ACCA - The global body for professional accountants

by David Kelly
04 Feb 2005

  
This article examines the way in which the law tries to prevent unsuitable individuals from acting as company directors. Such an individual can be disqualified from acting as a director for up to 15 years under the Company Directors Disqualification Act 1986 (CDDA).

The Act was introduced in an attempt to prevent the misuse of the company form. One of its specific aims was the control of the 'phoenix company'. This is a company set up by a director of a very similar company which ceased trading due to extensive debts. The new company carries on essentially the same business, but with no liability to the creditors of the former company. Such behaviour is reprehensible and is clearly an abuse of limited liability. The CDDA1986 seeks to remedy this practice by preventing certain individuals from acting as company director, but the ambit of the Act's control is much wider than this one instance.

Categories of conduct
The CDDA1986 identifies three distinct categories of conduct which may, and in some circumstances must, lead the court to disqualify certain persons from being involved in the management of companies. These are:

    a. General misconduct in connection with companies

  • Misconduct is defined as:

- a conviction for an indictable offence in connection with the promotion, formation, management or liquidation of a company or with the receivership or management of a company's property (S2 of the CDDA1986). The maximum period for disqualification under S2 is five years where the order is made by a court of summary jurisdiction, and 15 years in any other case.

- persistent breaches of companies legislation in relation to provisions which require any return, account or other document to be filed with, or notice of any matter to be given to, the registrar (S3 of the CDDA1986). Section 3 provides that a person is conclusively proved to be persistently in default where it is shown that, in the five years ending with the date of the application, he has been adjudged guilty of three or more defaults (S3(2) of the CDDA1986). This is without prejudice to proof of persistent default in any other manner. The maximum period of disqualification under this section is five years.

- fraud in connection with winding up (S4 of the CDDA1986). A court may make a disqualification order if, in the course of the winding up of a company, it appears that a person:
   - has been guilty of an offence for which he is liable under S458 of the Companies Act 1985, that is, that he has knowingly been a party to the carrying on of the business of the company either with the intention of defrauding the company's creditors or any other person or for any other fraudulent purpose
    - has otherwise been guilty, while an officer or liquidator of the company or receiver or manager of the property of the company, of any fraud in relation to the company or of any breach of his duty as such officer, liquidator, receiver or manager (S4(1)(b) of the CDDA1986). The maximum period of disqualification under this category is 15 years.


b. Disqualification for unfitness

  • This covers:

- disqualification of directors of companies which have become insolvent, who are found by the court to be unfit to be directors (S6 of the CDDA1986). Under S6, the minimum period of disqualification is two years, up to a maximum of 15 years

- disqualification after investigation of a company under Pt XIV of the CA1985 (S8 of the CDDA1986).

A disqualification order may be made as the result of an investigation of a company under the companies legislation. Under S8 of the CDDA1986, the Secretary of State may apply to the court for a disqualification order to be made against a person who has been a director or shadow director of any company, if it appears from a report made by an inspector under S437 of the CA or Ss94 or 177 of the Financial Services Act 1986 that 'it is expedient in the public interest' that such a disqualification order should be made. Once again, the maximum period of disqualification is 15 years.

The CDDA1986 sets out certain particulars to which the court is to have regard where it has to determine whether a person's conduct as a director makes them unfit to be concerned in the management of a company (S9). The detailed list of matters to be considered is set out in Schedule 1 to the Act.

In addition, the courts have given indications as to what sort of behaviour will render a person liable to be considered unfit to act as a company director. Thus, in Re Lo-Line Electric Motors Ltd (1988), it was stated that: 'Ordinary commercial misjudgement is in itself not sufficient to justify disqualification. In the normal case, the conduct complained of must display a lack of commercial probity, although... in an extreme case of gross negligence or total incompetence, disqualification could be appropriate.'

A 'lack of commercial probity', therefore, will certainly render a director unfit, but, as Vinelott J stated in Re Stanford Services Ltd (1987): '...the public is entitled to be protected, not only against the activities of those guilty of the more obvious breaches of commercial morality, but also against someone who has shown in his conduct of a company a failure to appreciate or observe the duties attendant on the privilege of conducting business with the protection of limited liability.'

Consequently, even where there is no dishonesty, incompetence may render a director unfit. Thus, in Re Sevenoaks Stationers Ltd (1990), the Court of Appeal held that the director was unfit to be concerned in the management of a company on the basis that: 'His trouble is not dishonesty, but incompetence or negligence in a very marked degree, and that is enough to render him unfit; I do not think it is necessary for incompetence to be "total" to render a director unfit to take part in the management of a company.'

c. Other cases for disqualification

  • This relates to:

- participation in fraudulent or wrongful trading under S213 of the Insolvency Act 1986 (S10 of the CDDA1986)
- undischarged bankrupts acting as directors (S11 of the CDDA1986)
- failure to pay under a county court administration order (S12 of the CDDA1986).

Disqualification orders
For the purposes of most of the CDDA1986, the court has a discretion to make a disqualification order. Where, however, a person has been found to be an unfit director of an insolvent company, the court has a duty to make a disqualification order (S6 of the CDDA1986).

The precise nature of any such order is set out in S1, under which the court may make an order preventing any person (without leave of the court) from being:

  • a director of a company
  • a liquidator or administrator of a company
  • a receiver or manager of a company's property
    in any way, whether directly or indirectly, concerned with or
  • taking part in the promotion, formation or management of a company.

However, a disqualification order may be made:

i. with leave to continue to act as a director for a short period of time, in order to enable the disqualified director to arrange his business affairs (Re Ipcon Fashions Ltd (1989))
ii. with leave to continue as a director of a named company, subject to conditions (Re Lo-Line Electric Motors Ltd (1988))
iii. with leave to act in some other managerial capacity but not as director (Re Cargo Agency Ltd (1992)).

Period of disqualification

With regard to the period of disqualification, in Re Sevenoaks Stationers (Retail) Ltd (1990), Dillon LJ in the Court of Appeal divided the potential maximum 15 year period of disqualification into three distinct brackets:

i. over 10 years for particularly serious cases (for example, where a director has been disqualified previously)
ii. two to five years for 'relatively not very serious' cases
iii. a middle bracket of between six and 10 years for serious cases not meriting the top bracket.

Penalty for breach of a disqualification order
Anyone who acts in contravention of a disqualification order is liable for either:

i. imprisonment for up to two years and/or a fine, on conviction on indictment
ii. imprisonment for up to six months and/or a fine not exceeding the statutory maximum, on conviction summarily (S13 of the CDDA1986).

Under S14 where a company is guilty of an offence under S13, then any person who consented or contributed to its so doing will also be guilty of an offence. In addition S15 imposes personal liability for company debts arising during a period when a person acts as a director while disqualified, either under an order or while personally bankrupt. The Secretary of State is required to maintain a register of disqualification orders which is open to public inspection (S18).

Re Uno, Secretary of State for Trade and Industry V Gill
The operation of the CDDA1986 was considered extensively in Re Uno, Secretary of State for Trade and Industry v Gill (2004). This case related to a group of two furniture companies which, although in severe financial difficulties, continued to trade while the directors investigated possible ways of saving the businesses. During this period one of the companies, Uno, continued to raise its working capital from deposits taken from customers to secure orders that were never to be met, as the company eventually went into liquidation.

Although the directors were advised that they could have safeguarded the deposits by placing the money in a trust account for the customers, they decided not to do so, as they needed the money to keep the business going in the short term. An application from the Department of Trade and Industry for the disqualification of the directors on the basis of this behaviour was unsuccessful. In refusing the application, the court emphasised the fact that in order to justify disqualification there had to be behaviour that was either dishonest, or lacking in commercial probity. Moreover, that behaviour had to be such as to make the person concerned unfit to be involved in the management of a company. Under the circumstances of the case the court found that the directors had pursued realistic opportunities to save the businesses and consequently were blameless for the eventual failure of the businesses and the loss to the customers.

David Kelly is examiner for Paper F4

 

Last updated: 6 Jun 2013