Fraud Insights: Director Disqualification and Compensation Orders: An Update
In August 2017, we commented on the developments and consequences arising from the Small Business, Enterprise and Employment Act 2015 in relation to director disqualification, which included the implementation of compensation orders. The Government has recently published guidance on compensation orders which will be of interest to directors and practitioners.
Compensation orders aim to make directors financially accountable for the consequences of their unfit conduct. Upon the application of the Insolvency Service, the court may make a compensation order if the director is subject to a disqualification order or has given a disqualification undertaking and their conduct has caused a quantifiable loss to one or more creditors of an insolvent company. Alternatively, a director may agree to enter into a compensation undertaking thereby avoiding court proceedings and further liability for the costs of the Insolvency Service.
The guidance makes clear that, when deciding whether to grant a compensation order, the court will consider whether a director has made any other financial contribution in recompense for the conduct. This means it is unlikely that a compensation order will be made where (1) an insolvency practitioner has taken or is going to take civil recovery action against the director (for instance, in respect of antecedent transactions such as wrongful trading or transactions at an undervalue (s.214 and s.238 of the Insolvency Act 1986)) or (2) where the director has made a contribution to the assets of the company.
There have yet to be any reported proceedings on compensation orders and therefore it remains to be seen in what circumstances compensation orders will actually be sought. However, the key question is likely to relate to identifying whether a quantifiable loss to one or more creditors of the insolvent company has been caused by the director’s conduct. The principles considered when calculating loss include: (i) the nature of the creditors and whether they have other forms of redress, (ii) the ability to readily identify the creditors affected and quantify the loss to each creditor and (iii) whether there is predicted to be a material payment to creditors.
Compensation orders could provide an additional avenue of recovery where (i) the requirements for an antecedent transaction claim have not been made out; (ii) the insolvency practitioner does not have sufficient funding to bring such a claim and (iii) a particular creditor or particular class of creditor has been especially affected. Unlike recovery from an antecedent transaction claim, compensation orders allow for the provision of compensation to a particular creditor, rather than solely a contribution to the assets of the company and so may be a popular tool where one creditor has been distinctly affected. The application for a compensation order must be brought within two years of the director’s disqualification and compensation can only be sought for conduct that occurs on or after 1 October 2015. Therefore, one significant feature of the new regime is that when considered in the context of the recent extension of the time limit to bring director disqualification proceedings, compensation orders may not be made until up to seven years after the date of insolvency, long after the limitation period for antecedent transactions has expired. Directors need to be aware about this potential liability and ensure they seek professional advice as soon as they are involved in an insolvency situation.
Some have argued that the introduction of compensation orders may decrease the instances of directors agreeing disqualification undertakings on the basis that these may well lead to compensation orders and that directors may well be more inclined to fight disqualification on issues of principle. However, it is clear that directors, criticised for conduct post October 2015 should not be considering providing undertakings without dealing with the issue of compensation at the same time. Again, it is wise for directors in such a situation to seek legal advice as soon as they become aware of a potential investigation by the Insolvency Service.
Whilst the new guidance focuses mainly on the loss caused to creditors, it is worth remembering that the amount of compensation will also be determined by reference to the nature of the director’s conduct that caused the loss. However, there appears to be some scope for representations to be made on behalf of the relevant director. Mitigating factors should also be highlighted when the Insolvency Service is deciding whether to pursue a compensation order in the first place. The guidance clarifies that such an order will only be pursued when it is in the public interest and so it will always be worth engaging with them on this.