Director disqualification: what you need to know

Director disqualification: what you need to know – “News International and its parent News Corporation exhibited wilful blindness, for which the companies’ directors …should ultimately take responsibility”; “We conclude, therefore, that Rupert Murdoch is not a fit person to exercise the stewardship of a major international company,” so concluded the cross party bench committee of MPs.

Media regulator Ofcom intends to examine the report to consider its options but there is another government body that could also be interested.

The Department for Business, Innovation and Skills (BIS) has the power to disqualify directors from holding corporate office (in any company be it a small private limited one or large News Corporation-size plc’s) where it is satisfied that there is sufficient evidence of “unfitness” as under the Company Directors Disqualification Act 1986 (CDDA) .

Disqualifications other than in relation to insolvency proceedings are extremely rare; most disqualifications being dealt with by the Insolvency Service (IS – as part of the BIS) but its work is limited to cases of wrongdoing resulting in insolvency. According to IS statistics, there were 20,000 corporate insolvencies in 2011 with the number of directors disqualified being 1,437.

Grounds for disqualification

No director should be punished for commercial misjudgement but the IS will need to be satisfied that there is a case for gross negligence or total incompetence.

There are in fact, many grounds for disqualification which may be automatically enforced depending upon the relevant Act section, for example:

•Individual bankruptcy – unless the court allows the director to continue
•Breach of Health and Safety regulations (although according to an HSE-commissioned report published in 2007 on the effectiveness of the CDDA, company directors are almost 300 times more likely to be disqualified for financial reasons than for breaching health and safety rules)
•Wrongful or fraudulent trading
•Mental Health legislation
•Infringement of competition rules
•Persistent breach of statutory obligations (e.g. failure to submit accounts on time – cases have been brought following false accounting and evading VAT)
•Conviction of an indictable offence connected with the promotion, formation, management or liquidation of the company
What is considered?

Insolvency practitioners (IP’s) are required to make a report for the IS to consider whether:

•there were any mitigating factors (e.g was it solely the downturn that affected the company’s cash position and profit) or the directors negligence that caused the company’s insolvency
•the directors continued trading or otherwise defrauded the company’s creditors while the company was known to be insolvent
•the case is a matter of public interest
•there was deliberate and persistent failure to pay liabilities (e.g. VAT and PAYE deductions) to the Crown
It is also understood that cases that the IS considers “too small” will not be pursued even if there is a prima facie case although this policy and its criteria are not publicised; a few years ago, the cut-off point was thought to be a deficiency to creditors of £100,000.

End result

The IS will apply to the court for a Disqualification Order or, alternatively, the Secretary of State may accept a Disqualification Undertaking. An ‘undertaking’ is a way for both sides to avoid the expense and upset of a court hearing where the director does not dispute the facts agreeing to the disqualification and to the conditions imposed. The conditions are the same as for an order although directors giving an undertaking can generally expect a shorter ban.

Implications

For the period of the order or undertaking (anything between two and 15 years – the average is six years), the individual is prevented from:

•being a director of a company
•acting as if they were a director
•instructing others in the management of a company
•being involved in any way in the promotion, formation or management of a company (including raising capital pre-company formation)
•acting as a company receiver or IP
•acting as a trustee of a charity or pension scheme without permission

Other bodies may not take too well to a disqualified director sitting on their committee and may not allow them to be

a school governor,
director of a housing association, or
member of a social care body.

Disqualification is usually reported to professional bodies which may affect their membership.

It is not enough to not have the title “director” – while the order or undertaking is in place that person cannot be involved in the usual running of a company and in fact, the CDDA specifically prohibits the ordering from, paying or negotiating with suppliers or customers; undertaking management consultancy or any governing role within a company or making it appear that one is able to do so. Breach is a criminal offence carrying a maximum of two years imprisonment and/or a fine.

But is disqualification effective?

Disqualification is supposed to act as a deterrent for directors’ wrongdoing, intending to raise standards of commercial governance however large the company but the vast majority of companies that fail do not go down the liquidator route. If is difficult to detect infringements of orders or undertakings, relying on members of the public to report those whom they believe are acting in breach via the Disqualified Directors hotline.

IS statistics show a total of 166 convictions in 2011 for a range of offences relating to corporate and individual insolvencies although these do not specify how many prosecutions were brought for breaches of disqualification orders or undertakings. The low number could mean the legislation is having a remarkable deterrent effect or that it simply is not being enforced

The director of a company in trouble will obviously think of the here and now.
- Over-borrowing and personal guarantees mean directors will try to keep trading in order to avoid a collapse of their business and the subsequent enforcement of personal liability for their company’s debts.
- It is when their companies are facing the prospect of insolvency that such directors are most likely to treat creditors unfairly and behave in a manner which might render them unfit.
- The most common tactic is to withhold crown monies to ease cash flow but it is not unusual for directors to reduce or extinguish a personally guaranteed bank overdraft; pay off debts due to themselves or their families, or divert assets such as stock, equipment or vehicles away to be used in a phoenix company

Don’t think that the IS is just interested in the larger plc companies and that they will not act if a breach of an order or undertaking is proved. Take the case reported in the Bolton News last month where Matthew Sixsmith, was disqualified for eight years for allowing his father to act in the management of his company. His father had previously been disqualified for five years from April 2005.

The IS representative, Claire Entwistle, told the local newspaper that:

“Where disqualified directors continue to manage the affairs of a company, they will find the protection of limited liability is not given to them and they may be criminally prosecuted… the Insolvency Service will act robustly against those who allow disqualified directors to act”. You have been warned!

http://www.accountingweb.co.uk/article/director-disqualification-what-you-need-know/527281