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Director Disqualification: What is unfit conduct?

14 Apr 2022
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    Section 6 of the Company Directors Disqualification Act 1986 (CDDA 1986) provides that “the court shall make a disqualification order against a person in any case where, on an application under this section, it is satisfied that they are or have been a director of a company which has at any time become insolvent (whether while they were a director or subsequently), and that their conduct as a director of that company (either taken alone or taken together with one or more other companies or overseas companies) makes them unfit to be concerned in the management of a company.”

    If the court makes a finding of unfitness against a director, it is obliged to make a disqualification order against that director for a minimum period of two years. For the purposes of section 6 of CDDA 1986, the minimum period of disqualification is two years and the maximum period 15 years. The period of disqualification is in the court’s discretion.

    Disqualification periods will usually fall into one of the following brackets:

    • less serious: 2-5 years
    • serious: 5-10 years
    • very serious: 11-15 years

    The types of allegation of unfitness to act as a director are:

    1. Crown allegations.
    2. Accounting records allegations.
    3. Non-cooperation.
    4. Transactions to the detriment of creditors.
    5. Illegal/unlawful dividends.
    6. Trading with knowledge of insolvency/wrongful trading.
    7. Previous failures.

    Whatever your current circumstances, it is always sensible to try and negotiate the lowest period of disqualification as possible. Not only is this down to the fact that the disqualification will naturally come to an end more quickly, but it will also open up the opportunity to apply to court for permission to become a director again even if you are still disqualified. Accepting whatever is offered to you at the outset without attempting to negotiate the period down can have unintended long term consequences. If possible, it is always best to be in the lower bracket – and our legal expertise can help you achieve this.

     Tania Clench

    Legal Director
    Commercial disputes

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    Each type of allegation is explored further

    1. Crown allegations
    It is important to remember that the existence of Crown debts does not in itself constitute misconduct. Crown allegations have a common theme, that a debt to the Crown has arisen as a result of the actions (or inaction) of a director that were unsatisfactory or unfair to a degree that they amount to unfit conduct deserving of disqualification. (a) Trading to the detriment of the Crown
    • Need to show that the Crown has been treated differently to other classes of creditor.
    • Crown needs to be the overall majority creditor, i.e. more than 50% of overall deficiency of the company.
    • The Insolvency Service generally look for at least a 12 month period of non-compliance with HMRC or 4 quarters during the period of trading for VAT.
    • Periods of less than 12 months can be looked at. e.g. company traded for less than 12 months and no payments to Crown but liabilities paid to other classes of creditor.
    • Successor company where Crown had been mistreated in previous failure.
    • Aggravating factors such as director taking excessive remuneration or dividends.
    • Preference payments made during the period.
    (b) Failure to submit statutory returns It must be shown that returns were due, and subsequently not submitted. There must be a financial consequence, e.g. where assessments were raised well below the actual amounts due, and for a prolonged period of time. More commonly, this is an allegation that is included within another Crown allegation. (c) Context
    • The overall context of the case must be considered.
    • Is the failure to pay the Crown due to genuine commercial misfortune (bad debts, loss of key customer/contract) and did the directors reasonably expect to pay them when they occurred?
    • Has the director provided financial support and lost proportionally more than the Crown in the final trading period?
    • However, if the director has provided financial support, how has this been used and has any gone to the Crown?
    • High Crown liability does not necessarily mean misconduct. Would the type of business lead to high Crown liabilities, e.g. recruitment agencies, consultancy firms, where wages is major expenditure?
    • If a significant proportion of the Crown liability is corporation tax, when did this liability become due and could it be offset against later trading losses?

    2. Accounting records allegations
    (a) Identify detriment
    • To succeed with an accounting records allegation, detriment or a consequence of the lack of or poor records must be established.
    • The loss to creditors must be clear, quantifiable and material when compared to the overall deficiency.
    • An allegation that just identifies the technical aspect of a breach in the requirements to maintain, preserve or deliver up records is unlikely to be taken forward in the public interest — the ‘so what’ test.
    • The loss must be actual. e.g.
    (i) bank statements obtained showing cash withdrawals or transactions that cannot be readily accounted for; (ii) lack of records has prevented the IP from doing his job, such as testing the cause of failure and/or realising assets.
    • Have the inadequacies of the records prevented book debts being recovered?
    • Can the whereabouts of assets on the last set of accounts be established?
    • Can the ownership of assets be established, e.g. retention of title (ROT) claims?
    • Can creditor claims be established and are there material disputes over amounts that cannot be resolved, especially if director or connected party creditors are involved and there may be a dividend?
    • Can the IP deal with redundancy claims if payroll records inadequate?
    • The director(s) must have been asked for an explanation by the office holder.
    (b) Collection and custody of records To consider an allegation in respect of accounting records, the IS must have a copy of the list of records delivered up/collected. There should be a clear audit trail of the records delivered, collected, or still with third parties such as accountants or bookkeepers. A common defence against such an allegation is that there is some element of doubt as to what records were delivered up, when, and to whom. In the first instance it is vital that the directors have been asked whether they have any records, and if so to deliver them up as soon as possible. The IS would also need specific details of what the office holder has done to request and chase up any records.

    3. Non-cooperation
    The non-cooperation must be significant, and there must be a specific, quantifiable detriment, such as material book debts cannot be collected, or material transactions cannot be explained as a result of the non-cooperation.

    4. Transactions to the detriment of creditors
    In bringing proceedings, the Insolvency Service tend to use the heading transactions to the detriment of creditors rather than use terms such as ‘preference’ or ‘transactions at undervalue’. This is to avoid falling into the constraints of statutory definitions.
    • Could be detrimental to wide body of creditors or specific creditors such as the Crown.
    • The timing of the transaction is important in identifying the detriment and culpability of a director. e.g.
    (i) a deliberate transaction to the detriment of creditors which is close to the date of insolvency is likely to be a more deliberate and culpable act than a transaction 2 years before insolvency. (ii) has any event happened prior to the transaction for instance a winding up petition, an HMRC inspection, advice regarding the solvency of the company?
    • Who was the beneficiary of the transaction – often the director or connected company?
    • Was the company insolvent at the time of the transaction or did it become insolvent because of it?
    • The materiality of the transaction or transactions compared to the overall deficiency.
    • Need to show there was a liability to the creditor(s) at the time of the transaction and at onset of insolvency.
    • Some common reasons why such an allegation may be turned down are:
    (i) the company was solvent at the time of the transaction and did not become solvent as a result of it; (ii) other classes of creditor were being paid at the same time – can be identified by looking at bank statements to see what payments made in the same period and to whom; (iii) a particular creditor was exerting pressure at the time; (iv) the director’s explanation for the transaction is valid and supported by evidence.

    5. Illegal/unlawful dividends
    • Important to clarify whether the director was acting upon the advice of an accountant, i.e. was the director being paid dividends in lieu of remuneration for tax purposes?
    • Check previous accounts to see if dividends are historic.
    • Have the dividends increased recently, particularly if the director ought to have been aware that the company was insolvent?
    • Are the amounts material? Would this have been reported to the Insolvency Service if the dividends had been shown as remuneration? If salary has been low, this may provide sufficient mitigation.

    6. Trading with knowledge of insolvency/wrongful trading
    • This is often a difficult allegation to sustain, and therefore a higher standard of evidence is required, particularly if it is the sole allegation.
    • The Insolvency Service usually need to see a period of at least 6 months where the company has continued to trade after the director knew or ought to have known that the company was insolvent.
    • What is the detriment caused by the company continuing to trade and how material is this to the overall deficiency?
    • Look at who/which classes of creditor have suffered as a result of the continued trading. If it is the director (or connected/parent company) who has supported the company, and is the biggest ‘loser’, then the allegation may be weakened.
    • Have the directors injected funds into the company? If so, does the amount give the director reasonable grounds to believe that the financial position would improve, or were the injections token gestures?
    • Look at the reasons behind the increase in the deficiency. If the deficiency has increased due to factors beyond the director’s control, such as write downs/write off of assets, then the allegation may be weakened.
    • Is the reason behind the failure of the company genuine, and if so, has it been tested?
    • Were there periods of profitability after an insolvent balance sheet? This is likely to give the director an argument that he genuinely believed the company could trade out of difficulty. Will this move the knowledge of insolvency date on?
    • Were the directors genuinely attempting to sell the business? If so, was professional advice sought, and were any offers made?
    • Did the director(s) introduce any changes to try to turn the business around? May include cost cutting measures, changes in production/operation methods, changes to products/services offered. If so, what length of period is appropriate to judge the success of these and justify continued trading?
    • Are there one or more strong insolvency indicators such as the following (and if so, provide copies or details of this evidence).
    (i) An insolvent balance sheet. But take note of when the accounts were made available to the director and when he signed them as there is often a delay between the date of the accounts and approval, which may affect the date the director knew or ought to have known. Reason for insolvent balance sheet might be important, such as insolvency due to a long term loan. (ii) Significant unsatisfied judgments (and the timing of these). (iii) Winding up petitions (and the timing of these). (iv) Dishonoured cheques, but this may depend upon numbers, over what period and whether they were successfully represented. (v) Unauthorised overdrafts. (vi) Aged creditor schedule/prints showing creditors were not paid as and when due.

    7. Previous failures
    • This is another allegation that is difficult to evidence.
    • The existence of previous failures in itself would not be sufficient to recommend the case for further investigation. Additionally, the spirit of the Enterprise Act 2002 encourages those people behind a failed business to ‘have another go’.
    • For such an allegation to have a chance of succeeding, it is necessary to show that there has been a continuation of a failed business. That is that each successor company has carried on trading in exactly the same manner, with the same method of finance and without any changes that would give rise to a reasonable expectation that the new company could succeed.
    • Indicators would include (again provide details or copies of any evidence):
    (i) same directors, premises/address; (ii) re-use of company logos, registered name, trading name and lettering; (iii) same customer lists; (iv) same assets; (v) same systems of work (vi) same financing – e.g. lack of capital; (vii) overheads; (viii) terms of trade; (ix) pricing; (x) margins; (xi) sales expectations; (xii) same workforce and wages; (xiii) significant purchases of stock by previous failed company close to insolvency and at a time when struggling financially. This stock then sold on at undervalue. Additionally, the Insolvency Service would also consider: (a) Period of time which has elapsed between failures. (b) Reasons for the failure of each company. (c) Were any changes implemented that could have enhanced the company’s chances of success? Has the IP asked the director about this and what was the reply? (d) Is there a common loser in the insolvencies (quite often, the Crown)? (e) Has the director taken any advice from a solicitor or accountant when setting up the new company? (f) Has a proper price been paid for the assets? (g) Has the new company made a profit? If so, the allegation will fail.

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