Brief overview

Directors Disqualification Process

Company in financial distress

Seek help from accountant – try to mitigate threat

Threat over

Continue running business (in safe mode)

Threat continues

Seek help from Insolvency Practitioner

Company goes into liquidation

Insolvency Practitioner files “D” report with The Insolvency Service for review

Insolvency Service decides no further action

No further action is required

Further action required

Section 16 letter is sent to the defendant (director)

Seek legal advice to review case on merits

Disqualification Undertaking Defendant agrees not to act as a director

Seek leave to act as director

Defendant does not give Disqualification Undertaking

Submit evidence/defence or make representation in mitigation

Continue defending proceedings

Trial
Seek leave to act as a director Negotiate on costs

or

Accept reduced period of disqualification
if offered

How can a director be disqualified?

The reasons why a director may be disqualified can vary from negligence or incompetence, through to criminal behaviour and repeat offending.

Directors disqualification proceedings are often referred to as ‘quasi-criminal’ as they have a penal element to them. They are classed as civil proceedings, but in reality they are a hybrid.

There are various ways in which a director can be disqualified from acting as a director of a limited liability company. The most common of these is to be disqualified for ‘unfit conduct’ as a director of an insolvent company under CDDA 1986, s 6. Shadow and de facto directors are also subject to the provisions under the CDDA 1986.

However, there are various other sections contained under the CDDA 1986 and the Insolvency Act 1986 (IA 1986) that allow for the disqualification of a company director, which are less common.

Whatever enactment is used to disqualify a director, what is prohibited to a person once disqualified as a director is generally the same.

Any disqualification will be for a minimum of two years, and a maximum of 15 years. This will depend on the level of misconduct.

What constitutes unfitness under CDDA 1986, s 6?

What constitutes unfitness is extremely wide ranging, and there is no specific definitive answer in the legislation, as to do so might restrict what the courts can hold to be unfit.

‘Unfit conduct’ includes but is not limited to:

  • allowing a company to continue trading when it can’t pay its debts
  • not keeping proper company accounting records
  • not sending accounts and returns to Companies House
  • not paying tax owed by the company
  • using company money or assets for personal benefit

NB. You’re not usually allowed to be a company director if you’re under restrictions from bankruptcy or a Debt.

You may be fined, prosecuted or disqualified if you don’t meet your responsibilities as a director. These responsibilities include but are not limited to:

As a director of a limited company, you must:

  • follow the company’s rules, shown in its articles of association
  • keep company records and report changes
  • file your accounts and your Company Tax Return
  • tell other shareholders if you might personally benefit from a transaction the company makes
  • pay Corporation Tax
  • register for Self Assessment and send a personal Self Assessment tax return every year

You don’t need to register for Self Assessment or send a tax return if your company is a non-profit organisation (for example, a charity) and you didn’t get any pay or benefits, like a company car.

You can hire other people to manage some of these things day-to-day (for example, an accountant) but you’re still legally responsible for your company’s records, accounts and performance.

Pre-action

Directors disqualification—pre-action protocol and considerations

All proceedings under CDDA 1986, s 6 are brought by the Secretary of State for Business, Energy & Industrial Strategy (SoS), working within the Department for Business, Energy & Industrial Strategy.

Proceedings will either be brought in the name of the SoS, for voluntary winding up, or by the official receiver (OR) in compulsory winding up cases. Both exercise the same functions and, for ease, when we refer to SoS in these notes, we also include the OR.

Under CDDA 1986, s 7(3), the OR in a compulsory liquidation or the responsible insolvency practitioner (IP)—i.e. the voluntary liquidator, administrative receiver or administrator—must report a director’s ‘unfit conduct’ within six months of the date of insolvency.

The IP has a duty to investigate any company wrongdoing under Statement of Insolvency Practice (SIP) 2. However, his report is very much a starting point, and the SoS may either drop some or all of the allegations, or add others as he completes his own investigation. The IP must consider SIP 4 when investigating and submitting his report.

Note that from October 2015, paragraph 11 of Schedule 6 to the Deregulation Act 2015 (DA 2015) amended CDDA 1986, s 7(4) to allow the SoS (or the OR) to obtain information on a director’s misconduct from any person without requiring authority from the insolvency office-holder for the purpose of investigation in non-compulsory insolvency cases. This affects insolvencies after 1 October 2015. For details of the DA 2015, see: The Deregulation Act 2015.

The SoS has a duty to act fairly, and in the public interest, and this includes during the assessment stage of the process. This duty is ongoing throughout the proceedings and affects how his evidence is presented.

The court process

CDDA 1986—the process

The legislation surrounding applications under CDDA 1986, s 6 can be found mainly under both the Disqualification Rules 1986, SI 1987/2023.

The Civil Procedure Rules (CPR) also apply, except to the extent that they are inconsistent with the Disqualification Rules 1986, when the Disqualification Rules will take precedence. The claim form is drafted under CPR 8.

An application for a disqualification order must be supported by written evidence.

The evidence in support of the application should be filed in court when the claim form is issued, and exhibits should be lodged with the court.

The defendant will then be given an opportunity to file evidence in defence.

There is normally no disclosure of documents under the Part 8 procedure. A party to disqualification proceedings does not, therefore, have to disclose documents unless he is specifically ordered to do so, or is requested to produce documents referred to in his written evidence.

In practice, the SoS will disclose everything that he is able to, in accordance with his duty of fairness, and will always produce documentary evidence of anything that he relies on in his affidavit if it is available.

It should be noted that because of the public interest nature of these proceedings, and because the penalty can be severe for the defendant, potentially affecting his livelihood, the courts tend to allow both parties sufficient time to file their evidence, although being mindful of avoiding unnecessary delay.

Procedural issues and undertakings and Carecraft settlements

It is possible for a defendant to settle his case without having to go to court. The usual way this occurs these days, from the date when undertakings were first introduced by the Insolvency Act 2000 (IA 2000) (in force 2 April 2001), is for the defendant to provide an undertaking to the SoS not to act as a director for a specified period of time. However, it is still possible to use the old form of Carecraft agreement, although the benefit of these has diminished as the process takes longer and is more expensive than providing an undertaking. As a result, these are rare since undertakings were provided for in the IA 2000.

Post-disqualification order

Commencement of the order or undertaking, and sanctions for breach

CDDA 1986, s 1(1) provides that a disqualification order must be for a period specified in the order, and that ‘unless the court otherwise orders, the period of disqualification…imposed…[under a disqualification order] shall begin at the end of the period of 21 days beginning with the date of the order.’ This provision allowing 21 days’ grace has been in place since April 2001 as a result of changes brought in by IA 2000, s 5(2). It allows a short time for a director to put his house in order while still a director, but avoiding sanctions for breach.

Once the disqualification is in place, there are both criminal and civil sanctions for breach.

Publicity

Once a disqualification order is made, the SoS will issue a press release, which may be picked up by any press, although this would usually be a publication local to the defendant unless the matter is particularly high-profile. This adverse publicity for the defendant will serve both as a deterrent to others, and as a warning to anyone who may have dealings with the director that he is disqualified.

Any director who is disqualified by whatever provision will have his name included on a central Register of Company Directors, which is available to the public at Companies House and at the Insolvency Service website and is searchable by the public.

Setting aside/variation of order

Usually, any application to set aside or vary the period of disqualification that has been made at a contested hearing or at a hearing which the defendant has attended should be by way of appeal.

However, it may also be possible to set aside or vary both a disqualification order and/or the period of disqualification in certain limited circumstances.

It is rare for an order to be rescinded or varied.

Costs

Inevitably, on a disqualification order being made, or when a disqualification undertaking is given, the defendant will be responsible for the SoS’s costs unless agreed otherwise. However, this is the starting point, and other matters will be taken into consideration, including the conduct of all parties.

 

Disqualification proceedings are civil proceedings and, as such, the general principles relating to costs that apply to other civil proceedings under CPR 44.3 also apply to these proceedings.

The court will usually carry out a summary assessment of any costs that it orders a party to pay if the matter has ended from either an undertaking or a trial that lasted less than a day.

Permission to act as a director despite disqualification—CDDA 1986, s 17

There is a mechanism within s 17 of the CDDA 1986 for a director to obtain permission to act as a director despite disqualification in certain limited circumstances. This is important if a director is absolutely integral to a company’s success and his disqualification may well mean the failure of the company with a consequent loss of employment to others as well as himself. However, this is to be balanced against the importance of the protection of the public, and the deterrent effect that disqualification has.

Permission is only ever granted over named companies and depending on the reason for disqualification, is often subject to conditions.

Any application for permission for the purposes of CDDA 1986, s 1(1)(a) shall be made to any court which, when the order was made, had jurisdiction to wind up the company (or, if there is more than one such company, any of the companies) to which the offence (or any of the offences) in question is related.

On the hearing of an application for permission, the SoS has a duty to appear and call to the attention of the court to any matters which seem to him to be relevant, and may himself give evidence or call witnesses. See s 17(5) CDDA 1986. If the matter is one of the OR’s, in practice all applications go through the Insolvency Service (SoS) now, who usually discuss the case with the OR acting if they feel it appropriate. The court is not obliged to follow the SoS’s recommendations, but in practice the opinion of the SoS will be influential in whether leave is to be granted or not.

It should be noted that the SoS is not a party to the proceedings and should not be stated as such in the pleadings. However, he should be given notice of the claim form (see below) and be provided with all evidence.

It should be noted that often, leave to act will be subject to certain conditions from the court that the director and the company in question must comply with.

Prohibited names under IA 1986, s 216

IA 1986, s 216 is aimed at preventing phoenix companies from causing a disadvantage to creditors by creating more transparency surrounding the re-use of company names. A phoenix company may typically be where a director or directors trade a successive company with a similar name, taking the valuable parts of the company in liquidation, leaving behind its creditors. The re-use of the name is seen by many as a way of deceiving creditors into thinking they are dealing with the same company. This practice (known as ‘phoenixing’) is therefore often met with distrust by creditors.

In some circumstances, however, the purchase of the business and assets of the company in liquidation and the continuation of the business can be positive, especially for employees, and can be a way of bringing money into the liquidated company by way of sale proceeds which may not otherwise have been available. The re-use of the old name can be vital to this process in order to harness the goodwill; however, for this to be fair and transparent, the re-use of the name has to be regulated.

The general rule is that a director of a company that goes into liquidation cannot use the name of that company in liquidation in a new business for a period of five years, or they risk criminal and/or civil penalties. However, there are of course exceptions. This includes statutory exceptions that do not require permission of the court, and the ability of a person to apply to the court for leave to use a prohibited name.

It is very important when providing evidence in support of an application that the relevant information is provided, to prevent rejection or delay of the application. For more information on what is required,

The Insolvency Service

The Insolvency Service publishes a series of publicly available guides that cover directors disqualification.

Note that the Small Business, Enterprise and Employment Act 2015 (SBEEA 2015) received Royal Assent on 26 March 2015 and introduced a number of changes that affect directors disqualifications under the Company Directors Disqualification Act 1986 (CDDA 1986).

The Insolvency (England and Wales) Rules 2016, SI 2016/1024

The Insolvency (England and Wales) Rules 2016 (IR 2016), SI 2016/1024 were published and laid before parliament on 25 October 2016, with a commencement date of 6 April 2017. For further detail the reader is referred to the following sources:

  • the full text of IR 2016, SI 2016/1024
  • Explanatory memorandum
  • Guide to the destination of the Insolvency Rules 1986, SI 1986/1925 in the Insolvency (England and Wales) Rules 2016, SI 2016/1024

The disqualification regime has not been subject to any significant amends under the IR 2016, however, if any updates have been necessary, these will be found in the individual practice notes in this sub topic. For more detail on the changes made by the new rules see: Insolvency and The Insolvency (England and Wales) Rules 2016—overview.

Question and Answer section

How and why does Department of Business, Innovation and Skills (DBIS) become involved?
If your company goes into some form of insolvency, the Insolvency Practitioner has a duty to submit a ‘D’ form which will include his/her comments on your role as a director in the insolvency of the company. That said, DBIS does not necessarily investigate each insolvency situation, or apply for disqualification every time.

How do you know whether a disqualification order will be made?
The test is whether your conduct as a director falls below the standards of probity and competence required by the court thereby making you unfit to manage a company.

The court’s approach to this question consists of a combination of fact and law. It will make a finding of fact that there was unfitness. It will then have to decide whether your conduct fell below the standards required of directors, by law.

In reaching this decision, the court will take into account factors including:

  • misuse of company funds
  • the extent to which you were responsible for causing the company to become insolvent
  • whether you allowed the company to enter into transactions to defraud its creditors
  • the extent to which you were responsible for a failure to keep full and proper accounting records and/or submit annual returns/file accounts on time
  • trading to the detriment of the Crown (effectively using monies owed to the Crown in respect of PAYE, NIC and VAT as working capital)
  • trading to the detriment of the body of creditors as a whole
  • failure to co-operate with the liquidator/deliver up the company’s property

How long is the period of disqualification likely to be?

Period of Disqualification Example of behaviour
Not so serious 3-5 years Allowing co-director to act whilst disqualified, causing or allowing payments to be made to family member/co-director when you knew or ought to have known company was insolvent
More serious 6-10 years Failure to pay corporation tax/PAYE/NIC/VAT whilst declaring dividends and repaying loans despite existence of these HMRC liabilities/trading to the detriment of the Crown
Very serious 10-15 years Acting as a director whilst disqualified or whilst bankrupt

Are there any defences a director can rely on?
Yes. However, the first thing to mention is that you should seek legal advice at the first sign of trouble. Don’t ignore the warning signs: there is much that can be done to either defend proceedings or, at the very least, to try and mitigate the disqualification period.

This can often be crucial where the director is a member of a professional body and may potentially risk disciplinary action by that body.

Mitigating factors might include:

  • you having suffered personal financial or other loss emphasising, if appropriate, the absence of dishonesty (ensuring that a disqualification of 10-15 years is unlikely to be ordered)
  • delay in bringing the disqualification proceedings
  • reliance on the professional advice of others
  • your youth and inexperience
  • compromised ability to perform your duties due to other commitments, such as caring for a terminally ill relative or domestic pressure
  • co-operating with the office-holder and those involved in disqualification proceedings
  • admitting responsibility

Is there any way to short circuit the procedure?
Yes. If, on receipt of the Insolvency Service’s notification of DBIS’s intention to bring disqualification proceedings or at any stage before trial, you do not wish to contest the proceedings, you can offer to give an Undertaking not to act as a director.

Be warned that the costs become more and more onerous the longer the proceedings are ongoing and the closer you get to trial.

What happens once the Order is made?
If you have no need to act as a director or be concerned in the management of a company, then nothing happens.

However, if you have a need to act as a director of a specific company, then we can assist in the preparation of an application for permission to act under Section 17 of the Company Directors Disqualification Act 1986.

We have extensive experience of these types of applications from DBIS’s perspective, and so we are very well placed to prepare them from your perspective as a defendant director.

Case Law

A substantial body of case law has arisen since The Company Directors Disqualification Act 1986 was enacted. That is not surprising when you consider the serious impediments to earning an income that a disqualification order can have on an individual.

The fact that a company is insolvent when it goes into liquidation is not a ground for a disqualification order, there must be much more.

Areas which the court will consider when deciding whether or not to make a disqualification order will include:

  • Misfeasance or breach of duty
  • Misapplication or retention of company money or property
  • Transactions defrauding creditors
  • Failure to comply with the Companies Acts

You may be interested in reading the following abridged case law summaries of cases concerning directors disqualification under The Company Directors Disqualification Act 1986 and the legal principles derived from those cases:

•   Directors Disqualification Case Law – The Duty of fairness; Re: Hickling

•   Directors Disqualification Case Law – Allegations must be clear (The clarity principle); Re: Laing

•   Directors Disqualification Case Law – Wrongful Trading; Re: Taylor

•   Directors Disqualification Case Law – Reliance on professionals; Re: Douglas Construction

•   Directors Disqualification Case Law – Hindsight; Re: Living Images Ltd and Re: C.U. Fittings

•   Incompetence or lack of probity

These are only some of the many cases on directors disqualification under the Company Directors Disqualification Act 1986 but they do highlight the key legal principles.

Company Directors Disqualification Case Law – Re Hickling – The duty of fairness

This page summarises a legal case brought under The Company Directors Disqualification Act 1986 where a director was alleged to be unfit to act as a director. The case identified a legal principle known as the “duty of fairness”.

This is a leading case as to the “duty of fairness” to be applied in company directors disqualification proceedings.

Duty of Fairness – The Judge’s remarks:

It is well settled that, in presenting the evidence in support of an application for a disqualification order, the applicant has a duty to be fair. This was summarised in the Hickling case as follows:

“At this stage I want to say a little about the applicants duties. It is accepted that these are not adversarial proceedings but have an element of public interest and may entail penal consequences. It follows that there is a duty on the applicant to present the case against each respondent fairly. Many of these applications go by default or are defended by litigations in person, and the practice is for an official in the Department of Trade and Industry to swear a short affidavit referring to charges, specified in a detailed affidavit sworn by the receiver or liquidator.

In my judgment that second affidavit (ie the one sworn by the liquidator) should not omit significant available evidence in favour of any respondent. It should attempt to deal with any explanation already proffered by any of the respondents. It should endeavour to apportion responsibility as between the respondents and it should avoid sweeping statements. I do not know who drafted the receivers affidavit in the present case, but it does seem to me to fall down on all four counts.”

Directors Disqualification Act Case Law – Allegations must be clear – Re Laing

“Allegations must be clear” in any case against an allegedly unfit director under The Company Directors Disqualification Act 1986

Related to the duty to be fair is the fact that the applicant has a statutory duty to summarise the charges by virtue of The Insolvency Rules 1986 Rule 3(3). Whilst not a pleading, that summary must be clear. As Evans-Lombe J said in Secretary of State for Trade and Industry -v- Laing (1996) 2 BCLB 324 (at 347g-h):

“It is well established by authority that in proceedings under section 6 of the Company Directors Disqualification Act 1986 Act a respondent director is entitled to know with reasonable clarity the nature of the case which he has to answer.”

For instance, the following is a hopeless formula for expressing a wrongful trading allegation:

“the respondents caused or allowed the company to continue trading insolvently after (date) when they knew or ought to have known that they were trading to the detriment of creditors.”

Obviously, trading whilst insolvent can be to the detriment of creditors, but this formula has little to do with an assessment of unfitness. The “trading whilst insolvent” allegation is by far the most prevalent and troublesome. If the allegation is not clear and is not supported by evidence how can the defendant director possibly respond?

Directors Disqualification case law principles – Wrongful trading – Re Taylor

The “No Reasonable Prospect” Principle

Allegations of Wrongful Trading and how they impact on a director alleged to be unfit to act as a director under The Company Directors Disqualification Act 1986 – The legal principles.

Technical insolvency does not trigger unfitness within the meaning of Section 6 of the Company Directors Disqualification Act 1986 when seeking a disqualification order. Through temporary cashflow crises, many companies are unable to pay their debts. Equally, many companies can only continue to trade with the support of their bankers. Without more, reasonable and competent businessman would not find anything repugnant in continuing to trade in such circumstances. Doing so would not and does not, of itself, render a director unfit.

Technical insolvency on either basis (ie balance sheet or cashflow) is only the beginning of the inquiry, not the end. Were it otherwise, especially in recessionary times, the burden on directors would be prohibitive and, itself, against public interest. Likewise, “trading to the detriment of creditors” is a meaningless phrase in the context of a Section 6 application.

Often, evidence against a respondent comprises many paragraphs directed at establishing insolvency without going on to explain why or on what grounds it is alleged the respondent was unreasonable when he caused the company to continue to trade.

The point can be seen readily in the following statement of Chadwick J of what constitutes “wrongful trading” in Secretary of State for Trade Industry -v- Taylor (1997) I WLR 407 (at 141f-h).

“The companies legislation does not impose on directors a statutory duty to ensure that their company does not trade while insolvent: nor does that legislation impose an obligation to ensure that the company does not trade at a loss. Those propositions need only be stated to be recognised as self-evident. Directors may properly take the view that it is in the interests of the company and of its creditors, that although insolvent, the company should continue to trade out of its difficulties. They may properly take the view that it is in the interests of the company and its creditors that some loss-making trade should be accepted in anticipation of future profitability. They are not to be criticised if they give effect to such views, properly held. But the legislation imposes on directors the risk that trading while insolvent may lead to personal liability. Section 214 of The Insolvency Act imposes that liability where the directors knew or ought reasonably to have concluded that there was no prospect that the company would avoid going into insolvent liquidation.

If it is established in proceedings under Section 6 of the Company Directors Disqualification Act 1986, that a director has caused a company to trade when he knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation that director may well be held unfit to be concerned in the management of a company.”

In other words, for the applicant to make out his case, he must set out why there was “no reasonable prospect” at the time in question. The test is what a reasonably diligent person in the position of the particular respondent should have known or ascertained. The Court must consider the knowledge skill and experience which someone in the respondents position should have had and also the knowledge skill and experience which he did have.

Company Directors Disqualification Act – Case Law – Reliance on professionals – The legal principle

Legal case known as “Re Douglas Construction”

There have been a series of legal cases on the Company Directors Disqualification Act 1986 concerning the legal principles that should be applied when the Court considers whether a director is “fit” or “unfit” for disqualification purposes. One of these disqualification legal principles concerns the degree to which a director can place “reliance on professionals advice” when defending disqualification proceedings.

“Reliance on professionals” – The legal principle

A director may not shirk his responsibility by leaving everything to others. He must take proper steps to see that there is an apparently proper management system in place which is apparently working and providing the directors with what appears to be proper information. He cannot (nor is he required) to do more than that.

Thus, for example, in Re: Douglas Construction (1988) BCLC 397 the non-finance directors conduct was held not to be unfit when he appointed an apparently competent finance director (an accountant) who produced management accounts which appeared to be satisfactory and assured the non-finance director that things were going well, despite the fact that the company was trading in an increasingly precarious position and (unknown to the non-finance director) had received a welter of writs and summonses for unpaid debts from creditors and had mounting Crown debts.

 

When assessing the question whether the non-finance director is unfit on the grounds that there was no reasonable prospect that the company would avoid insolvent liquidation, much will depend upon:

 

·         the quality of information provided to the non-finance director by the finance director/advisor and others (bookkeepers, financial managers etc); and

 

·         whether the non-finance director can be criticised (to the extent that his conduct is in itself unfit) for relying upon that information or not ensuring a better quality of information

Thus, suppose the Court should find in a given case that:

·         the other directors reasonably regarded their finance director or financial adviser as competent and diligent and someone whom they had no reason to believe was not performing his job properly; and that

 

·         the finance director or financial director ought to have concluded at a particular date that there was no reasonable prospect that the company would avoid insolvent liquidation but that

  • the finance director did not provide his co-directors with the information to enable them to appreciate this.

The conduct of his co-directors will not be culpable (or at least sufficiently culpable) for disqualification purposes. In Secretary of State for Trade and Industry v Tjolle and others (unreported) 2nd May 1997, Jacob J. absolved the 3rd respondent from any blame because it was reasonable for her to have relied on the mere presence of an accountant advising the board:

“So far as Mrs Kenning was concerned, a responsible chartered accountant had come on the scene. She knew he had knowledge of the company was a trusted advisor of her boss, Mr Tjolle. I do not see why she should have inquired further.”

For company directors disqualification purposes a defendant director can use the legal principle known as “reliance on professionals” in the scenario set out above.

Directors Disqualification Case Law – Hindsight principle -Re Living Images Ltd

In the many reported Company Directors Disqualification Act cases where directors have been alleged to be unfit to act as a director in future the Courts have identified a number of legal principles that directors can use in their defence. One such legal principle is known as the “hindsight principle”.

The Hindsight Principle

Note, in particular, the comments in Sherbourne Associates concerning the dangers inherent in the use of hindsight. This familiar theme through-out the reported cases was summarised  by Laddie J in Re: Living Images Limited (1996) BCC 112 (at 116H):

“I should add that the Court must also be alert to the dangers of hindsight. By the time an application comes before the Court, the conduct of directors has to be judged on the basis of statements given to the official receiver, no doubt frequently under stress, and a comparatively small collection of documents selected to support the official receivers and respondents respective positions. On the basis of this the Court has to pass judgment on the way in which the directors conducted the affairs of the company over a period of days, weeks or, in this case, months. Those statements and documents are analysed in the clinical atmosphere of the courtroom. They are analysed, for example, with the benefit of knowing that the company went into liquidation. It is very easy therefore to look at the signals available to the directors at the time and to assume that they, or any other competent director, would have realised that the end was coming. The court must be careful not to fall into the trap of being too wise after the event.”

Professor Goode (Principles of Corporate Insolvency Law (1997) (2nd Edn)) summarises the position as follows:

“It is necessary to be particularly cautious in applying hindsight to cases involving personal liability, eg, for wrongful trading, or the setting aside of a preference. Business life is neither static nor certain. Information has constantly to be updated, predictions made about a range of uncertain events, snap judgements formed, rapid decisions taken and adaptations continually made in the light of shifts in customer demand, tax changes, industrial actions, political events, international relations, and the like. Just as it is all too easy for historians to pick their way leisurely across the battlefields of Waterloo identifying Napoleons errors in the confusions engendered by blazing guns, cavalry charges, mud, darkness, uncertainty as to the current arrivals or dispositions of troops and ignorance of the intentions of the enemy, so also a professional acquainted with subsequent events in a company’s life is all too readily beguiled into the view that he would have done things differently, that what is now apparent was obvious from the start.

It is submitted that where the question is whether a director ought to have concluded that there was no reasonable prospect of the company avoiding insolvent liquidation (a question which arises in proceedings for wrongful trading under Section 214 of the Insolvency Act 1986) the directors reliance on a reasonable accounting view that if the company did go into liquidation its assets would be sufficient in value to cover its liabilities and the expenses of winding up should suffice to render him or her immune from liability, even if in the event the assets realise a much lower figure than estimated, with the result that at the time of liquidation the company in fact has an asset deficiency.”

If you are pursued as an allegedly unfit director in Company Directors Disqualification Act proceedings consider if you can use the legal principle known as the “hindsight principle” in your defence.

Directors Disqualification Case Law – More on the hindsight legal principle

Case discussed – Re C U Fittings 1989

How to avoid a company directors disqualification order by using in your defence as an allegedly unfit director the legal principle known as the hindsight principle.

Experienced judges have expressed an appreciation of the difficulties of making decisions in the “heat of battle” in various ways. Thus, Hoffmann J in Re: C U Fittings 1989 (BCLC) 556 (at 559d) was to say:

“It may be that in January, or even earlier, a dispassionate mind would have reached the conclusion that the company was doomed. But directors immersed in the day to day task of trying to keep their businesses afloat cannot be expected to have wholly dispassionate minds. They tend to cling to hope.

Obviously there comes a point at which an honest businessman recognises that he is only gambling at the expense of his creditors on the possibility that something may turn up. But this is not such a case.”

 

There are numerous other examples (Re: Bath Glass Ltd (1988), Re: Dawson Print Ltd (1987), Re: McNultys Interchange Ltd (1989) and Re: Cladrose (1990)). Directors are not disqualified for failing to have a crystal ball or for failing to take a week off to consider their position.

Just because it is alleged that you are an unfit director does not mean that the allegations are either fair or are allegations made with the benefit of hindsight. Take note of several legal principles that defendants in Company Directors Disqualification Act proceedings can use:

– The Fairness principle and

– The Hindsight principle and

– The principle concerning your right to rely on professionals

and you will then see that you might avoid any disqualification order or proceedings may be stopped. Who has the benefit of hindsight? The Court recognises that you do not have that benefit.

The incompetence principle

Should an incompetent director be disqualified for that incompetence?

In the fourth Annual Leonard Sainer Lecture (26/11/96), Lord Hoffmann summarised the position as follows:

“In a recent case in the Court of Appeal it was said that the question which the court had to ask was whether a directors conduct had fallen below the standard of probity and competence required by the law of a person concerned in the management of a company. It did not actually say what that was. But what that shows is that the court is not concerned merely with probity. Incompetence is also, at any rate in theory, a ground of disqualification. And yet the cases in which directors have been disqualified simply for incompetence have been extremely rare. The courts tend to emphasise the importance of conduct which does not constitute some breach of accepted commercial morality. This attitude has been attacked by writers, or some of them, as giving insufficient effect to the protective purpose of the statute. To the creditors who lose their money, it does not especially matter whether the people running the company were dishonest or merely genially incompetent. It is said that incompetent directors ought to be put off the road for a while like incompetent drivers, simply for the protection of members of the public. But the courts have never completely accepted this philosophy and I want to explain why.

Firstly, disqualification is a very serious matter. In theory it does not prevent the director from going back into business as a sole trader but in practice it may make it very difficult for him to earn a living. A finding that a director was unfit carries with it a mandatory minimum 2 year period of disqualification and it does not matter that the unfortunate conduct in question happened several years before and it had taken the intervening period for the Department of Trade to wind itself up to bring the proceedings and that since then the director has gone on to run a prosperous business. The trouble with mandatory sentences, as was found when the mandatory sentence for sheep stealing was death and no doubt will also be found under the new mandatory sentences which the Government proposes to introduce, is that if the sentence is too harsh, it will be very reluctant to convict at all.

Secondly, where the law does not require any kind of qualification for becoming a director, it is not easy to fix an ex-post facto standard of competence for disqualification.

Thirdly, the process by which people land up at the receiving end of an application for disqualification is bound to be fairly arbitrary. It depends first of all upon the directors incompetence having been followed by the insolvency of the company. Whether or not this happens is very often a matter of luck. A rise in the market can compensate for the effect of some perfectly hair-raising piece of incompetence. One is very conscious of how thin is the line between success leading to wealth and knighthood and failure leading to disqualification or even imprisonment. Indeed, the defendants in the Guinness case had landed on both the snakes and the ladders in the course of their careers.

Fourthly, the disqualification procedure is necessarily weighted against the defendants. The applicants have all the resources of the State. The defendants, as directors of insolvent companies, tend to be a bit short of money and unless they are on legal aid they cannot afford the considerable expense of instructing solicitors to defend them. I had a case myself about a young printer whose company had become insolvent and he decided to defend himself. He struck me as honest and at least as intelligent as a number of rich and successful businessmen who had given evidence before me in the past. To his obvious astonishment. I dismissed the summons.

So the cases under the Disqualification Act are therefore directed to a special problem, that is to say the abuse of limited liability. The points which they raise are concerned mostly with fairness under the insolvency law and the obligations of a businessman to his creditors rather than general corporate government.”

In summary, cases where directors have been disqualified under the Company Directors Disqualification Act 1986 for incompetence are extremely rare.

Carecraft orders and Disqualification undertakings

Following the introduction on The Company Directors Disqualification Act in 1986 for any director to be classed as “unfit” (and therefore subject to being disqualified to act as a director) that person had to be taken to Court for an appropriate Court Order to be made. That led to much expensive litigation with the Defendant director on the one side and the DTI (as they then were) on the other.

The concept of a Carecraft Order first arose in a case where a director agreed to disqualification for a set period of years prior to the case having to go to trial. By coming to such an agreement, the director avoided much of the court costs which can be substantial. The director however, still had to meet the costs incurred up to the point at which he agreed to the disqualification.

Under the carecraft procedure the director agreed with the DTI Company Directors Disqualification Unit:

  •  a statement of facts and
  • a set period of disqualification

The agreement would then be submitted to the court so that the appropriate court order could be made.

Following the introduction into law of the Insolvency Act 2000 the procedure has been simplified even further. The relevant sections of the Insolvency Act 2000 were brought into effect on the 2nd April 2001. From that day on it has been possible for directors to enter into “disqualification undertakings” direct with the DTI without there having had to have been any court appearances.

The Company Directors Disqualification Act 1986 and Section 6 of The Insolvency Act 2000 set out the cheaper “disqualification undertaking” process leading to disqualification of a director as and from the 2 April 2001

In appropriate cases the Insolvency Act 2000 allows disqualification orders to be made without referring the matter to court through the use of disqualification undertakings. This clearly reduces the cost when the DTI and the director concerned have agreed:

  • a statement of facts and
  • a period of disqualification.

Section 6 of the Insolvency Act 2000 concerning “disqualification undertakings” became law on the 2nd April 2001. The power to accept disqualification undertakings is conferred on the Secretary of State. Where there is agreement, disqualification can be achieved administratively by the director giving a disqualification undertaking to the Secretary of State. This will result in earlier disqualification for those who give an undertaking. It will also save time and money.

Section 6 of the Insolvency Act 2000 provides:

“This section amends the Company Directors Disqualification Act 1986 by providing that directors whom the Secretary of State considers unfit may consent to a period of disqualification without the need for court involvement by giving a disqualification undertaking to the Secretary of State”.

The period of disqualification could be for a period of between 2 and 15 years.

In consequence, these days Carecraft Orders are not applied for as there is now a statutory route to agree a Disqualification Undertaking and therefore substantially limit the costs of the disqualification process.

If however a director who the DTI considers to be unfit does not agree a disqualification undertaking then the matter is taken to Court. If in the Court’s assessment the director is “unfit” then the Court may make a Disqualification Order barring the individual from being a director for a period of between 2 and 15 years.

The costs of defending disqualification proceedings

Contested Company Directors Disqualification Act hearings can be very costly.

Costs accumulate very quickly when you consider the preliminary and expensive costs of the Secretary of State before a Court case is even issued. Those costs include:

  • the costs of the Secretary of State’s solicitor
  • counsel’s cost
  • witnesses’ costs

By the time an affidavit together with exhibits is issued by the Secretary of State the costs are usually £2,500 and much more than that in involved cases. This is an important issue when you consider that the court usually order the ‘loser’ in disqualification hearings to pay all parties costs. While the sum of £2,500 may not be regarded by some as being material the extra costs which arise when the matter is taken to court are substantial.

While it is impossible to give an accurate estimate of costs here, we have seen costs incurred of £30,000 in some cases rising to £80,000 in others. In more involved cases the costs can be even higher.

Until the 1st April 2001 court proceedings could be effectively avoided by entering into what were known as Carecraft Orders. Post 2nd April 2001 the Insolvency Act 2000 simplified the matter even further, with a consequent reduction of costs, by introducing into law the concept of  “disqualification agreements” under an arrangement called a “disqualification undertaking”.

The temptation may be therefore for you to accept a disqualification undertaking – But before you do that read the case law on this website concerning the various principles that judges consider in Company Director disqualification hearings. You then may by using those principles in legal argument be able to reduce the Secretary of State’s suggested disqualification period avoid or minimise the costs of any disqualification proceedings should you not reach a satisfactory conclusion by negotiation.

Future employment by a limited company

One effect of a disqualification order under The Company Directors Disqualification Act 1986 is that that individual who is made subject to a disqualification order cannot be a registered director of a limited company for the period of the disqualification order (or disqualification undertaking).

Another effect is that neither can that person act as a de facto director or as a shadow director.

If the disqualified individual gets involved with a company after the disqualification order and acts as if he were a director then the following severe penalties may follow:

Criminal Sanctions

On conviction, the “director” could be imprisoned for not more than two years or be fined (or both). (Crown Court)

OR

Civil Sanctions

The “director” may be personally liable for the company’s debts.

A disqualification order is not intended to deprive a person from earning a living. In our experience through contact with the Insolvency Service and by providing them with full written information a disqualified person can work for a limited company during the period of disqualification. The person must have a job description that ensures that in reality that individual is not involved in financial matters.

Any failure to accept the spirit and the wording of a disqualification order can result in imprisonment and personal liability for the debts of the company with which the disqualified director became involved after disqualification.

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