What constitutes unfitness under s 6 Company Director s Disqualification Act 1986?

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1 under s 6 Company Director s Company Director s Disqualification Act 1986 (CDDA 1986), s 6 This section is set out below for ease. Section 6 says: the court shall make a disqualification order against a person in any case where, on an application under this section, it is satisfied: > > that he is or has been a director of a company which has at any time become insolvent (whether while he was a director or subsequently), and > > that his conduct as a director of that company (either taken alone or taken together with his conduct as a director of one or more other companies or overseas companies) makes him unfit to be concerned in the management of a company In this section references to a person s conduct as a director of any company or overseas company include, where that company or overseas company has become insolvent, references to that person s conduct in relation to any matter connected with or arising out of the insolvency For the purposes of this section and the next, a company becomes insolvent if: > > the company goes into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of the winding up: > > the company enters administration, or > > an administrative receiver of the company is appointed In this section references to a person s conduct as a director of any company or overseas company include, where that company or overseas company has become insolvent, references to that person s conduct in relation to any matter connected with or arising out of the insolvency Proceedings will either be brought in the name of the Secretary of State (SoS), for voluntary winding up, or by the Official Receiver (OR) in compulsory winding up cases. Both exercise the same functions and for ease when we refer to SoS in this note, we also include the OR. Burden of proof and standard of care required for a director exercising his duties The burden of proof is on the claimant and the standard of proof is the usual civil standard of balance of probabilities. See: Re Normanton Wells Properties Ltd, Official Receiver v Jupe [2011] 1 BCLC 191 Secretary of State for Trade and Industry v Hollier [2006] All ER (D) 232 (Jul) Secretary of State for Trade and Industry v Swan [2005] All ER (D) 102 (Apr) The standard applying to a director in the execution of his duties is both objective and subjective. This standard is now set out in sections 171 to 177 of the Companies Act 2006 (CA 2006), specifically s 174(1) which says that a director must exercise reasonable care, skill and diligence. According to CA 2006, s 172(2), this means the care, skill and diligence that would be exercised by a reasonably diligent person with: the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and the general knowledge, skill and experience that the director has Mandatory nature of disqualification when unfitness is established As can be seen from the wording of s 6, the court shall (emphasis added) make an order if the conditions are satisfied and unfitness is found. This is not discretionary. The Secretary of State must establish unfitness to the requisite standard of proof. Once the facts have been established, the court must be satisfied that this conduct makes the director unfit to be concerned in the management of a company, and has fallen below the standards of probity and competence appropriate for persons fit to be directors of companies. See Etherton J in Re Finelist PLC, The Secretary of State for Trade and Industry v Swan [2005]; and Blackburne J in Re Structural Concrete Ltd [2001]. The case of Re Grayan Building Services Ltd, Secretary of State for Trade and Industry v Gray [1995] 1 BCLC 276 set out a threestage process for the court to consider when making the decision to impose an order. That is: do the matters relied on amount to misconduct? if they do, do they justify a finding of unfitness? if they do, what period of disqualification should result? It is possible that misconduct is established, but due to the circumstances of the case before the court, that misconduct is not considered sufficient to make the director unfit to be

2 a director in the future. See the many cases on this subject, including Re Bath Glass [1988] BCLC 329, Re Northstar Multimedia Ltd, Secretary of State for Trade and Industry v Johnson [2001] All ER (D) 109 (Jun) and Official Receiver v Dhaliwall [2006] 1 BCLC 285. See also further reading: Mithani: Directors Disqualification, Division III, Chapter 2 Unfitness under the CDDA 1986, section 6: mandatory disqualification. Unfitness Unfortunately, there is no definition of unfitness in the CDDA 1986 to help us. This is no doubt deliberate so that there can be no restrictions on what might constitute unfitness, as each case falls on its own facts. Any attempt to set out what might specifically constitute unfitness in the courts has been discouraged. See the case of Re Sevenoaks Stationers (Retail) Ltd [1991] BCLC 325 by Dillon LJ who said that the words laid down in s 6 are ordinary words of the English language and they should be simple to apply in most cases. Guidelines for determining unfitness There are some helpful broad guidelines in the CDDA 1986 Schedules as to what might determine unfitness. CDDA 1986, s 9(1) directs that the court shall have regard to the matters mentioned in Schedule 1. Both parts of Schedule 1 apply to applications under CDDA 1986 s 6, because while Part II relates to insolvent companies only, this is a prerequisite for applications under s 6 in any event. It is not proposed to set out the guidelines here, but please go to the substantive law for detail. See also Mithani: Directors Disqualification for analysis of individual cases. Misconduct is not confined to the matters of unfitness set out in sch 1, however. This is illustrated by the wording of CDDA 1986, s 9(1), which requires a court when determining unfitness to have regard in particular to the matters set out in the schedule. The list is not exhaustive. See: Re Bath Glass Ltd [1988] BCLC 329 at 333. Lewison J, in Secretary of State for Trade and Industry v Goldberg [2004] 1 BCLC 597, emphasised that the courts must take a broad brush approach in making a judgment about a director s unfitness, applying to the facts of the case the standard of conduct laid down by the courts appropriate to a person fit to be a director, that being a question of mixed law and fact. Any guidelines that have arisen for determining unfitness have evolved as a result of case law over the years. There is nothing prescribed, but some of the main guidelines that have emerged from case law and re-applied are set out below. It is not necessary for the misconduct to have led either directly or indirectly to the insolvency of the company. See Re Country Farm Inns Ltd [1997] 2 BCLC 334 at 347. All misconduct whether specified in the Act or not, may be taken into account, including misconduct in the disqualification proceedings themselves. See the case of Re Howglen [2002] EWCA Civ 497, [2002] 2 BCLC 625. The director s conduct as a whole will be taken into account. Provided that unfitness is found overall, it is not necessary for any particular allegation specifically to amount to unfitness. All circumstances will be taken into account cumulatively. See Re Bath Glass Ltd [1988] BCLC 329 at 333. There need only be one allegation or instant of misconduct that could lead to a finding of unfitness, depending on the severity of the conduct. Even if several allegations are made, the court is entitled to disqualify a director based on only one of the acts of misconduct if it is established. See Re Barings plc (No 5) [1999] 1 BCLC 433. Behaviour in other companies, including where ordinarily they would be out of the two-year limitation period, and companies that have not become insolvent but have simply dissolved, can also be taken into account in establishing unfitness overall. (CDDA 1986, s 6(1)(b)). These are called collateral companies, and as long as there is also a lead company involved which went into insolvency within the two-year limitation period, evidence of misconduct in these collateral companies may also be used to establish unfitness. The misconduct does not need to be the same in the lead and the collateral company. See HH Judge Weeks QC in Re Country Farm Inns [1997] 2 BCLC 334 at 346 and also Re Surrey Leisure [1999] 2 BCLC 457. Previous good conduct in other companies cannot be taken into account in determining unfitness, although this may be appropriate for mitigation if a finding is made. See Re Bath Glass [1988] BCLC 329 at 333. Commercial misjudgment in itself will not usually be sufficient to amount to unfitness. According to Re Lo Line Electric Motors Ltd [1988] BCLC 698 at 703, the conduct must display a lack of commercial probity. There is a fine line here, and the facts and circumstances will dictate what amounts to a lack of commercial probity. It has been stated that the touchstone is lack of regard for and compliance with proper standards, and breaches of the rules and disciplines by which those who avail themselves of the great privileges and opportunities of limited liability must abide, and also that the question is whether the conduct makes the defendant unfit to be a director and not whether it is in the public interest more widely that the defendant be disqualified: Re UKLI Ltd Secretary of State for Business Innovation and Skills v Chohan [2013] All ER (d) 253 (Mar). The court must try not to look at the misconduct with the benefit of hindsight. See J Laddie in Re Living Images [1996] 1 BCLC 348. Professional advice It is possible for a director to rely on the fact that he sought professional advice, such as from an accountant, or lawyer, etc. For example, if the company accountant has prepared inaccurate accounts that were relied on by the director in taking decisions which may amount to unfitness, or if advice was sought on whether to put the company into liquidation at a particular time. It will of course depend on the circumstances, what the director s own experience and knowledge was, what information the professional was given in order to provide advice, etc. It is not a blanket defence that the director sought professional advice. See Re Uno plc and World of Leather [2004] EWHC 933 (Ch) at [673A], [2004] All ER (D) 345 (Apr).

3 The Sevenoaks bands of unfitness Under CDDA 1986, s 6, disqualification can range from a minimum of two years, to a maximum of 15 years depending on the seriousness of the unfitness. The case of Sevenoaks Stationers (Retail) Ltd [1991] BCLC 325, [1991] Ch 164 sets out a series of bands of unfitness, which suggests that unfitness falls into three brackets of seriousness. This is now widespread practice. The three bands are: lower bracket: two to five years. According to Sevenoaks, this bracket should be applied where the case is relatively not very serious middle bracket: six to ten years. The middle bracket should apply for serious cases that do not merit top bracket top bracket: 11 to 15 years. This should be reserved for particularly serious cases, which may include for example, when a director has been previously disqualified or where fraud is involved Unfortunately, Sevenoaks does not really provide much guidance as to what conduct might fall within each bracket. This is inevitably because some conduct that may be considered relatively not serious in one case may be considered much more serious in another case, depending on the circumstances, the director, the damage caused, etc. While considering past cases may give an indication as to what might be the appropriate bracket of disqualification in any given case, be wary of raising case law in front of a judge in proceedings. It was held in Re Westmid Packaging, Secretary of State for Trade & Industry v Griffiths [1998] 2 All ER 124 that the citation of cases as to the period of disqualification will, in the great majority of cases, be unnecessary and inappropriate. All judges familiar with disqualification proceedings will be familiar with this and will rarely allow cases to be cited by either party in favour of their argument. Legislation update - the Small Business, Enterprise and Employment Act 2015 (SBEEA 2015) Note that the Small Business, Enterprise and Employment Act 2015 (SBEEA 2015) received Royal Assent on 26 March 2015 and introduced a number of changes that affect directors disqualifications under the Company Directors Disqualification Act 1986 (CDDA 1986). These changes are set out below. The majority of the provisions came into force on 1 October 2015 via two statutory instruments: the Small Business, Enterprise and Employment Act 2015 (Commencement No 1) Regulations 2015, SI 2015/1329 dated 20 May 2015 and the Small Business, Enterprise and Employment Act 2015 (Consequential Amendments) (Insolvency and Company Directors Disqualification) Regulations 2015, SI 2015/1651 dated 1 September One disqualification measure under the SBEEA 2015 which did not come into force on October 2015 is the streamlined reporting of director misconduct in insolvent companies (SBEEA 2015, s 107). This measure is expected to be implemented from April 2016 with the first of the new online conduct reports expected to be submitted in June There will be transitional arrangements in place until September 2016 to allow for the final D1s and D2s. Section 104 convictions abroad SBEEA 2015, s 104 introduces a new CDDA 1986, s 5A, which allows the SoS to bring proceedings against a director for relevant offences committed while acting as a director of an overseas company. The relevant offences under CDDA 1986, s 5A will be those serious offences in connection with the promotion, formation or management of a company overseas, and the maximum disqualification will be 15 years. Therefore, it appears these offences will be the same as for UK companies. The SoS will be able to accept a disqualification undertaking as an alternative to an order from such a director if appropriate in the same way as is possible with a UK company. Section 105 persons instructing an unfit director SBEEA 2015, s 105 introduces a new offence and a new CDDA 1986, s 8ZA: that of instructing an unfit director. This is aimed at persons who are not directors or shadow directors, but who exert requisite influence over a director. The object is that if any of the conduct for which the director was disqualified was caused because the director followed the instruction or direction of someone else, the person giving that direction or instruction may also be disqualified. Anyone providing advice in a professional capacity will not be caught under this new section, according to the exemption set out in CDDA 1986, s 8ZA(3). SBEEA 2015, s 105 affects instructions that gave rise to conduct after 1 October 2015 that result in disqualification. Section 106 determining unfitness and disqualifications: matters to be taken into account SBEEA 2015, s 106 expands the matters that the court should take into account when determining unfitness under CDDA 1986, ss 6 and 8, and amends CDDA 1986, Sch 1, accordingly. In particular, SBEEA 2015, s 106(2) amends CDDA 1986, s 6(1) to allow the court to take into account conduct in relation to overseas companies when considering a disqualification application. SBEEA 2015, s 106(3) amends CDDA 1986, s 8 to allow a person s conduct in relation to more than one company, including any overseas companies, to be taken into account by the court when deciding whether or not to make a disqualification order under CDDA 1986, s 8 and when deciding whether to accept a disqualification undertaking see earlier new CDDA 1986, s 5A brought in under SBEEA 2015, s 104. CDDA 1986, Sch 1 (Matters determining unfitness: matters to be taken into account) is amended accordingly to reflect the above. SBEEA 2015, s 106 affects conduct after 1 October 2015.

4 Section 107 reports of office-holders on conduct of directors of insolvent companies This section inserts a new CDDA 1986, s 7A regarding the requirement for an office-holder (the OR, liquidator, administrator or administrative receiver) to report on the conduct of directors of insolvent companies. Currently, under CDDA 1986, s 7(3) office-holders must submit a report to the SoS if it appears to them that the conduct of a director makes them unfit to be concerned in the management of a company. The new section requires the office-holder to submit a report to the SoS on every director of a company that becomes insolvent. The conduct report must describe any conduct which may assist the SoS in deciding whether it is in the public interest to apply for the making of a disqualification order. The report must be submitted in all cases within three months of the insolvency date (previously it was within six months). In addition, there are further requirements under the new CDDA 1986, s 7(5) to (6), which will require an office-holder at a later date to send any new information that should have been included in a conduct report as soon as practically possible after it comes to the attention of the office-holder. New CDDA 1986, s 7(7) to (8) mean that office-holders will not need to submit a report if a report has already been submitted by an office-holder, either where the company has moved between insolvency procedures or where a new office-holder has been appointed in the same procedure. This change gives less discretion to office-holders and puts the onus of investigation more squarely on the SoS. The officeholder does not decide to report on certain directors only he must report on all directors and the SoS then considers if further investigation is required on any of those directors. This measure will be implemented from April 2016 with the first of the new online conduct reports expected to be submitted in June There will be transitional arrangements in place until September 2016 to allow for the final D1s and D2s. Section 108 unfit directors of insolvent companies: extension of period for applying for disqualification order CDDA 1986, s 7 is amended to increase the period the SoS may bring disqualification proceedings from two to three years from the date that company became insolvent. This gives the SoS more time to investigate possible wrongdoing and may lead to less claims of unfairness and breach of duty, and the sorts of issues that arose from cases such as The Secretary of State for Trade and Industry v Swan; Re Finelist [2003] EWHC 1780 (Ch). SBEEA 2015, s 108 affects all insolvencies after 1 October Section 109 directors: removal of restriction on application for disqualification order CDDA 1986, s 8 is amended to remove the restriction on the type of investigative material that may be used by the SoS in disqualification proceedings in the public interest. Currently, only reports made by certain inspectors, and information or documents obtained under certain legislative powers, may be used for this purpose. By removing this restriction, the SoS may use any information to decide whether or not to bring disqualification proceedings. Like SBEEA 2015, ss 107 to 108, this removal of restriction should make the investigation role of the SoS easier. With less red tape hurdles to overcome, the idea is to enable the SoS to bring more disqualification proceedings and increase confidence in the disqualification regime. SBEEA 2015, s 109 affects conduct after 1 October Section 110 compensation orders and undertakings SBEEA 2015, s 110 introduced a new power of the court to compensate creditors of companies where a director or directors misconduct has been found to have caused loss to that creditor or group of creditors. A new CDDA 1986, s 15A sets out the circumstances where this may be appropriate and the conditions where this may apply. The SoS may apply for the compensation order at any time before the end of the period of two years, beginning with the date on which the disqualification order was made, or the undertaking was accepted. The amount of compensation is not set out in the new section, but there are some wide guidelines under CDDA 1986, s 15B(3) where the court must have regard to the nature of the loss caused and if the person has made any other financial contribution in recompense. The introduction of this new section will inevitably have a twofold effect: both deterrent and compensatory. This can only be a positive. For some time now, it is arguable that the public confidence in the disqualification regime has been low. It has been seen as somewhat ineffective, with leave to act being given frequently in the desire to encourage entrepreneurial spirit, leaving creditors out of pocket and no real deterrent effect. The possibility that directors may have to pay for their actions will inevitably be welcomed by creditors. SBEEA 2015, s 110 affects conduct after 1 October Section 111 sections 104 to 110: consequential and related amendments SBEEA 2015, s 111 and Sch 7 make various amendments to the CDDA 1986 and other enactments consequential on or related to the amendments made by SBEEA 2015, ss 104 to 110, and came into force in May Note that from October 2015, paragraph 11 of Schedule 6 to the the Deregulation Act 2015 (DA 2015) amended CDDA 1986, s 7(4) to allow the SoS (or OR) to obtain information on a director s misconduct from any person without requiring authority from the insolvency office-holder for the purpose of investigation in non-compulsory insolvency cases. This affects insolvencies after 1 October 2015.

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