An Introduction To Director Disqualification Proceedings

Pursuant to the Companies Act 2006 (CA 2006), company directors owe the following general duties to the companies in which they are directors:

• A duty to act within their powers (i.e., only acting per the company's constitution and only exercising powers for the purposes for which they are conferred).
• A duty to promote the company's success for the benefit of its shareholders.  In doing so, a director must have regard to the likely consequences of any decision in the long term, the interests of the company's employees, the need to foster the company's business relationships with its suppliers and customers, the impact of the company's operations on the community and the environment, the desirability of the company maintaining a reputation for high standards of business conduct and the need to act fairly as between the company's shareholders.  NB: if the company becomes insolvent, then a director must consider or act in the best interests of the company's creditors. 
• A duty to exercise independent judgement (i.e. directors must exercise their powers independently and free of any influence from others). 
• A duty to exercise reasonable care, skill and diligence. 
• A duty to avoid conflicts of interest (i.e. a director must not place themselves in a position where there is a conflict, or possible conflict, between the duties they owe to the company and either their personal interests or other duties to a third party). 
• A duty not to accept benefits from third parties.  Specifically, a director must not accept any benefit from a third party which is conferred because they are a director, or they agree to do or not do something as a director. 
• A duty to declare an interest in any proposed transaction or arrangement with the company. 

There are many reasons why a director can be disqualified.  The CDDA 1986 sets out several circumstances in which a court either must make a disqualification order or may make a disqualification order. 

Some examples where a court may make a disqualification order are:

• When a person is convicted of a serious criminal offence in the UK or abroad concerning the promotion, formation, management, liquidation or striking off of a company.
• Where a person has persistently been in default in relation to the provisions of companies legislation requiring returns, accounts, and documents to be filed at Companies House or where a person has been convicted of an offence for failing to file returns, accounts and documents at Companies House.  
• Where a person has been found guilty of the criminal offence of fraudulent trading under section 993 of the CA 2006.
• Where a person is guilty of fraud in relation to the company while they are an officer of that company or where they have committed any breach of duty while acting as an officer of the company. 

Section 6 of the CDDA 1986 sets out the court's mandatory powers. 

Most applications for disqualification made under the CDDA 1986 are made under section 6. 

The court must make a disqualification order against a person in any case where, on an application to the court, the court is satisfied that:

• The person is or has been a director of a company which has become insolvent or that the person has been a director of a company which has at any time been dissolved without becoming insolvent; and
• The person's conduct as a director of that company makes that person unfit to be concerned with the management of a company. 

Generally, director disqualification proceedings will be initiated by the Insolvency Service on behalf of the Secretary of State. 

The Insolvency Service can investigate the conduct of directors of insolvent companies, for example, when there is a complaint. 

When a company is placed in liquidation, a director's conduct will be automatically investigated by the company's liquidator, and the liquidator must make a confidential report to the Insolvency Service on the director's conduct. 

Notwithstanding this, anyone can report a director's conduct as being unfit.  Once a report is made, the Insolvency Service will review any information reported and consider whether to investigate the company and/or its directors. 

Below is a non-exhaustive list of what 'unfit conduct' can include:

• Abuse of the COVID bounce-back loan scheme;
• Allowing a company to continue trading when it can't pay its debts;
• Not keeping proper company accounting records;
• Not sending accounts, returns and other documents to Companies House;
• Not paying tax owed to HMRC;
• Using company money or assets for personal benefit;
• Fraudulent dealings; and
• Acting contrary to the public interest.

Early enquiries from the Insolvency Service

When a company is placed in liquidation, the Insolvency Service will often write to directors of companies asking for information about the company.  It is normal practice for the Insolvency Service to ask directors to complete a detailed questionnaire. 

These questionnaires will ask for information on a range of matters, including:

• How the company was run;
• Who was involved in the management of the company;
• The company's relationship with its suppliers;
• HMRC and tax-related payments;
• Why the company went into liquidation;
• The location of the company's documents and IT information;
• Certain financial transactions and details of creditors and debtors;
• Details of company contracts; and
• Details of director and employee remuneration.

It is important to consider carefully how you respond to such requests for information. 

Any information provided can be used as evidence by the Insolvency Service in later disqualification proceedings. 

We would recommend taking legal advice before responding to the Insolvency Service.

Section 16 letters

If disqualification proceedings are going to be issued against a director, the Insolvency Service will send what is known as a section 16 letter to the director.  This letter will include:

• The allegations of the director's misconduct;
• Confirmation of the Secretary of State's intention to issue legal proceedings;
• Details of the disqualification procedure;
• An indication of the period of disqualification the Secretary of State is seeking (this will range between 2 – 15 years depending on the seriousness of the allegations); and
• Reference to the ability of the director to provide a voluntary disqualification undertaking in order to avoid formal director disqualification proceedings and the risk of having to pay the Secretary of State's costs in relation to those proceedings.  It is commonly the case that the Secretary of State will agree to a shorter disqualification period if an undertaking is agreed upon.      

If you receive a section 16 letter, seeking legal advice as soon as possible is important.

Failure to respond to this letter is likely to result in disqualification proceedings being issued against you. 

Individuals who receive section 16 letters have the right to respond to the same, setting out the reasons why they believe they should not be disqualified as a director and may take the opportunity to engage with the Insolvency Service to avoid proceedings being initiated altogether and/or to agree on an undertaking for a period of disqualification. 

Court application

If director disqualification proceedings are commenced by the Secretary of State, then broadly speaking, the court procedure is as follows:

1. A claim form and affidavit are prepared by the solicitor representing the Secretary of State (commonly, this is the Insolvency Service, but an external law firm could also be instructed).
2. The claim form and affidavit are filed with the court, which will issue them and set a date for the first hearing.
3. The claim form and affidavit are served on the defendant director or their solicitors.
4. An acknowledgement of service is filed with the court and sent to the Secretary of State's solicitors, setting out how the director intends to deal with the proceedings (i.e., whether they intend to fully defend the proceedings or submit evidence to try to reduce the length of the disqualification period).
5. Affidavit evidence is then exchanged between the parties, ideally before the first hearing of the disqualification proceedings.  Typically, an affidavit is provided by the defendant director in response to the proceedings, and then an affidavit in reply is provided on behalf of the Secretary of State.  Sometimes, affidavits can be provided by third parties in support of the defendant director, particularly if the director is fully defending the proceedings. 
6. At the first hearing of the disqualification proceedings, the court will either determine the case, give directions, or adjourn it. If directions are given, this will ensure that the disqualification proceedings can be determined as soon as possible. 
7. If the case is not determined at the first hearing (see above), the parties must prepare for and attend trial.  Preparing for trial includes work such as producing trial bundles and the barristers representing the parties drafting skeleton arguments.  At the trial, all parties who have provided evidence of affidavit can be cross-examined on that evidence, and the judge will determine the proceedings based on all the evidence before it.  Depending on the outcome of the proceedings, the judge will also decide who is going to be responsible for paying the costs of the proceedings.  The general rule is that the loser pays the winner's costs.     

Pursuant to section 17 of the CDDA 1986, it is possible for a director to obtain permission from the court to act as a director of a company despite disqualification.  This is only possible in certain limited circumstances. 

In determining a section 17 application, the court will look at whether a director is integral to a company's success and needs to remain a director and whether their disqualification could entail the failure of the company with a consequent loss of employment to others as well as the director themselves.

This has to be balanced against the importance of protecting the public and disqualification's deterrent effect.

Permission to act, or to continue to act, as a director is only ever granted over named companies and, depending on the reason for disqualification, is often subject to specific conditions (which are intended to ensure that the misconduct previously identified can be avoided). 

On the hearing of an application for permission under section 17 of the CDDA 1986, the Secretary of State has a duty to appear and call to the court any matters that appear to the Secretary of State to be relevant.

The court is not obliged to follow the Secretary of State's recommendations, but in practice, the Secretary of State's opinion will be influential in determining whether permission to act is granted or not.