Director disqualification: Get the details right
NOTE: This article has been updated as at April 2016 to include relevant clauses contained in the Small Business, Enterprise and Employment Act 2015. The comments under the article refer to the original 2012 article.
Under the Company Directors Disqualification Act 1986 (CDDA) the Department for Business, Innovation and Skills (BIS) has the power to disqualify directors from holding corporate office where it is satisfied that there is sufficient evidence of “unfitness”. The proposals contained in the Small Business, Enterprise and Employment Act 2015 (SBEEA) are intended to tighten the current directors’ disqualification rules by introducing "new grounds for disqualification, create a new way in which creditors may receive financial redress for loss suffered through director misconduct, make the disqualification regime more efficient and update the matters that courts must take into account when considering a director disqualification.” The proposals will be implimented in July 2016 and the governments' fact sheet describing the reasoning behind the new measures and the intended requirements can be found at this link.
Disqualifications other than in relation to insolvency proceedings are extremely rare, most disqualifications being dealt with by the Insolvency Service (IS - as part of the BIS) but its work is limited to cases of wrongdoing resulting in insolvency. According to IS statistics, the number of directors disqualified in 2014 stood at 1,208- a rise of 25 per cent after having seen a drop in the previous two years. A list of directors disqualified over the last 12 months and the reasons for their disqualification can be found at this link.
Grounds for disqualification
No director should be punished for commercial misjudgement and the SBEEA intends to widen the scope of the measures under which a director is deemed unfit to make it easier for directors to determine whether he or she should simply undertake not to act as a director for a number of years and therefore avoid the costs of disqualification proceedings. Where a company is insolvent, the Insolvency Service now has three years to initiate disqualification proceedings instead of two years. There will also be measures put in place for disqualification for certain convictions abroad and it will be the duty of the court to disqualify directors of insolvent companies based abroad. New sections will permit a court to disqualify a person instructing an unfit director of an insolvent company.
There is a new section 7A compelling the office-holder dealing with the insolvent company (be that the official receiver, liquidator, administrator or administrative receiver) to report on the conduct of every director of a company which becomes insolvent including all persons who were directors (including shadow directors) at any time within the three years prior to insolvency. The report must be sent to the Secretary of State within 3 months of their appointment and there is an ongoing obligation to report where new information comes to the attention of that office holder.
A new section gives the court power to make a compensatory order against a disqualified director where their conduct has resulted in the loss to a creditor. This application must be made within 2 years of the disqualification order and the Secretary of State is allowed to accept a compensation undertaking from a director.
Apart from the two Act mentioned there are also other Acts which detail grounds for disqualification which may be automatically enforced depending upon the relevant Act section, for example:
- Individual bankruptcy - unless the court allows the director to continue
- Breach of Health and Safety regulations
- Wrongful or fraudulent trading
- Mental Health legislation
- Infringement of competition rules
- Persistent breach of statutory obligations (e.g. failure to submit accounts on time - cases have been brought following false accounting and evading VAT)
- Conviction of an indictable offence connected with the promotion, formation, management or liquidation of the company
The IS will apply to the court for a Disqualification Order or, alternatively, the Secretary of State may accept a Disqualification Undertaking. An ‘undertaking’ is a way for both sides to avoid the expense and upset of a court hearing where the director does not dispute the facts agreeing to the disqualification and to the conditions imposed. The conditions are the same as for an order although directors giving an undertaking can generally expect a shorter ban.
For the period of the order or undertaking (anything between two and 15 years - the average is six years), the individual is prevented from:
- being a director of a company
- acting as if they were a director
- instructing others in the management of a company
- being involved in any way in the promotion, formation or management of a company (including raising capital pre-company formation)
- acting as a company receiver or IP
- acting as a trustee of a charity or pension scheme without permission
Other bodies may not take too well to a disqualified director sitting on their committee and may not allow them to be a school governor, director of a housing association, or member of a social care body. Disqualification is usually reported to professional bodies which may affect their membership.
It is not enough to not have the title “director” - while the order or undertaking is in place that person cannot be involved in the usual running of a company and in fact, the CDDA specifically prohibits the ordering from, paying or negotiating with suppliers or customers; undertaking management consultancy or any governing role within a company or making it appear that one is able to do so. Breach is a criminal offence carrying a maximum of two years imprisonment and/or a fine.
But is disqualification effective?
- Disqualification is supposed to act as a deterrent for directors’ wrongdoing, intending to raise standards of commercial governance however large the company but the vast majority of companies that fail do not go down the liquidation route.
- The director of a company in trouble will obviously think of the here and now. Over-borrowing and personal guarantees mean directors will try to keep trading in order to avoid a collapse of their business and the subsequent enforcement of personal liability for their company’s debts. It is when their companies are facing the prospect of insolvency that such directors are most likely to treat creditors unfairly and behave in a manner which might render them unfit. The most common tactic is to withhold crown monies to ease cash flow but it is not unusual for directors to reduce or extinguish a personally guaranteed bank overdraft; pay off debts due to themselves or their families, or divert assets such as stock, equipment or vehicles away to be used in a phoenix company.
Jennifer Adams FCIS TEP ATT (Fellow) is Associate Editor of AccountingWEB. A professional business author specialising in corporate governance and taxation, she has written for many of the leading specialist providers of legal, tax and regulatory publications. Jennifer runs her own accounting and consultancy business with offices based in Surrey and Dorset. Many thanks to Alan Price, managing director of Marshman Price, who provided valuable help in the production of this article.