Rogue directors will find themselves in the firing line if and when The Rating (COVID-19) and Directors Disqualification (Dissolved Companies) Bill, which is currently making its way through parliament, comes into force. The proposed bill will enable the investigation and potential disqualification of directors of dissolved companies, and responds in particular to concerns around COVID-related fraud.
Background
Ensuring that the directors of insolvent companies are held to account for their conduct – and do not profit from the demise of the company at the expense of its creditors – is an important aspect of English insolvency law. The risk of scrutiny from an appointed insolvency practitioner and potentially the Insolvency Service, with sanctions including disqualification, personal liability and criminal proceedings, is a major consideration for directors of a failing company. It is perhaps unsurprising then that unscrupulous directors may look at voluntary strike-off as an attractive, not to mention cheaper, alternative to formal insolvency – potentially enabling them to leave behind debts and other liabilities, without facing investigation or disqualification proceedings.
Although the voluntary strike-off procedure includes safeguards – notably in the requirement that notice be given to all known creditors, who have the opportunity to object – there is still a risk of misuse of the procedure. In particular, there is a concern that it could be used at the expense of small business creditors, consumers and employees – who may lack the means or ability to object or apply for restoration of the company to the register. The Insolvency Service does not currently have the power to investigate or pursue disqualification proceedings against the director of a dissolved company, however bad their conduct may have been, without first restoring the company to the register.
This is of course contrasted with the position where a company enters an insolvency procedure, when the director’s conduct will be investigated by the appointed insolvency practitioner, who is required to submit a report to the Secretary of State. If there appears to have been misconduct, the Company Directors Disqualification Act 1986 (CDDA) gives the Secretary of State (acting through the Insolvency Service) power to investigate, and apply to the court for disqualification and/or for an order that the director must financially compensate creditors.
COVID fraud concerns
This legal loophole was raised in the government’s consultation on insolvency and corporate governance in 2018. Following this, the government announced its intention to extend the current regime to include former directors of dissolved companies, thus closing the loophole and reducing the attractiveness of dissolution as an "alternative" to insolvency. In the wake of the pandemic, the need for such measures has become more pressing. Concerns around the conduct of a minority of fraudulent directors have been amplified due to the propensity for fraud relating to the COVID support measures. Assuming it is passed, the proposed bill will, it is hoped, bring some of these COVID-related misdemeanours to light.
Although misconduct in dissolutions may be relatively rare (according to an estimate by the Insolvency Service around 1% of dissolutions, or 5000 per year, involve wrongdoing), it can have a disproportionate effect on small business creditors. The amounts involved may not justify them objecting to the dissolution or taking steps to restore the dissolved company to the register. The behaviour is largely a problem in the SME market and affects certain sectors in particular. Notably, widespread support for the measures from the construction industry featured in the responses to the 2018 consultation.
The concern that unscrupulous directors will dissolve their companies to avoid repayment of COVID support appears to be borne out by the figures. In the first three months of 2021, almost 40,000 companies were struck off the Companies House register – an increase of 743% on the same period in 2020. It has been speculated that this reflects a large number of businesses simply shutting down to avoid having to repay COVID-related financial support. The bounce back loans (BBLS) targeted at small businesses were particularly vulnerable to fraud due to the extremely limited underwriting checks carried out, and this may be reflected in these strike-off figures.
Proposed legislation
The proposed bill essentially extends various provisions of the CDDA to directors of dissolved companies. It will enable the Secretary of State (through the Insolvency Service) to:
- Require information relating to a person’s conduct as director of a dissolved company
- Apply to the court for an order disqualifying a director of a dissolved company
- Apply to the court for an order that the director must financially compensate creditors, where their actions caused identifiable losses
- Accept a disqualification undertaking or an undertaking to pay financial compensation from the director
Criminal proceedings may also be brought where evidence of criminal conduct is found.
With the Insolvency Service encouraging the reporting of suspected fraud, this may offer some degree of comfort for those small creditors who are unlikely directly to pursue a dissolved debtor. Where a direct remedy is required however, creditors should be aware of their rights to object to strike off of a company, or to apply for restoration of a dissolved company to the register.
In the long term, these measures are likely to act as a deterrent to this type of unscrupulous behaviour – although much will depend upon the perceived likelihood of enforcement. There may be an increased demand for investigations into failed companies, if the expected increase in insolvencies materialises following the lifting of restrictions on winding up petitions and the withdrawal of government support. The Insolvency Service has indicated the intention to prioritise those cases where investigation is most strongly in the public interest – and, at least in the short term, this is likely to correspond with a focus on cases involving BBLS and other COVID support scheme fraud.
Other penalties for directors of dissolved companies
It is worth noting also that potential financial penalties for directors of dissolved companies were introduced by the Finance Act 2020. This enables HMRC to make a director personally liable by way of a Joint Liability Notice for the unpaid taxes of their dissolved or insolvent companies in "phoenix" type cases. The provisions are complex but broadly the individual must have been a director of at least two companies (the old companies) during the previous five years, which were dissolved or went into an insolvency procedure with outstanding tax liabilities. The individual must also be connected (either as a director, or involved in management) to a new company which is carrying on a trade or activity similar to that previously carried on by the old companies. The effect of a Joint Liability Notice issued in such a case is that the individual becomes jointly and severally liable for any tax liabilities both of the new company and of the old companies.
Tim Carter
Helen Martin