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Director disqualification: Get the details right

10th May 2012
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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

End result

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.

Implications

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.

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David Winch
By David Winch
10th May 2012 17:41

Acting whilst disqualified
There have been a number of cases of persons convicted of acting in the management of a company whilst disqualified where, following conviction for so acting, the prosecution have gone on to pursue confiscation proceedings under Proceeds of Crime Act 2002.

In such cases the 'benefit' has been held to be the net pay received by the disqualified person over the period he has been in breach.

In effect that means that the convicted person is ordered to pay into court the whole of the net pay he received whilst in breach of the disqualification.

The offence may also result in a finding that, for confiscation purposes, the disqualified person has a 'criminal lifestyle' (which can result in a substantially greater 'benefit' figure).

David

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By The_Saint
11th May 2012 11:18

Article Acting Whilst Disqualified

With cuts to Government Department spend and a reduction in investigations the likelihood of a miscreant director being punsihed, unless the offences are black and white, are remote.

The rate of detection, reporting and succesfull prosecution of CDDA offences is pitiful.

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Replying to David Treitel:
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By arprice
11th May 2012 11:50

Article Acting Whilst Disqualified

I agree totally with Saint - 1,400-odd disqualifications arising from 20,000 administrations and insolvent liquidations a year is very disappointing.

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By Romanista
11th May 2012 11:32

Ineffective reporting

Most insolvency practitioners openly admit that it is very difficult to prove that a directordeliberately acted in a way to knowingly prejudice creditors except in the most blatant cases.  That would suggest to me that only the very obvious cases get reported and many others are too difficult or expensive to substantiate. 

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Replying to Willow Warbler:
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By arprice
11th May 2012 12:00

Ineffective reporting

Romanista wrote:

Most insolvency practitioners openly admit that it is very difficult to prove that a director deliberately acted in a way to knowingly prejudice creditors except in the most blatant cases.  That would suggest to me that only the very obvious cases get reported and many others are too difficult or expensive to substantiate. 

On the contrary, our experience is that in the past we fairly frequently found cases we considered were suitable for disqualification, only to have them turned down by the vetting section of the disqualification unit. Some of these were, in our view, blatant however they were not pursued - often on what we considered particularly woolly grounds, such as not being "in the public interest". We have altered our reporting criteria to reflect the fact that some cases we think are worthy of disqualification do not accord with the Insolvency Service's apparently very strict criteria, and there is no justification in incurring costs at creditors' expense for no result.

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Replying to Kent accountant:
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By Romanista
11th May 2012 15:33

Thanks for keeping me right. 

Thanks for keeping me right.  I suppose that it is similar to trying to prove that someone who puts a bank account in a family pet's name does it deliberately to avoid tax.  The onus of trying to prove criminal intent is much more demanding.

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By The Minion
11th May 2012 12:05

Public Domain

I had a (thankfully ex) client who was disqualified.

when i tried to check how long the disqualification was for by going onto Companies House website he didnt appear as disqualified and still doesnt.

Having now found out, that he is to be prosecuted for acting as a shadow director i am now being told that CH isnt that accurate and to try checking on the BiS system!

It doesnt help if we are doing MLR checks on potential new clients (passport etc) and looking at CH to confirm directorship if the info isnt up to date.

Is there a place where all details are accurate and up to date?

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By The Rogue
11th May 2012 12:07

Can they still operate?

I am aware of one case where a disqualified director formed a new ltd company but made his wife a director.  He was on the payroll and, presumably, calling the shots.  As far as I know she did not have any relevant experience.  This one was being investigated by the DTI (at the time - I'm not sure what they are called this year) and they came to my company for witness statements.  I am also aware of a couple more cases where similar things were happening but they were not investigated as far as I know..  Should my company dob them in it?  We certainly refused to trade with them on credit.  The article does say they should not be doing this but how can it be proved?  Perhaps that is why the prosecution rate is low.

Another ex-customer went bust and the director immediately started up a new ltd company with himself as director but the record showed a different date of birth and the credit reference agencies hadn't made the link.  I don't know if Companies House had.  Is this another way of getting round a barring?

Is disqualification only applied to ltds and plcs?  The article says companies.  Could a barred director still trade as a sole trader or partner with no effective bar except the personal liability.  Which could be got round by becoming insolvent.

I suspect the unscrupulous director can still get round the rules but I don't have any ideas on how to improve things!

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By arprice
11th May 2012 12:31

Can they still operate?

The Insolvency Service has withdrawn the online search facility for both directors' disqualification and bankruptcy restrictions orders, although a bankruptcy search online should reveal if an individual is subject to a BRO.  We are therefore limited to only the Companies House information in respect of directors - which, presumably, is supplied by the Insolvency Service.

There is a "hotline" to complain about disqualified directors who are acting illegally - see http://www.bis.gov.uk/insolvency/Companies/insolvent-companies/complain-... In my view anybody who suspects a disqualified director to be acting in this way has a public duty to report it.  The Insolvency Service will no doubt pursue the matter with its customary level of enthusiasm.

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Replying to elvina:
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By The Black Knight
17th May 2012 10:52

Government department apathy

arprice wrote:

The Insolvency Service will no doubt pursue the matter with its customary level of enthusiasm.

Yep not really interested.

Neither are companies house (just use another name there) and most of what is filed at companies house is incomplete or incorrect.

P.S. The link did not work ?

 

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David Winch
By David Winch
11th May 2012 15:21

Reporting

Just to be clear, an insolvency practitioner has a duty in certain circumstances to report to the Insolvency Service on the conduct of a director / former director of a company.

An insolvency practitioner has a quite separate and additional responsibility to report under s330 PoCA 2002 / MLR 2007 to SOCA where he suspects a person may be engaged in money laundering.

In practice one would normally expect a statutory obligation to report under s330 to be triggered quite soon after appointment (because it is based on a suspicion - not on the results of an investigation) whereas a report to the Insolvency Service might be filed later (as an outcome of an investigation).

David

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By GACL
10th Jun 2016 14:57

Thanks for the article.

I am embroiled in a dispute with a customer. The statutory demand has been ignored and next step seems to be putting the co into liquidation.
However there may or may not be assets and I could be looking to the assets put back in.

My Q in relation to your article is : "No director shuld be punished for commercial misjudgement".

What does really mean? - in my case the client screwed up a contract and was negligent incompetent etc in the work involved in the contract yet I am on the end of the unpaid bill - which is significant.

Does this new legislation really provide any teeth?

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