Directors and those advising them – reasons to be careful

Our presentation to Insolvency experts – 7th September 2023

This is an abridged note of the presentation delivered to 75 delegates from the South Eastern Society of Chartered Accountants (‘SESCA’) for their annual Insolvency Conference at the Henley Business School of Reading University on 07 September 2023. As Insolvency Lawyers, the title of our presentation was ‘Directors and those advising them – reasons to be careful’ and focused on the real-life consequences of a director breaching their duties, from Director Disqualification to Insolvency Claims and everything in between.

Presented by: Neil Davies, Solicitor and Managing Director of N D & P Solicitors Ltd (‘NDP’) and Contributory Editor to ‘Mithani: Directors’ Disqualification’ – the leading work on Director Disqualification law and practice.  Neil regularly speaks on the topic of Directors’ duties.

And by: David Hanman, NDP’s Consultant Solicitors with 30 years + of Criminal Defence and Regulatory Law experience.  David regularly lectures to the Police on their sphere of operations.

Our presentation focused on:

• To what duties are directors subject?
• Real-life consequences for a director breaching those duties (or being suspected of so doing)
• Examples: what director conduct is likely to result in action against him/her?
• Three recent Bounce Back Loan (BBL) cases: where over £47.4 billion was advanced to SMEs and where £20.5 billion is thought to be at risk of non-payment, a closer look at this area is merited.
• Example: SoS v Marion Ghimpu (2023) re Deea Construct Ltd – decision 25 July 2023
• Another BBL decided case example: SoS v Regan (June 2023) – ICCJ Prentis (unreported)
• Office holder recovery actions against directors (to include shadow directors and de facto directors)
• The directors’ duty owed to company creditors.  Question: when is that duty engaged? All change – see the supreme court decision in Sequana Sa (October 2022).
• Any good news for directors?  Lots – how should the well-advised director respond to a range of issues?
• Questions for discussion

Slide 1 – to what duties are directors subject? There are many. Here are some examples

1.        Consolidated statutory duties – see sections 170 to 177 of the Companies Act 2006.  The seven general duties.  Examples include:

• Duty to avoid conflicts of interest.

• Duty to promote the success of the company for the benefit of its members.

• Duty to exercise reasonable care, skill and diligence.

• Duty to act within powers and to use those powers for the purpose for which they were conferred.

2.        NB: Directors are also subject to much wider and more extensive duties under, for example:

• The Companies Act 2006.

• The Insolvency Act 1986.

3.        The Company Directors Disqualification Act 1986 (‘CDDA’).

4.        The Health and Safety at Work Act 1973 (‘HASAWA’).   A very recent HASAWA decided case is below.

Secretary of State (SoS) v David James – CR-2022-BHM-000231

• This was a Director Disqualification, single allegation of Unfit Conduct case where the Insolvency Service (‘IS’) alleged that Mr James was unfit to be a Director, because none of the planning or risk assessment for working at height on a roof removal, had (according to the IS) been done.

• The company had by the time of this Directors Disqualification Trial, already been criminally convicted under the HASWA legislation.   This was the first case the Secretary of State (‘SOS’) had prosecuted to Trial, of this nature.

• The SOS case failed and the case seeking to disqualify Mr James was dismissed.

Slide 2 – real-life consequences for a director breaching those duties (or being suspected of so doing)

1.        In a ‘live’ company, the consequences include:

a.        Dismissal from office or legal recovery actions against the Director (for example – by the company) or a Derivative action by the company against the defaulting Director, or

b.       Section 447 Companies Act Investigation.   The SOS has powers to compel the production of documents and to provide specified information (scary stuff) from a company under investigation by it.  Such 447 investigations may lead to a company winding-up action and/or Director Disqualification against the Director.

2.        Formal insolvency – When the music stops.   Consequences for the Director in Liquidation/Administration scenarios include:

1. Director Disqualification Investigation (‘DDI’) by the Insolvency Service (IS).

• Director Disqualification Proceedings (‘DDP’), following a DDI, alleging ‘Unfit Conduct’ under section 6 of the CDDA to include (as examples) Unfit Conduct allegations of:

• Trading to the detriment of HMRC.

• Failing to maintain and/or preserve and/or deliver up company books and records to the office holder (also a Criminal offence).

• Abuse of Bounce Back Loans (‘BBL’) or the CBILS loan regime.

• Two common types of Unfit Conduct allegations are misapplication of the BBL (e.g. – the Director overstating turnover).

• and/or misuse of BBL funds once received.  BBL funds can only be used for the economic benefit of the company.

• Failure to comply with other statutory or extra statutory rules – e.g. – Education, Skills and Funding Agency (‘ESFA’) and Information Commissioner’s Office (‘ICO’) based allegations of Unfit Conduct.  We have a significant caseload of such cases to defend currently.

NB. It remains incumbent on the IS to conduct its own independent investigation.  It should not simply rely on what an external agency (such as HMRC, ESFA or the ICO) alleges.

• See fuller list of Unfit Conduct schedule 1 of the CDDA.

• Director Disqualification Financial Compensation applications from the IS but only where a Court disqualifies a Director or the Director agrees to a voluntary disqualification ban) and where the Directors conduct ‘has caused a quantifiable loss to one or more creditors’.

• Criminal Law investigation possibly followed by Criminal Law prosecution by the IS, Environment Agency, Crown, Trading Standards, HMRC etc.

• Last but not least! Misfeasance/other antecedent transaction claims from the Liquidator, seeking financial recovery action against the Director(s) – see below.

Conclusion:

Get advice early, when the problem emerges.

Slide 3 – examples: what director conduct is likely to result in action against him/her?

Some very recent case examples from the Courts:

Failure to keep accounting records – breach of section 387 of the Companies Act 2006 – KDM Trading Ltd (in liquidation).

• This is a 2023 Criminal Law decision. The Director, Mr Hulme (KDM Trading Ltd) delivered up very little by way of records to the Liquidators of his failed limited company in breach of his obligation to do so.  He ignored requests for delivery up of the balance of the records, made of him by the Liquidator (a poor decision by the Director).

• Consequence: The Liquidator could not identify the source of £2m plus of income nor £2m plus of expenditure and no explanation was provided for £682,000 invoiced out by the company but never banked.

• The Director was criminally prosecuted and found himself in the Crown Court where he was sentenced as follows:

• 12 months imprisonment (suspended for 2 years).

• 150 hours unpaid work.

• Disqualified as a Director (Undertaking) for 7 years.

• £5,000.00 costs payable.

• The Director’s previous good character was noted by the Court (?!) – he was however still sentenced to imprisonment.

Comments

The Criminal conviction often has hidden, serious consequences for the Director such as travel restrictions (some countries will see the conviction as an impediment to travel), reputational damage and an impediment to employment prospects.

All of the above could have been avoided had the Director obtained legal advice.

Slide 4 – 3 recent BBL cases: where over £47.4 billion was advanced to SMEs and where £20.5 billion is thought to be at risk of non-payment, a closer look at this area is merited

EXAMPLE: R V DAGISTAN (2023) – EWCA CRIM636

• Criminal Law prosecution by the IS (cf: Ghimpu below) against husband and wife Directors.

• The case involved a £50,000 fraudulent BBL application (turnover was overstated in the BBL application and then to compound matters, funds were not used for the economic benefit of the company).

• Both Directors were sentenced to 18 months immediate imprisonment for Fraud and Money Laundering Offences, reduced from 2 years on Appeal to the Court of Appeal Criminal division who said:

‘only immediate custody would sufficiently mark and punish the serious offending’

• Imprisonment imposed despite (mitigating factors) full repayment of the BBL (but only after a request was made to interview the Directors under criminal caution) and no previous convictions.

• The Court noted the BBL Scheme was an exceptionally vulnerable target at a time of National Emergency.

• So the Directors now enjoy the status of convicted money launderers and fraudsters and the burden of the practical consequences referred to above.

Question

Why was this case chosen for criminal action (rather than civil Director Disqualification proceedings?) We have surely all seen much worse?

Slide 5 – example: SoS v Marian Ghimpu (2023) re Deea Construct ltd – decision 25 July 2023

Nature of case: false information in BBL application (decision of chief ICCJ Briggs)

• The company Accounts revealed that it had turned over £4,500. The application to the Bank for BBL however stated turnover was £200,000 (true BBL entitlement was therefore £2,000).

• Director used the £50,000 BBL to pay himself/for his benefit – loan obtained October 2020.

• The Director then put the company into creditors voluntary liquidation in April 2021.  The Liquidator tried to recover the loan from the Director but was unsuccessful.

• Final hearing outcome: Director disqualified in a hearing in the High Court for 13 years, on 25 July 2023.
• A £52,163 Director Disqualification Compensation Order (‘DDCO’) was also obtained by the IS/SOS.  The IS commented that the wrongful obtaining of the BBL gave the company an unfair advantage over other businesses.

•         The Court found deliberate deceit and concluded that the UK Government was a soft target due to lockdown.

Our notes/comments

• This case is the first Compensation Order obtained by the SOS from the Court (many more have been obtained voluntarily by negotiation with Directors).

• Many Directors are agreeing voluntary Compensation Orders on favourable terms (i.e. as to the amount to be repaid and the time given for repayment), once disqualified by agreement.

• Why was this case civil and not criminal? (cf: Dagistan case, above).

• Why the 13-year disqualification period?  What does a Director need to do to justify a maximum 15-year ban?

Slide 6 – another BBL decided case example: SoS v Regan (June 2023) – ICCJ Prentis (unreported)

Re: Pro Athlete Management ltd (‘the company’) – in creditor’s voluntary liquidation

• Turnover was again overstated in the Company’s BBL application to its Bank, signed off by its Director, Paul Regan.

• 9-year (middle bracket) director disqualification, commencing June 2023 ordered by the High Court – i.e. – a case of marked seriousness.

Case outcome

• The Director, Paul Regan, then successfully applied for permission (section 17 of the CDDA) to continue to be a Director of his ongoing trading company, despite the 9-year ban subject to (unknown) conditions. 

What do we know?

• The Court accepted the Director’s contrition at face value and his role in charity work and ‘in doing public good’.  The Court concluded that he had presented a cogent case as to why he needed to be a Director of PPC (his ongoing business).

• Conditions?  It will be interesting to learn what conditions the Court imposed in granting Permission, to protect the public interest.

Questions

1. What factors go to determine whether a particular case merits civil or criminal proceedings from the IS?

Answer: It seems the more blatant the conduct, the greater the prospects of Criminal Law action.

2. Can there be parallel civil and criminal investigations into the same conduct and what is the effect of them?

Answer: Our experience is yes, there can be.  Directors need to take particular care when agreeing to give a Director Disqualification Undertaking.  Civil law admissions given by a Director often then find their way into Criminal Law investigations, with disastrous consequences.

3. Has the bar got lower for Directors on Permission applications?

           Answer: Possibly yes.  Every case turns on its own facts.

They may well in doing so, be leaving themselves open to Criminal Law proceedings.

Slide 7 – office holder recovery actions against directors (to include shadow directors and de facto directors)

Common allegations made (Misfeasance and/or Breach of Duty) by Liquidators against Directors include:

1. Allegation: Declaration and payment of illegal/unlawful dividends.

Dividends can only be paid from available distributable reserves in the company.  Breach this principle and dividends become unlawful and repayable to the company via its Liquidator.

2. Overdrawn Directors Loan Account claims.

This is often pursued as a simple debt claim by the Liquidator.

3. Wrongful Trading – section 214 of the Insolvency Act 1986.

i.e. – Trading on beyond that point when a Director concludes (or should have concluded) that there is no reasonable prospect of the company avoiding insolvent liquidation.

• Consequence of breach of that duty – personal financial recovery action against the Director.

• The Court can on the application of the Liquidator order that the Director makes a financial contribution to the company assets.

NB: Section 214 claims are often brought together with other recovery claims against the Director.

• Preference Claims and Transaction at an Undervalue (‘TAAU’) Claims.

• The targeted Director has factual, practical and Statutory Defences available to Liquidator claims to include those in:

• Section 238(5) of the Insolvency Act 1986 (re: Transaction at an Undervalue).

• Section 239(5) of the Insolvency Act 1986 (re: Preferences); and

• Section 240 of the Insolvency Act 1986 (requirement for the Applicant Liquidator to prove the insolvency of the company when the offending transaction was entered into).

• Section 1157 Companies Act 2006 which states:

‘1157 Power of court to grant relief in certain cases

(1)      If in proceedings for negligence, default, breach of duty or breach of trust against—

• an officer of a company, or

• a person employed by a company as auditor (whether he is or is not an officer of the company),

it appears to the court hearing the case that the officer or person is or may be liable but that he acted honestly and reasonably, and that having regard to all the circumstances of the case (including those connected with his appointment) he ought fairly to be excused, the court may relieve him, either wholly or in part, from his liability on such terms as it thinks fit.’

• VAT fraud claims

• Causing the company to participate in transactions connected with the fraudulent evasion of VAT, such conduct being something that the Director knew or ought to have known about (OR v Andrew Kelly 21 April 2023).

Comment

The Kelly decision perhaps represents a much stronger line from the Court than previously.  Protection of the Public Interest in Tax collection matters, remains paramount.

Why not criminal prosecution in this case?  Such cases were historically pursued criminally – how times change.

Slide 8 – the directors’ duty owed to company creditors.  Question: when is that duty engaged? All change – see the supreme court decision in Sequana Sa (October 2022).

The decision in Sequana decided that:

• The Director owes a duty to the company’s creditors, which duty is engaged when either:

• The company is insolvent, or insolvency is imminent.

or

• When insolvent liquidation or administration is probable.

Comment

Sequana will make it easier for Liquidators to successfully pursue claims against Directors.

Our conclusions on Liquidator claims against Directors:

1. The noose is tightening for Directors – they must give more thought at an earlier point to solvency issues in their company (or face personal consequences if they don’t).

Message: Why run the risk?  Directors should take professional advice early (and follow it!).

Professional accountancy advisors should:

• Carefully draw their terms and conditions with the company and/or the Director and temper their advice (to avoid unintended criticism and consequences).

• Refer the company/Director to a Licensed Insolvency Practitioner or an Insolvency Law Solicitor at the earliest moment.  The earlier advice is taken, the greater the positive opportunities for the company and the Director to avoid personal financial liability if the company fails.

Message: Formal and informal insolvency procedures are an incredibly versatile tool in the right hands. The many and various insolvency and restructuring options are excellent and positive tools available to the Director and to the company.

Slide 9 – Any good news for directors?  Lots – how should the well-advised director respond to:

1. Claims from liquidators

• Take advice early from an experienced insolvency Solicitor – know and increase your options and minimise the risk of personal liability.  Taking such advice may prove to be a Defence or be a relevant consideration further down the line for the Director – see Sequana below and above.

• Liquidators are commercial animals (in the main!) with excellent litigation funding and claim assignment options available to them.  Liquidators are looking to achieve the best commercial return for creditors.  Engage early with the Liquidator.  Avoid contested litigation.  Mediate where possible. There will usually be only one winner in that liquidation scrap with the Liquidator. 

• The Director should use Part 36 CPR to best advantage, early doors.  It is a great tool available to the Director.

• Never underestimate the commercial sense in making full personal financial disclosure to the Liquidator (albeit on a protected ‘without prejudice’ basis).  Give the Liquidator the reason and justification to settle (‘you can’t get blood out of a stone’).

2. Director Disqualification Investigations and claims

• The SOS has a well-established duty to – and does – act fairly (in most cases!) to Directors and does regularly abandon DDI’s and DDP’s when right to do so.

• Obtain early specialist legal advice.

• Respond to and engage early and positively with the IS.  Tell the IS what it does not yet know – the IS is a stranger to the company’s trading history – explaining ‘all the circumstances of the case’ is always beneficial.

• Demonstrate to the IS why it is ’not expedient in the public interest’ to pursue the DDI (i.e. the legal test) – ‘all the circumstances of the case’.

• Beware Director Disqualification Compensation Applications – negotiate them out when need to do so (only applicable where the Director ban has been agreed/ordered by the Court).

• Consider a Director Disqualification Undertaking (DDU) and an application for Permission to act as a director (section 17 of the CDDA) in respect of ongoing company businesses – see this testimonial where we successfully applied for permission to act as a director for a director who had accepted a DDU and the encouragement provided by the Regan decision, above.

3. Criminal law investigations/proceedings (arising out of company failure)

Comment: we are seeing the IS pursuing very many such investigations. Our advice:

• Seek and obtain specialist advice on day one – we are well used to advising in such cases.

• Prepare and decide on the tactics and approach to the interview under caution.  Attend the interview with a Solicitor experienced in such work (the criminal interview process merits a talk on its own).

• Challenge the evidence relied upon by the Criminal Investigator.  Consider obtaining third party evidence to weaken and rebut the claims.

• Do not rule out doing a deal with the Investigator.  Timing is everything!

4. Section 447 Companies Act Investigations

• Comply with the requests/demands of the Investigator.

• As ever, get specialist legal help, early on.

Slide 10 – Questions for discussions

• Who should pursue recovery of the BBL? (Bank, IS or Liquidator).  Who benefits from the recovery?

• Is the IS consistent with the cases it seeks to pursue (and those where it does not)?

• Tax Schemes – will the recent decision in Hunt v Singh [2023] EWHC 1784 open the floodgates for claims against Directors?

Background to this case

The Liquidator made financial claims against the Director, claiming the company was insolvent at the relevant time of the transactions complained about, on the basis of a substantial disputed tax liability.

Key question determined by the Court in Hunt v Singh

Following Sequana (see above), whether it is necessary to establish some form of knowledge (actual or constructive) of insolvency on the part of the Director, so as to engage the ‘creditor duty’, even where the company was, at the relevant time, actually insolvent or whether the mere fact of insolvency is sufficient to trigger the duty.

Outcome

On Appeal applying Sequana, Zacaroli J concluded the creditor duty is triggered:

‘If the Director knew or ought to have known that there is at least a real prospect of the company failing’.

Outcome: The Director lost.  This is the first case of significance for Directors, post Sequana.  It emphasises the need for the Director to obtain (and follow) specialist legal advice, early on, if personal financial liability claims are to be avoided.

We were delighted to present at the Conference. If anyone reading this has any questions about the real-life consequences of a director breaching their duties at insolvency, then please do get contact us or call us on 0121 200 7040. We would be delighted to hear from you.