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Directors – Beware of Compensation Orders!

06 Nov 2019

Many directors will be aware of the company director disqualification regime that has now been in force for over 30 years. Currently, each year approximately 1200 directors are made subject to either a disqualification order imposed by the Courts or agree to give an undertaking that prevents them from being a director or concerned in the management of a company for between 2 to 15 years.

Most directors targeted for disqualification by the Insolvency Service do not contest the matter, with consistently well over 80% opting to give an undertaking without ever reaching the Courts.

However, recent changes to the Company Directors Disqualification Act 1986 (CDDA) have substantially increased the risks to directors by enabling the Courts, in appropriate cases, to make a compensation order against a disqualified director where the conduct of that director “has caused loss to one or more creditors of an insolvent company of which the person has at any time been a director.”

The impetus for this change is that, although a disqualification order will protect society from the future activities of an errant director (at the risk to the director of criminal sanction if breached), it will not (of itself) compensate those who have already suffered loss. The objective of a compensation order is to:-

  • Disgorge any profit made by the errant director resulting from his (or her) unfit conduct; and
  • Enable those (particularly creditors) to receive recompense for their existing losses without the need for separate litigation, rather than merely the vicarious “pleasure” of seeing the errant director prevented from acting in the future.

It should be noted that compensation orders are a new, free standing regime and must be interpreted as such, with liability being based not on loss to the relevant company but on loss to its individual creditors. The Court must however have regard to whether the director has made any other financial contribution in recompense for the conduct (whether under a statutory provision or otherwise), so that the director does not face a double liability.

The first compensation order was made earlier this month (November 2019) in the case of Re Noble Vintners Limited [2019] EWHC 2806 (Ch). The Court found the conduct of the director to be unfit (by reason of him having misappropriated the sum of £559,484) and disqualified him for the maximum of 15 years. The Court noted that the liquidator had insufficient funds with which to pursue the director. It therefore made a compensation order against the director in the sum of £559,484.

As for the division of the compensation order amount, the Court held that there were 28 creditors whose debts (totaling £460,067) accrued after 2 November 2015 (being the date that the director took over sole control of the company) and at whose direct expense the director benefited himself. The balance of £99,416 of loss was ordered to be paid as a contribution to the assets of the company, out of which the liquidation fees and expenses were to be paid and to allow a distribution to the creditors generally. All recoveries were to be attributed pro-rata between the two classes (creditors and liquidator) in the event that the full amount of the compensation order was not recovered.

New Law

Although Re Noble Vintners Limited concerned an egregious case of misappropriation by the director, the scope to make compensation orders is much wider than such conduct and it is expected that in future cases the Insolvency Service will target directors who have continued trading “beyond the point of no return” for the company, irrespective of whether or not the directors have personally enriched themselves at the direct expense of creditors.

Conclusions

There are lessons from this case for both directors and creditors.

For directors of companies facing financial difficulties, their risks of being held personally liable for their actions have markedly increased; it is not limited to “merely” giving a disqualification undertaking after their company has entered administration or insolvent liquidation with no further adverse consequences. Prudent directors will document their actions and why they are believed to be in the best interests of creditors. They will also seek independent advice from either a licensed insolvency practitioner or specialist insolvency solicitor as to whether continued trading can be justified or whether the company should enter into a formal insolvency procedure such as administration. Needless to state, directors who believe that they may be at risk of disqualification and/or a compensation order should seek urgent legal advice.

For creditors, particularly for those who have continued to supply the company up to the point of its “death”, compensation orders (which can only be made on the application of the Secretary of State) open up a new potential means for the recovery of their losses. This will become more important when the imminent reintroduction (from 6 April 2020) of preferential treatment of the Crown for unpaid PAYE/NIC and VAT will serve to diminish the pool of assets available for distribution for trade and other general unsecured creditors in a liquidation.

Finally, it must be emphasised that this is a new area of law and, as such, the understanding of how it operates in practice will continue to evolve as future cases make their way through the Courts.

For further information, please contact Neil Harrold, or call 0191 232 8345.