Director Disqualification: What it is, why it happens, and what Directors must do next

By Neil Davies, Solicitor and Managing Director of NDP and Contributory Editor to ‘Mithani: Directors’ Disqualification’ – the leading work on Director Disqualification law and practice, with contributions from the wider NDP Insolvency and Director Disqualification Team.

Directors facing the possibility of Director Disqualification (“DD”) are often dealing with one of the most stressful periods of their professional lives. The Insolvency Service (“IS”) process can feel opaque, technical and unforgiving, particularly when a company has failed and questions are now being asked about what went on.

Here, our specialist Solicitors explain what DD is, the consequences of it and the mechanics of an Insolvency Service (‘IS’) investigation into a Director’s conduct in a liquidated company (or company in administration).

Company Directors have extensive legal duties and responsibilities when dealing with the affairs of a company.  Breaching those duties can have Civil Law and, increasingly, Criminal Law consequences.

How the IS investigates directors after insolvency

Following a company’s insolvency (most commonly liquidation or administration), one of the consequences arising from the insolvency of the company will be an IS investigation into a Director’s conduct, in relation to the events leading up to a company’s formal insolvency.  There is a statutory duty on Liquidators to report to the IS on the conduct of all persons who have held office as a Director.  The Liquidator can often look back up to 3 years and sometimes further back.

What director disqualification means – and the real‑world consequences

DD is one of the remedies and outcomes that the IS can seek under the Company Directors Disqualification Act 1986 (‘CDDA’).  A DD action will always be preceded by a Director Disqualification Investigation (‘DDI’) by the IS so that the Director has every opportunity to make his/her factual and legal position known to the IS.  This is a window of opportunity that the Director must embrace.  The IS Investigator is a complete stranger to what went on in the Company.  

Do the IS abandon DDI’s?

Yes – the IS do routinely abandon DDI’s when the Director persuades the IS that there has been no ‘Unfit Conduct’, i.e. the statutory test. Take a look at our article about the 10 Most Common Mistakes Directors Make When Responding to Insolvency Service (IS) Questionnaires pending a Director Disqualification investigation.

A Director Disqualification Order (‘DDO’) will:

1. Prohibit an individual Director of an insolvent company (this includes a non-executive Director, De Facto and/or Shadow Director) from acting as a company Director (either directly or indirectly) for between 2 to 15 years (without prior permission of the Court); and
2. Prohibit an individual being involved in a company’s formation, promotion, and Management* of any company registered in the UK during the period of the ban (without the permission of the Court). A DDO extends to overseas companies with connections in the UK.

(*Management Is a very widely defined term.  Breach of a DDO by being involved in directing or the management of a limited company business or LLP is a Criminal Law offence.)

Warning! A growing risk: criminal investigations into replacement directors

We are seeing more and more cases where persons appointed as Directors (in the place of disqualified Director) are facing Criminal Law investigation and prosecution for aiding and abetting the disqualified Director.  This ties in with the more pro-active approach to Criminal Law investigations from the IS.  The IS has in recent times significantly ramped up its investigative capacity.

As well as not being able to be a Director of a company (without prior permission of the Court) disqualified Directors may also face the following far-reaching consequences which can have a wider professional and reputational impact.

For example, a disqualified Director may not:

• act as a Trustee of an incorporated charity;

• act as a Receiver of a company’s property;

• act as an Insolvency Practitioner; and

• on a practical level, be easily able to travel overseas to certain destinations.

A disqualified Director may still work for a company in a non-Directorial role, operate as a sole trader or as a Partner with others, provided that the individual in question is not involved in a company’s formation, promotion and/or management (that word again) of any company registered in the UK or an overseas company with connections to the UK, without the prior permission of the Court.

Permission to Act as a Director whilst disqualified

A Director can apply for such Permission.  We are well placed to advise on and we do successfully pursue such Permission applications for Directors on a regular basis – take a look at this case study where we applied successfully for a client to receive permission to act as a director.

A disqualified Director can also serve as a Company Secretary and hold shares in a company, on the basis that he/she avoids management duties.

How directors should respond to the IS

It is important to seek legal advice from experts in this field before a response is sent to the IS to understand a Director’s options, including an application for Permission to continue as a Director or to be involved in management whilst disqualified, and before accepting any Voluntary Director Disqualification Undertaking (‘DDU’) preventing the Director from acting as a company Director. NDP have extensive experience acting for Directors based in both England & Wales and Scotland – from our Birmingham/West Midlands office to London and the rest of the country.

Grounds the IS rely on to disqualify directors

There are many types of conduct by and for which company Directors may be disqualified because of their Unfit Conduct.

Unfit Conduct

Unfit Conduct by the Director has to be demonstrated by the IS before DD can be imposed by the Court, on application to it by (most commonly) the IS.

Examples of IS allegations of ‘Unfit Conduct’ we regularly see include:

• Misuse of Government financial support schemes – in recent months and years, there has been a sharp rise in DDI’s and DD claims arising from the misuse of the COVID-19 Bounce Back Loan and CBILS position;

• Failure to submit Tax Returns or pay any Tax (or the correct amount of tax) owed by the company whilst allowing the company to continue to trade and pay other trade creditors (‘trading to the detriment of the Crown’);

• Allowing a company to continue trading whilst insolvent (also known as ‘wrongful trading’ or ‘Misfeasant trading’);

• Fraudulent activities, such as the misappropriation of client monies, customer money, company funds or company assets;

• Failure to maintain, preserve and deliver up proper and adequate company books and records, so as to enable explanation to the Liquidator of the company’s trading activities (also a Criminal offence);

• Failure to file financial Accounts and/or confirmation statements at Companies House within the required statutory periods; and

• Breaches of competition law include price-fixing and market sharing. The CDDA gives the Competition Markets Authority (‘CMA’) powers to apply to the Court for a DDO against a Director of a company who has breached competition law and where his/her conduct makes him/her unfit to be concerned in the management of a company. The CMA can also accept a DDU from a Director instead of bringing proceedings. A DDU has the same legal effect as a DDO.

Bankruptcy and automatic disqualification

A Director who is made bankrupt will automatically be disqualified for a defined period from acting as a company Director, without prior permission of the Court being applied for and obtained by the Director.

Acting while disqualified: the penalties are severe

If a Director breaches a DDO, by acting as a Director of a company or (for example) being involved in the management of a company whilst banned from doing so, he/she will likely receive an extension of their disqualification, along with the potential for a Criminal Law Investigation and a prison sentence of up to 2 years.  Serious stuff.

Appointing a disqualified Director

If a Director appoints another Director who is disqualified or who allows such a person to be involved in the management of a business, without prior permission of the Court, or otherwise unfit to act, they may find themselves become subject to DD proceedings or a Criminal Law Investigation or Prosecution, for aiding and abetting a breach of a DDO. 

The Director Disqualification process

Typically, the procedure used by the IS for disqualifying a Director follows a process:

1. Investigation (including completion of a Director Questionnaire (‘Questionnaire’))

• Section 16 Letter: formal notification of an intention to seek DD (letter sent from IS under Section 16 of CDDA).

• Director’s response to Section 16 Letter.

• Court proceedings.

• Disqualification.

The process can take up to 2 years if the matter goes to Court, although cases that are resolved via negotiation and by the targeted Director accepting a voluntary DDU usually conclude much more quickly (albeit a voluntary DDU can be accepted during Court proceedings also).

What a DDU is and when directors use one

A DDU is a formal and binding agreement of the matters of Unfitness and records the Disqualification period. It avoids the expense of the Court process but it is equally important for the Director to seek specialist advice to negotiate the wording of the alleged misconduct and length of Disqualification depending on the Director’s individual circumstances, including whether leave is required from the Court so that the Director can continue to act as a Director whilst disqualified, of other specified limited company entities or LLP’s.

We have outlined each step of the process in more detail below.

Investigation

1. Upon his/her appointment, the appointed Insolvency Practitioner is required to investigate the conduct of the company’s Directors over the past 3 years and report to the IS on that conduct.
2. The IS will then undertake their own investigations and decide whether to investigate further with the Director.

It is also possible for a concerned party (e.g. a creditor) to raise concerns about a Director directly with the IS or the Liquidator.

Questionnaires from (a) the Liquidator and (b) the IS – why they matter

• Should an IS investigation be directed to the Director, the IS (acting on behalf of the SOS) will decide whether further investigations are in the public interest. If they decide to investigate further, the IS will usually ask the Directors of an insolvent company to complete a Questionnaire.  Here is where trouble often begins for the Director.

Beware the Questionnaire: common traps for directors

• If the IS makes contact with you, it is important to take early and expert legal advice before any questions are answered relating to the circumstances leading to a company’s insolvency. Contact our experienced DD Solicitors for help.  The answers given will be relied upon against the Director.

• Following this, the IS may then send a ‘pre Section 16 Letter’ providing the Director with a summary of any alleged misconduct and providing the Director with an opportunity to provide further information which the IS or SOS should take into account. 

How a director should act during an investigation

• The Director should usually engage with the IS early and with enthusiasm, asking for draft evidence, key documents on which the IS rely etc.  This is the Director’s window of opportunity.  Set out the Director’s side of the story.  Provide documents to support the Director’s position if possible.  This is really important.

Our Comment

The IS does abandon DDI’s, once persuaded by the Director it is no longer ‘expedient in the public interest’ to carry on.  The Director must skilfully and accurately set out his position in writing. Take a look at some of our testimonials where we have persuaded the IS to abandon.

Section 16 Letter: formal notification of Disqualification (letter sent from IS under Section 16 of CDDA)

If the IS decides to proceed with DD proceedings, they will issue the Director with a Section 16 Letter. The Section 16 Letter from the IS informs a Director of the SOS’s intention to seek a DDO from the Court and outlines the allegations of Unfit Conduct identified by the IS. The Section 16 Letter will also set out whether the SOS intends to seek a Director Disqualification Compensation Order (‘DDCO’) for the financial loss resulting from some or all the misconduct alleged. A DDCO can only be made where a DO has been made by the Court or where a DDU has been entered into.

• If the IS continues to make contact with the Director, it is important to take expert legal advice, prior to the issue of DD Court proceedings.

Contact our Team of experienced Director Disqualification Solicitors for help.

Director’s response to Section 16 Letter

The Director has options upon receipt of a Section 16 Letter from the IS, including defending the case or offering a voluntary DDU. It is vital that the Director seeks legal advice before deciding which option is right in the circumstances. Contact our specialist DD Solicitors for help.

A Director’s response to a Section 16 Letter is crucial, involving request for and then a review and analysis of the IS draft evidence. We have substantial experience in persuading the IS to discontinue claims alleging Unfit Conduct by setting out strategic and robust written representations. Every case is different.  DD will impact an individual’s livelihood and reputation, particularly if he/she holds current Directorships. With the consequences of DD being so severe, it is vital to seek expert legal advice, so a robust, technical and strategic approach is set out by the Director in the response to the Section 16 Letter.

Using evidence effectively to challenge allegations

Supporting written representations to the IS with documentary evidence (emails, cashflows, professional advice, letters etc) is always a great option.  Third party evidence is always helpful.

What happens if the case goes to Court?

If the matter progresses to Court, the investigator from the IS and the Director at risk of Disqualification and any witnesses will both give evidence before a Judge at Trial.

Disqualification

In the absence of a voluntary DDU and if a DDO is made by the Court, the Judge will impose the length of the Disqualification. A disqualified Director will usually be responsible for paying the costs of the SOS and IS, as well as the Director’s own legal costs, if the DD application succeeds against him/her.

The period of Disqualification – How the length of a ban is set by the Court

The Court sets the length of Disqualification according to how serious the Director’s conduct was found to be. Three ranges apply:

• Lower bracket, 2 to 5 years. Applied where conduct is judged reckless rather than deliberate, or where this is the Director’s first such finding against them.

• Middle bracket, 6 to 10 years. Applied to more serious misconduct, or where a Director has repeatedly failed to meet their legal obligations.

• Higher bracket, 11 to 15 years. Reserved for the most serious or fraudulent conduct, or for a Director who has already breached an earlier DDO.

The bracket a Director falls into shapes every decision that follows, including whether a voluntary DDU is realistic and on what terms, and whether a later application for Permission to act stands any real chance of success.

DDCOs – when the IS seeks compensation from directors

The IS can ask the Court to grant a DDCO under Section 15A of the CDDA. A DDCO is a Court Order that requires a disqualified Director to pay financial compensation in relation to losses to creditors of the insolvent company as a result of the Director’s misconduct.

DDCO’s can be sought only by the SOS or by the IS acting on their behalf.

A DDCO can only be made once a DO has been made by the Court or a DDU entered into.

The amount of DDCO’s granted and the total amount to be repaid via CO’s has been steadily increasing over the last few years, as can be seen from the table below.

That number we predict will continue to rise.

Applying for Permission to act as a Director while disqualified

It is possible for the Director to apply for Permission to act on behalf of a specific company (or companies) under Section 17 of the CDDA, where the Court may be willing to allow a disqualified Director to continue to act as a Director often subject to certain conditions.

To obtain permission, the disqualified Director will need to demonstrate a ‘reasonable need’ for him/her to continue to be involved in the company’s management as a Director and also demonstrate that adequate safeguards will be put in place to protect the public from any reoccurrence of the misconduct that gave rise to the original company failure.

Comment: Specialist legal advice should be sought.  We are well used to successfully making such applications for Directors.

When to apply for permission — timing is critical

The timing of accepting a voluntary DDU and application for Permission or a ‘Section 17’ application is critical. If you are considering offering a DDU, we can work with the Director to ensure minimal disruption by preparing the application swiftly and avoiding the need to resign from your current, ongoing Directorship(s).

The Director will need to demonstrate to the Court that there is a genuine need for him/her to be involved in the company’s management and that adequate safeguards are in place – it is usual for the well-advised Director to suggest those safeguards.

Appealing a DDO

In limited circumstances, a DDO can be appealed in Scotland and England & Wales. Seeking specialist advice to the grounds for an Appeal is imperative and to understand the merits of success of any Appeal. We have experience in dealing with the Court process in both England & Wales and Scotland, including attendance at Court.

Talk to our specialists about Director Disqualification

Directors facing the prospect of disqualification are often dealing with complex facts, tight deadlines and significant personal and professional risk. The key is to understand the process early, engage with it properly and take advice from those who deal with these cases every day.

Our team has extensive experience acting for in investigations, negotiations, Permission applications and Court proceedings. If you are facing a Director Disqualification issue, early specialist advice can make a real difference to the outcome. Talk to us for an initial free of charge discussion.

It doesn’t matter where you are based, from London, Birmingham (where our physical office is based) to the South East, Wales, northern England, Scotland or internationally, our experienced Director Disqualification solicitors – some of whom have experience working for the Insolvency Service, so they know how they work – are always ready to help. We frequently meet first by secure video links, meaning location is rarely an issue, and we’re always glad to meet in person as and when necessary.