Directors can be disqualified for a number of reasons and in a number of circumstances.
However, the most common circumstance where disqualification as a director will be considered is following the placing of a company into liquidation or administration, which are the most commonly adopted insolvency procedures for companies.
What is insolvency?
Insolvency is a term defined generally as being one of two events (or usually both) – either where a company cannot pay its debts as and when they become due (i.e. cash flow insolvency) or where a company’s debts exceed its assets (often referred to as Balance Sheet Insolvency).
A company can be profitable on paper yet still be insolvent, especially where the “on-paper” profit cannot be converted to liquid resources sufficient to pay creditors.
Insolvency itself is not necessarily a prerequisite for a director to be disqualified – may companies may continue to trade despite being insolvent. It is only where the company is placed into a formal insolvency process (as described above) that director disqualification becomes a real threat.
What happens following insolvency?
The formal insolvency of a company will lead to the appointment of either the Official Receiver or an independently qualified insolvency practitioner as a liquidator or administrator, dependent on which process is adopted.
This individual (or individuals – there are often joint office holders) will complete an initial review of the period leading up to the company’s failure and then produce a report on the director’s conduct.
This report is required to be produced on an ongoing basis, in the event any further conduct issues are discovered by the administrator/liquidator.
This document sets out the reasons for the failure of the company, the extent of involvement of the director or directors, the extent of their contribution to failure and any grounds on which the office holder believes that their actions may have caused the insolvency of the company or in any way breached their public interest and fiduciary duties (which are, in the event of insolvency, owed to creditors).
The report on a director’s conduct is required to be delivered to the Insolvency Service, an executive agency of the Department for Business, Energy and Industrial Strategy (the title as of writing).
The Insolvency Service is responsible for all director disqualifications in the UK following a company insolvency. Although the legislation is mostly identical, as the Court and litigation system is different in Scotland and Northern Ireland, they are dealt with slightly different there and this page is only relevant to the litigation procedure in England and Wales.
Once this report is received by the Insolvency Service then it will be assigned to the relevant department and a case officer will review it initially and determine whether further investigation of the director is warranted.
If it is then an initial questionnaire is sent to the director for them to complete.
Dependant on the response to this questionnaire, and evidence received from other sources, it may then be determined within the Insolvency Service that there is a case to answer and so full investigations may be pursued.
Approach by Insolvency Service
The Insolvency Service may follow this initial questionnaire with further enquiries in an attempt to build up the volume of evidence that could be potentially used in support of a director disqualification claim. All responses provided by a director, no matter how well intentioned, will be used against them in such proceedings.
From experience we find that the more cooperative directors face the greatest risk of being targeted for director disqualification.
Once the investigations have been concluded, a letter will be sent to the director(s) pursuant to Section 16 of the Company Directors Disqualification Act 1986 setting out a summary of the allegations of misconduct and inviting the director to voluntarily agree to undertake to be disqualified, with the incentive of a slightly lower period of disqualification and the avoidance of legal costs.
Risks attached to a Disqualification Undertaking
The risks attached to an undertaking cannot be underestimated.
In summary a Disqualification Undertaking will impact on your successor business (either current or intended), the publicity may limit your future business prospects and it could be used as a springboard for an appointed liquidator to pursue an insolvency claim against you.
Most importantly, a Disqualification Undertaking will not always protect you from onerous costs as, following the introduction of the Small Business, Enterprise and Employment Act 2015, a director may be automatically liable for a Compensation Order once a Disqualification Undertaking (or Disqualification Order) takes effect.
Read more about Compensation Orders and the risk you face of being subject to one once you have been disqualified, at which point it may be too late to try and defend your position.
At Francis Wilks & Jones we are able to advise on any risk you or your business may face as a result of an Order or threat to disqualify you as a director or, alternatively, assist you when faced with threatened or issued proceedings which may result in your disqualification as a director (including claims by liquidators and Compensation Order claims).
Please call any member of our Director Disqualification team for a consultation now on 020 7841 0390. Alternatively please email us with your enquiry and we will call you back at a time convenient for you.