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The Company Directors Disqualification Act 1986: will it affect me and why?
The
legislation
The
CDDA came into force on 29 December 1986 . It repealed and
consolidated the disqualification provisions in the Companies
Act 1985 and the Insolvency Acts 1985 and 1986. It deals
with information that an insolvency practitioner "IP" provides
to the director disqualification unit at the DTI and gives
guidance on what might constitute unfit conduct.
The
reporting duties of an IP
The
reporting requirements are dealt with under section 7 of
the CDDA. The detailed provisions are contained in The Insolvent
Companies (Reports on Conduct of Directors) ( Scotland )
Rules 1996 "the reporting rules" which came into force on
20 September 1996 . The procedure for disqualification applications
is laid down in The Insolvency Companies (Disqualification
of Unfit Directors) Proceedings Rules 1987 (as amended by
The Insolvent Companies (Disqualification of Unfit Directors)
Proceedings (Amendment) Rules 1999) "the proceedings rules"
and with guidance notes issued by the DTI.
Section
7(3) of the CDDA places a duty on an IP to submit a report
to the DTI as soon as he thinks that:
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his
conduct as a director of that company either taken alone,
or taken together with his conduct as a director of
any other company or companies, makes him unfit to be
concerned in the management of a company.
The
reporting rules require an IP to submit either a report
or a return no later than six months after initial appointment
in a formal insolvency process, or sooner in the case of
earlier vacation of office.
When
reporting to the DTI, an IP has due regard to the reporting
rules and schedule 1 of the CDDA which lists certain matters
to be considered by the court in determining whether the
conduct of a director in relation to the affairs of a company,
or companies, makes that person unfit to be a director of
companies generally. The list is not exhaustive and the
decision whether to initiate disqualification proceedings
is made by the DTI. The DTI considers the matter of unfitness
reported, together with any matters reported on previous
occasions and any other relevant information available.
When
forming a view of whether conduct is unfit, an IP tries
not to be pedantic about isolated technical failures. For
example, the occasional lapse in filing annual returns etc.
would not normally be seen as a major issue and an IP will
be objective about each director's conduct.
R3,
an insolvency governing body, formerly know as the Society
of Practitioners of Insolvency, has issued Statements of
Insolvency Practice "SIP", two of which are relevant when
discharging an IP's reporting duties under CDDA. SIP2 (
Scotland ) "a liquidator's investigation into the affairs
of an insolvency company" and SIP4 ( Scotland ) "disqualification
of directors" are the relevant ones to check.
If
proceedings begin against a director, the IP will be asked
to prepare a further detailed statement, and may be called
to give evidence in court. Court proceedings can take several
years to settle.
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The
director disqualification unit
The
Scottish director disqualification unit of the DTI is based
in Edinburgh . The CDDA contains other provisions which
enable disqualification applications to be made, but the
director disqualification unit deals with applications based
on unfit conduct reports from IPs.
Upon
receiving a report, the DTI considers it carefully and is
responsible for determining whether, on the face of the
information provided, there is sufficient unfit conduct
for it to be in the public interest to seek disqualification
and if so, from reading the report and any other information
which the DTI holds, whether adequate evidence appears to
be available. The DTI will liaise with the IP and prepare
a draft report for the IP to review and swear.
The
DTI arranges for legal input from a solicitor or counsel
as appropriate. An application is taken through court by
the solicitor/counsel appointed by the DTI and can be heard
in a sheriff court or the court of session.
How
does the DTI decide when to apply for disqualification?
Every
report is considered on its merits and if the DTI considers
that the director is unfit to be concerned with the management
of a company, an application for disqualification is instigated.
Clearly,
all evidence must be sound and of substance because the
court regards disqualification as a severe restriction on
the rights of an individual. The DTI must be satisfied that
there is a reasonable prospect of success because the disqualification
process can be lengthy and expensive: hence the DTI must
have due regard to the proper use of government funding.
It is not appropriate to seek disqualification based on
unsubstantiated assertions, presumptions or assumptions,
or a general feeling of "unhappiness" about the conduct
of the director, or the circumstances surrounding the failure
of the company.
Since
the introduction of the Insolvency Act 2000 the DTI have
offered a director the opportunity to sign an undertaking
which, as with a disqualification order, will be for a period
of between two and fifteen years. The more severe the cause(s)
of unfit conduct, the longer the term. An undertaking avoids
the need for lengthy and expensive court proceedings and
specialist advice is required at an early stage from an
independent licensed insolvency practitioner regarding the
most appropriate route to follow.
Reporting
dates
The
CDDA says that an application must be made within two years
of the date of formal insolvency but the court may allow
the DTI to make an application after the statutory two year
period. However, several judicial decisions have made it
clear that such leave will not be granted readily and that
the DTI must show good reason for leave to be granted. In
assessing whether there are good grounds for granting leave,
the court can consider the length of delay, the reasons
for it, the strength of the case and the degree of prejudice
to the defendant(s).
The
late submission of an unfit conduct report by an IP to the
DTI is not sufficient grounds for a late application to
court and thus, an IP will concentrate his enquiries from
the outset of his appointment such that the report can be
submitted timeously.
It
is an offence to hinder an IP in discharging his duties
and thus, unlikely that a delinquent director will be able
to avoid an adverse report being submitted by delaying the
provision of information. An IP has a number of options
available to him to compel the provision of information/representations
and, at all times, the cost effectiveness of the options
will be weighed against the requirement to observe the two
year deadline.
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Preparing
the DTI report
If
an IP forms the opinion that the DTI should be advised of
the actions of a person whose conduct as a director, either
taken alone or together with his conduct as a director or
any other company or companies, makes him unfit to be concerned
in the management of a company, the IP will give due thought
to:
A
report will list all the directors, including shadow and
de facto directors of the company, and any other person
who appears to have been a director or shadow director in
the three year period immediately before the date of formal
insolvency. It is only those directors which the IP considers
unfit that will be highlighted for the DTI's attention.
The
fact that a director is living abroad does not preclude
the DTI from seeking disqualification and will not stop
an IP from submitting a report. If a director cannot be
traced it may prevent proceedings being brought, but the
DTI often locate directors by using tracing agents.
Shadow
or de facto directors
The
DTI want to be advised of anyone who acted as a director
whether or not each person was formally appointed.
The
term "de facto" director includes any person occupying the
position of director, by whatever name called, if that person
has not been formally appointed. Several court cases have
shown that proceedings against such people succeed if a
high standard of evidence is produced to show that they
acted as directors.
A
"shadow director" means a person in accordance with whose
directions or instructions the appointed directors of the
company are accustomed to act. However, a person is not
treated as a shadow director merely because the directors
act on advice he gives in a professional capacity. The fact
that one member of a board acts on the instructions of a
third party does not necessarily mean that the third party
is a shadow director: the capacity to influence the whole
board, or at least a majority, is the key issue.
Thus,
even if a person was not an appointed director in terms
of documentation filed at companies house, he can still
be subject to disqualification action at the instance of
the DTI.
Unfit conduct
Unfit
conduct is described in schedule 1 of the CDDA 1986 which
states the types of evidence needed to support an allegation.
Evidence should be viewed in the context of the duties of
all directors, which may be summarised as:
Unfit
conduct falls within the following general categories:
Whatever
the nature of unfit conduct, the IP will have to determine
who was responsible, when did it happen, and what are the
sums involved. An IP will always consider the materiality
of matters of unfitness and, for example, may ask:
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Matters
to consider in determining unfit conduct
Misfeasance
or breach of duty
-
have directors
received any money or other consideration from the
company, except for proper remuneration for services
provided, which has resulted in a material loss to
the company? When did this take place and what was
the company's financial position at the time?
-
has a director
been responsible for the non-disclosure to the company
of any contracts, dealings or other transactions in
which the company's assets or property, including
goodwill, were used and resulted in a material loss
to the company?
-
has the director
been responsible for any material loss to the company
through the sale, assignment, transfer or other disposal
of any company assets or property, except in the normal
course of business?
If
the answer is yes to any of the above questions, then loss
requires to be quantified and the director(s) asked by the
IP to provide an explanation(s) for their actions.
Breach
of duty can cover many matters of unfit conduct. Examples
might be failing to forward pension contributions deducted
from employees, or allowing the company to make loans for
which it received no benefit. An allegation covers any conduct
by a director which was not in the proper interests of the
company or where such director appears to have operated
to the detriment of creditors, employees, shareholders or
other stakeholder groups.
Misapplication
or retention of company money or property
- Has a director retained or misapplied, or been responsible
for the retention or misapplication of, any money or other
company property resulting in an obligation to account
which has not been fulfilled, or a trading, capital or
other loss?
Transactions
defrauding creditors
- Matters to consider under this heading include disposal
of any of the company's property, assets or undertaking
a transfer, gift at significant undervalue for the purpose
of placing such assets beyond the reach of the company,
its members or creditors.
- Each director's responsibility will be determined and
any explanations given made available to the DTI. Also,
it may be that the IP becomes aware of a company selling
goods which are the property of a third party. In this
regard, matters for consideration by the IP will include:
Failure
to comply with the Companies Acts 1985 and 1989
Accounting
records
The
IP will have uplifted, or at least sought recovery of, all
accounting records. This will be reviewed in order to determine
if everything has been provided. If not, an IP will advise
the DTI why other people may be holding company records
and what steps have been taken to obtain them.
If
the accounting records are not produced or are inadequate,
and the lack of information/ records cannot be explained
adequately, the director(s) will be asked for an explanation
before an adverse report is submitted. In terms of accounting
records generally, the IP will wish to assess if the company
kept accounting records regularly, recording all transactions,
assets and liabilities as required by section 221 of the
companies act 1985. If inadequate accounting records were
kept the IP should enquire about each director's responsibility
for the default. He will note the explanation each director
gives and is likely to ask if an accountant or bookkeeper
was employed.
If
reasonable accounting records were kept, the IP's enquiries
will include:
-
have the inadequacies hindered the IP's administration
of the insolvency? For example, the collection of book
debts, verification of creditors' claims, identification
of assets belonging to the company, and benefits received
by the directors?
In
general terms of corporate governance and responsible approach
to acting as a director, an IP will also turn his attention
to:
Preservation
of accounting records
Statutory
records
Annual
returns
Minute
book
A
company's minute book can be an important source of information.
Often it provides evidence of what information was available
to the directors and what action they took at various points
in time. Thus, the IP will want to know if a minute book
has been kept and written up.
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Causes
of failure and insolvency
The
DTI will want to know the extent of each director's responsibility
for the causes of a company becoming insolvent. Such conduct
can be categorised in terms of:
-
trading
without regard to the interests of creditors, and shareholders,
through incompetence or negligence, or
Trading
without regard to the interests of creditors
In
this aspect of his enquires, the IP will ask
-
having regard to the size and nature of its business
and their own professional qualification and experience,
did the directors have available enough financial information,
management accounts, feasibility studies or professional
advice, to make effective policy decisions?
Trading
without reasonable prospect of paying creditors' claims
In
addition to those matters set above, the following considerations
would also be addressed:
-
is the date in a. above evidenced by accounting information,
decrees/claims, threatening letters, dishonoured cheques,
attachment orders, PAYE or VAT arrears?
-
was professional advice ever received about continued
trading? If so, what advice was given, when, by whom,
and on what information was such advise based?
-
to what extent was the continuation of the company's
trading facilitated by withholding crown monies? By
its forbearance, has the crown suffered disproportionately
to the creditors generally? Over what period, compared
with other creditors, has the crown debt accrued?
-
with regard to f. above, what level of funds was introduced
directly or indirectly by the directors in the relevant
period? If debts have been guaranteed, will those guarantees
be honoured? What is the extent of collateral security?
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Crown
debts
The
level and age of debts due to the crown when formal insolvency
incepts, e.g. VAT, PAYE and NIC are not, of themselves,
evidence of unfit conduct. The existence of crown debts
can provide evidence of a company's inability to pay its
debts and if an IP is to make a specific allegation in relation
to crown debts, he will wish to demonstrate that:
-
that the forbearance of the crown departments has been
abused when, for example, deferred collection arrangements
have been agreed but not complied with, to the detriment
of the crown.
Phoenix
companies
These
are companies which rise from the ashes of the old one,
and appear to be trading along similar lines with the same
directors. An IP will consider how far the business
of the company under consideration was the successor of
an earlier failed company. Considerations will include the
time elapsed between two, or more, failures and how far
the same people were responsible for managing each company.
Enquiries are likely to focus on questions such as:
-
how similar is any business acquired and continued?
For instance, did the successor company continue the
same contracts or deal with similar customers? Was the
workforce substantially unchanged? Did the successor
company use the same or similar trading style, advertising
material etc?
Consumer
prepayments/deposits
The
fact that a company has taken customer deposits and failed
to deliver goods or services does not automatically constitute
unfit conduct on behalf of a director. It would be appropriate
for an IP, or the DTI if a report has been lodged, to source
evidence that such failure was not readily excusable. Thus,
an IP might focus his enquiries on whether the company was
using deposits for general trading purposes at a time when
orders were not being met on time, such that the company
was jeopardising deposits without realistic prospect of
delivering the goods or services, or being able to repay
deposits.
If
it can be shown that a company had neither the intention
nor the ability to deliver the goods or services, the taking
of deposits may well constitute unfit conduct even if the
company is, or was, solvent at the time the deposit was
taken.
Finally,
if the company's treatment of deposit money is in breach
of the express terms of a contract, the receipt and handling
of such deposits may amount to unfit conduct. If the IP
submits an adverse report relating to deposits, his report
is likely to address the following issues:
-
did the company ever maintain a separate bank account
e.g. trust account, into which deposits were, or should
have been, paid?
-
what, if any, explanation has been offered by each director
for the failure to supply goods or services, or to give
refunds?
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Transactions
at an undervalue, preferences and dispositions of property
Matters
that can be put before the court are those for which an
application has been, or could reasonably be made, for an
order of the court to set aside a transaction under sections
242 or 243 of the Insolvency Act 1986. Such an application
would be required to highlight any benefit to a director
or connected person(s), at a time when the company was insolvent
or which exacerbated the failure of the company. Thus, the
details sought would include:
Duty
to assist the IP and to deliver property
Sections
234 and 235 of the Insolvency Act 1986 place a legal requirement
on directors to co-operate with the IP. As part of the review
of a director's unfit conduct, the IP will advise the DTI
if:
-
a director has failed to deliver to the IP when requested,
any property, books, papers or records of the company.
In
finalising his DTI submission the IP will be invited to
advise:
In
conclusion, anyone providing advice to directors of a company
in financial distress will require to be conversant with
the operation and requirements of the CDDA. Frequently,
in order to avoid a potential challenge to their professional
advice, advisors not fully acquainted with insolvency legislation
and director disqualification procedures refer clients to
a licensed insolvency practitioner.
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Scottish
references
The
primary legislation is the Insolvency Act 1986 and the CDDA
and reporting provisions are set out in The Insolvency Companies
(Reports on Conduct of Directors) ( Scotland ) Rules 1996.
The
statutory forms used in Scottish cases are D1(Scot) and
D2(Scot).
The
procedure for making applications to the sheriff court is
set out in the Act of Sederunt (Company Directors Disqualification)
1986 and the Rules of the Court of Session. The detailed
provisions of the Insolvent Companies (Disqualification
of Unfit Directors) Proceedings Rules 1987 (as amended by
The Insolvent Companies (Disqualification of Unfit Directors)
Proceedings (Amendment) Rules 1999) do not apply in Scotland
.
Court
proceedings in Scotland tend to follow the following process:
Petition:
Court of Session receives DTI petition.
Summary
application: Sheriff Court receives the DTI application.
Answers:
sets out the defendant's case in answer to the petition/application
Adjustments:
submitted by both parties until agreement on content or
entrenched disagreement is reached.
Debate:
to dispose of preliminary pleas in law.
Proof
before answer: general points agreed but pleas in law are
outstanding.
Proof:
the final hearing of the case. Each side calls witnesses
to support the facts of the case.
Contact
Scottish
cases are dealt with by:
Director
Disqualification Unit ( Scotland )
J Floor
B Block
Argyle House
3 Lady Lawson Street
Edinburgh
EH3 9SA
Telephone:
0131 222 6531
Fax: 0131 222
6565
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