Understanding director disqualification in England & Wales and Scotland

Company directors have legal duties and responsibilities when dealing with the affairs of a company.

Following a company’s insolvency (for example liquidation or administration), one of the consequences arising from the insolvent company will involve the Insolvency Service’s investigations into a director’s conduct, or misconduct, of an insolvent company and the events leading up to a company’s insolvency.

In this article, we explain:

• What is director disqualification and what is the effect of it?
• The most common grounds for director disqualification.
• The director disqualification process.
  • Investigation (including completion of questionnaire, options available to a director include accepting a voluntary disqualification undertaking)
  • Formal notification of disqualification (letter sent under Section 16 of CDDA)
  • Director’s response to Section 16 letter
  • Court proceedings
  • Disqualification (including length of disqualification)
• Compensation orders
• Applying for permission to remain as a director whilst disqualified
• Appealing a director disqualification order

What is director disqualification and what are the consequences of it?

Director disqualification is one of the legal measures that the Insolvency Service can take under the Company Directors Disqualification Act 1986 (CDDA). A director disqualification order will:

1. prohibit an individual of an insolvent company (who can also be a non-executive director, de facto and/or shadow director) from acting as a company director (either directly or indirectly) and;
2. prohibit an individual being involved in a company's formation, promotion, and management of any company registered in the UK. A director disqualification order extends to overseas companies with connections in the UK.

As well as not being able to be a director of a company or to form a new company, disqualified directors may also face the following far-reaching consequences which has a wider professional and reputational impact. For example, a disqualified director may not:

• act as a trustee of an incorporated charity;
• act as a receiver of a company’s property;
• act as an insolvency practitioner; and
• act in a school governance capacity.

A disqualified director may still work for a company in a non-directorial role, operate as a sole trader, or partner with others on the basis the individual in question is not involved in a company's formation, promotion and management of any company registered in the UK or an overseas company with connections to the UK. A disqualified director can also serve as a company secretary and hold shares in a company, on the basis that he/she avoid management duties.

It is important to seek legal advice from experts in this field before a response is sent to the Insolvency Service to understand a director’s options, including an application for leave to remain as a director whilst disqualified, and before accepting any voluntary disqualification undertaking preventing you from acting as a company director. Weightmans have extensive experience acting for directors based in both England & Wales and Scotland.

Grounds for director disqualification

There are several grounds through which company directors may be disqualified. The most common grounds that we have defended following the Insolvency Service’s investigations against company directors are:

Unfit conduct

Unfit conduct is the most common ground pursued by the Insolvency Service for director disqualification under the CDDA. A company director may be deemed unfit to hold his/her position if he/she fails to demonstrate the “probity and competence” test.

Examples of ‘unfit conduct’ include:

• misuse of government financial support schemes — in recent years, there has been a sharp rise in director disqualification actions amounting to misuse of the COVID-19 Bounce Back Loan;
• failure to submit tax returns or pay any tax (or the correct amount of tax) owed by the company whilst allowing the company to continue to trade;
• allowing a company to continue trading whilst insolvent (also known as ‘wrongful trading’);
• fraudulent activities, such as the misappropriation of client monies or company funds;
• failure to keep proper company records, such as statutory books;
• failure to file financial accounts and/or confirmation statements at Companies House within the required statutory periods; and
• breaches of competition law include price-fixing and market sharing. The CDDA gives the Competition Markets Authority (CMA) powers to apply to the court for a director disqualification order against a director of a company who has breached competition law and his/her conduct makes him/her unfit to be concerned in the management of a company. The CMA can also accept a disqualification undertaking from a director instead of bringing proceedings. A disqualification undertaking has the same legal effect as a disqualification order.

Bankruptcy

A director who is made bankrupt or is subject to a debt relief order will automatically be disqualified from acting as a company director.

Acting while disqualified

If a director breaches a disqualification order, by acting as a director of a company whilst banned from doing so, he/she will likely receive an extension of their disqualification, along with a prison sentence of up to two years.

Appointing a disqualified director

If a director appoints another director who is disqualified or otherwise unfit to act, they can find themselves subject to disqualification proceedings.

The director disqualification process

Typically, the process used by the Insolvency Service for disqualifying a director follows this sequence:

1. Investigation (including completion of questionnaire)
2. Section 16 Letter: formal notification of disqualification (letter sent from Insolvency Service under Section 16 of CDDA)
3. Director’s response to Section 16 letter
4. Court proceedings
5. Disqualification

The process can take up to two years if the matter goes to court, although cases that are resolved via negotiation and accepting a voluntary director disqualification undertaking usually conclude much more quickly (albeit a voluntary undertaking can be accepted during court proceedings also).

A disqualification undertaking is a formal and binding agreement of the matters of unfitness and disqualification period. It avoids the expense of the court process but it is equally important to seek specialist advice to negotiate the alleged misconduct and length of disqualification depending on director’s individual circumstances, including whether leave is required from the court so that the director can continue to act as a director whilst disqualified.

We’ve outlined each step of the process in more detail below.

Investigation

Director disqualification proceedings will start with an investigation, which is usually triggered when an insolvent company enters an insolvent process for example liquidation or administration. Upon taking over the company, the appointed insolvency practitioner is required to investigate the conduct of the company’s directors over the past three years.

The appointed liquidator or administrator of an insolvent company has an obligation to submit a confidential “D Report” to the Secretary of State concerning a former director’s conduct.  The Secretary of State will then ask the Insolvency Service to undertake their own investigations and decide whether to investigate any misconduct in addition to the liquidator’s or administrator’s own duties to investigate the demise of the insolvent company and the conduct of directors during the lead up to the company’s insolvency.

It is also possible for a concerned party to raise concerns about a director directly with the Insolvency Service.

Should an investigation be opened, the Insolvency Service (acting on behalf of the Secretary of State) will decide whether further investigations is in the public interest. If they decide to investigate further, the Insolvency Service will ask the directors of an insolvent company to complete a questionnaire.

If the Insolvency Service makes contact with you, it is important to take early and expert legal advice before any questions are answered relating to the circumstances leading to a company’s insolvency. Contact our experienced director disqualification solicitors for help.

Following this, the Insolvency Service may then send a “pre Section 16” letter providing you with a summary of any alleged misconduct and providing you with an opportunity to provide further information which the Insolvency Service or Secretary of State should take into account.

Section 16 Letter: formal notification of disqualification (letter sent from Insolvency Service under Section 16 of CDDA)

If the Insolvency Service decides to proceed with director disqualification proceedings, they will issue the director with a Section 16 letter. The Section 16 letter from the Insolvency Service informs a director of the Secretary of State’s intention to seek a director disqualification order and outlines the allegations. The Section 16 letter will also set out whether the Secretary of State intends to seek a compensation order for the loss resulting from some or all the misconduct alleged.

If the Insolvency Service continues to make contact with you, it is important to take expert legal advice at this stage and prior to the issue of director disqualification court proceedings. Contact our experienced director disqualification solicitors for help.

Director’s response to section 16 letter

The director has a couple of options upon receipt of a Section 16 letter from the Insolvency Service, including defending the case or offering a voluntary disqualification undertaking. We highly recommend that you seek legal advice before deciding which option is right for your circumstances. Contact our specialist director disqualification solicitors for help.

A director’s response to a Section 16 letter is crucial including a review and analysis of the draft evidence. We have substantial experience in persuading the Insolvency Service to discontinue claims alleging unfit conduct by setting out strategic and robust representations.  Director disqualification will impact an individual’s livelihood and reputation, particularly if he/she holds current directorships. With the consequences of director disqualification being so severe, it is vital to seek expert legal advice so a robust, technical and strategic approach is set out in the response to the Section 16 letter.

Court proceedings

If the matter progresses to court, the investigator from the Insolvency Service and the director at risk of disqualification and any witnesses will both give evidence before a judge at trial.

Disqualification

In the absence of a voluntary disqualification undertaking and if a disqualification order is granted, the judge will confirm the length of the disqualification. A disqualified director will usually be responsible for paying the costs of the Secretary of State and Insolvency Service.

The period of disqualification depends on the seriousness of the director’s conduct and usually is categorised into the following three brackets:

• 2 to 5 years: This is the lowest bracket and is generally reserved for less serious offences (reckless rather than criminal) and first-time offences.
• 6 to 10 years: A disqualification in this range will often be given for more serious conduct or for directors who repeatedly fail to meet their legal obligations.
• 11 to 15 years: Disqualifications of this length are usually reserved only for the most serious and fraudulent offences or for directors who have breached a previous disqualification order.

Compensation orders

The Insolvency Service can ask the court to grant a compensation order under Section 15A of the CDDA. A compensation order is a court order that requires a disqualified director to pay compensation in relation to losses to creditors of the insolvent company as a result of the director’s misconduct.

These orders can be sought only by the Secretary of State or by the Insolvency Service acting on their behalf and they are often issued at the same time as a disqualification order or undertaking. The Section 16 letter will usually set out the Secretary of State’s intention to seek a compensation order.

The amount of compensation orders granted and the total amount to be repaid via compensation orders has been steadily increasing over the last few years, as can be seen from the table below.

Applying for permission to act as a director

It is possible to apply for permission to act on behalf of a specific company under Section 17 of the CDDA whereby the court may be willing to allow a disqualified director to continue to act as a director under certain, limited conditions.

The disqualified director will need to demonstrate a “reasonable need” for him/her to continue to be involved in the company’s management as a director and that adequate safeguards will be put in place to protect the public from any reoccurrence of the misconduct that gave rise to the original company failure. Specialist legal advice should be sought. We have extensive experience in negotiating a voluntary director disqualification undertaking and preparing detailed and persuasive witness evidence to support a section 17 application for leave to remain as a director.

When should I apply?

The timing of accepting a voluntary disqualification undertaking and application for permission or a 'section 17' application is critical. If you are considering offering a disqualification undertaking, we can work with you to ensure minimal disruption by preparing your application swiftly and avoiding the need to resign from your current directorship.

You will need to demonstrate to the court that there is a genuine need for you to be involved in the company's management and that adequate safeguards are in place.

Appealing a director disqualification order

In limited circumstances, a disqualification order can be appealed in Scotland and England & Wales. Seeking specialist advice to the grounds for an appeal is imperative and to understand the merits of success of any appeal. We have experience in dealing with the court process in both England & Wales and Scotland, including attendance at court.