Director disqualification: what do I need to know?

When a company director fails to carry out their legal responsibilities, they run the risk of being disqualified. This can be a lengthy procedure resulting in a period of disqualification during which it is not permitted to form, promote or manage a company.

The main law governing disqualification is contained in the Company Director Disqualification Act 1986.

Grounds for disqualification as a company director

Director disqualification usually arises from insolvency and misconduct, but can also be as a result of incompetency and even disorganisation. The grounds for director disqualification include:

• Carrying out business illegally while insolvent
• Persistently failing to file company returns and accounts with Companies House
• Unfit conduct, where a company has become insolvent
• Breach of competition law

The director disqualification procedure

When a company enters into administration, liquidation or receivership, the behaviour of its directors will be subject to scrutiny. The official involved in the insolvency is required to report any unfit conduct to The Insolvency Service. If the Insolvency Service believes it is in the public interest, it will make an application to the court for a disqualification order.

If the court finds that a company director is not fit to manage a company, it can order a period of disqualification of between 2 and 15 years, depending on the severity of the unfit conduct.

It is possible to enter into a disqualification undertaking to voluntarily disqualify yourself from acting as a director. This option has the advantage of avoiding a court case and may reduce the time taken to deal with the process. It can also result in a lesser disqualification period.

If you are facing possible disqualification as a director, it is always advisable to seek independent legal advice as to the best way to proceed to minimise the impact on your business and your future.

Unfit conduct

If an application is made for a disqualification order, the court will look at whether a director’s conduct has fallen below the required standards of probity and competence, i.e. whether it is ‘unfit’. All behaviour will be taken into account, including evidence of the following:

• Trading while the company is known to be insolvent
• Inadequate keeping of financial records
• Failure to file returns and accounts in accordance with Companies House rules
• Failure to pay tax
• Fraudulent activity
• Attempting to deprive creditors of assets
• Using company funds or assets for personal benefit
• Failure to comply with the requirements of the insolvency official
• Being an undischarged bankrupt

The director should put together a defence which includes evidence of any valid reasons there may be for their actions.

The effect of disqualification

Once an order has been made disqualifying someone from being a company director, they are no longer able to be the director of any UK-registered company or overseas company with connections to the UK. They are also prohibited from managing, forming or promoting a company.

This extends to making executive decisions and hiring staff.

Other exclusions include sitting on the boards of schools, charities or health authorities or acting as a pension trustee, accountant, solicitor or barrister.

A disqualified company director is also banned from directing someone else to act on their instructions or directing a company by proxy. This can result in prosecution not only for the disqualified director but also for the third party who acts on their direction. There is a further risk that the third party could incur personal liability for company debts by getting involved in company affairs in this way.

Breaching a disqualification order is a criminal offence and could result in a prison sentence of up to two years plus an increased period of disqualification.

Compensation orders

In addition to being disqualified, a director may also be the subject of a compensation order.

Compensation orders were introduced on 1 October 2015 by the Small Business, Enterprise and Employment Act 2015 for the purposes of making disqualified directors financially liable for their unfit conduct. It is the role of the Insolvency Service to decide whether a compensation order is in the public interest.

In the case of Secretary of State for Business, Energy & Industrial Strategy v Eagling [2019] EWHC 2806, which was the first reported case brought by the Secretary of State since the introduction of compensation orders, the High Court ordered that the director, Mr Eagling, pay the sum of £559,484 which was the full amount he was alleged to have misappropriated from the company.

What can a disqualified director do?

A disqualified director may work for a company as its employee, however, they would need to be able to clearly show that they were not involved in anything which could be construed as the role of a director.

It is also permitted to carry on business as a sole trader while disqualified, or be in a partnership although not a limited liability partnership.

There is scope for a disqualified director to apply to the court for permission to act as a director if they can show that there is a reasonable need for them to take on this role. If the court agrees, it may attach restrictions.

What do I do if I think I might be facing disqualification?

If your company is involved in insolvency proceedings, then a report will be sent to the Secretary of State setting out details of the conduct of all directors for the three years prior to the insolvency. The Insolvency Service then decides, on behalf of the Secretary of State, whether it is in the public interest for any individual director to be further investigated.

If you are notified about an investigation, you should take legal advice as to how best to defend your position and mount any defence you may have. It is advisable to seek professional help in preparing any response to Insolvency Service enquiries to give you the best possible chance of putting across your reasons for acting as you did.

If an application is made to the court for a disqualification order against you, you will have the chance to respond to the case and provide a written statement of truth. Again, it is recommended that you seek professional legal advice in drafting this document as it is your chance to explain the situation and defend the Insolvency Service’s allegations.

Robert Starkins, partner at CVR Global, offers his insights from the perspective of an Insolvency Practitioner. Starkins shares his view on the importance for directors to act in the interests of creditors during difficult trading times and maintain the company’s books and records.

“The legal duties of directors under English law comprise common law duties, codified duties in the Companies Act 2006 and various statutory duties. The Companies Act 2006 provides that when companies are solvent, the duties of directors are to promote the success of the company for the benefit of its shareholders. However, when a company is insolvent (or likely to become insolvent) the duties change, and directors are required to act in the best interests of the company’s creditors. This is something that should be at the forefront of every directors’ mind when experiencing difficult trading conditions. This is also something that is considered when directors conduct is under the microscope. Accordingly, directors should make every effort to document their decision making and keep up to date financial information. This is especially prevalent during these uncertain times and is often forgotten in the battle to keep a company operating. However, failing to do so may result in a negative conduct report being filed, if the company was to enter an insolvency procedure.

It is therefore important that directors maintain and safeguard the records and don’t allow them to be lost. A typical example may be when data cloud storage fees are not paid, and the company’s records are subsequently deleted by the hosting company or where records are stored on computers that have been returned to a leasing company. The director must take practical steps to retain the records so that they can be reviewed. As a liquidator, it is important that directors are open and honest and assist when required, after all they know more about the company than a newly appointed insolvency practitioner! Having regard to the above will greatly reduce the risk of disqualification proceedings being started, and the stress that an investigation can cause”.

Catherine Doran, barrister of Radcliffe Chambers regularly acted for the Secretary of State and Official Receiver in disqualification claims against directors when she was on HM Attorney General’s Panel. Doran provides her insights for directors who have become the subject of investigation by the Insolvency Service.

“If your company has gone into insolvent liquidation, and is selected for investigation by the Insolvency Service, the investigator allocated to your case is likely to send a fairly generic questionnaire about the demise of the company, then more specific follow up questions. Whilst it is tempting to bury your head in the sand, it is important to cooperate with the investigator, and respond to requests in a timely manner. In the event a directors disqualification claim is made, your responses are likely to be exhibited by the Secretary of State, so you want to give a good impression to the judge who will be reading them.

In many cases there are thousands of pages of potentially relevant documents and emails, which can be overwhelming. Ask for more time if you need it, to locate, digest and take advice on the documents. The Secretary of State has a deadline of 3 years from the date of the liquidation to issue a directors disqualification claim, so the Insolvency Service will be flexible on timing if they can be.

If you have decided to offer a voluntary disqualification undertaking, it is best to do so before a claim is issued because it means you will not have to pay the Secretary of State’s legal costs. 

If a claim is served on you, the Directors Disqualification Practice Direction requires an affidavit in response within 28 days. However, in reality the Secretary of State’s solicitors and the court will readily agree to give you more time to prepare your evidence, and, if you have not already done so, instruct solicitors to act on your behalf.

It is possible to offer a disqualification undertaking at any time during the proceedings, if you decide you no longer wish to fight the claim. Once an undertaking is given you can then apply to the court for permission to act as a director of a specific company, which is known as a section 17 application”.

At Lincoln & Rowe we understand the importance of helping our clients keep their businesses running smoothly. We have wide-ranging experience in commercial law and were named as the ‘Best Firm for Commercial Disputes in London’ in the 2019 SME Legal Awards as well as ‘Boutique Litigation Law Firm of the Year’ in the 2019 Global Awards by ACQ5.

If you would like to talk to one of our expert legal team about any queries you may have regarding directors’ disqualification, contact the author, Dipesh Dosani, or call the team today on 020 3968 6030 and we’ll be happy to help.

The above information is for general guidance on your rights and responsibilities and is not legal advice. If you need more details on your rights or legal advice about what action to take, please contact an adviser or solicitor.