Podcast transcript: a corporate recovery perspective on related party transactions, with Mark Supperstone

The following transcript has been lightly edited for clarity. The original interview can be heard on The LCN Legal Podcast here.

Paul Sutton: Well, today I'm delighted to welcome Mark Supperstone to this podcast. Mark is someone that I've known for a number of years. He is an extremely experienced restructuring specialist. So welcome, Mark.

Mark Supperstone: Hi, Paul. Nice to see you today.

PS: Great to have you, too. The focus of this podcast is really to give a different perspective on international cross border group structures, in addition to the tax perspective and the transfer pricing perspective and the high-level corporate governance perspective. And is to really call on Mark's experience as a restructuring professional to say, OK, supposing you had a multinational group, and let's say it's US-headquartered. And let's say within the group, there are significant operating entities in various countries, and one of them includes a UK entity. So in a situation where maybe there are financial concerns or maybe there's distress, and in a situation where maybe things go in the wrong direction and a formal restructuring process needs to be put in place, the question is: what would that look like? What kind of thought processes apply there? And therefore, what kinds of thought processes do we as professionals and do directors need to consider when designing and monitoring their structures? So really, that's the context here.

So, Mark, I'd really like to start by asking you in this hypothetical situation – so you're looking at a UK entity within a multinational group, and that UK entity obviously has its own creditors and liabilities and employees and so on, and if you were being asked to assist as a restructuring professional, maybe with a view to taking a formal appointment – what would your main duties be in an insolvency situation, or administration, liquidation?

MS: It's a good question. Paul and I'll talk about it on the basis of a formal insolvency appointment, where we might be appointed administrator, liquidator. And that would be where a company is insolvent and just very high-level: generally, a company is insolvent on one of two bases. And that's either where their liabilities are greater than their assets or more commonly, where they’re cashflow insolvent. And that means they can't pay their debts as and when they fall due.

And when a company becomes insolvent, the responsibility of the directors turns from acting in the best interest of the shareholders to acting in the best interest of the creditors. So the directors of the company, their responsibility is to make sure they're doing the best thing by their creditors. If I'm appointed as administrator or liquidator, my job is to make sure I get the best result for the creditors. So I have to maximise the realisation for the benefit of the creditors, and I need to communicate with the creditors and keep them updated as to what I've realised, what job I'm doing. And as well as that, I need to investigate the conduct of the directors – which is a very key point for directors – to make sure that they have acted professionally, properly and considered the creditors at the point in time they believe they're insolvent.

So, in summary, the key responsibility of an insolvency practitioner in this situation is to maximise the return for creditors, with the intention of trying to get some money back for those creditors.

PS: Yeah, absolutely. And I guess that's the key point out of this whole conversation in the context of group structures, which is that this dynamic, or this circumstance, immediately completely changes the whole control framework of the group. Because it reduces it to that legal entity perspective, the creditors’ perspective. And the overall group interest becomes a very distant priority in that scenario.

MS: Yeah, I can see that's a tough balancing act for directors of the UK company, in your example, because they'll have pressure from other group entities and they'll have their own pressure as directors and doing the right things for the creditors. So it is a tough balancing act for directors in those situations where they might be insolvent.

PS: Yeah, we'll come on to this, but in a number of the situations where we've been asked to review arrangements from a legal implementation of transfer pricing perspective – on things like cash pooling arrangements – actually, the number one concern that local boards have is not so much the tax or the transfer pricing, it's actually their personal positions, and is this a proper thing to do. And it becomes very sensitive, because it means that they're, in effect, considering whether they need to rebel against the instructions from head office and how do they handle that. Maybe we can come on to that.

So if we're continuing this hypothetical scenario where it is a formal restructuring process that is being put in place and you have taken office as the office holder – so administrator or liquidator – what would your first steps in that capacity be?

MS: Yeah, normally, the first thing we do on any insolvency appointment is we freeze the bank account, if there's any cash in there, to protect that as an asset. We put insurance in place over all the assets so that they're fully insured. We would communicate our appointment to all the creditors and any other interested parties, including notifying Companies House, so there's a record of our appointment. But then our job would very much turn to realising the assets.

So it depends on the type of business that we're dealing with. But there might be plants and machinery we have to deal with, there might be stock, there might be intercompany balances. There might be a whole range of things – including potentially a trading business that we might be able to sell. So for us, it's how can we maximise the realisation? So we take control of those assets, we protect them the best we can – as I said, for example, getting insurance over them, but making sure no one comes in to try and remove assets or any other issues that might occur. But our job, as I said earlier, is very much about maximising the assets. So our key focus is trying to work out how we can get the greatest return for any assets that the business has.

PS: Right. So that process or that exercise of preserving, maximising the return for creditors: it might include trading the business for an interim period, trading with a view to a sale, if there is something that is saleable, or it may not include that.

MS: Yes, that's correct. Although it depends on the type of business, I guess, that is being asked to be traded. And back 20 years ago, when I started in the profession, it was quite common for an insolvency practitioner to be appointed and trade the business, but nowadays there's a lot of risk in doing that. And if this is a loss-making business, who's going to fund that? Because the insolvency practitioner is unlikely to want to fund those losses whilst a purchaser is sought. But in reality, yes, one option is to trade the business and see whether we can find a buyer that wants to purchase the business as a going concern. That's always the best result, if that can be done. But often there's obstacles that make it quite difficult to trade a business in administration.

And that's why you may have heard the term pre-pack administration, and that is effectively where a buyer is found before the company goes into administration and then the business sale is completed very quickly after administration, which means there is no trading period, because the buyer has already been sought in the period leading up to administration. So that's quite a common thing that has developed over the past 20 years, and means that trading businesses in administration still happen, but are much rarer today than they were maybe 20 years ago.

PS: Right. I suppose in a group context, there's the additional complexity of having to make an assessment: is there actually an independent business which could be independently operated by you as the office holder, or is it so integrated with the other group entities that in fact there's very little that can be realised other than physical assets, cash, those kind of things?

MS: Yeah, it's a very good question. I guess it depends what type of business it is and where it's located and who's key. So the key personnel, are they located in the UK? Could they take on the business and run it, or are they largely located overseas? So there'd be quite a lot to consider in those situations. The other thing we see with group entities quite a lot, is if one of the entities goes into an insolvency process, could it potentially bring down the rest of the rest of the group? For example, if a UK entity went into an insolvency procedure and was owed significant sums from an overseas entity, the insolvency practitioner would be demanding that money back, and it may be the overseas entity couldn't afford to pay that and might therefore need an insolvency process themselves. And that can have a knock-on effect across the group, and we often see that. So a bit of planning is always needed, to make sure that we can potentially segregate one entity: it's not going to pull down the rest of the group. So there's always a bit of planning in those situations.

PS: OK, so moving on from that, are there any specific statutory requirements that apply in terms of the investigations that you need to carry out?

MS: Yes, and this is an interesting point for directors. So once we're appointed as either administrator or liquidator in a situation, we have a statutory duty to investigate the directors. We have to submit a report to the insolvency service within three months of our appointment. And that report covers not only current directors, but anyone that was a director in the three years prior to insolvency. And the type of things we look for there are, largely, has the director done the right thing? Have they tried to look after the creditors of the company, or have they paid themselves in priority to other creditors? Or have they distributed money to group entities when maybe they should have been paying their PAYE instead? If we submit a report that ticks a number of boxes that suggest the directors haven't done the right thing, then the insolvency service may – and they don't always – may decide to investigate that further, and that could potentially lead to disqualification proceedings against the directors.

PS: And I guess that the point here is to emphasise the fact that on one of these formal processes starting, it crystallises the self-contained nature of that legal entity. And so, yes, in many cases, groups are run on a line of business basis as opposed to a legal entity basis. But it just really emphasises the fact that the legal entity perspective becomes the main thing that you are investigating and have a statutory duty to report on. So it's not an optional?

MS: Very much so, yeah. As you said, it's the legal entity. We look at that particular UK legal entity and we do our report based on the directors of that entity. And that's where the directors need to be conscious of their responsibilities, because although they might be getting pressure from other group entities, as a director of a UK company, they have certain responsibilities, and that's what we will look into. And it's not a defence for a director to say, ‘I was told to do this by the States. They told me I had to make these payments.’ We look at it very much as: did you comply with your responsibilities as a director of a UK entity?

PS: Yeah, absolutely. And that aligns with the company law view of being a director. Company law does not distinguish between different types of directors, like non-executive or overseas or whatever. You are either a director or not a director. And if you are, the question is: have you fulfilled your duties or not?

MS: Yes agree.

PS: So in terms of key issues or claims that could be made potentially against directors personally, what do they look like and in what circumstances, if any, could personal liability arise?

MS: Yeah, generally, if it's a limited company, the directors are protected by the limited liability status of the company, so they shouldn't have personal liability. Where they might have an issue is if they've given any personal guarantees. And sometimes directors do give personal guarantees, when they're taking credit from suppliers/ Or I guess that there might be potential claims if they've done things such as made preference payments to themselves.

A preference payment is where a payment is made to someone in priority to another person. So for example, if a director had provided a loan to the business and – just before insolvency – decided, I'm going to pay that loan back to myself, that would be a preference payment because they've preferred themselves over a supplier or HMRC or a landlord or someone else. So that'd be called a preference payment and that could be claimed back from an insolvency practitioner. There's also something called ‘transactions that undervalue’. So if there's an asset that the directors sell in the period leading up to administration or liquidation for less than it is worth, that could potentially be clawed back. Now, it depends who that asset was sold to as to who an insolvency practitioner pursues.

And I guess the final thing really to think about is wrongful trading. And that is where a director continues to trade the business when it is insolvent. So when a business is insolvent, a director has a responsibility to take some action. If they continue to trade the business and continue to incur losses and continue to rack up creditor claims, then potentially they could be liable for wrongful trading and that could result in some personal liability on their part.

PS: Right, so we're talking about personal recourse against directors – and it's not automatic recourse because as you said, it is a limited liability entity. However, in these circumstances – and we're talking about UK law at the moment – I just wanted to be clear in terms of these situations. My understanding is, it's not necessary for the director to personally benefit from those transactions in order to be subject to that personal recourse. Or have I got that wrong?

MS: Yeah, I think it's more the wrongful trading, which is where the directors could become personally liable. With the preference and transaction at undervalue, that is more depending on who benefited from the preference or transaction at undervalue. So it wouldn't necessarily be a claim against the director unless they were the beneficiary of that action. It's largely the wrongful trading claim that they could become personally liable for. And any personal guarantees they'd obviously become liable for, if they've issued any.

PS: Yes, fine. So I guess that the personal guarantees will be probably less relevant in a large group context, but the wrongful trading considerations definitely can still apply there. So in that context of preferences and transactions at undervalue and so on: how would you regard transactions between the UK entity and other members of the group?

MS: Yeah, and this comes back to that balancing exercise where directors need to be very wary that they're complying with their fiduciary duties, and acting in the best interests of creditors; and the responsibility they have to the other group entities. And I think the directors need to be very wary of that responsibility. And if I was appointed insolvency practitioner, one of the things I do is I go through the bank statements to have a look at who was paid in the period leading up to my appointment. Now, where I guess I could get concerned is if lots of payments have been made to another group entity, but at the same time big liabilities are accruing to suppliers, HMRC and others. And therefore that might be an area I do investigate to say, ‘Well, why was that money being paid to a group entity and not paid to your creditors?’ And the directors would have to have some quite clear and good explanation for that reason.

And there may be a reason for that. In the period leading up to administration, there's nothing to say the directors can't make any payments. They just have to make sure they're making payments that are in the best interest of the creditors, and that might be making critical payments to suppliers that keep the lights turned on. So it may be, for example, that if a payment wasn't made to the group entity, the staff wouldn't turn up tomorrow because they wouldn't get paid – maybe the group entity pays the payroll. I'm just using examples.

So there may be valid reasons for making payments to group entities, which is in the interest of the creditors, which is in the interest of making sure the business survives. So there could be reasons. And what directors need to do is just be wary of their responsibilities, wary of their responsibility to the creditors, and potentially documenting reasons why they are doing certain things – and if they're unsure, take some advice.

PS: Absolutely. I think what I'm hearing, or the way that I would look at this, is number one in this kind of process, there's obviously a very close focus on cash payments. So that's part of what you're talking about, Mark, in terms of you being appointed as office holder, you reviewing transactions and specifically cash payments going out and understanding what was the reason, the rationale for those cash payments being made at that time to that entity. So that's one thing.

Another thing is the approval of transactions or arrangements between the related parties, the group entities. So the entry into a loan agreement or the variation of the terms of a loan agreement or whatever, may not necessarily result in a cash payment at that exact moment, but it may materially affect the position of that UK entity, in this example, within the overall corporate group. So classic examples would be intercompany loans and cash pooling arrangements or changes in the trading arrangements between parties. And so having that regard to the interests of the UK entity. And did it make sense.

MS: Yeah, and I guess it comes down to partly to the time that the agreement is signed. So if the UK company is solvent and the future looks rosy, I think it would be very difficult for someone to criticise a director for signing an agreement at that point in time, as long as it was a fair agreement. If a company is on the brink of insolvency and a director signs something that may not be in the interest of its creditors, then that could be looked at.

So, for example, let's say a business is close to insolvency – and this isn't necessarily a group example – but let's say they take on twenty leased vehicles one month before an insolvency process, and that's a three year lease. I would look at that and say, ‘Well, should you have been signing that lease at the time? Because you've paid one month of the lease and you've got 35 months left. That leasing supply now becomes a creditor, and therefore you've increased your creditor liabilities by signing that and you should probably have known better at the time.’

I think it's just directors being wary, and if they do sign an agreement when they are solvent, then they have some protection as long as what they're signing is fair and reasonable. And they have to consider what it might look like if the UK business does experience some financial difficulties. Is this agreement going to be looked back on and considered unreasonable, unfair, and not in the interest of the creditors? So I think directors just need to always consider – it's a horrible thing to do, you don't want to be thinking negative – but what would happen if the future didn't quite work out as anyone thought? And I'm in a situation where the company could be deemed insolvent, could this agreement be looked back on as doing the wrong thing? Yes, I think it’s just going in with open eyes.

PS: Absolutely. And what I find really interesting is that from a transfer pricing perspective: one of the major developments or evolutions in the TP world over the last couple of years has been the emphasis on contemporaneous documentation. So explaining the rationale as to why changes are made to intercompany transactions and especially during times of distress or change or whatever, to explain the steps that were taken. And from a TP perspective, that is looked at often at global level, at the level of the global tax and transfer pricing function, knowing that they may be asked by the tax authorities in all the relevant countries, why did you do that? Why did you make that change? And so, in many ways, that aligns with the legal entity restructuring office holder view of the world, but just applies that to legal entity level. Actually with a bit more intensity in saying, OK, specifically, how did this affect the UK entity in this example, and why did that make sense?

And the challenge is, obviously, in this multinational group, you're not just doing this from the perspective of UK and the parent’s country, it's all the other entities at the same time which are being managed. And so what it means is that in terms of global changes to transfer pricing policies and intercompany transactions, it's applying or having regards to the individual stakeholders, including the individual directors, and as much as possible, not proposing arrangements that they would not be able to defend as being in the best interest of the entity.

MS: Very much so. And you made a very important point there, which is something I always recommend to clients, and that is file noting. So if there's a decision that you've made, make a file note of the reason you did it, the reason behind it. And hold board meetings, if necessary, and minute the board meetings. For two reasons, really. One is, in years to come, you might forget why you made that decision. And the second thing is it becomes much more difficult for a claim against you if you went through a thorough thought process, and at the time believed you were doing the right thing as a director. And if you've documented it, that is certainly a good defence for you. It doesn't mean you get out of everything, but it certainly helps and shows that you were acting as a good director at the time.

PS: Yeah, absolutely. So here we're talking about practical things that directors can do to minimise their risk, both personally and from a corporate perspective. And absolutely, I'd say number one is file noting and recording the transactions. Number two is probably reaching out. If someone does have concerns, to reach out to a professional – someone like you, Mark – and just have that conversation.

MS: Yeah, I think I'd say to anyone: if you're worried about insolvency or you've got concerns, or you think it might be something that could happen in the future, I'm always happy to speak to people. I'm sure other firms in the restructuring field would be happy to do the same. I don't charge for that. I'm always happy to have an hour's phone call and just talk someone through their concerns. And hopefully they walk away at the end of that phone call, feeling not necessarily happier, but understanding the position a little bit, and feeling that they've got a phone number for someone to call if things don't go as they hope. So: always happy to speak to people. And I think it's important that where a director has concerns, they do take advice and see whether there's anything they should be doing.

PS: Absolutely. And just going back to the group dynamic, which is, looking at the situation of a local director, they may not want to immediately object to the proposals from head office, but they will probably value having an independent view on an informal basis to start with. And going back to the sort of practical protections or the defences. Number one is contemporaneous file notes. Why do we do this and what was the reason? What was the context? Then the sort of step above that is to get formal advice on that, because that's all part of the paper trial, isn't it, to show that the directors have properly considered the options, the relevant steps.

MS: And we would see companies like that taking legal advice at the point in time, and documenting that, and getting proper letters from the lawyers so that they've got something on file. And then that makes our job more difficult to pursue a director where they've gone through a proper thought process, they've got file notes and they've taken proper legal advice.

PS: Yeah, absolutely. Well, listen, Mark, I'm incredibly grateful. I think it's been really helpful. Including, from my perspective, just to reconfirm the perspective from someone like you at the coalface, who is an actual office holder in these kind of restructuring formal processes. So thank you so much for the time you shared with us.

MS: No problem. Nice to speak, Paul.