Directors' duties

A director owes a variety of duties, primarily to the company to which he or she is appointed, but also in certain circumstances, to its shareholders, its creditors and the state. A director's general duties, originally based on common law rules and equitable principals, are codified under the Part 10 of the Companies Act 2006 and include the duty to act in a way which is most likely to promote the success of the company for the benefit of its members, the duty to avoid conflicts, the duty to exercise independent judgement and the duty to exercise reasonable care, skill and diligence. The majority of the duties are fiduciary in nature, i.e. they reflect the relationship of trust and confidence that exists between a director and the company to which he or she is appointed.

Outside of the company, directors' duties extend to third parties in certain situations, for example duties to the state to file returns and accounts and comply with health and safety legislation.  Critically, a director has a duty to act in the interests of the company's creditors from the point at which he or she knows or should know that the company is or is likely (in the sense of probable) to become insolvent, in which case its assets should be preserved to discharge its liabilities.

Where a director breaches his fiduciary duties, he is at risk of a claim for misfeasance from the company, its liquidator or in limited circumstances, derivative claims from its members. With the exception of a breach of duty of care, skill and diligence (for which the remedy remains damages), remedies for breach of fiduciary duties include injunctions, setting aside of the transaction, restoration of company property and compensation, which is payable to those to whom the director owes his duties, therefore primarily to the company itself, rather than to any individual member or creditor of the company. 

Disqualification proceedings

Whether arising pre or post insolvency, breach of a director's duties can lead to disqualification proceedings being brought against the director under the CDDA, together with compensation claims in circumstances where the company became insolvent. Disqualification proceedings can also be brought under s.10 CDDA where a director of an insolvent company is found liable for wrongful or fraudulent trading under s.213 or s.214 of the Insolvency Act 1986.

The CDDA applies to de jure directors (i.e. those formally appointed as directors), de facto directors (those who act as directors without having been validly appointed) and shadow directors. For the purposes of CDDA, a shadow director is a person in accordance with whose direction or instructions the directors of a company are accustomed to act[1]. The CDDA also applies, as detailed further below, to persons whom the court is satisfied have influenced the director in question.  

Applications for disqualification under the CDDA may be brought where a person has been convicted of an indictable offence in connection with the promotion, formation, management, liquidation or striking off[2] of a company (s.2 CDDA), where they have persistently breached statutory filing requirements (s.3 CDDA) or where they are guilty of any fraud in relation to the company (s.4 CDDA). Such applications may be brought by the Secretary of State, but also by the Official Receiver or any liquidator, member or creditor of the company in relation to which the person against whom the order is sought is alleged to have committed the offence or other default.

Applications may also be brought where the court is satisfied that the person is or has been a director of a company which has at any time become insolvent and the court is satisfied that the person's conduct as a director of that company makes the person unfit to be concerned in the management of a company (s.6 CDDA), or where the court is satisfied that a person’s conduct in relation to the company makes him unfit to be concerned in the management of a company (s.8 CDDA).  Such applications may be brought by the Secretary of State or (in the case of s.6 CDDA) the official receiver on the direction of the Secretary of State where the company is in compulsory liquidation.

Notably, although creditors can bring such proceedings under sections 2, 3 and 4 CDDA, there is no specific compensation regime for creditors provided for under the CDDA where a director is disqualified on criminal grounds. Any fines arising as a result of the offence are payable to the Crown. In contrast, compensation orders which benefit specific creditors are available as part of disqualification proceedings brought on the civil grounds of unfitness under s.6 CDDA in relation to directors of insolvent companies, or otherwise for unfitness by the Secretary of State under s.8 CDDA in relation to solvent companies.

The Secretary of State's powers to bring proceedings under s.8 CDDA were previously restricted to circumstances where a solvent company was subject to investigation, and it appeared to the Secretary of State from 'investigative materials' gained in those investigations, that the director was unfit to be concerned with the management of a company. That restriction was lifted under the Small Business, Enterprise and Employment Act in 2015. As a result, the Secretary of State may now rely on any information (whether or not arising as part of formal investigations) in considering whether it is in the public interest for a director to be disqualified. However, the company must still fall within the definition of 'company' under the CDDA, which refers to companies either registered under the Companies Act 2006 in Great Britain, or which may be wound up under Part V of the Insolvency Act 1986 (i.e. unregistered companies). Where a company has been dissolved, the Secretary of State has no power to pursue its former directors under s.8 CDDA. Until the coming into full force of the Act, the position was the same under s.6 CDDA for companies dissolved without first having been in an insolvency proceeding.

The Insolvency Service will assist the Secretary of State in conducting the necessary investigations for the purposes of deciding whether an application for a disqualification order should be made, and will consider any misfeasance or breach of fiduciary duty by the director as part of those investigations. The Insolvency Service is supported in this process by the fact that, since May 2015[3], creditors' voluntary liquidators, administrators and administrative receivers are obliged under the CDDA to make a report to the Secretary of State in relation to the conduct of each director of the insolvent company to which they are appointed.

Where proceeding are brought, on a finding of unfitness under s.8 CDDA, the court has discretion to make the disqualification order, but under s.6 CDDA, the court is obliged to make it. The minimum period of disqualification is two years and the maximum period is 15 years. However, in each case, the director or shadow director may offer a disqualification undertaking to the Secretary of State, effectively agreeing not to act as a director for up to 15 years, which if acceptable, will remove the need for a disqualification order to be made.

Where a director is disqualified on the grounds of unfitness, or has given a disqualification undertaking in relation to the same, any person who the court is satisfied influenced that person can also be disqualified as a director. If the company is insolvent, both the director in question and any person found to have influenced them, can be subject to a compensation order. The amount ordered to be paid will be based on the amount of the loss caused and the nature of the conduct which led to the loss to one or more creditors. Amounts payable under compensation orders can be for the benefit of specific creditor(s) or classes of creditor or payable as a contribution to the company's assets. Therefore, disqualification proceedings can offer individuals prejudiced by a director's conduct a mechanic by which to receive compensation, rather than seeing any recoveries paid to the company's estate for the benefit of its creditors generally, for example as a result of wrongful trading proceedings under s 214 of the Insolvency Act 1986.

The need for reform

Prior to the coming into force of the relevant provisions of the Act, the ability to seek to disqualify a director on the grounds of unfitness was restricted to circumstances in which the company was still 'live' or had at any time “become insolvent”, meaning that it had been the subject of insolvent liquidation, administration or administrative receivership. However, where a company was dissolved without first having become insolvent, there was no ability for the Secretary of State to pursue its directors for disqualification on the grounds of unfitness unless and until the company was restored to the Register of Companies. This meant incurring the additional time and cost of  applying to court for restoration given the administrative restoration regime, by which application for restoration can be made direct to the Registrar of Companies rather than the court, is only available to directors or members themselves and therefore unlikely to be of great assistance in relation to pursuing errant directors.

Sections 6, 7, 8ZA and 8ZB CDDA have now been amended so that their provisions extend to directors of companies which have been dissolved without first becoming insolvent. Proceedings can be taken against the former director in the three year period following the date of dissolution. Such dissolution would arise, for example, where a director voluntarily strikes off a company from the Register of Companies under s.1004 Companies Act 2006 (CA06). It is an offence if a director acts in contravention of the specific requirements of s1004 CA06, (which prohibit further trading and use of the company name once the application for voluntary strike off has been made). It is also an offence if a director fails to comply with statutory filing requirements – which could lead to the Registrar of Companies taking action to strike off a company under s.1000 CA06. Where an offence was committed, the Secretary of State could previously have relied on its powers under s.2 CDDA to pursue former directors for disqualification. With the changes to CDDA introduced under the Act, the ability of the Secretary of State to pursue directors of dissolved companies for misconduct has now been widened.  

In announcing the changes, the Government has emphasised the increased ability of the Insolvency Service to "tackle unfit directors who dissolve companies to avoid paying their liabilities", and specifically to "tackle directors dissolving companies to avoid repaying Government backed loans put in place to support business during the Coronavirus pandemic"[4]. It will be interesting to see, in practical terms, the extent to which the amendments increase the number of disqualifications orders and disqualification undertakings, which in the period April 2018 to March 2021, saw a decline from 217  orders and 1029 undertakings, to 121 orders and 860 undertakings being obtained. The fact that the court is obliged to disqualify a director where they are found to be unfit under s.6 CDDA (as opposed to this being a discretionary matter), means that with the extension of s.6 CDDA, there is potential for the number of disqualification orders to increase. However, given the company will not have become insolvent (within the meaning of the CDDA) prior to dissolution, there will be no office holder responsible for reporting on the conduct of its directors prior to dissolution. It appears, therefore, that the Insolvency Service will be heavily reliant on creditors of a dissolved company to raise concerns regarding its directors' conduct in order to initiate their investigations. The fact that creditors may be able to benefit personally from any resulting compensation orders (which would not be the case if directors were struck off following criminal actions) may encourage such involvement. Any creditor hoping to receive compensation, however, should tread carefully – the Insolvency Service, in its guidance Dissolved Company Investigations, makes it clear that the primary purpose of any investigation is to protect the general public or the business community, not the repayment or recovery of assets for creditors, and that before it will consider bringing a case the Insolvency Service must be satisfied that the expense (as the costs are paid for from taxpayer money) is justified.