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When directors get disqualified, don’t make things worse

MIchael Reid
MIchael Reid

The vast majority of limited liability companies in the UK operate profitably and those at the helm, normally referred to as directors, enjoy the responsibility, challenge and social acceptability that accompany such position. However, not all companies succeed and there are about 1,100 companies each year in Scotland who tumble into formal insolvency.

For many individuals, corporate collapse is seen as a personal failing and can cause both social and domestic strife as well as a collapse in self belief. Contrary to urban myth, a director of a company which is subject to liquidation, administration or receivership is not banned automatically from acting as a director (or made bankrupt) but there is a process which can result in disqualification and hence, further personal difficulty may lie ahead.

Within six months of being appointed, an insolvency practitioner “IP” must submit documentation to the director disqualification unit of The Insolvency Service who are then given a period of up to 18 months to decide whether the documentation merits taking steps through court to disqualify someone from being a director. The term director includes “shadow director” i.e. someone under whose instructions a company is accustomed to act, and while the Companies Act uses the word director fairly liberally, there is no clear definition. It has been suggested that a director is one who acts in a certain way e.g. attends board meetings and makes decisions, is a signatory to the bank account, VAT returns etc, offers planning/strategy advice and assists with its implementation, deals with third parties, and holds himself out to be in charge.

The principal legislation is the Company Director Disqualification Act 1986 which says that a person can be disqualified for a period of between two and 15 years. Generally, The Insolvency Service operate three bands: two-five years, six-10 years and 11-15 years depending upon the severity of the conduct. Common grounds for considering whether someone is unfit to be a director include:

Trading to the detriment of creditors generally, or specific creditors e.g. demonstrating a policy of non payment to one creditor such as HMRC.

Paying one creditor in priority to others when formal insolvency is imminent.

Wrongful trading i.e. continuing to operate a company when there is no obvious hope of returning the company to a solvent position and thus, the creditor position worsens.

Fraudulent trading i.e. taking deposits from people with no intention of providing goods/services.

Trading in breach of legal or regulatory requirements.

Misapplication or retention of company money or property, either for less than the market value or for no consideration i.e. a company selling assets to a director at less than full value.

Allowing a company to pay large salaries and benefits to directors without concern for the welfare of other stakeholder groups.

Failing to prepare/file annual accounts, annual returns etc.

Failure to maintain and preserve proper accounting records such that a financial assessment can be undertaken.

Failing to deliver company documents and property to the IP when requested to do so.

Failing to co-operate with the IP in the furtherance of his duties.

The Insolvency Service is, like many government departments, struggling for resource and experience shows that only those directors whose conduct is demonstrably bad tend to be pursued. Further, the public interest is also taken into account when deciding to seek disqualification, not necessarily in terms of someone being famous but simply acting in a way which, if replicated elsewhere, could cause significant damage.

An individual will know if The Insolvency Service is contemplating proceedings because there tends to be a few letters seeking clarification of various transactions, actions/roles. That tends to be the time to consult with another IP experienced in director disqualification issues, or perhaps an insolvency lawyer. If court action is instigated and, despite one’s best efforts, a Disqualification Order issued, it stops someone from being a director of a limited liability company in the UK for a specific period. Acting in contravention of a Disqualification Order can result in a fine, a term of imprisonment of up to two years, and being personally liable for debts incurred by the company while one acted as a director of it. Scary thoughts.

In Scotland there tend to be about 40 Orders each year with the majority being for three or four years’ duration. While these may be seen as relatively few, no self respecting director wants to be part of these statistics.