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 Directors 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
- Bounce back loan fraud or misuse of funds
- Closing a business to avoid repayment of bounce back loan funds
- Failing to notify creditors and banks after applying to strike off a company, including a bank that has paid a bounce back loan to the company
- Making a dishonest application to strike off a company
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.
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.
Disqualification for alleged breaches of bounce back loan terms
Following the government’s issuing of more than £46 billion in Covid-19 support schemes, Insolvency Service figures have revealed that half of all director disqualifications are on the basis of alleged fraud or misuse of funds intended for business support. The majority of these relate to the bounce back loan (BBL) scheme.
National Audit Office figures have revealed that an estimated £4.9 billion has been fraudulently obtained via the BBL scheme. Their report entitled, “The Bounce Back Loan Scheme: an update”, states under its key facts that:
“£4.9 billion the Department for Business, Energy & Industrial Strategy’s (the Department’s) most likely, but highly uncertain, estimate of the value of fraudulent loans in the Scheme as of 31 March 2021, based on a sample of 1,067 loans.”
Directors are facing both civil and criminal court proceedings, with penalties including:
- Disqualification from acting as a director
- An extensive ban on forming or managing a limited company
- Director disqualification compensation orders requiring repayment of funds
- Prison terms
- Orders to pay the costs of the proceedings
Fraud in obtaining a BBL and misuse of BBL funds
Common causes of disqualification proceedings against company directors are from wrongly stating their company’s financial position when applying for a bounce back loan and/or misuse of the loan funds once received.
In many of the cases that have come to court to date, directors have been accused of exaggerating company turnover in order to secure a larger loan than they were entitled to. The National Audit Office estimates that around 11% of loans were issued following fraudulent applications.
It is also the case that many directors have misused funds. This includes using funds personally to buy assets, putting funds into a personal bank account, taking an increased salary or dividend or giving the money to a family member.
If your BBL repayments fall behind you can expect to be investigated and if issues are found in respect of your application for the loan or use of the funds, you could face disqualification proceedings.
If a business goes into liquidation or administration, the insolvency practitioner is bound to investigate how this has arisen. The investigation is likely to include looking at the bounce back loan and where the funds were used.
The Insolvency Service has been given new powers to investigate the directors of dissolved companies where it is suspected that the decision to close the business has been taken to avoid having to repay a Covid-19 support loan.
Andrew Hook, partner at Begbies Traynor, offers his insights from the perspective of an Insolvency Practitioner on the industry’s reporting requirements in respect of BBLs.
“If a company enters into an insolvency process, the Insolvency Practitioner(s) are required to report on the director(s) conduct to the Insolvency Service within three months of their appointment. Insolvency Practitioner(s) are required to report on whether the company (a) obtained the correct amount and (b) whether the funds were used correctly. As a result, it is important that director(s) keep adequate records to justify transactions entered into by the company.
Misuse of a the Bounce Back Loan scheme can result in directors getting disqualified for a period of time. In addition, an Insolvency Practitioner can also commence claims against directors personally to recover funds for the benefit of the insolvency estate”.
Bounce back loan fraud and misuse cases and penalties
London businessman given six-month sentence
A director of consultancy company RKV Consultancy Ltd, who claimed a BBL of £25,000, was given a six-month prison sentence for abusing the BBL scheme. Rajesh Vaghela secured £25,000, then closed his business within a week of receiving the funds to avoid having to repay the money. He transferred it to his personal bank accounts. He failed to notify the bank of his application to dissolve the consultancy, which also was unlawful.
The director pleaded guilty to a range of charges under the Companies Act 2006 and the Fraud Act 2006. He repaid the loan prior to sentencing, when his six-month sentence was suspended for 18 months. He was also ordered to pay £2,150 in court costs.
Director of London-based gift company ordered to repay £43,570
A director of Health & Tasty Ltd, a company selling hampers and gift baskets of fruit, flowers and chocolates, was investigated by the Insolvency Service after going into liquidation.
The high court found that the director, Grisha Valchev, had provided false information in order to obtain the maximum bounce back loan of £50,000. His company’s turnover meant that he was entitled to less than £9,000.
He told the court that he was unable to repay the money, but the judge rejected this and made an order requiring repayment of £43,570, the amount of the excess claim plus interest. He was also disqualified from being a director for nine years.
The director of telecoms firm given 15-month suspended jail term
Ben Hamilton, director of telecoms firm Netelco Ltd, secured a BBL of £25,000. Within 24 hours of the money being paid into the company’s bank account, the director submitted paperwork to close the company. He did not notify the bank that funded his BBL that he was doing so, a criminal offence.
Following an investigation by the Insolvency Service, he was convicted of fraud and sentenced to 15 months in prison, suspended for 18 months. He was also ordered to pay costs of £2,500 and has now repaid the loan.
Construction company director banned from being a director and ordered to repay £50,000
Director of construction company Deea Construct Ltd, Marian Ghimpu, had a turnover of a little over £4,000 when he applied for a BBL, but he told his bank that it was in excess of £200,000. This secured him a BBL of £50,000, when he was actually entitled to only £2,000.
Ghimpu transferred £40,000 to himself from his company’s bank account and withdrew the rest in cash. He then put his company into liquidation, at which point the Insolvency Service started an investigation.
He was ordered to repay £52,163 and given five weeks in which to do so. He was also banned from being a company director for 13 years.
Haulage company director given 12-month prison sentence
Kulwinder Singh Sidhu, director of haulage company Wavylane Ltd, made a fraudulent application for a BBL and then dissolved his company as soon as the money was received. He took the maximum BBL available of £50,000 and transferred the funds to his personal bank account within two days of receipt. He then filed papers at Companies House to dissolve the business in an attempt to avoid repayment.
It is a requirement of striking-off applications that all interested parties and creditors, including banks with outstanding loans, should be notified within seven days of any application to dissolve a company. Mr Sidhu failed to do this, which was a criminal offence.
On investigating the business, the Insolvency Service also found that the company turnover had been falsely inflated.
Mr Sidhu pleaded guilty to charges under the Companies Act 206 and the Fraud Act 2006. The court made a confiscation order for £50,000, sentenced Mr Sidhu to 12 months in prison and disqualified him from acting as a director for six years.
Help with bounce back loan investigations and charges
If you are facing an investigation in respect of funds received during the pandemic, you are strongly advised to speak to an expert company director disqualification solicitor as soon as possible. Putting forward a robust defence early on can prevent proceedings from going ahead and protect both your reputation and your business.
We have an in-depth understanding of the complex government funding schemes relating to the pandemic and can advise you on your situation.
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 may 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.
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  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 written evidence. 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.
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. Catherine 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. However, do check to see if the Insolvency Service intend to apply for a compensation order against you, and if the answer is ‘yes’, factor that into your decision as to whether you want to offer an undertaking. Seek advice if you can.
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”.
For more information, see:
Company director disqualification
Directors’ personal liability for misrepresentation
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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.