The Challenges Faced by Directors at Liquidation – Director Disqualification, Misfeasance, Criminal Proceedings and More
This is the first of 2 articles on the likely challenges that can be faced by directors when they liquidate their company following insolvency. These can be severe and life changing, both financially and in terms of reputation. They include the threat of director disqualification, misfeasance claims and even criminal proceedings. This article looks at what duties the director owes and what claims the director is likely to face after liquidation and from whom.
The second article, to be published in our next e-shot, on or around 12 July, will look at the positive steps that the liquidating director can take to protect his/her position, both pre and post liquidation.
The Likely Challenges that the Director May face After Liquidation
Prior to liquidation, whilst a company is trading, the Directors of a company can, in large part, do what they like with the company’s assets, and this includes money in its bank account.
Yes, the Directors are subject to Statutory and Fiduciary duties (see for example sections 171 to 178 of the Companies Act 2006) as to what they can and cannot do with company assets. In reality, the only policing of those obligations comes from the company’s Auditors at financial year end or more relevantly from a Liquidator when the music stops, insolvency strikes and liquidation kicks in.
As insolvency and director disqualification solicitors much of our work focuses on the consequences of insolvency and liquidation. This article looks briefly at the main statutory duties of a company director, and the main areas that a Liquidator will investigate upon liquidation.
What Are the Main Statutory Duties Of Directors?
The main statutory duties are to:
- Act within powers,
- Promote the success of the company (section 172 of the Companies Act 2006),
- Exercise independent Judgement (section 173 of the Companies Act 2006) and a duty to avoid conflicts of interest, for example between what is best for the company and what is best for the Director, (section 175 of the Companies Act 2006),
- Exercise reasonable care, skill and diligence (section 174 of the Companies Act 2006). It is generally accepted that a Director acting in the best interests of a company and with reasonable skill and care would keep adequate accounting books and records as required by section 386 of the Companies Act 2006 – see below.
What is the Liquidator Looking For?
The Liquidator, upon appointment, will investigate, for example (this list is not exhaustive):
- The company bank account (and spending from it).
- The amount of remuneration and benefits taken by the Directors of the company and the Associates and family of the Director. If excessive remuneration has been taken, the Liquidator can and often does seek to recover it from the Director personally.
- Dividend payments. Whether the Directors/Shareholders of the company have taken their remuneration as Dividends, rather than PAYE income. Unless there was ‘sufficient, available distributable profits’ to justify the payment of those Dividends, then they can be (and often are) reclaimed by the Liquidator from the Directors/Shareholders, as illegal dividends.
- The level of Crown debt (PAYE, NIC, Corporation Tax, VAT) owed by the company to HMRC. The Liquidator can, seek to recover some or all of that Crown debt from the Director personally (as a Misfeasance claim), as can the Secretary of State in the context of Director Disqualification Compensation claims. Crown Debt at insolvency is one of the biggest causes of Director Disqualification.
- Whether the Directors or any of them, at the point of liquidation, have an overdrawn Directors’ Loan Accounts (‘DLA’). In other words, that situation where the Director has taken money out of the Company that is not classed as a Dividend or salary and where the figure exceeds any money that the Director has put into the company. The sad reality of matters is that when businesses face insolvency due to financial problems, around 75% of those cases will have a Director with an overdrawn DLA. It is not unusual for Directors to ‘help themselves’ to company funds, intending to pay it back at some future time, only for the company to see profits and cash nose-dive.
So what will the Liquidator do?
Experience shows that the Liquidator may sue the Director personally to recover. This depends on a number of factors, to include the amount involved, the amount of money owed by the company to its creditors at liquidation and the enthusiasm of the Liquidator to sue or seek recovery on the facts of the particular case.
- Keeping Adequate Accounting Books and Records
This is touched upon above. As experienced Insolvency and Director Disqualification Solicitors, we know that much angst and many consequences flow from a failure by the Director to ensure that the company keeps proper books and records. The answer, of course, is for the Director to ensure the company keeps, preserves and delivers up to the Liquidator adequate books and records that comply with the statutory obligation to do so – sections 386 – 389 of the Companies Act 2006.
Often, that requirement is overlooked by the Director with expensive financial and reputational consequences.
- The Consequences of Failing to Keep Adequate Records
A failure to maintain/preserve/deliver up adequate books and records of the company to the Liquidator can have significant practical, legal and personal financial consequences for the Director to include:
A. An inability to defend a financial claim from a Liquidator alleging Misfeasance under section 212 of the Insolvency Act 1986.
B. The commencement of Director Disqualification proceedings (or at least a Director Disqualification investigation) based on the failure to keep/maintain/preserve/ deliver up books and records, with the Insolvency Service alleging that the absence of company records has prevented the Insolvency Service from, for example:
- Verifying the purpose of payments out of the company bank account and whether such payments were for legitimate company purposes.
- Deciding the amount of the debt owed by the Director to the company.
Director Disqualification proceedings are intrusive, expensive and time consuming for the Director to deal with.
C. Criminal proceedings against the Director in respect of that books and records failure- see section 387 of the Companies Act 2006 which makes it clear that failure to keep proper company records is punishable by imprisonment (yes – that does happen) and/or a heavy fine .
The absence of adequate books and records may well result in the Director facing and being unable to deal with the above types of case.
The consequences of liquidation are very serious. Our Insolvency and director disqualification Solicitors are experienced in acting on behalf of directors who are facing investigations and claims from Liquidators or are threatened with Director Disqualification. Contact us for help and advice.
Directors Under Attack at Liquidation. Who can bring claims against the Director of the liquidated company?
When a company is insolvent and is liquidated, it is not just claims from the Liquidator that the Director has to worry about. There are broadly speaking, 2 types of claim the Director of the insolvent company may face, post liquidation:
- Financial claims and investigations.
- Regulatory claims (to include Criminal investigations and criminal prosecutions).
Here, one of our insolvency and director disqualification solicitors looks in more detail about these claims.
Financial claims and investigations against Directors
These are brought by:
- The Liquidator of the company who most commonly brings financial claims under section 212 of the Insolvency Act 1986, alleging Misfeasance against the Director (i.e. the misapplication by the Director of company money or property).
- Creditors of the company – e.g. under section 423 of the Insolvency Act 1986 (alleging transactions were entered into at undervalue to defraud creditors of the company) or pursuant to Personal Guarantees given by the Director.
- The Secretary of State for Business, Innovation & Skills (‘Secretary of State’) seeking compensation (within or subsequent to Director Disqualification proceedings) for loss caused to creditors of the company by the conduct of the Director.
- Guarantee liabilities. Persons to whom the Director has given Personal Guarantees in respect of obligations of the insolvent company (e.g. to landlords or trade suppliers). A Personal Guarantee to a Landlord may extend to not only paying outstanding rent, but also: 1. the rent for the rest of the lease term, 2. the costs of cleaning, repairing and making good the leased premises, and 3. the costs incurred by the Liquidator in re-letting the premises.
- HMRC, perhaps arising out of the trading of the Company over the last months of its trading life.
Regulatory claims against directors
These can come from:
The Secretary of State
Seeking the Disqualification of the Director pursuant to section 6 of the Company Directors Disqualification Act 1986 (‘CDDA’) on the grounds that the Director has engaged in ‘Unfit Conduct’ in relation to the company. Common examples of ‘Unfit Conduct’ relied upon by the Secretary of State include:
- Acting as a Director in the Management (widely defined) of a company whilst an undischarged bankrupt or whilst already disqualified from office (both are also criminal offences).
- Trading to the detriment of particular creditors (often HMRC) of the company i.e. – deliberate non-payment of Crown debt.
- Failing to maintain and/or preserve and/or deliver up books and records to the Liquidator (see above!).
- Misleading creditors and/or the Liquidator.
- Misuse of company assets.
The Official Receiver, alleging for example:
- Breach by the Director of section 216 of the Insolvency Act 1986 by using a ‘Prohibited Name’ – see below – a civil and criminal offence, punishable by fine, imprisonment and Criminal Confiscation of assets.
- Failure to keep, maintain, preserve and/or deliver up books and records of the company (civil and criminal).
External Criminal Investigators, such as the Police, HMRC, the Insolvency Service and the Environment Agency. Such investigations that NDP are (for example) dealing with for Directors at this time include:
A. An ongoing investigation as to whether the Directors traded the company fraudulently, as envisaged by section 213 of the Insolvency Act 1986,
B. Allegations that Directors are in breach of section 216 of the Insolvency Act 1986 by using a ‘Prohibited Name’ (so easily avoided but so often breached by the Director). Inadvertent (aka careless) breach of section 216 by a Director is a common occurrence. The Director who breaches section 216 faces the following consequences: The defaulting Director commits a Criminal offence, which is a strict liability offence, i.e. there is no defence to it. The penalty for breach is imprisonment and/or a fine.
But it’s not serious – is it? So seriously is the offence of unfit conduct considered, that the Sentencing Council for England and Wales has recently recommended that the starting point for this offence should be a minimum of a 1 year custodial sentence for the defaulting Director. When it comes to Personal financial liability for the debts of the successor company, the Director can on application by one or more the creditors of company 2, have to pay the debts of company 2. This is Serious stuff.
C. Defence of a Criminal prosecution alleging that the Directors of the company acted in breach of the terms of their existing Director Disqualification Orders. A successful Criminal prosecution may of itself result in Criminal Confiscation proceedings (serious stuff but outside the scope of this article) and/or the imposition of a Director Disqualification ban by the Criminal Court.
So what can or should the Director under attack do?
The above claims inevitably cause the Director (and his/her family) stress and inconvenience and put a strain on what may be scarce personal financial resources to defend such claims. The financial claims inevitably attack the Director’s financial base and often, his/her financial interest in the family home.
All of this at a time when the Director may be trying to get his new company up and running. There is only so much that a person can deal with.
In our next article on this topic area (due out on or around 12th July), we will look at the important points that can assist the director in facing such actions, both pre and post liquidation.
What Should Directors Facing Director Disqualification, Misfeasance Claims and even Criminal Proceedings at Liquidation do?
Our Insolvency and director disqualification Solicitors are experienced in advising and defending the director facing claims from Liquidators, financial claims and investigations and regulatory claims. We have a good track record in advising and helping directors in these areas – click her to see some testimonials.
Our mantra is that is that ‘no hole is too deep for us to be able to help to make a difference’. If your company is insolvent and is facing liquidation, and you are facing a financial or regulatory claim, contact us or call us on 0121 200 7040 for a FREE initial discussion of your case.