law firm RPC reported in 2020 that the value of court cases and cash held directly by litigation funders in the UK hit a record high of £1.9 billion in 2019, up 46% from £1.3 billion in 2017/18. According to RPC, the funding market has doubled over the past three years.

Key actions to take

In light of the changing economic landscape, it is crucial boards of directors and their advisors carry out the following: 

  • A full and careful review of all aspects of risk that influence their insurance coverage. Concerning the provisions of their D&O policies, they should review where cover is restricted by insolvency exclusions.
  • An assessment to ensure they are overseeing their companies’ approach to potential insolvency events in an informed and deliberative manner. This may require taking professional advice. Directors should ensure they create and maintain accurate records so that they can clearly demonstrate their activities to investors, lenders, stakeholders, D&O insurance underwriters, regulators, and courts.

If you have any questions on D&O insurance and insolvency, please contact your Marsh adviser.

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