Sadly, for some directors who have put their business’s interests first and taken their company through a formal insolvency process, there is further professional pain to be endured.
We’ll look at how directors can be disqualified, what it means in reality and how the effects can be lessened. We’ll also look at what happens if a director is sued or subject to legal action against them, their company, shareholders and even in some cases, their families.
Directors Disqualification Process
When a company enters into a creditors voluntary liquidation (CVL), compulsory liquidation or an administration, an insolvency practitioner is appointed to act as either liquidator or administrator.
They are then obliged by the Insolvency Act and Rules to carry out investigations into the running of that company and conduct of directors to that effect. They then have up to six months from the date of their appointment to prepare a report detailing their findings.
The format will be one of three outcomes. Either be a ‘D2 final report’, which means that the insolvency practitioner believes their investigations have concluded and there’s nothing material to report; or ‘a D2 interim report’.
The interim report means the insolvency practitioner needs more time to continue their investigations.
The third option is a ‘D1 report’ which is a full report highlighting one or more areas of mismanagement and concern on 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 insolvency company.
All reports are sent to the Insolvency Service – which is the executive insolvency arm of the Department for Business, Innovation & Skills (BIS. The Insolvency Service reviews the reports and also takes into account any previous company failures the directors may have had.
They then make the decision on whether or not to pursue disqualification proceedings against the directors. Note, if one director in a company is singled out for action, it doesn’t mean that all will be. The D1 reports are broken down specifically to apportion blame, if there is any, to individual directors rather than a collective.
If the Insolvency Service feels there is a case to answer they have up to two years to commence disqualification proceedings. They may seek to obtain a court order to extend the period but they must have a good reason to do so. They will spend time collating evidence and will try to contact the relevant directors, usually between 10 to 14 months after the company first went into liquidation or administration.
Once contact is established, they will ask the directors to explain their case and ask for comments or further details on any alleged misconduct. This is the stage when you should seek professional advice if you’re in this position as it is still early enough in the process to make a real difference in the decision making process.
One piece of inside information we can reveal is that in order to keep the cost (and risk of losing a case) down, the Insolvency Service prefer to enter into an agreement with directors where in view of their previous alleged misconduct, the director cooperates and agrees to be disqualified for a period of years – this process and final agreement are referred to as an ‘undertaking’.
The disqualification period will usually be a lot less than if they don’t cooperate and the Insolvency Service has to launch disqualification proceedings against them.
If this happens and it’s successful then the directors may find themselves liable for all costs including their own. A Disqualification Order is then made against them which will be more severe than if they had accepted an undertaking.
The vast majority of disqualifications – 80% – are through undertakings.
Reasons for Directors’ Disqualification
The table below shows the breakdown of allegation types that led to disqualification in the year 2010/2011.
The most frequent offence leading to a ban relates to Crown Debts.
These occur when companies accrue large levels of HMRC arrears that are disproportionate to the total amount owed to other creditors. One reason why this is so frequent is that it’s the easiest to prove.
There are defences and mitigating circumstances that can be shown against these kinds of allegations so it’s important to get advice if this applies to you.
Surprisingly, at the other end of the spectrum, only 2% of allegations leading to disqualification are because of ‘phoenixing’ or ‘trading whilst insolvent’.
Phoenixing is the practice of shutting a company down and restarting it again and again and again. Leaving debts and creditors behind each time. The Insolvency Service views this extremely harshly as do most business people and it frequently comes up as a priority concern in perceptions of the insolvency industry.
Sadly the burden of proof required to prove the intention of the directors makes it difficult for the Insolvency Service to pursue successfully. Similarly with ‘trading whilst insolvent’. Directors are continually advised of the ramifications of doing this against closing the company but the technical expertise and costs required to prove these cases mean the Insolvency Service rarely pursues them.
As a note of caution, we’d just like to point out that we are only referring to disqualification proceedings. In other words, while the Insolvency Service might be reticent in issuing proceedings regarding insolvent trading, 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.
What is the likelihood of being Disqualified?
The Insolvency Service would point out that a slightly upward trend in the number of disqualifications either by undertaking or disqualification order as evidence of their success over the past six years. The table below shows there’s been a small increase since 2007:
However, if you take into account the rate of increase in the number of corporate insolvencies in the same period, then 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 three 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’s 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 choosing 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.
Now 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.
In the second part of this blog, we’ll explain in more detail how disqualification is 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 as a punishment for those involved.
With that in mind, anyone who’s disqualified, either by a court order or undertaking, is registered at Companies House, which is both 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’ve managed to obtain bans against. These press releases generally get picked up by the local press and social media sites quite quickly.
On the punishment side, you’re 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 six years.
When it comes to 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’ve got a dedicated hotline for members of the public or the business community to report them.
It’s a criminal offence to act as a director whilst disqualified and successful prosecutions for doing so, end with a criminal record, a fine, and increasingly, a custodial sentence of usually between six months and two years.
What assistance can Robson Scott provide?
We’re an Insolvency Practice with lots of experience of dealing with director’s actions from both sides of the fence.
As in any aspect of life or business, getting expert advice from people who understand the workings of a system, greatly improves the chances of a better outcome.
If instructed by directors at an early stage, we can assist them in building a ‘counter-case’ against allegations brought by the Insolvency Service. Where possible, we’ll look to avoid a ban altogether, but if we’re not able to, then we’ll negotiate for a reduction in the length of ban to be agreed by an undertaking. We’ll also assist in dealing with any monetary claims brought against directors brought by their company’s liquidators or administrators.
If you’ve been contacted by the Insolvency Service then get in touch today so we can start working on your defence – together.