Director Disqualification Compensation Orders. New Law, bad news for Directors and possibly office holders.
Has the law changed on Director Disqualification? The answer is yes. The changes began on 01 October 2015, when new provisions relating to the Company Directors Disqualification Act 1986 (‘CDDA’) were introduced as part of the Small Business, Enterprise and Employment Act 2015.
Essentially, these new provisions tightened up the rules on Director Disqualification in several areas, to prevent Directors who have shown themselves to be unfit, from continuing to act as Directors for a specified, future period, without permission of the Court.
This article looks specifically at one of these areas, Compensation Orders and concludes that the changes are likely to be bad news for Unfit Directors and quite possibly for Liquidators and Administrators.
The framework and necessary subordinate legislation needed to see compensation claims pursued is being put in place now. It is expected to come into force on 01 October 2016. In our view, this change is likely to result in significant personal claims against disqualified Directors. That is precisely what Compensation Orders are intended to achieve.
What is this change regarding Compensation Orders?
Section 100 of the Small Business, Enterprise and Employment Act 2015 inserts a new section, 15A, into the CDDA regarding Compensation Orders and Compensation Undertakings.
Changing the face of insolvency claims.
Section 15B(1)(a) introduces an entirely new concept into English Insolvency Law, allowing compensation to be paid directly to creditors (or a class of creditors) instead of a contribution to the insolvent estate.
This new jurisdiction (enabling claims to be pursued against Directors personally) provides a further avenue of recovery against Directors, over and above:
- The claims a company has against its Directors (in essence, Misfeasance claims).
- Other statutory claims by which a Liquidator can seek to recover assets for the benefit of the insolvent estate – see below.
It gives the Secretary of State powers to seek a Compensation Order against a disqualified Director, where the conduct of the disqualified Director has caused losses to one or more creditors of the insolvent company of which he/she was a Director.
What has to be proved against the Director for a Compensation Order to be obtained?
The conditions for a Compensation Order or Compensation Undertaking to be sought are set out in sub-section (3) of the Act as follows:
- The person must be subject to a Director Disqualification Order or Disqualification Undertaking under the CDDA; and
- Conduct for which the person who is subject to the Order or Undertaking, must have caused loss to one or more creditors of an insolvent company of which the person has at any time been a Director.
How much can be claimed against the Director?
Upon application by the Secretary of State, a Compensation Order can claim the loss that the Director is alleged to have caused to some or all of the creditors of the company. That raises questions of remoteness of loss and causation of loss, both of which principles are applicable in (for example) Misfeasance proceedings. They will surely have equal applicability in compensation proceedings.
- Many Director Disqualification Undertakings and Disqualification Orders flow from Crown Debt that was owed by the company at the date of liquidation, which debt then gives rise to allegations of Unfit Conduct against Director(s) in threatened disqualification proceedings.
- In our view, these new provisions mean that in the above example, the disqualified Directors may be found personally liable for some or all of the HMRC debt, that can be shown to flow from the Director’s personal misconduct.
What of the Director who is disqualified for causing or allowing his/her company to fail to file statutory accounts for that company. There is no obvious financial loss to a creditor of that company arising of that ‘unfit’ conduct…… is there?
What if a major creditor of the company, who goes unpaid at the date of liquidation of the company, alleges that he would never have traded with the company (and thus not suffered a loss) had he had access to those accounts and knowledge of the company’s appalling financial position, which would have been revealed had the Director caused his/her company to file accounts?
One can imagine such a case being pursued by the Secretary of State in a compensation context.
In summary, anyone signing a Director Disqualification Undertaking or being made subject to a Disqualification Order faces the risk of further proceedings being brought against them by the Secretary of State, seeking financial compensation for the loss suffered by one or more creditors as a result of that Director’s misconduct.
It is therefore vitally important that a Director fully understands the financial and other wider consequences of signing off a Disqualification Undertaking.
When can a Compensation Order be sought?
The Limitation date for bringing Compensation Order proceedings is 2 years from the date when the Director Disqualification Order was made or the Disqualification Undertaking accepted. The 2 year Limitation period starts when the Disqualification Order/Disqualification Undertaking is executed.
However, the intention of the Secretary of State, as presently understood, is that the claim for a Compensation Order will be included in the same Claim Form as the claim for a Disqualification Order.
Letter before Claim?
The Director under attack will, we presume, have an opportunity to receive full details of the underlying compensation claim against him, in the same way that the Director now has the ability to see the evidence to be relied upon against him in a disqualification claim and then respond with written representations.
Can we imagine a situation where, based on written representations from the Director, the Secretary of State decides to pursue the disqualification application but abandons the proposed claim for a Compensation Order? What effect might that have on the disqualification claim? Such a situation is, we think, well capable of arising on the particular facts of a case.
What are the likely practical consequences of Compensation Orders for Directors and office holders?
- A successful recovery through such proceedings may then lead to yet further claims by a Liquidator, who may issue yet further, claims against Directors under (for example) the Insolvency Act 1986.
- See, for example:
Section 212 Insolvency Act 1986 – claims by Liquidators alleging ‘Misfeasance’ (i.e. misappropriation of company money or assets).
Section 214 Insolvency Act 1986 – claims by a Liquidator alleging Wrongful Trading.
Section 238 Insolvency Act 1986 – claims by a Liquidator alleging Transactions at an undervalue.
Section 239 Insolvency Act 1986 – claims by a Liquidator alleging Preference.
Section 423 Insolvency Act 1986 – claims by a Liquidator (or others) allegations Transactions Defrauding Creditors.
The competing financial claims of the Secretary of State and the Liquidator
The compensation regime appears to sit uncomfortably with the role and specific power of the Liquidator or Administrator to seek recovery on behalf of all the creditors of the insolvent estate.
Depending on how compensation is directed to be distributed by the Secretary of State, the position of the Liquidator may be prejudiced.
Liquidator’s costs and expenses
In a case where compensation is ordered to be paid to the Secretary of State and is ordered to be distributed for the benefit of a class of creditor(s), that will on the face of it, have the effect of by-passing the office holder (and the statutory trusts in a liquidation or administration) and overreach the office holders own claim for costs.
Double jeopardy for the Director?
It seems unlikely that the Court will expose the Director (who is ordered to pay Compensation) to the prospect of having to pay twice for the same offending conduct.
Will office holders in practice thus lose the very real practical remedy of seeking recovery?
Consultation by the Secretary of State with the Liquidator
Can or should the Liquidator be consulted by the Secretary of State in cases where the Secretary of State intends to seek a Compensation Order? Can or should the Liquidator be joined as a party to such proceedings? It occurs to us that the Court in the compensation action will want to know the views of the Liquidator, not only as to the proposed amount of the recovery but also as to the destination of any funds recovered from the Director.
On the latter point, the Liquidator will surely wish to see any recovery made by the Secretary of State, paid as a contribution to the assets of the company, thus (presumably) making them available to the Liquidator of the company. Will the Court however want that to happen, if the compensation is only going to pay the costs of the liquidation?
- The extent to which a Liquidator might be able to rely on admissions made or findings made in Disqualification Compensation proceedings, will, we suspect, be the subject of much future argument.
- Professional advisors need to be sure to advise Directors who are contemplating entering into a Director Disqualification Undertaking of the real financial risks that they now face. Accepting the Disqualification Undertaking might not now be the end of the problems.
Solicitor and Director, Neil Davies and Partners
Neil is an advisory editor to the leading text on this area of law – Mithani : Directors’ Disqualification’