Rachel Grant, partner at Brodies LLP, explains the complex issue of director disqualification.

Director disqualification, under the Company Director Disqualification Act 1986 (CDDA), is part of the statutory framework that’s designed to deal with insolvency, and the financial misconduct that sometimes causes, or arises from, insolvency. The CDDA contains a number of grounds for disqualification, but the most common ground is where a person is a director of an insolvent company.

During 2013:

• there were 1,273 director disqualifications
• the average length of disqualification was 6 years
• 41% of disqualifications were for more than 5 years
• 10% of disqualifications were for more than 10 years

 (Source: The Insolvency Service Annual Report and Accounts 2013–14)

Procedure for disqualification  

When a company enters into any formal insolvency regime (administration, liquidation or receivership), a director’s behaviour will come under scrutiny. If it appears to the office holder (official receiver, liquidator, administrator or receiver) that the director’s conduct makes them unfit to be concerned in the management of a company, the office holder must report to the secretary of state (also known as the D Report).

On receipt of the D Report, the Insolvency Service investigates the director’s conduct, and disqualification action will be taken if it is in the public interest.

If the secretary of state decides to take disqualification action, at least 10 days’ notice must be given to the director, although a longer notice period is usually given. Disqualification action must be raised within 2 years of the date of the company’s insolvency. There are, however, proposals to extend that period to 3 years, under the Small Business, Enterprise and Employment Bill 2014.

Where an application for a disqualification order is made to the court, the court must make a disqualification order if it is satisfied that the director’s conduct makes them unfit to be concerned in the management of a company. The period of disqualification is between 2 and 15 years.

As an alternative to court action, if a director accepts that they should be disqualified, they can offer a disqualification undertaking and avoid court action. This has the same force and effect as a court order.

Effect of disqualification

A disqualification order not only prevents a person from being a director, but it also prevents them from being concerned with, or taking part in, the promotion, formation or management of a company. Accordingly, a disqualified director cannot simply resign as a director, have a family member or friend appointed in their place, or carry on running the company themselves.

As well as the prohibitions and restrictions under the CDDA, restrictions can arise under other statutes or rules of organisations.

Acting as a director while disqualified is a criminal offence, and may also make the individual concerned personally liable for company debts. An undischarged bankrupt is also automatically disqualified from being a director, and it is an offence for him to act as a director.

Unfit conduct

Unless a disqualification undertaking is offered and accepted, the court must determine whether a director’s conduct has ‘fallen below the standards of probity and competence appropriate for persons fit to be directors’. Each case turns on its own facts and circumstances, and there is no set test for establishing unfit conduct.

The CDDA sets out matters to be taken into account for determining unfitness, including, for example:  breach of duty; misapplication or retention of company funds or property; failure to lodge accounts; failure to supply goods and services that have been paid for; entering challengeable transactions; and failure to cooperate with the office holder.

Proposals to replace the current list of matters to be considered with a broader and more generic provision are contained within the Small Business, Enterprise and Employment Bill 2014.

The current list of matters to consider is not exhaustive, and the courts regularly take into account factors beyond those listed, so it is questionable whether these changes will have any significant impact on director disqualification.

Leave to act while disqualified

It is possible to apply to the court for leave to act as a director, or take part in the management of the company while disqualified. Leave is essential if a disqualified director is to avoid committing a criminal offence. However, no guidance is given in the CDDA, and the matter is very much at the court’s discretion.

Changes and compensation orders

The government has recently proposed measures to modernise and strengthen the disqualification regime, to give businesses and consumers greater confidence that wrongdoers will be banned from being directors. There could soon be greater transparency of the conditions that can lead to disqualification, and compensation for creditors who suffer as a result of director misconduct, should the Small Business Bill be passed.

The Bill also proposes that the court could make a compensation order, or the secretary of state accept a compensation undertaking where there has been loss or harm to creditors, which is almost certain to be the case if a company is insolvent and disqualification action is taken. Account will also be taken of the amount of loss caused, the nature of the conduct, and whether financial contribution as recompense for the conduct has already been made.

The introduction of compensation orders and undertakings is designed to make directors more financially accountable for their actions. But some question this approach, simply because the primary focus of director disqualification to date has been protecting the public.

About the author

Rachel Grant is a partner at Brodies LLP. For more information, or to contact Rachel, visit the Brodies website, or follow on Twitter @BrodiesLLP.