Voluntary strike-off: New legislation proposed to discourage abuse of the process and combat fraud

Voluntary strike-off: New legislation proposed to discourage abuse of the process and combat fraud

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A bill currently making its way through parliament is intended to enable increased scrutiny of the actions of directors of dissolved companies – and discourage the abuse of the voluntary strike-off procedure as an ‘alternative’ to insolvency proceedings. The measures relating to dissolved companies in the Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Bill (the “Bill”) have been contemplated for some time, originally raised in the government’s consultation on insolvency and corporate governance in 2018 (the “2018 Consultation”). The Bill addresses a lacuna in current legislation which leaves former directors of dissolved companies free from the risk of disqualification, and other sanctions under the Company Directors Disqualification Act 1986 (the “CDDA”).

Mounting concern regarding the extent of potential fraud relating to the claiming of government- backed coronavirus loans, together with concerns that the voluntary strike-off process may be used as a way of avoiding repayment, was a key driver in the introduction of the Bill in May of this year. It is expected to reach the statute book in early autumn, although its provisions regarding director disqualification are retrospective. The Insolvency Service is currently taking a zealous approach to the investigation of companies and directors suspected of covid-related fraud, and the powers contained in the Bill will add another string to its bow.

Background: the current legislative framework

Where a company has entered into an insolvency proceeding (either insolvent liquidation, administration, or administrative receivership), the office-holder is required to submit a “conduct report” to the Secretary of State, with regard to each individual who has been a director of the company at any point during the three-year period leading up to insolvency event. The Secretary of State (acting through the Insolvency Service) has powers to investigate the directors’ conduct and, if it finds it to be in the public interest, make an application to court for a disqualification order. Under section 6 of the CDDA, the court is required to make such an order where it finds that a director’s conduct makes them unfit to be concerned in the management of a company.

Alternatively, a disqualification undertaking may be accepted by the Secretary of State from the director concerned, enabling the individual to avoid court proceedings. Ultimately the effect of a disqualification order or undertaking will be the same, with a disqualification period (pursuant to section 6 of the CDDA) of between 2 and 15 years. There is also the potential for an order to be made pursuant to section 15A of the CDDA, requiring the director to compensate any creditors which have suffered loss as a result of their conduct.

The conduct of directors of live (solvent) companies may also be investigated by the Secretary of State, pursuant to Part XIV of the Companies Act 1985. In such cases, directors may be made subject to a disqualification order or undertaking on the grounds of unfit conduct under section 8 of the CDDA. However, there is currently no power for the Secretary of State to investigate the conduct of former directors of companies which have been struck off the register without having been through a prior insolvency process. To do so, it would be necessary first to have the company restored to the register – a time-consuming procedure involving the expense of a court application.

What constitutes unfit conduct?

An individual’s behaviour may fall short of criminality or fraud but still constitute “unfit conduct” and lead to disqualification. Cases pursued by the Insolvency Service often involve HMRC being treated less favourably than other creditors (for instance, directors choosing to pay commercial creditors while failing set aside money to meet PAYE, NIC and VAT debts), or the misuse of company funds for the personal benefit of directors. In a recent example published by the Insolvency Service, a director was disqualified for 12 years after claiming £50,000 through the Bounce Back Loan Scheme (“BBLS”) before transferring the full amount to himself, shortly before the company went into administration.

Other conduct pointing to “unfitness” can include failure properly to maintain and preserve accounting records, misleading customers and creditors, permitting transactions to the detriment of creditors (at a time when the company was insolvent, or would become insolvent as a result of the transaction), or trading or continuing to draw remuneration at a time when the company was insolvent.

It is worth noting that non-executive directors, whose involvement in a company’s affairs may be only intermittent or passive, still face the risk of disqualification if they have allowed other directors to act improperly.

The risk of disqualification is, of course, in addition to other potential criminal or civil liabilities which a director may face in relation to their activities, either under the Insolvency Act 1986 or otherwise. Breach of a disqualification order or undertaking is a criminal offence under section 13 CDDA, often leading to a suspended sentence or community order.

Dissolution and covid-related fraud

Concerns about directors’ behaviour in the 2018 Consultation focused particularly on the potential losses to small business creditors and employees, where companies were improperly dissolved as an alternative to winding up. The voluntary strike off procedure is intended to be used only by dormant companies with no liabilities – however when compared to voluntary liquidation, the lack of scrutiny and substantial cost saving can make it appear an attractive prospect. Misuse of strike off was felt to be largely a problem in the SME market, where the sums involved would in most cases not justify small creditors taking action to restore the company to the register in order to pursue their claims. Although there was broad support for the measures at the time of the 2018 Consultation, the actual extent of the problem was thought to be relatively limited.

However, in the context of the current crack down on covid-related fraud, the need to combat abuse of the strike off process has gained a new urgency. Bounce back loans were particularly vulnerable to fraud due to the limited underwriting checks carried out at the point of lending. Altogether around £46.5billion was lent under the BBLS, to over 1.5 million businesses – with the National Audit Office estimating that over 50% of this could be lost to fraud if the government does not pursue a robust policy of debt collection and fraud investigation. This is illustrated by winding up orders made recently in respect of two companies, following investigation and petitions presented by the Insolvency Service. These companies had between them submitted false documents to at least 41 local authorities, as well as the BBLS, in order to obtain covid-related business grants and bounce back loans amounting in total to £230,000.

An extraordinarily high figure of almost 40,000 companies struck off in the first quarter of this year - an increase of 743% on the same period in 2020 according to research from accountancy firm Mazars – may reflect an increase in the use of strike off process by companies which have fraudulently claimed financial support. It would have been fairly straightforward for a rogue director to obtain a loan in the name of a non-trading company, transfer the funds to themselves, and then simply leave the company dormant for three months before applying for it to be struck off. If the directors fail to follow the statutory procedure and notify creditors - in itself a criminal offence - then it may be possible for a strike off to (at least initially) fly under the radar of creditors, notwithstanding notice published in the Gazette by the registrar of companies.

Extension of the disqualification regime

The Bill amends the CDDA and extends the current regime, as it relates to directors of insolvent companies, to former directors of dissolved companies. In particular it will enable the Secretary of State (acting 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; or
  • Accept a disqualification undertaking or an undertaking to pay financial compensation from the director.

Investigations are expected to be triggered either where a complaint has been made to the Insolvency Service by a member of the public, or through a connection with an existing live or insolvent company investigation. The Insolvency Service will target investigations in cases which are most strongly in the public interest, which will inevitably, in the current climate, correspond to a large extent to cases involving fraudulent covid support claims.

Creditor remedies

Although the potential for a compensation order to be made will go some way in protecting the small creditors of dissolved companies, this will depend on the Secretary of State pursuing the case – there is no direct right either under the CDDA or the new Bill for a creditor to take action.

Creditors will therefore still need to take matters into their own hands where a direct remedy is required. If a creditor obtains notice of the strike off before it takes place (either directly or through the Gazette), they have the opportunity to object to the registrar of companies, who will suspend the striking off for a period (usually 3 or 6 months) to enable creditors to pursue their claims.

If, however, for any reason an objection has not been made and the company has already been struck off, creditors face a longer and more costly process to obtain a remedy. At the point of striking off, the company ceases to exist as a legal entity, its liabilities are extinguished and any assets remaining in the company will be transferred to the Crown as “bona vacantia”. Any creditor with a claim against the company will therefore have to apply to court for restoration of the company to the register. This requires service of a claim form and evidence on Companies House and the Treasury Solicitor. The court will usually, once an order has been agreed with the Treasury Solicitor, deal with the matter by way of a consent order and without a hearing. However, the whole process is likely to take at least three months.

Once the company is restored, it is deemed to have continued in existence as if the dissolution had never happened, enabling a creditor to bring action in relation to any debts owed. In practice, in many cases, a winding up petition will accompany the application for restoration and be heard at the same time. It seems probable that, as well as investigations by the Insolvency Service if the new Bill is passed, we will also see an increased amount of creditor applications for restoration following the significant increase in dissolutions earlier this year. It will be interesting to see whether the number of dissolutions returns to more usual levels, if and when the new Bill becomes law.

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