Why retrospective powers for The Insolvency Service will unsettle even today's unfit directors

Limited company contractors following the rule book are often not alone in believing The Insolvency Service’s powers don’t go far enough, so new legislation to grant the government body more powers to investigate the affairs of dissolved companies – and their unfit directors, should reassure many, writes Gareth Wilcox, partner at Opus Restructuring & Insolvency.

What are these new powers for The Insolvency Service?

At present, The Insolvency Service has powers to investigate directors of live companies, or those companies which have entered a form of insolvency.

If wrongdoing or malpractice is found, directors can face sanctions including being issued with a ban from being able to act as a director for up to 15 years. It was a ban of almost this length which many didn’t think was sufficient enough in the contractor sector back in August 2013.

But in insolvency circles, there has always been a bit of a perception that there is loophole, on the basis that The Insolvency Service’s powers have not extended to companies which were simply struck off -- without having been through an insolvency procedure.

What was the loophole now being plugged?

Liquidators and administrators have a statutory duty to investigate the conduct of directors (and former directors) of all companies they are appointed over. And these professionals must report their findings to The Insolvency Service. 

They also have wide-ranging legal powers to assist them with that process. The perception was that a strike-off application gave unscrupulous directors an opportunity to quickly ‘bury’ their company, without the same degree of scrutiny that arises where a liquidator (or administrator) has been formally appointed. 

While the strike-off process requires directors to send a copy of the application to 'interested parties' (including creditors), so as to provide an opportunity to object, there was a risk, particularly in the case of HMRC, that the company could be dissolved before such a notice was processed.

Where this occurred, in order for investigations to be carried out into the company’s dealings, an affected party would have to apply to court for a company to be restored and thereafter put into liquidation. This may have significant cost implications, with often limited certainty that the action would give rise to a recovery for the applicant.

Is the timing of these new powers significant?

Some may consider it a coincidence that the new powers arise following a period where, as a result of Bounce Back Loans and CBILs, company borrowing has increased exponentially.

This borrowing is partially government-backed and coincides with HM Revenue & Customs giving unprecedented forbearance to companies with their arrears during the covid-19 pandemic.

The fact is that the timing is no coincidence at all. The government’s own announcement of the new powers specifically states that the measures are retrospective, so as to enable The Insolvency Service to tackle directors who have inappropriately wound-up companies that have benefited from Bounce Back Loans. Perhaps this is hardly surprising, since it has been widely reported that a 40% default rate is expected in relation to BBLs.

How do disqualification proceedings arise?

Under the new powers, The Insolvency Service can take action against any person who has been a director of a company within the past three years prior to closure (whether liquidation or dissolution), and the service has three years to do so. 

Examples of conduct which The Insolvency Service considers ‘unfit’ includes:

• allowing a company to continue trading when it can’t pay its debts;
• not keeping proper company accounting records;
• not sending accounts and returns to Companies House;
• not paying tax owed by the company;
• using company money or assets for personal benefit.

It is therefore clear that any directors who have misapplied Bounce Back loans, as well as those whose companies have significant tax arrears, are likely to be in the firing line under the new powers.

How will The Insolvency Service come at unfit directors?

If misconduct is alleged, The Insolvency Service will notify the director in question that they intend to bring proceedings, provide details of the basis for the allegation, and supply details of how they can respond. 

Depending on the nature of the allegation or response, one of the following will occur:

1. The Insolvency Service will bring court action seeking an order for the director to be disqualified;
2. The director may agree to a disqualification undertaking (which has the same effect as an order, but usually a shorter period can be negotiated);
3. The action will be discontinued.

A disqualification order/undertaking will have effect for a period between two and 15 years, depending on the severity of the misconduct.

On receipt of a notification of disqualification proceedings from The Insolvency Service, a director would be well-served by taking legal advice. Fortunately, there are many solicitors who specialise in this area.

What are the implications for being disqualified as a director?

A person disqualified by an ‘Order or Undertaking’ cannot be a director of a company, act as receiver of a company’s property or in any way, whether directly or indirectly, be concerned or take part in the promotion, formation or management of a company. 

This therefore precludes a scenario where a director gets another individual to act in their place, while they pull the strings as a ‘shadow’ director.

In addition, there is a specific preclusion on a disqualified individual acting as an Insolvency Practitioner, and it is likely to impact certain other professional qualifications. However a disqualified director can apply to court for permission to act as a director notwithstanding the ban, yet they must get specific leave for every instance where they intend to act in that capacity while disqualified.

The penalties for breaching a disqualification can be severe. It is a criminal offence to breach an order, which can result in a prison sentence of up to two years and a fine, plus a further period of disqualification. 

There can also be significant civil consequences since any director who acts in contravention of a disqualification is personally liable for the debts of any company in relation to which they are found to be acting as a director. Personal liability also extends to any other person involved in the management of a company, who acts on the instructions of a person they know to be disqualified.

How common are disqualifications?

The Insolvency Service obtained or had significant involvement in obtaining 1,280 disqualifications for the reporting year March 2019/20 (being the most recently available pre-covid). And ‘unfair treatment of the crown’ was cited in 711 of those cases, representing by far the most common ground. 

Given that there were a reported 17,224 insolvencies in 2019, this represents a relatively small percentage and should not detract from the fact that the UK has a recovery culture. It is recognised and accepted in law that companies and individuals are entitled to use insolvency processes as a mechanism to move on from unmanageable debt, with disqualification only being appropriate following an abuse of that process.  

How the statistics will be affected by the new powers remains to be seen.

What are the implications of these new retrospective powers?

The conclusion is that is now clearer than ever that it will be imperative for directors to seek professional advice when considering how to close a company. This in the interests of all stakeholders, including themselves. 

An open and honest chat with a qualified professional before a closure process is embarked upon can allow potential issues to be dealt with in an orderly and compliant fashion as part of the overall strategy (which may not involve an insolvency process at all). Be aware, it is a different story if issues are identified after a process is in place, as a result of either liquidator/administrator or Insolvency Service investigations.

Do you know my mate down the pub?

On a personal level, my own hope is that the new measures will see a gradual end to the anecdotal story-led objection to having a liquidation, which the likes of me (a licensed insolvency practitioner) hear all too often:

‘Why should I bother with a liquidation? My mate down the pub told me he managed to dissolve his company and walk away from the debts. He made a few quid, cut, closed and run, assets-in-hand, over the hill, scot-free never to be seen again!’

Almost needless to say, the listener probably hasn’t been given the whole story because I’ve yet to meet any of these ‘mates’ in person, although a surprising amount of people seem to have them! These new powers from the Insolvency Service will likely give such mates, if they do exist, a little less of a good night’s sleep.

Finally, let’s talk it out

And if you’re thinking that you’ve got no choice but to become such an undesirable mate, or if you have any concerns or queries regarding these new retrospective powers, please contact me for a free, confidential no obligation conversation. As mentioned, an open and honest exchange can work wonders for making messy situations palatable.