Definition and Legal Requirement
Once a company enters into Administration or Liquidation, the appointed Administrator or Liquidator is required by law to submit to the Insolvency Service a Conduct Report detailing their findings as to the conduct of the company’s Directors.
This will include those individuals who have been acting in a directorial capacity, albeit that they are not recorded as directors in the company’s records. The report will detail findings in relation to, amongst other things Transactions at an Undervalue, Preferences, Wrongful Trading and Misfeasance.
Based upon the contents of the report, the Insolvency Service will then decide whether or not to bring disqualification proceedings against the Director. A claim will be successful, either through court proceedings or by the obtaining of a Disqualification Undertaking. This is when the Director agrees to be disqualified without the need of a court hearing.
Following a Director’s disqualification, the Secretary of State has the power to seek a Compensation Order against that individual. This avenue of recovery is over and above any claims that a company may have against its Directors (being Misfeasance claims) or actions that may be taken by a Liquidator or Administrator to recover assets for the benefit of the insolvent estate.
Aside from the Director having to have been disqualified, a Compensation Order will only be successful if it can be shown that the Director has caused loss to one or more creditors of the insolvent company of which that person at the time was a Director.
When a Director is disqualified there are a number of ramifications, the most important being:
- The Director will not be permitted to act in a directorial capacity for a specified period. The length of time will depend upon on the severity of the individuals actions and can range from 2 to 15 years;
- The Director details will be entered on to a central register which provides information concerning the length of the disqualification and reasons why the disqualification took place; and
- Subsequently acting in contravention of a Disqualification Order can result in the Director being subject to a fine and imprisonment.
Any defence to disqualification proceedings will depend upon the various claims raised by the Insolvency Service as initially set out in the Conduct Report. The defences will reflect those available to claims brought directly by the Liquidator or Administrator when seeking recovery of assets for the estate.
Compensation Orders are a relatively new process, only being in operation since 2015. Accordingly, there is not much in the way of caselaw to determine how such claims are defeated. It looks to be that in alleging that the Director caused some or all of the loss to a company’s creditors will mean that there will be scope to question whether or not the actual loss that is being claimed was caused by their own misconduct.
When Can a Compensation Order Be Brought?
Compensation Order proceedings must be brought within 2 years of the date when the Disqualification Order was made or the Disqualification Undertaking was executed.
What are the Potential Consequences of Compensation Orders?
It is possible that a recovery through Compensation proceedings may lead to further claims by the Liquidator or Administrator. This may therefore result in actions being brought for Wrongful Trading, Misfeasance, Preferences and Transactions at an Undervalue. It is however, unlikely that a Court would permit that a Director who has been ordered to pay Compensation to pay twice for the same offence.
Does Agreeing to a Disqualification Undertaking Reduce the Risk of a Compensation Order?
No. The fact that a Director has agreed to enter into a Disqualification Undertaking does not mitigate the chances of any action for a Compensation Order taking place. This means that the decision to enter into such an undertaking must not be taken lightly since it may simply pave the way for subsequent compensation proceedings.
How Can the Defence to Disqualification Proceedings be Demonstrated?
There are various measures that could be put into place to demonstrate that the Directors attempted to act in a way that was not in contravention of the company’s and creditors best interests. Such measures would include holding regular board meetings to discuss the company’s finances and record the thinking behind their actions, keeping financial records updated and obtaining professional advice.
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