Statement of Insolvency Practice 2 - a liquidator s investigation into the affairs of an insolvent company ( SIP2)

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1 Introduction 1.1 This chapter is intended as a practical guide to the issues relating to disqualification proceedings, the steps directors can take to avoid unfit conduct and how the Department of Business Innovation and Skills conduct disqualification proceedings. 1.2 There is readily available information for directors relating to the Company Directors Disqualification Act 1986 ( CDDA ) on the websites of the Association of Business Recovery Professionals ( R3 ) and The Insolvency Service. If members of the IFT would like to refer to the full text of these documents further information is summarised below. This chapter highlights those matters considered to be of more immediate concern to IFT members. 1.3 Statements of Insolvency Practice ( SIPs ) give guidance on best practice to insolvency practitioners. The following information is held on the website of R3 ( Statement of Insolvency Practice 2 - a liquidator s investigation into the affairs of an insolvent company ( SIP2) Statement of Insolvency Practice 4 - disqualification of directors ( SIP4 ) 1.4 In addition The Insolvency Service have issued guidance notes for the benefit of both directors and Insolvency Practitioners. The website address is Company Directors Disqualification Act 1986 And Failed Companies Information on Disqualification Procedures Company Directors Disqualification Act 1986 and Disqualified Directors Effect of disqualification orders and disqualification undertakings Disqualified Directors Hotline - What the Hotline is and how to use it Company Directors Disqualification Act Guidance Notes for the Completion of Statutory Reports and Returns 1.5 The IFT Information Note 123: Danger Areas also includes sections on wrongful trading, fraudulent trading and disqualification proceedings. The Law Relating to Directors Disqualification 2.1 This chapter concentrates on the provisions of Section 6 of the CDDA relating to the disqualification of unfit directors of insolvent companies. There are other grounds for which directors can be disqualified under the CDDA including:- - conviction of certain criminal offences IFT Information Note Page 1 of 7

2 - persistent breaches of companies legislation (e.g. failure to file accounts) - competition disqualification order - participation in wrongful trading - fraud in a winding up. 2.2 Under S6 CDDA the Courts have the power to disqualify directors and others from managing limited companies for a period of between 2 and 15 years for a variety of reasons. 2.3 To put the number of such disqualification orders into context, there were over 1,200 disqualifications (including disqualifications following conviction for an indictable offence) in the 2008/2009 year. 2.4 Every administrator, administrative receiver or liquidator (as the case may be) is required to submit to the Department of Business Innovation and Skills, within 6 months of the commencement of the insolvency procedure, a report or return covering all directors in the preceding three years. In practice this is sent to The Insolvency Service. This applies even where a liquidator is appointed after an administrative receiver or administrator. 2.5 The report is confidential between the office holder (or Insolvency Practitioner ( IP )) and The Insolvency Service. In the event that The Insolvency Service take disqualification proceedings, the directors may request a copy of the report from The Insolvency Service, which will normally be granted, subject to conditions. 2.6 Not all IP s have the same duty. Liquidators have a positive duty to investigate the affairs of the company and the directors conduct. An Administrator or an Administrative Receiver will report on those matters which have come to his attention during the ordinary course of his work. Upon his appointment the office holder will write to all creditors and suppliers to notify them of his appointment and information provided by creditors in response can often draw attention to issues to be considered when preparing the report. 2.7 If The Insolvency Service target a case for further investigation then an examiner from The Insolvency Service s Disqualification Unit or solicitor instructed on its behalf will carry out the investigation and the IP has a duty to provide information when requested by The Insolvency Service. On what grounds might a director be disqualified? 3.1 The Courts may disqualify individuals from managing companies for periods of up to 15 years, in addition to any other penalties, on the grounds that they are unfit. Unfitness covers a multitude of types of conduct deemed to be contrary to the public interest and specifically contrary to the interests of the company s creditors (and shareholders). The law perceives the management of a limited liability company as a privilege which may be IFT Information Note Page 2 of 7

3 withdrawn from an individual who is shown to have been fraudulent, irresponsible or simply incompetent whilst in a position of authority. 3.2 It is not necessary for a director to have set out to deliberately deceive or defraud a creditor or group of creditors to be accused of unfit conduct. It is sufficient that there is evidence to suggest trading without due regard for the interests of creditors. In particular, careful consideration will be given to an individual s actions from the point at which the director(s) knew or ought to have been aware of the impending insolvency. 3.3 Experience has shown that in particular where a company s business involves taking deposits from consumers or payments in advance of delivery of the relevant goods or the provision of the relevant services, the Court will regard the directors continuation of trading in the absence of a realistic prospect of delivering the goods or providing the services as unfit conduct. In a business of this nature, professional advice should be sought at the first signs of any impending financial difficulties. 3.4 The Court will also consider the extent to which the director(s) were responsible for the company s failure, although it is not the purpose of the legislation to penalise directors for commercial misjudgement. However, the Court will take into account any evidence that the company was run negligently, recklessly or incompetently and will look at factors such as:- - The events leading up to the company s failure. - Where the business was relatively new, the realism of the business plan and the availability of committed capital to fund its early development. - Evidence that due consideration was given to the company s trading policy and its viability. - The availability of sufficient and timely financial information and professional advice to enable effective policy decisions to be taken. - The date of the latest audited accounts and any qualification of the auditor s opinion. - The accuracy of any information supplied to the company s creditors on which they could be expected to have relied. - The amount by which various categories of the company s debts increased after the point at which insolvency became unavoidable and particularly where Crown debts have been allowed to grow disproportionately. - Any monies introduced directly or indirectly by the directors, debts waived, personal guarantees honoured or remuneration moderated after the company became insolvent. IFT Information Note Page 3 of 7

4 3.5 The standard of competence and expertise expected of a director by the Court must be assumed to be a high one, and the excuse that a director was not kept informed by the other directors, or did not understand the seriousness of the position, cannot be relied upon as a defence. 3.6 Note that the CDDA applies to all those who acted as directors, whether recorded directors, shadow directors or de facto directors. Matters determining unfitness/unfit conduct 4.1 Schedule 1 of the CDDA list the matters for determining unfitness of directors. 4.2 IPs will have regard to the matters listed in Schedule 1 when considering whether a report is appropriate. However, the Schedule is not exhaustive and SIP4 lists the following matters to which The Insolvency Service attaches particular importance and which the office holder should consider when preparing a report:- attempted concealment of assets or cases where assets have disappeared or a deficiency is unexplained; appropriation of assets to the other companies for no consideration, at an undervalue, or on the basis of unreasonable charges for services; preferences; personal benefits obtained by directors; overvaluing assets in accounts for the purpose of obtaining loans or other; financial accommodation, or to mislead creditors; loans to directors in making share purchases; dishonoured cheques; use of delaying tactics; non payment of Crown debts to finance trading; phoenix operations; misconduct in relation to operation of a factoring account; taking of deposits for goods or services ultimately not supplied; and cases where criminal convictions have resulted. How is a disqualification order made? IFT Information Note Page 4 of 7

5 5.1 The decision whether to proceed with an application for disqualification is made by The Insolvency Service, who must issue proceedings within 2 years of the insolvency. 5.2 For the purposes of the two year time limits for bringing proceedings a company becomes insolvent when:- it goes into liquidation (as defined in section 247(2) of the Insolvency Act 1986); it enters administration; or an administrative receiver is appointed. Where there are successive events in respect of the same company the two year limit runs from the date of the first event. 5.3 The Department for Business, Innovation and Skills is responsible for making any application for disqualification orders. 5.4 The Court can also make a disqualification order after making a declaration of wrongful trading, without the need for an application by The Insolvency Service. (See IFT Information Note 123 Danger Areas ). What is the effect of a disqualification order? 6.1 The effect could be devastating. An individual against whom an order is made (or a disqualification undertaking has been accepted see below), could not act as a director of any other company (either as an executive or non-executive director) or in any way, whether directly or indirectly, be concerned or take part in the promotion, formation, or management of a company for the duration of the disqualification order/undertaking. The Court has the power to allow directors to continue to act as a director of specific companies, notwithstanding that disqualification, but only if it is satisfied that specific criteria have been met and then usually subject to terms. The minimum period of disqualification is 2 years and the maximum period of disqualification is 15 years. It is particularly rare for individuals to be given permission to act notwithstanding their disqualification where they have been disqualified for more than 5 years. 6.2 The shadow director provisions will also effectively preclude a person from taking up any responsible management position in any company for the duration of the disqualification, even below board level. 6.3 It is a criminal offence to contravene a disqualification order (or undertaking), punishable by a fine and/or imprisonment. Furthermore, a person is personally liable, without limit, for the debts of a company if he is involved in its management in breach of a disqualification order/undertaking or, as a person who is involved in the management of the company, he acts on instructions given by a person whom he knows at that time to be the subject of a disqualification order/undertaking. Disqualification Undertakings IFT Information Note Page 5 of 7

6 7.1 It is possible for a director to offer to the Secretary of State a disqualification undertaking rather than the case having to go to court. This enables proceedings to be conducted more quickly and cheaply. 7.2 Another advantage for a potential defendant will be that if a disqualification undertaking is offered prior to the issue of proceedings the Secretary of State will not usually seek to recover his costs. It will still be possible for the Secretary of State to accept an undertaking after proceedings have been issued, but in that situation the Secretary of State would normally seek his costs. 7.3 A disqualification undertaking will normally include a schedule of unfitness setting out the basis on which it has been accepted by the Secretary of State and will be a public document in the same way as a court order. 7.4 It will normally come into effect 21 days after acceptance by the Secretary of State. 7.5 A disqualification undertaking has the same effect as a disqualification order. So what must a director do to avoid personal liability and/or disqualification? 8.1 The most important thing is to ensure that the Board have adequate and timely management information to enable the business to be properly managed, and to minimise potential losses to creditors. 8.2 The information needed will depend on the size, structure and type of business concerned, but as a minimum the directors should be preparing:- (a) (b) (c) (d) Monthly management accounts; Profit/loss projections, from which can be derived; cashflow projections; and projected balance sheets. Each member of the Board should receive and familiarise themselves with this information on a regular basis. 8.3 Variances between actual results and forecasts should be analysed, and together with any revisions to the forecasts these should be discussed and the reasons recorded. 8.4 If it is believed that there is any basis for suspecting that the company may be heading towards a crisis and potential insolvency, you, as a director should advise the Board and ensure that your concerns are noted in writing. A statement of the company s financial position with details of the amounts currently owed to the company s creditors should be drawn up. 8.5 The Board should then consider taking professional advice. The company s solicitors should be able to advise on the legal implications for the company and its directors, but IFT Information Note Page 6 of 7

7 a licensed insolvency practitioner should be consulted who will have practical experience of companies in difficulty as well as insolvencies, and will be able to offer down to earth advice on the options available to the directors and the detailed measures they should take. 8.6 From the first warning signs it is important that the directors document the decisions taken and the information and advice relied upon, so as to form a trail of evidence to support their actions in the light of any subsequent investigation into their conduct. 8.7 It is particularly important that the directors avoid the accusation of preferring one or more creditors over other creditors, and therefore, any substantial payments that fall outside of the day to day trading of the business should be fully considered and the reasons for making the payment recorded. 8.8 It is also important that the decision as to whether to continue trading or to close down the business is made in the light of all the options available. Provided that the warning signs are noticed and professional advice sought at an early state, there could be a number of different strategies available, which may allow the company to escape insolvency completely, or at least preserve some or all of the business intact. These strategies are also inevitably better for the creditors. The number of alternatives available quickly reduces as time passes, and undue delay on the part of the directors can lead to formal insolvency in which the creditors are likely to suffer significant losses. Professional advice should be taken as early as possible! 8.9 See also the IFT Information Notes [123] Danger Areas, [63] Board Meetings and [10] Sources of Advice, which have information relevant to show that a director acted properly. Additional Notes by The Chairman of the BPWG on disqualification proceedings To the extent that it is possible, IFT members might like to consider insurance against the possibility of a CDDA investigation. Their actions prior to any insolvency should mitigate the possibility of such action. However, if it does occur members should be aware that they would be involved in a process that will be expensive for them in legal costs and un-billable time. Furthermore, should they be disqualified as a director this of itself will be a disciplinary matter under the terms of their membership of IFT. IFT Information Note Page 7 of 7