Director’s Disqualification

By way of introduction, I have written this piece to highlight the various pitfalls and knock-on effects commonly seen by Directors whose business has gone through a formal insolvency process.

Due to the scope of the assignment, I have broken the blog into two parts, Director’s Disqualification and ‘Directors Being Sued’. This first part will concentrate on the why’s and wherefores of disqualification proceedings, detailing how common they are, the potential effects of disqualification and concluding with advice on how to proceed if there is a chance this affects you. The second part will deal with what happens when directors are sued by Insolvency Practitioners. It looks at the types of action that can be brought by liquidators and administrators against directors, shareholders, and even their families, and examines ways to lessen their effect.

Director’s Disqualification Process

When a company enters into either Creditors Voluntary Liquidation, Compulsory Liquidation or Administration, the Insolvency Practitioner appointed to act as either Liquidator or Administrator is obliged by the Insolvency Act and Rules to carry out investigations into the running of that company and to prepare a report within 6 months of his appointment (this can be extended to longer if investigations are not concluded within that time). This report will either be 1. ‘a D2 final report’, which means that the Insolvency Practitioner believes his investigations are concluded and there is nothing material to report; or 2. ‘a D2 interim report’, whereby the Insolvency Practitioner requests more time to continue investigations, or 3. ‘a D1 report’, which is a full report highlighting area of mismanagement and concern with how the directors ran their company. These reports are entirely confidential and Insolvency Practitioners have to be very careful to ensure that their contents are not divulged to any stakeholders of the insolvent company.

All of the reports are sent to the Insolvency Service (the executive insolvency arm of the Department for Business, Innovation & Skills (“BIS”). The Insolvency Service reviews the reports and taking into account any previous company failures the directors may have had, they decide whether or not to pursue disqualification proceedings against the directors. Please note that just because one director in a company is being pursued, it doesn’t mean that all will. The D1 reports are broken down to apportion blame, or not, to directors individually rather than as a whole.
If the Insolvency Service feels there is a case to answer, they have two years in which to commence proceedings for disqualification, unless they have good reason to obtain a court order extending that period. The Insolvency Service will spend a period of time collating evidence and will then make contact with the relevant directors (in our experience this is generally around 10-14 months after the company first went into Liquidation or Administration).

Once contact is made, the Insolvency Service will explain their case and the elements of alleged misconduct (more below on this) and ask for comments from the directors. This is really the best stage to be seeking advice from a firm such as ours, as it is early enough to still make a material difference in the decision making process.

To keep cost (and the risk of losing) down, the Insolvency Service much prefer to enter into an agreement with directors, whereby in view of their previous alleged misconduct, the directors agree to be disqualified for a period of ‘x’ number of years. This process and the final agreement is referred to as an ‘undertaking’.

If the directors do not co-operate, then the Insolvency Service can launch disqualification proceedings against them. If successful, the directors may then be held liable for the Insolvency Service’s costs, as well as their own. To rub salt into the wounds, if proceedings are issued and a Disqualification Order is made against them, they will be more likely to receive a longer ban from acting as directors than they might if they had agreed to the Undertaking! Approximately 80% of disqualifications are via Undertaking and 20% via Disqualification Order.

Reasons for Directors’ Disqualification

We’ve looked at the process, now we can look at the reasons why directors are usually disqualified.
The table below shows the breakdown of allegation types that led to disqualification in the year 2010/2011.

directors-disqualification-chart

You’ll note that by far the largest offence leading to a ban is in relation to Crown Debts. This occurs when companies purposely and materially accrue large levels of HMRC debts in disproportion to the total money owed to other creditors. Cynically, I am going to say that my belief is that this is the most popular simply because it is the easiest to prove! There can be defences and mitigating circumstances put forward against an allegation of this kind, so it’s important to seek advice where this applies.

Somewhat surprising, at the bottom end of the spectrum with just over 2% of allegations leading to disqualification is ‘phoenixing’ and ‘trading whilst insolvent’. I say this is surprising because firstly Phoenixing (whereby directors shut companies down and restart over and over again), is viewed extremely harshly by the Insolvency Service and moreover by the general UK business community. In terms of negative perceptions of insolvency, it always features very highly as a priority concern. However the burden of proof in terms of the intention of the directors makes it much more difficult for the Insolvency Service to pursue. Similar in that respect is ‘trading whilst insolvent’ – Directors are continually advised of the ramifications of trading whilst insolvent, above most other considerations, but again the technical expertise (and therefore cost for the Insolvency Service), as against the likelihood of a successful outcome means that it is rarely pursued by them. I will insert a note of caution now though, in that, for the purposes of this part of the blog, I am only referring to Disqualification proceedings – in other words, although the Insolvency Service might not like the look of issuing proceedings regarding ‘Trading Insolvently’, an Insolvency Practitioner can and will separately pursue an action for insolvent trading, not for the purpose of disqualification, but to recover funds back from the Directors concerned! – But more about that in Part 2 of my blog – ‘Directors Being Sued’.

What is the likelihood of being Disqualified?

The Insolvency Service would point to a very slightly upward trend in the number of disqualifications as evidence of their success (either by Undertaking or by Disqualification Order) over the past 6 years. The table below demonstrates a small increase since 2007.

directors-disqualification-chart2

However, if you take into account the rate of increase in the number corporate insolvencies in the same period, it is evident that the level of disqualifications has fallen in real terms. This is further evidenced by the report prepared by R3, showing the upsurge in ‘D1’ reports sent to the Insolvency Service in the same period being much greater than the rate of actual disqualifications – see the graph above. Furthermore, a review of the Insolvency Service website shows that there have only been approximately 230 disqualifications for the 3 months to May 2013, which would point to a further fall in recent levels.

What does this mean? In simple terms, the Insolvency Service is underfunded, so it is unable to pursue as many disqualifications as it would like. Furthermore, if you refer back to the first graph, it seems that they are most likely to pursue the ‘easy pickings’, such as non payment of Crown Debt over the more complex matters such as Insolvent Trading. The full effects of the recent round of funding cuts have also yet to be felt, so the Insolvency Service will feel further budgetary pressure in the foreseeable future.

By no stretch does this let Directors off the hook – when the Insolvency Service decide to pursue disqualification, they employ good quality investigators who have excellent track records in getting results. Also, in the 2nd part of this blog, I will explain in more detail how disqualification is in some way the smaller, but more widely known, element of various actions that can be taken against alleged malcreant directors. Considerably more actions are taken separately by Insolvency Practitioners pursuing directors for a host of reasons, some the same as those listed for disqualification and some much more complex, but for a different purpose – the recovery of monies as opposed to disqualification.

What is the effect of disqualification?

The purpose of disqualification is firstly to be a public admonishment of individuals involved in bad business practice and secondly to punish those involved. With that in mind, anyone who is disqualified, either by Court Order or Undertaking, is registered as such on Companies House, which is a public register and a primary source of information for identity and credit referencing agents. Also, the Insolvency Service is generally quite proud of its successes, and issues regular press releases on who they have managed to obtain bans against. As you might imagine, these press releases generally get picked up by the local press and social media sites as well.

On the punishment side, you are banned from acting as a director, or acting in a way that may be construed as acting as a director. The period of the ban will be for as long as agreed in the Undertaking, or as long as the Court might order. At the moment, the average period of disqualification is about 6 years.

In terms of enforcement, the Insolvency Service holds a very dim view of those directors that either continue to act as actual Directors, de facto Directors or shadow Directors. So much so that they have a dedicated ‘hotline’ for members of the public or the business community to report them. It is a criminal offence to act as a director whilst disqualified and successful prosecutions for doing so, end with a criminal record, a fine, and more increasingly, a custodial sentence of usually between 6 months and 2 years.

What assistance can Robson Scott provide?

Robson Scott is an Insolvency Practice with experience of dealing with help for Directors from ‘both sides of the fence’.

As in any aspect of life, having expert advice from people who understand the workings of the system, greatly improves the chances of a better outcome.

If instructed by directors at an early stage, we can assist in building a ‘counter-case’ against that brought by the Insolvency Service. Where possible, we will look to avoid a ban altogether, but if we are not able, then we will negotiate for a reduction in the length of ban to be agreed by Undertaking. We will also assist in dealing with any monetary claims brought against Directors by their company’s liquidators or administrators.

Please comment below if you have a query and I will be more than happy to respond. If you would like to contact me about Directors Disqualification proceedings in confidence, you can do so on ewall@robsonscott.co.uk.