DIRECTORS DUTIES FOR COMPANIES IN FINANCIAL DIFFICULTIES

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1 Tests of insolvency The different types of director Director s disqualification Wrongful trading and other potential liabilities DIRECTORS DUTIES FOR COMPANIES IN FINANCIAL DIFFICULTIES Actions the well advised director should take What duties does a director owe?

2 May 2015 What are the tests of insolvency? What is Insolvency and how is it tested? Insolvency involves a company being in a position where it cannot meet its financial commitments. There are two statutory measures of insolvency: the cashflow test where a company is unable to pay its debts as they fall due; and the balance sheet test where the value of a company s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities. Establishing cashflow insolvency For the purpose of the cashflow test, a company is unable to pay its debts as they fall due if any of the following apply: a statutory demand has been served and remains unsatisfied for three weeks; the attempted execution of a judgment is returned unsatisfied; or it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due - failure by the company to pay an undisputed debt which is due may be sufficient proof for the court. What should a director do in the event of suspected Insolvency? The key issue for directors is to recognise the financial and commercial signs which signal that their company may not be able to avoid going into an insolvency process. Potential signs might include: increasing pressure from trade creditors and key stakeholders such as lenders; late filing of accounts and issues faced when seeking to sign off the accounts; accounts which show that the value of a company s assets are less than its liabilities; stretching creditor payment terms or only paying creditors when letters before action, proceedings or statutory demands have been issued; judgments having been brought against the company for nondisputed debts; adverse credit reports being returned by specialist debt recovery providers such as RedFlag and ANT NNA; or the refusal or amendment of credit terms. The [Director s disqualification] section of this site provides an important insight for directors in respect of what they should be doing both to recognise the threat of insolvency and then to deal with it in the most appropriate way going forward. In many cases the first port of call will involve seeking professional advice from those with experience in this area and pursuing the twin aims of: working to save the company from insolvency through business change, investment and restructuring; and undertaking contingency planning, assessing what insolvency process might be most appropriate in the circumstances and how that can best be achieved with the position of the company s creditors maximised. The insolvency processes likely to be considered are: administration, company voluntary arrangement, administrative receivership and creditors voluntary liquidation. 2

3 The main implications of Insolvency A company can be wound up (i.e. put into liquidation) by the court if it is insolvent under either the cashflow or balance sheet tests. Directors can be made personally liable for some or all of their company s debts if the company goes into insolvent liquidation in circumstances where the directors should have realised this was likely to happen but failed to take appropriate steps to minimise loss to the company s creditors. See [Wrongful Trading and other director s liabilities] for further information on this issue. If a company is insolvent when it enters into a transaction at an undervalue or enters into an arrangement with a creditor which is influenced by a desire to improve the position of that creditor should the company go into liquidation, the transaction or arrangement may be overturned and the director may suffer criticism and personal liability. See [Wrongful Trading and other director s liabilities] for further information on this issue. A director of a company which goes into insolvent liquidation, administration or administrative receivership may be disqualified from acting as a director if the court considers that the director s conduct in connection with the company makes him or her unfit to be concerned in the management of a company. See [Director s disqualification: what it is it and how can it happen?] for further information on this issue. As a final note of caution, the fact that a company is insolvent does not of itself make a director liable for its debts or liable to be disqualified or, generally, make transactions invalid. Insolvency is only one condition which must be satisfied before directors can face personal liability or disqualification and before transactions can be overturned. 3

4 May 2015 The different types of director There are essentially three types of company directors: De jure directors De facto directors Shadow directors Only the first category covers formally appointed directors but each category of director owes duties under the Companies Act 2006 (CA) and are potentially personally liable for failures under both the companies and insolvency legislation. An individual cannot escape liability for breach of duty simply because they are not called a director, as a court will always look at the reality of the role they perform within the company. In two instances the legislation goes further by imposing liabilities on those who may not be a director: the provisions relating to fraudulent trading (s.213 Insolvency Act 1986 (IA)) impose liability upon anyone who is knowingly a party to carrying on the business with intent to defraud; and the misfeasance provisions (s.212 IA) impose liability on anyone concerned in the promotion, formation or management of the company. De Jure Directors and Non-Executive Directors A de jure director is someone who has been validly appointed in accordance with the requirements of the law and will therefore cover all those directors who appear on the company s appointments register at Companies House. It is likely that many non-executive directors will fall into this category and in general terms there are no special rules for non-executive directors who may therefore potentially attract the same liability as executive directors in the context of insolvency. However, in assessing a non-executive director s conduct the courts accept that they cannot be expected to have the detailed knowledge required of an executive director but nevertheless are required to take reasonable steps to guide and monitor the management of the company in difficult times. De Facto Directors A de facto director is one who acts as a director without being validly appointed as one. The courts have recently set out that the following are all key potential factors in determining if a person is a de facto director: They hold themselves out as acting as a director; They are part of the corporate governing structure and participate in directing the affairs of the company; They are the sole person directing affairs or a substantial, predominant influence and force; The functions they perform are ones that are properly undertaken by a director and are not ones which could properly be performed by someone below that level Other potential indicators include a lack of accountability to others, involvement in major decisions and having the power to intervene to prevent some acts on behalf of the company. A de facto director needs to be more than a mere agent, employee or advisor and have direct involvement and influence on the major aspects of a company s management. 4

5 Shadow Directors A shadow director is defined as a person in accordance with whose directions or instructions the directors of the company are accustomed to act but a person is not deemed a shadow director by reason only that the directors act on advice given by him in a professional capacity. By their nature, shadow directors are more difficult to identify because their influence whilst having the same effect as that of a de facto director is less obvious because it is exercised from afar or the shadows and exerted on the company s directors. The General Duties imposed by the CA are said to apply to shadow directors where and to the extent that the corresponding common law principles applied and therefore the nature of the duties imposed on shadow directors is subtly different and potentially slightly less onerous in certain respects, to those applying to the other classes of directors. Whilst in the past the courts have generally considered the position of de facto and shadow directors to be mutually exclusive, the more modern approach is to accept that a director can switch between the two roles, acting as a de facto director in some aspects of the business and a shadow director for others. 5

6 May 2015 What duties does a director owe? Through the Companies Act 2006 (CA) the government sought to codify and implement the existing common law on directors duties to improve the clarity and accessibility of the law in this area. The Magnificent Seven codified duties Much of the previous law on directors duties had been developed by the courts over many years and the CA codifies most of these principles with a statement of directors duties known as the General Duties. They are: to act within the company s constitution and only exercise powers for a proper purpose (s.171); to act in good faith to promote the success of the company (s.172); to exercise independent judgement (this does not restrict a director seeking informed advice) (s.173); to exercise reasonable care, skill and diligence (s.174); to avoid conflicts of interest (s.175); not to accept benefits from third parties (s,176); and to declare interests in proposed transactions or arrangements with the company (s.177). The final three duties embody the common law fiduciary duties owed by a director. The General Duties are cumulative and directors are required to comply with each one that applies to a particular case or circumstance. What are the key General Duties for directors acting in the twilight zone? 1 The duty to promote the success of the company and the Subsidiary Six Prior to the introduction of the CA, the key common law duty was to act in the best interests of the company, this has been codified into the duty to promote the success of the company. The CA expands upon this, stating that a director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. Albeit that the emphasis of this duty changes when a company faces insolvency as explained below. The CA lists (non-exhaustively) the following factors the Subsidiary Six that directors must have regard to when seeking to act in the way they consider would be most likely to promote the success of the company: the likely long-term consequences of any decision; employee interests; the need to foster business relationships with suppliers, customers and others; the impact on the community and environment; maintaining a reputation for high standards of business conduct; and the need to act fairly as between shareholders. 2 Exercising reasonable care, skill and diligence This section is modelled on section 214 of the Insolvency Act 1986 (IA) which is the test for Wrongful Trading [Wrongful Trading and other potential liabilities] and contains both an objective and subjective test for directors. In summary, a director owes a duty to his company to exercise the same standard of care, skill and diligence that would be expected by a reasonably diligent person with: the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions of the director in relation to that company (objective test); and 6

7 the general knowledge, skill and experience that the director actually has (subjective test). The standard can be increased if a director is particularly experienced and there may also be some scope for making an allowance in respect of non-executive directors. The same high standards may not apply in all cases as it has also been accepted that the objective standard does require the court to have regard to the size and sophistication of the company. In our [actions the well advised director should take] section we set out the type of steps that a director exercising reasonable care, skill and diligence and acting in the twilight zone would be expected to take. Who are the General Duties owed to? The impact of possible insolvency When a company is solvent, the General Duties are owed to the company and it follows that only the company will be able to enforce them. The General Duties are not owed to individual shareholders but to the shareholders as a whole, both present and future. However, the CA codifies the fact that where a company is insolvent, the directors need to consider or act in the best interests of the company s creditors, rather than the shareholders. Again, that duty is owed to the group of creditors as a class so that acting in the interests of a particular creditor without believing the action to be in the interests of creditors as a class, will be a breach of duty. The consensus from the cases would suggest that the duties to creditors will override where a company is insolvent, near insolvent or in a parlous financial position such that it is likely that only the creditors position will be affected by actions taken in the company. In order to recognise the switch in duties, directors need to be acutely aware of the financial position of the company and its realistic prospects. For details of what steps a director should take and what considerations need to be in the forefront of a director s mind when acting in the best interests of the creditors and the potential liabilities that can arise if they don t, see links [Actions the well advised director should take] and [Wrongful trading and other potential liabilities]. Who do the General Duties apply to? The General Duties will apply to anyone occupying the position of director (whatever name they are given), shadow directors and, in certain cases, former directors. So just because you are not called a director does not mean you do not owe the duties. The General Duties are the same whether directors are executive or non-executive directors, although as noted above the test of reasonable skill, care and diligence is likely to impose a higher standard on executive directors For further information see link [Shadow directors, de facto directors the different types of directors] The challenge for any director is knowing when the duty shifts from acting for the benefit of the shareholders to acting for the benefit of the creditors; recognising that the company has moved from a position of solvency to a likely insolvency. This is an issue the courts have considered on a multitude of occasions with no single test propounded making life less straightforward for directors and those advising them. 7

8 May 2015 Actions the well advised director should take When a company is faced by financial difficulties whether temporary or not, it is important that its directors are able to recognise this and to make correct, informed decisions because the stakes can be much higher for both the directors and the company if they don t. Set out below are a range of steps we consider that directors should be taking: Take professional advice Many directors are concerned that accessing professional advice costs money at a time when their business and they personally have least access to it. However, at such a key time it is important that directors obtain advice from professionals, both legal and financial, who have been there and done it. Obtaining proper advice at an early stage can make the difference between a company that survives rather than fails and, at the very least, can ensure that company problems do not result in personal liabilities arising for directors through wrongful trading and/or other potential liabilities (see our link on wrongful trading). You will normally find that professional advisers, like the Bond Dickinson Directors Duties Team, are willing to provide an initial consultation free of charge and this may be all you need. Often professional advisers can also provide links to others who work with distressed businesses; for example, lenders who can provide access to working capital or turnaround professionals with a proven track record who have the specific skill set that your business needs. Record keeping and accurate financial data When it comes to protecting themselves when trading in financially distressed situations, it is not only important that directors take the right steps and ask the right questions but also that they can prove they did this to anyone who seeks to question that at a later date. This means that Board and management meetings should be held regularly and such meetings and other key day to day decisions should be minuted so that there is an appropriate paper trail which enables you to confirm what decisions were made and when, the commercial reasons for them and any documents or information which supported the decisions. For that decision making process to be completed properly and thoroughly it is important that directors have access to up to date, accurate and properly prepared financial data. Directors should also be careful to monitor compliance with financial covenants contained in any arrangements with lenders. Involving professional advisers can also help to build the picture of a director group which is acting rationally, properly and with due attention to their duties. A director s conduct will be judged on what was reasonable at the time, not what is reasonable with the benefit of hindsight, so being able to show reasoned, rationale thinking at the time is a real positive. Discussing matters with your Bank Some directors we have advised initially expressed the following concerns, we have been going through some tough trading times but I am loathe to discuss these with my bank in case they just pull our funding. The reality is that most banks have very sophisticated programmes in place which ensure in most cases they pick up signs of stress and distress in customers at an early stage. Therefore in most cases you won t be telling them anything they don t already know! 8

9 Furthermore, the main clearing banks have invested heavily in their business support teams because the last thing they want to do is lose a customer to insolvency. Most of the banks quote figures to support the fact that over 80% of their customers who are taken on by their business support teams return back to full financial health and rejoin the bank s good book. As such, it is often a very sensible step to pick up the phone to your relationship manager and tap into their knowledge and experience with a view to working collaboratively alongside the bank to reach a common goal; particularly where you consider that refinancing or restructuring might be the solution. Resignation not always the easy solution it appears to be It is a rare case where by resigning you are doing the right thing and fulfilling your duties because the company s problems remain and you will have done nothing to resolve them and by resigning you surrender any ability to remedy the problem in the future. From a personal point of view, it could mean you are more (rather than less) likely to be subject to the personal consequences referred to elsewhere on these pages. Customer deposits - should you continue to take these? A business should think long and hard about continuing to take money from customers where it has concerns about its continued ability to fulfil orders. However, one precaution that a company can take, especially in a business where deposits are generally taken, is to put those deposits into a specific trust account until the order is completed. This means that deposits that are held separately from the company s money, are not part of its general assets and can be returned to the customer if the company fails before the order is completed. There are a number of complex issues involved in setting up a trust account properly including the fact that you need to agree with your bank that the funds are not subject to any security they may have and that they will not try to seize them at any point. However, they can provide important protection against claims of wrongful trading. However, there are circumstances where a director has tried and failed to persuade their fellow directors as to the appropriate course of action to take when faced with potential insolvency when it may be appropriate for them to resign in protest against the board s conduct. A director would be well advised to take independent advice in such circumstances and ensure that their views and reasons for resignation are clearly set out in the company s records. 9

10 May 2015 Wrongful trading and other potential liabilities As set out in [What duties does a director owe?], while a company is solvent the directors owe their duties to the company itself. However, when a company is in financial difficulties and where insolvent liquidation becomes a possibility, the directors duties are from that moment deemed to be owed primarily to the creditors of the company rather than to the members. Directors who explicitly act in a manner which is contrary to the interests of those creditors in such circumstances face the possibility of action for one or more of the following offences: Wrongful Trading; Fraudulent Trading; Misfeasance or Breach of Duty; Transactions at an Undervalue; Preferences; Transactions Defrauding Creditors. Each of these areas is covered below in more detail. Section 1 claims against directors A) Wrongful trading What is wrongful trading? In essence, the wrongful trading provisions in section 214 of the Insolvency Act 1986 (IA) give power to the court to make a company director personally liable for the company s debts. When does it apply? Where a company has gone into insolvent liquidation, a court may, on the application of the liquidator, require a contribution from a person who is or was a director (or shadow director) of the company, where: at some point before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation. Is there are defence? The court will not make an order for wrongful trading if a director can prove that: knowing there was no reasonable prospect that the company would avoid going into insolvent liquidation, he took every step with a view to minimising the potential loss to the company s creditors as he ought to have taken. The key for any director is therefore to identify when their company is in a position where insolvent liquidation cannot be avoided and to ensure that they take the proper actions in the circumstances. Set out below in [How can I protect myself?] and [Actions the well advised director can take] is some further guidance on these issues. Who is liable for a wrongful trading claim? Only directors and shadow directors can be found liable for wrongful trading and only liquidators can apply to the court for a contribution to be paid. What can be claimed from me? Whilst there are relatively few reported cases on the interpretation of section 214, case law has established that the purpose of an order under section 214 is primarily compensatory and not penal in nature. Therefore the amount ordered to be paid by a director guilty of wrongful trading is usually measured by the level of loss between the time the director knew, or ought to have known, that the company was unable to avoid insolvent liquidation and the date of commencement of an insolvency process. 10

11 Who is entitled to any money recovered from the director? Any recovery made by the liquidator is paid into the general pool of assets which are available for distribution among all of the creditors. What standard is applied to the director s behaviour? The test is a mixture of a subjective and an objective test, taking into account the actual knowledge, skill and experience of the particular director concerned as well as the level of knowledge, skill and experience they ought reasonably to have. Therefore the facts that a director of a company ought to know or ascertain, the conclusions which he ought to reach and the steps which he ought to take, are those which would be known or ascertained, or reached or taken, by a reasonably diligent person having both: (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and (b) the general knowledge, skill and experience which that director has. In practice it is safer for directors to judge their own conduct on as objective a basis as possible. Burden of Proof As no criminal liability attaches for wrongful trading, the onus of proof is on the basis of the balance of probabilities rather than beyond reasonable doubt and dishonesty is not a requirement For the liquidator to succeed he will need to establish what a particular director knew and did and contrast this with what a reasonable director should have known and done in those circumstances. Factors such as size of the business and the director s function and position will be taken into account - for example, a finance director is expected to show greater financial awareness of accounting matters than perhaps a sales or marketing director would be. How can I protect myself? Of all the potential liabilities set out on this page, wrongful trading is likely to be the most common concern for directors. This is because it is all too easy for directors to fail to act promptly to signs of financial difficulties instead preferring to try and battle through, even where the chances of avoiding insolvent liquidation are not realistic. Set out at [Actions the well advised director can take] are details of the steps that a director should consider taking when financial circumstances bring the prospect of insolvency, in order to avoid personal liability. What if insolvent liquidation cannot be avoided? When directors conclude that the company will be unable to avoid insolvent liquidation their job is to ensure that they take every step possible to minimise the loss to creditors. Inevitably, if they haven t done already, directors will need to consider the following issues: a) seeking advice from specialist insolvency lawyers and/or licensed insolvency practitioners who will review the circumstances and suggest which insolvency procedure(s) might be the most appropriate; b) is it in the creditors interests for the company to continue trading in the short or long term? c) to what extent will creditors be paid or be better off if the company incurs fresh credit? d) if the company can only continue to trade with the benefit of third party funding, how confident are the directors that this funding will be made available? e) keeping any new financial commitments to a minimum and considering ways in which any exposure can be reduced. f) ensuring that payments to third parties (especially those connected to the business and its directors) are being made for genuine commercial reasons and not to prefer that creditor. g) ensuring that assets are being disposed of for the best value possible and on the basis of independent valuations. What if my fellow directors refuse to act in the interest of creditors? If a director fails, despite their best efforts, to persuade fellow directors that there is no reasonable prospect of the company avoiding insolvent liquidation, it may be appropriate for them to resign in protest against the board s decision to continue to trade. It would be sensible for them to seek independent legal advice concerning such a decision and have their concerns noted in the board minutes. They should also communicate their concerns clearly in writing to the rest of the board on resignation. The onus on the rest of the board will then be all the greater. B) Fraudulent trading What is Fraudulent Trading? If, in the course of the winding up of the company, it appears that any business of the company has been carried on with the intent to defraud creditors of the company or of any other person, or for any fraudulent purpose, the court may following an application by a liquidator, require a contribution from any persons who were knowingly parties to the fraud. As with wrongful trading the award is compensatory rather than punitive. When does it apply? Only those who were knowingly parties to the fraudulent trading (whether a director or not) are caught by these provisions and case law has shown that it is not sufficient just to show that the company continued to run up debts when the directors knew that it was insolvent; there has to be actual dishonesty, involving real moral blame. As such, it is far more difficult to establish than wrongful trading. 11

12 Are there any other consequences for fraudulent trading? Fraudulent trading is also a criminal offence under section 993 of the Companies Act 2006 and a person found liable under the fraudulent trading provisions may also have a disqualification order made against them. Who is entitled to any money recovered from the director? Any recovery made by the liquidator is paid into the general pool of assets which are available for distribution amongst all of the creditors. C) Misfeasance or breach of duty What is Misfeasance? If, during the course of the winding up of a company, it appears that a director or person involved in the promotion, formation or management of a company has: (a) misapplied or retained or become accountable for any money or other property of the company, or (b) been guilty of any misfeasance or breach of fiduciary duty or other duty in relation to the company, the court may examine the conduct of the person and order him to repay, restore or account for money or property with interest or make a contribution to the company s assets by way of compensation for losses arising from his misfeasance or breach of duty. Who can apply? The application for this remedy may be made to the court by the Official Receiver, liquidator, or any creditor or shareholder and the court can make such order as it thinks fit. However, no matter who applies, any recovery will be available to the general body of creditors only. Section 2 claims against 3rd parties A) Transactions at an undervalue What is a Transaction at an Undervalue? A company enters into a transaction at an undervalue with a person if:- (a) it makes a gift to that person or otherwise enters into a transaction with that person on terms that provide for the company to receive no consideration; or (b) the company enters into a transaction with that person for a consideration which is significantly less than the value of the consideration provided by the company in return. Who can bring a transaction at an undervalue claim? Transactions at an undervalue may be challenged by an administrator or liquidator by application to the court for an order to restore the position to what it would have been if the company had not entered into the transactions. Is there a time limit? To be challenged, the transaction must have occurred at a relevant time, which is within two years of the onset of the relevant insolvency process. However, a transaction is not deemed to be within a relevant time, unless, at the time the transaction took place, the company was Insolvent, see [What are the tests of insolvency?] or become insolvent as a consequence of the transaction. Connected Parties Special rules apply to transactions with parties who come within the definition of connected. In those circumstances the transaction is presumed to have taken place when the company was insolvent or that it became insolvent as a result unless the contrary is shown. Connected parties can include the directors of the company, a relative of such a director and companies connected by common ownership. Can I defend my actions? The court will not make an order in respect of a transaction at an undervalue if it is satisfied that the company which entered into the transaction did so: in good faith and for the purpose of carrying on its business, and that at the time it did so there were reasonable grounds for believing that the transaction would benefit the company. It is for these reasons that when disposing of assets in situations of financial uncertainty that directors ensure that proper value is obtained at the time and that they can evidence this is the case if ever called on to do so. B) Preferences What is a Preference? A company gives a preference to a person if:- (a) that person is one of the company s creditors or a guarantor of the company s debts; and (b) the company does anything or suffers anything to be done which has the effect of putting that person in a position which, in the event of the company going into liquidation, would be better than the position he would have been in if that thing had not been done. Who can bring a Preference claim? A preference may be challenged by an administrator or liquidator of a company by an application to the court for an order to restore the position to what it would have been if the company had not entered into the transaction. What turns a normal payment into a preference? Essentially, for the act or omission to be a preference, the company must improve the position of the creditor in the event of insolvency. An attackable preference only occurs in relation to a person who is preferred and who is either a creditor or guarantor of the company s liabilities. A preference can be as simple as making a payment to a creditor shortly before an insolvency process to ensure they get paid what they are owed in full and do not need to claim in the insolvency 12

13 Is there a time limit? As with transactions at an undervalue, the act complained of must have occurred at a relevant time. In the case of a preference given to a connected party, the relevant time is any time within the two years immediately preceding the onset of insolvency and in the case of a preference given to an unconnected person, the period is six months immediately preceding the onset of insolvency. However, a preference is not deemed to be within a relevant time, unless, at the time the preference took place, the company was insolvent, see [What are the tests of insolvency?] or become insolvent as a consequence of the transaction. The need to prove a desire to prefer This issue is generally the key point in preference actions because a court cannot make an order setting aside a preference unless the company which gave the preference was influenced by a desire to put the counterparty in a better position on an insolvency than it would have been in without the transaction. C) Transactions defrauding creditors What is a transaction defrauding creditors? The court can set aside transactions at an undervalue entered into at any time where the court is satisfied that the transaction was entered into by the transferor for the purpose of putting the assets beyond the reach of a person who is making, or may at some time make a claim against him, or otherwise prejudice the interests of such a person in relation to the claim which he is making or may make. Who can bring the claim? The provisions of this section are available to the victims of a transaction and there is no requirement for the company to be either in insolvent liquidation or administration. As such, merely making a preferential payment is insufficient to render that payment vulnerable, the act constituting the preference must be influenced by a desire to give the preference. 13

14 May 2015 Director s disqualification: what it is it and how can it happen? The power to disqualify? The power of the courts to disqualify individuals from acting as directors of companies has existed for many years. The Company Directors Disqualification Act 1986 (CDDA) consolidated all previous disqualification legislation and introduced new tougher provisions directed at those involved in the failure of a company and whose conduct calls into question their fitness to be involved in the management of other companies in the future. Enforcement of the provisions of the CDDA is by the Secretary of State of the Department for Business, Innovation and Skills (BIS). How does the Disqualification process start? Administrators, administrative receivers and liquidators appointed to companies are under a statutory duty to investigate and report to the Secretary of State for BIS on the conduct of the directors in relation to the company on what is commonly known as a D form. The D forms are confidential and are assessed by the Insolvency Service. In a small but significant proportion of cases of unfit conduct further investigations lead to the directors being prosecuted by the Secretary of State under the CDDA. The Secretary of State will in the most serious of cases investigate the conduct of the directors reported to it. Such investigations will involve a thorough review of all the available evidence including an assessment of the directors explanations for the failure of the company. Does the obligation to file a D Report apply if the Insolvency Practitioner is appointed by the directors? It does not matter who has appointed the Insolvency Practitioner. Official receivers, liquidators, administrative receivers and administrators are required by the CDDA to submit D reports about directors (including all de facto and shadow directors) to the Insolvency Service in relation to anyone who is or has been a director of the company in the period of 3 years preceding their appointment. What is a disqualification order? Generally, following an investigation, if a prosecution is made by the Secretary of State and upheld by the court then a court may make a disqualification order so that a person shall not be a director of a company, or be in any way, whether directly or indirectly, concerned or take part in the promotion, formation or management of a company. The order must be for a specified period of between 2 and 15 years. When assessing conduct, the court is entitled to judge a director as unfit on the strength of their conduct in respect of: the insolvent company in question alone; or the insolvent company and as a director of any other company or companies. A person s potential liability does not cease when they resigns as director because a disqualification order may be made against a person who is or has been a director of a company which has at any time become insolvent, whether while that person was a director or subsequently. 14

15 Factors taken into account in making a disqualification order In determining the question of unfitness, the court shall have regard to a number of factors contained in schedule 1 to the CDDA, including: a) any misfeasance or breach of any fiduciary or other duty by the director in relation to the company; b) any misapplication or retention by the director of, or any conduct by the director giving rise to an obligation to account for, any money or other property of the company; c) any failure to comply with the provisions of the Companies Act 2006 relating to the keeping of accounting records, registers of directors and secretaries, duty to make annual returns and to register any charges created; d) the extent of the director s responsibility for the company giving a preference or entering into a transaction at an undervalue; e) the extent of the director s responsibility for the causes of the insolvency; and f) the extent of the director s responsibility for any failure by the company to supply goods or services paid for in advance. In addition, a director can be disqualified if he has been found liable for fraudulent or wrongful trading. Alternatives to disqualification orders In appropriate cases, the Secretary of State may agree to accept an undertaking from a person not to act as a director of a company in order to bring the investigation to a conclusion and to avoid the time and costs of court proceedings from being incurred. Disqualification undertakings have the same effect as an order from the Court and their details are publically available on a register maintained by the Secretary of State. Exemptions It is open to a person who has been disqualified from acting as a director to apply to court for an exemption in relation to a particular company to enable them to act as a director or manager. Acting in contravention of a disqualification order It is a criminal offence to act in contravention of a disqualification order with the maximum penalty if found guilty being two years imprisonment, a fine, or both. 15

16 May 2015 Glossary Administration Administration Order Administrative receiver Administrative receivership Administrator Book debt Company Voluntary Arrangement (CVA) Compulsory liquidation Creditor Debenture Debt Debtor De facto director De jure director A process to effect corporate rescue, initiated by court order or by a floating chargeholder or the directors/company filing requisite notice with the court resulting in the appointment of an administrator An order made by a County Court of the High Court appointing an administrator to take control of the company Insolvency practitioner appointed pursuant to a floating charge in an administrative receivership A process to effect the realisation of secured assets for and on behalf of a floating chargeholder Insolvency practitioner appointed in an administration Sum owed but not as yet paid An agreement in the form of a statutorily imposed binding arrangement by a company debtor with its creditors A form of liquidation for a company or partnership which follows a court order A person/company who is owed money Instrument evidencing a secured debt over the assets of a company. Often used to describe a fixed and floating charge type security A legally enforceable liability whereby a debtor can be compelled to render what is due at the instance of a creditor A person/company who owes money Someone who acts as a director of a company but without having been validly appointed as one Someone who has been validly appointed to the company in accordance with the requirements of the law 16

17 Directors disqualification order Dividend Fixed charge Fixed chargeholder Floating charge Floating chargeholder Fraudulent trading Insolvency Insolvency practitioner Liquidation Liquidator LPA Receiver Member Member s voluntary liquidation Moratorium Nominee Officeholder An order made by the court, pursuant to Company Directors Disqualification Act 1986 following an application by the Secretary of State, disqualifying an individual from being a director (or concerned directly or indirectly in the control, management or promotion) of a company for a period of up to 15 years A sum distributed to a creditor during an insolvency process Security over specific and identifiable assets e.g. land, property and goodwill A secured creditor possessing a form of security over specific and identifiable assets of the debtor. Default in the terms of the security by the debtor may entitle the fixed chargeholder to appoint a receiver Security over general assets of a company that by their nature are liable to change from time to time during the ordinary course of business (e.g. stock). A secured creditor possessing a floating charge. If possessed over the whole or substantially the whole of a corporate debtor s business, on default in the terms of the security it may give them the right to appoint an administrative receiver and/or administrator A civil offence pursuant to s.213 IA 1986; also a criminal offence, committed by directors if the business of the company has been conducted with an intention to defraud creditors or for any other fraudulent purpose The status of a debtor when they have an inability to pay debts as they fall due (cash flow basis) or where total liabilities exceed total assets (balance sheet basis) A person authorised and licensed by a recognised professional body to act in relation to insolvency matters. Sometimes referred to colloquially as the IP or office-holder. Insolvency process leading to the dissolution of a company after realisation and distribution of available assets to its creditors and/or members An insolvency practitioner or Official Receiver appointed to realise company assets and distribute proceeds to creditors on the liquidation of the company Law of Property Act 1925 Receiver. An individual (not necessarily an insolvency practitioner) who is appointed to realise fixed charged assets on behalf of a fixed chargeholder A person registered as a shareholder or subscriber at Companies House in respect of a company. Also may refer to the member of a limited liability partnership A form of liquidation where the company has an ability to pay all of its debts and a return is likely to be made to its members after the payment of these debts. Also referred to as a solvent liquidation The suspension of the rights available to creditors to take action to enforce payment of their debt An insolvency practitioner who assists a debtor to put forward a voluntary arrangement with its creditors and who is proposed to be the supervisor of a voluntary arrangement approved by creditors A generic description applied to an insolvency practitioner taking an appointment during a process of insolvency 17

18 Official Receiver Preference Preferential Creditor Prescribed part Proof of Debt Provisional liquidator Proxy Receiver Receivership Ring-fenced sum Secured creditor Shadow director Solvent liquidation Statutory demand Supervisor Transaction at an undervalue Unsecured creditor An official of the Insolvency Service who deals with bankruptcies and compulsory company liquidations A payment or action taken by a debtor which leads to a creditor being placed in a better position vis-à-vis other creditors in the circumstances of an insolvency. The payment or action can be set aside in certain circumstances, IA 1986, s.239 (re company debtor) IA 1986, s.340 (re individual debtor) A creditor who by statute is accorded a status giving them special rights to be paid/receive a distribution subject to the claims of secured creditors (other than floating chargeholders) but ahead of unsecured creditors An amount set aside from floating charge realisations to pay unsecured creditors pursuant to s.176a IA 1986, sometimes referred to as the ringfenced sum. Only applies to security created after 15 September 2003 A statutory prescribed form completed by a creditor and submitted to an officeholder for verification in evidence of a debt due from the insolvent debtor Insolvency practitioner appointed by the court to safeguard and preserve the company s assets pending the hearing of a winding-up petition A form appointing a person to represent a creditor at a creditors meeting An individual (not necessarily an insolvency practitioner) who is appointed to realise fixed charge assets on behalf of a fixed chargeholder, sometimes referred to as an LPA Receiver. The term is also commonly misused to denote an administrative receiver A process to effect the realisation of secured assets for and on behalf of a fixed chargeholder, commonly also to denote the realisation of fixed and floating charge assets as per administrative receivership See prescribed part A creditor possessing a mortgage, charge, lien or other instrument effecting security over the property of a debtor. Sometimes referred to a chargeholder A person in accordance with whose directions or instructions the directors of the company are accustomed to act. This does not include a person who advises solely in the capacity of a professional adviser A form of liquidation where the company has an ability to pay all of its debts and a return is likely to be made to its members. Also referred to as a members voluntary liquidation A demand made by a creditor to a debtor in a prescribed manner for payment within 21 days of an undisputed debt in excess of 750 An insolvency practitioner appointed pursuant to the terms of an approved voluntary arrangement who will assist in the implementation of the proposals and enforce a debtor s compliance with the terms of the arrangement A transaction which results in the transfer of a debtor s assets to a third party for less than their true worth, which can be set aside in certain circumstances, s.238 IA 1986, (re company debtor) s.339 IA 1986, (re individual debtor) A creditor possessing no security over any property of the debtor, sometimes referred to as an ordinary creditor. Will receive payment/distribution subject to the claims of secured creditors and preferential creditors 18

19 VAT bad debt relief Voluntary arrangement Voluntary liquidation Winding-up order Wrongful trading Tax relief obtained by a creditor from Customs and Excise for a debt which remains unpaid for more than six months, and therefore commonly claimed on the insolvency of a debtor An agreement in the form of a statutorily imposed arrangement binding on creditors to accept a compromise or scheme of arrangement in respect of the payment of their debt. Can be either an individual voluntary arrangement or company voluntary arrangement A form of liquidation commenced other than by court order and taking the form of either a creditors voluntary liquidation or members voluntary liquidation Order made by the court following a winding up petition (or sometimes an administration order application), leading to the compulsory liquidation of a company. The term being wound up is often used in substitution for in liquidation. A civil offence pursuant to s.214 IA 1986, committed by directors if before the insolvent liquidation of a company it was inevitable that the company would enter into liquidation yet they failed to take every step to minimise loss to creditors BD.1703 This communication is provided for general information only and does not constitute legal or other professional advice. You should consult a suitably qualified lawyer on any specific legal problem or matter.

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