Directors Beware: Bear Traps on the Road to Liquidation!

What could possibly go wrong? Liquidators’ Claims, Director Disqualification, Compensation Orders and even Criminal Investigations.

Upon liquidation, Directors of liquidated companies can and do find themselves on the wrong end of several ‘Bear Traps’ all of which can be expensive, time consuming and potentially ruinous. Liquidations happen all the time and for lots of reasons, but, as the Government’s Covid-19 related support for business winds down, and we discover the true extent of Covid’s impact, we expect the number of liquidations to increase.

For this reason, vulnerable companies, and their Directors need to be aware of the pitfalls, know what to look out for and understand how best they can prepare to avoid them on liquidation.

  • In our experience, Directors often place companies into liquidation ‘blind’, without proper or necessary thought having been given by them (or those advising them), pre-liquidation, to the types of issues that we discuss below. That failure often has expensive, time consuming and worrying consequences for the Director.
  • This blog identifies some of the challenges the Director may face in the lead up to and after liquidation. The overarching advice is for the Director to get specialist legal advice as early as possible.

Director Disqualification

The Main Traps for Directors at Liquidation.

  1. Financial recovery action from the Liquidator, alleging Misfeasance (i.e., improper use of company money or assets) and/or breach of the statutory and fiduciary duties owed by the Director under the Companies Act 2006, to their failed company and to creditors of the company. We expand on this below.
  2. A Director Disqualification Investigation (‘DDI’) from the Insolvency Service, arising out of alleged ‘Unfit Conduct’ by the company, during the life of the company.
  3. Financial recovery action from the Insolvency Service (by way of a Director Disqualification Compensation Order claim (‘DDCO’)).
  4. A Criminal law investigation from the Insolvency Service, HMRC or other Agency, arising out of one or more of a myriad of criminal allegations connected to company insolvency.

Fixed-Price pre-liquidation review.

  • Here at NDP, we offer a pre-liquidation fixed price meeting with the Director, to address all the issues discussed in this paper and many others besides. The objective is to identify potential problems and identify how they can best be addressed, before the Liquidator takes office, on the particular facts of that case. The issues inevitably differ on a company by company basis.
  • Most responsible Liquidators will discuss such issues in the run up to liquidation with the Director. Not all Liquidators are, however, the same. We can also help the Director in choosing the right Liquidator for his company based on our extensive experience of acting for and against Liquidators over many decades.

The role of the proposed Liquidator.

A Liquidator may have been recommended to the Director by a trusted Accountant or other advisor. But not always. The Liquidator may have been found being found via Yellow Pages (remember that?) or the Internet, without any personal recommendation.

Warning – The Liquidator’s main role is to assist the Company, not the Director.

It is a fundamental misunderstanding for the Director to assume that the consulted Insolvency Practitioner is there to advise the Director(s).  The proposed Liquidator’s role and duties is primarily to assist the company, not the Director.

It is thus essential for the Director to carefully consider his/her position before liquidation, and to have ‘eyes wide open’ when considering liquidation for the company.

When is the right time to get advice? Answer: As soon as possible before Liquidation.

The fall of a company into liquidation may be forced on the company with little notice. A Winding-Up Petition from HMRC (or the threat of it), for example, may signal the beginning of the end.

Compulsory or Voluntary Liquidation?

It is usually open to the Director(s) to avoid the making of a compulsory winding-up by the Court, by taking steps to place the company instead into a voluntary liquidation process.

Taking this step will involve the company in expense.  However, the appointment of a recommended, private practice Liquidator (rather than the company falling into the hand of the Official Receiver) can have many benefits for the Director(s).

There are however a number of weeks between issue of the Petition and the Petition hearing.  The Director should use that time wisely and get legal advice.

The sooner that specialist legal advice is obtained, the greater the opportunity to take advice and to implement that advice to mitigate future problems. That legal advice may even be to defer putting the company into liquidation, to allow remedial steps to be taken for the Director before liquidation.  

Ideally, the Director should be seeking legal advice well before the point when formal action is taken against the company.

We look in this article at common post liquidation issues, the possible consequences of them and what to look out for.

Common Post-Liquidation issues for the Director. All are potential Bear Traps.

  1. Overdrawn Directors Loan Account (‘DLA’)

An overdrawn DLA happens when there is a balance owed from the Director to the company at liquidation. When the music stops and a Liquidator is appointed to the company, the Liquidator will look to recover the amount of that liability, as a debt owed to the company. Careful scrutiny of the composition of that balance is inevitably needed by or on behalf of the Director.

Even when there is a positive DLA balance in favour of the Director, transactions within the DLA will be scrutinised.

This very situation came before the Courts again in the recent case of Manolete Partners Plc v Matta [2020] EWHC 2965 (ch).  The perhaps inevitable outcome in that case was that despite protests from the Director, the Director was unable to explain why that DLA debt was owed by him to the company.  The Court ordered him to repay the liability to the Liquidator. The Director having ‘lost’ at Court will likely have been ordered to pay the Liquidator’s legal costs and his own legal costs. A potentially ruinous experience. Such outcomes can and should be avoided.

Movements on the DLA balance, typically in the 2 years before a Creditors Voluntary Liquidation, will be looked at by the Liquidator and particular transactions within the DLA may also be attacked as Preferences or Transactions at An Undervalue (‘TAAU’) by the Liquidator – see below.

The prevailing rules require that in the time-period leading up to formal insolvency, the interests of creditors not the Directors are paramount.   Declaring Dividends in the lead up to liquidation, to cancel or reduce an overdrawn DLA balance, is rarely going to be the solution. Other remedies are however available to the Director depending on the particular facts of the case.

  1. Significant Crown debt position/HMRC security request

Significant sums owed to HMRC (whether for VAT, PAYE, NIC or Corporation Tax) at liquidation is likely to lead to trouble for the Director, from one or more of the Liquidator, HMRC or the Insolvency Service (‘the Claimants’) and is the most common reason for a director disqualification investigation. However, the existence of such Crown debt at liquidation is not the end of the story.

All the circumstances of the case must be looked at. We regularly persuade such Claimants that on the particular facts of the case, proceeding against the Director because of significant Crown debt at liquidation is unnecessary and wrong.

  1. Books and records of the company

FACT

A failure to keep, maintain or deliver up books and records to the Liquidator is a civil and criminal law offence, punishable in a criminal sense by a fine and/or imprisonment. Directors go to prison for this most basic of offences, often arising out of a failure to deliver up records to the Liquidator.

Criminal law challenges to the Director on this front are most likely to come from the Insolvency Service. Early legal advice and early engagement with the Liquidator and/or the Insolvency Service is vitally important, once the Director has obtained specialist legal advice.

There are a number of answers available to the Director faced with such allegations.  For example, what constitutes ‘adequate’ books and records will differ in relation to each company, depending on what the company did as its trading activity. There are options for the Director faced with such allegations.

  1. Illegal Dividends

It never ceases to amaze us how many Directors continue to declare or take Dividends in the period down to liquidation, during a period when the company is likely to have been insolvent or of doubtful solvency.

The Liquidator can, and often does, seek to reclaim such Dividends from the Directors personally, on the basis that the Dividends were illegal.  Dividends are only payable from profits available for that purpose.

Paying Dividends

The adverse impact of coronavirus on the trading fortunes of a company now means business owners need to tread ever more carefully as they may be personally liable for Dividends paid before liquidation.

Typically sums taken out of the company by owners (school fees and non-business personal expenses) are charged to the Director’s personal DLA with the company and then, to redress their overdrawn position, a Dividend is declared to repay the sums due before the company’s Accounts are finalised.

The music of liquidation changes the rules about declaring and paying Dividends.

Why are Dividends different?

Dividends are different to other earnings because they represent a distribution of post-tax profits to the company’s Shareholders, payable to all Shareholders in proportion to their shareholding.  Shareholders can be legally required to repay unlawful Dividends received, on application by the Liquidator, if there were insufficient funds available to make the distribution/pay the Dividend/declare the Dividend.

  1. Co-operation with the Liquidator

Failure to co-operate with the Liquidator by the Director will almost inevitably lead to trouble, in the form of:

  • An allegation of Unfit Conduct in a Director Disqualification proceeding.
  • Action in the form of an application to Court by the Liquidator to compel co-operation from the Director, pursuant to sections 234 to 237 of the Insolvency Act 1986 (with the prospect of the Director being dragged into Court to answer questions under Oath and a big legal costs bill from the Liquidator).

All of this can be avoided – co-operate but if in doubt about the nature or extent of disclosures to be made by the Director, then do so with the benefit of legal advice.

  1. Antecedent transactions

The Liquidator can and does look back at events in the company, particularly in the 2 years leading up to liquidation.  The Liquidator can assert Preference claims, Transactions at An Undervalue claims, Wrongful Trading claims and section 423 of the Insolvency Act 1986 claims (transaction defrauding creditors).  Many such claims are intimated against the Director as Misfeasance payments, under section 212(1) of the Insolvency Act 1986.

Upon receipt of such a claim from the Liquidator or his Solicitor, the well-advised Director will get legal advice quickly and respond quickly.

  1. Use of prohibited name

This again is a civil and criminal offence.  Section 216 and section 217 of the Insolvency Act 1986 are the starting point.  A name is prohibited in circumstances where a person has been a Director of a company in the 12 months before that company went into liquidation, so that it is an offence for that Director to be involved in another company with the same or similar name for a period of 5 years (unless the Director falls within one of the 3 excepted cases).

Another no-no offence, that can lead to personal liability for the Director for debts of the next company and the prospect of criminal prosecution against the Director for using a prohibited name, with the prospect of a fine and/or imprisonment on conviction. We have a number of such cases where we are defending Directors, right now.

Prevention (pre liquidation) is better than cure but if this allegation is made post liquidation, there are steps the well-advised Director can take to get rid of the problem. Pre-liquidation there are also steps the well-advised Director can take to avoid the problem even arising.

  1. Action against non-involved spouse Director

Often, the wife/husband is made a Director of the company as a recognition of family ownership. She/he may however have had no active role in the day to day running or the management of the company.  She/he, however, owes the same duties to the creditors and to the company as her husband/ his wife, who is trading and running the business.   This can lead to all the types of action against her/him as are detailed at the beginning of this blog.

  1. Personal Guarantee obligations

How can this possibly be ignored?   Directors often give personal guarantees to:

  • Funders – Funding Circle appear as a guarantee creditor in a disproportionate number of liquidations.
  • Building material and other product suppliers to the company.
  • Lenders to include the bankers to the company and invoice discounters for very many different reasons.  We have significant experience of dealing with such claims.

On liquidation, those guarantees will crystallise and the obligation to pay arises on the Director personally.   Whether or not a guarantee is enforceable against the Director depends on the particular circumstances of each case.  Many guarantees are unenforceable for very many different reasons. We have significant experience of dealing with such claims.

 10. Dissolved companies – the Insolvency Service is given new powers to tackle unfit Directors of dissolved companies

Dissolving a company (rather than liquidating it) has historically been a route used to bury company liabilities, whilst avoiding the scrutiny of a Liquidator.

No more! The Insolvency Service is to be given powers to investigate Directors of companies that have been dissolved, closing the legal loophole.

Government backed loans and Covid.

This route for Directors to fraudulently avoid repayment of Government backed loans, given to businesses during the pandemic, will no longer be available.

The new measures are far reaching and are set out in the Ratings (Coronavirus) and Director Disqualification (Dissolved Companies) Bill. The measures are retrospective and the Insolvency Service will be investigating the conduct of Directors who have inappropriately wound-up companies that have benefitted from Coronavirus loans.

We are right now instructed by many Directors, faced with claims from the Insolvency Service and/or the Liquidator of the company, challenging the use to which Covid loans have been put.

Despite what the Liquidator or the Insolvency Service may say, the position is often not that straightforward.  We are well used to dealing with, opposing and (where necessary) settling such claims on the most advantageous terms.

What can be done by the director?

  • PRE-LIQUIDATION

The Director can and should address all the above issues insofar as applicable to the particular case, with the Accountants to the company and with Insolvency Solicitors experienced in dealing with the above issues.  The Director should engage with the liquidation process, knowing the issues to be faced and the financial and other consequences of them.

  • POST- LIQUIDATION

When the problems for the Director have actually materialised, all is not necessarily lost for the Director.   Our Insolvency Solicitors have 80 years of combined experience in negotiating solutions with Liquidators, with the Insolvency Service, with Criminal Law Investigators and other Agencies.

To avoid or mitigate the Bear Traps associated with Liquidation, including Director Disqualification, Talk to our Insolvency Litigation Solicitors.

Liquidation is an intensely stressful and difficult experience and can be made much worse if Misfeasance claims by Liquidators, Director Disqualification or even criminal action follow.

In this article we have identified the Bear Traps that await Directors and what to look out for. However, our best advice to Directors if insolvency looms is to take professional advice as soon as possible. That way, steps to reduce the risk of falling into a Bear Trap and paying the price can be taken.

Practical considerations

Solutions to financial claims against Directors do not rely solely on legal solutions.  Many practical considerations come into play, to include settlements based on part payments, with payments being made over time.  Achieving such settlements is an art not a science. We are very experienced and used to achieving such settlements.

Contact our Director Disqualification or Misfeasance Claims specialist for an initial FREE discussion or call us on 0121 200 7040. The sooner you contact us the more we can do to help.

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