New law aims to close loophole on company dissolution
The government is set to introduce new rules preventing company directors from avoiding personal liability for their unlawful conduct.
A loophole currently exists that allows company directors to prevent an investigation into their actions by informally striking off their own company. The so-called dissolution loophole prevents the Insolvency Service from conducting enquiries as only live companies or those in a formal insolvency process can currently be investigated for fraudulent trading or other wrongdoing.
Closing a company
There are two ways of formally closing down a company: dissolution, also referred to as striking off, and liquidation.
Using the striking off process to dissolve a company is not a formal insolvency procedure and it is this loophole that means an Insolvency Service Investigation can be avoided.
It involves the filing of form DS01 by the company directors at Companies House. Companies House will then advertise the impending striking off in the Gazette and, provided no objection is received, the company is dissolved.
Striking off was not intended for companies that are potentially insolvent. Instead, it was meant for companies that have not traded for the preceding three months, for example, where the directors wish to retire or the company is no longer needed. However, some company directors have taken advantage of the striking off process to avoid official scrutiny of their actions and liability for company debts. It has also been used to allow company directors to set up a near-identical ‘phoenix’ company, free of the liabilities that attached to the existing company.
Liquidation is a formal insolvency process and will always involve an investigation carried out by the liquidator or Official Receiver into the conduct of the company directors.
If wrongdoings or malpractice are discovered, then the directors could be held personally liable for company debts. They could also be disqualified from acting as a director for up to 15 years.
What are the duties of a company director and what happens if they are breached?
The proposed new legislation
The new legislation, contained in the Ratings (Coronavirus) and Directors Disqualification (Dissolved Companies) Bill, will close the dissolution loophole and aims to prevent directors from avoiding repayment of government-backed loans that were made to companies during the pandemic.
Currently, the only way the Insolvency Service can investigate once a company has been struck off is to apply to have the company restored to the Company Register and placed into liquidation.
It is also intended to stop directors of dissolved companies from simply walking away from liabilities such as unpaid creditors and customers and setting up a similar but unencumbered business straightaway, a so-called phoenix company.
Once the new bill becomes law, it will no longer be possible to dissolve or strike off a company with active liabilities.
If a company is closed by dissolution, then the Insolvency Service will still have the power to investigate the company directors’ conduct. The Insolvency Service will be able to impose penalties and sanctions such as personal liability for debts and disqualification from being a director.
Once enacted, the new law will apply retrospectively, meaning the Insolvency Service will be able to look at past cases, including where directors have dissolved companies that have taken Bounce Back Loans, intended to help them through the Covid-19 crisis, and failed to repay the sums borrowed.
The government’s Business Secretary, Kwasi Kwarteng said: “As we build back better from the pandemic, we need to restore business confidence, but also people’s confidence in business – which is why we will not hesitate to disqualify directors who deliberately leave employees and the British taxpayer out of pocket.
“We are determined that the UK should be the best place in the world to do business. Extending powers to investigate directors of dissolved companies means those who have previously been able to avoid their responsibilities will be held to account.” Gov UK.
Dr Roger Barker, Director of Policy and Corporate Governance at the Institute of Directors, said: “Company directors fulfil a central role in ensuring that their businesses are well-governed. Although corporate dissolution may be inevitable in some cases, it should only be used as a last resort – after all other realistic avenues for protecting the interests of stakeholders have been exhausted. Using company dissolution as a mechanism for the evasion of a directors’ duties has no place in the governance of a responsible enterprise.” Gov UK.
Options for companies in difficulties
For companies facing insolvency, formal liquidation is a sensible option as it shows a willingness on the part of the directors to deal properly with outstanding obligations and means that creditors will be treated fairly.
There may be options available to rescue a company that is potentially still viable and where the directors wish to try and return it to profitability. This could be by way of a Company Voluntary Arrangement, where negotiation takes place with creditors, or by entering into administration.
Administration can give a company some breathing time to attempt to reorganise and restructure with a view to rescuing it as a going concern. Find out more about the administration process here.
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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 a legal advisor.