When faced with a criminal or regulatory investigation, the usual ‘worst case scenario’ for an individual is the prospect of imprisonment, fines or regulatory prohibition. However, there is another sanction which, whilst on its face may seem a less severe, has the potential to wreak the same devastation on careers and reputations as (for example) a prison sentence or regulatory prohibition. Furthermore, the possibility of that sanction is weaved through various criminal and civil regimes, and can be imposed on a finding by a court of sufficiently severe incompetence or negligence, as well as dishonesty or deliberate misconduct.
The power for a court to disqualify a person from acting as a company director is consolidated in the Company Directors Disqualification Act 1986 (the Act), although the circumstances in which the court may or (in some cases) must exercise that power vary significantly:
- Under Section 2, where a person is convicted of an indictable offence in connection with the promotion, formation, management, liquidation or striking off of a company, or in connection with the receivership of a company’s property or being the administrative receiver of a company.
- Under Section 3 and Section 5, for persistent convictions or breaches related to Companies House filing requirements.
- Under Section 4, where a person appears to have been guilty (although not necessarily convicted) of fraud or any breach of duty as an officer, liquidator, receiver or administrative receiver in the course of the winding-up of a company.
- Under Section 5A, where a person has been convicted of an offence abroad, where such a conviction could give rise to disqualification under Section 2 had it taken place in England & Wales or Scotland.
- Under Section 10, where a court has made a declaration that a person is liable to make a contribution to a company’s assets as a result of wrongful or fraudulent trading.
All of the above confer a discretionary power on the court to make a Disqualification Order. However, Section 6 sets out conditions in which the court must make a Disqualification Order.
The first condition is that:
i) A person is or has been the director of a company which has at any time become insolvent, whether while that person was a director or subsequently; or
ii) Since February 2022, and in response to a perceived abuse of Covid-19 support schemes, a person has been the director of a company which has at any time been dissolved without becoming insolvent, whether while that person was a director or subsequently.
The second condition is that the person’s conduct as a director of that company (either taken alone, or together with that person’s conduct as the director of one or more other companies), makes that person ‘unfit to be concerned in the management of a company’. If both conditions are fulfilled, the court must disqualify that person for at least two years.
Section 8 also makes a general provision for the Secretary of State to apply for a Disqualification Order outside of an insolvency in respect of a person believed to be unfit to be concerned in the management of a company, where it is considered ‘expedient in the public interest’ to do so.
Separately, Section 9A requires the court to make a Disqualification Order where (i) a company of which a person is a director commits a breach of competition law and (ii) the court considers that his conduct as a director makes him unfit to be concerned in the management of a company. The prospect of this sanction is a key part of the Competition & Markets Authority’s whistleblowing, cooperation and leniency regime. In particular, it is the CMA’s published policy that, where a company is ‘first through the door’ to report a previously unknown cartel, its directors will be immune from disqualification proceedings.
In certain circumstances, it is possible for the subject (or potential subject) of a disqualification application to agree a Disqualification Undertaking. This has the same effect and potential penalties as a Disqualification Order, but gives the subject the opportunity to minimise the time and cost of court proceedings.
Test for unfitness
Statute sets out a number of conditions that the court, or the Secretary of State, must take into account when deciding whether to apply for or make a Disqualification Order, or accept a Disqualification Undertaking. These are set out in Schedule 1 of the Act and can be summarised as:
i) The extent and frequency to which the subject was responsible for the causes of any material legislative contravention by a company.
ii) The extent and frequency to which the subject was responsible for the causes of a company becoming insolvent.
iii) The nature and extent of any harm caused, or potential harm caused, by the subject’s conduct in relation to a company.
iv) Any misfeasance or breach of fiduciary duty by the subject, and the frequency thereof.
v)Any material breach of legislative or other obligations that arise as a result of being a company director, and the frequency thereof.
In applying the Act and the Schedule 1 factors, case law has consistently emphasised that mere incompetence or negligence is not sufficient to justify disqualification. Rather, in the absence of dishonesty or deliberate misconduct, the failings must be especially severe. This has been variously expressed as:
‘Commercial misjudgement is not sufficient to warrant disqualification. The conduct must be morally culpable, and such as to require protection of the public by means of disqualification. However, a case of really gross incompetence might suffice… In the normal case, the conduct complained of must display a lack of commercial probity, although I have no doubt that in an extreme case of gross negligence or total incompetence disqualification could be appropriate.
— Re Lo-Line Electric Motors Ltd (1988) Ch. 477
‘To reach a finding of unfitness the court must be satisfied that the director has been guilty of a serious failure or serious failures, whether deliberately or through incompetence, to perform those duties of directors which are attendant on the privilege of trading through companies with limited liability.
— Re Bath Glass Ltd (1988) 4 BCC 130)
Case law has also consistently emphasised that the purpose of the disqualification regime is to protect the public interest, both by protecting members of the public from companies being run incompetently, negligently, dishonestly or otherwise abusively, and maintaining standards in the regimes of limited liability companies and partnerships. With that in mind, Re Keeping Kids Co  EWHC 175 (Ch) held that different standards could and should be applied, according to the position and expectations of the directors concerned. In particular, it was in the public interest that the conduct of non-executive charity trustee directors be considered in the context of the roles and responsibilities that they had accepted. If not, it would likely discourage otherwise capable people from taking on such roles for fear of being exposed to disqualification proceedings. The same judgment also concluded that an application for a Disqualification Order must be considered on the merits (or lack thereof) of an individual director’s conduct. It was not sufficient to say that he had been part of a group of directors who had collectively failed to reach an expected standard.
Unsurprisingly, the effect of a Disqualification Order or Undertaking goes beyond prohibiting a disqualified person from being legally appointed as the director of a company, but extends to in any way, directly or indirectly, being concerning or taking part in the promotion, formation or management of a company without the specific leave of the court. It also prohibits that person from acting as the receiver of a company’s property, or as an insolvency practitioner. Breach of a Disqualification Order or Undertaking is a serious offence, carrying a maximum sentence of two years’ imprisonment. Furthermore, a person who acts in contravention of a Disqualification Order or Undertaking risks being made personally liable for the debt of a company that he is involved in managing.
When making a Disqualification Order, or accepting a Disqualification Undertaking, in relation an insolvent or dissolved company, the court may order the subject to pay compensation to any creditor of that company where they have suffered loss as a result of his conduct.
A Disqualification Order or Undertaking may also have ramifications outside the management of companies. For example, it is an automatic bar to acting as a charity trustee, and is undoubtedly a matter that the Financial Conduct Authority would expect an authorised person to disclose to them.
The challenge for those at risk is that, even in an insolvency, the prospect of disqualification proceedings is usually a secondary consideration, if it is considered at all. However, as set out above, the consequences of a Disqualification Order are extremely serious. As such, it is important for any person involved in the management of a company, where there are investigative proceedings (be they criminal, regulatory or insolvency-related) to take care to ensure that the responses and actions taken do not inadvertently increase the risk of disqualification proceedings once the substantive matter is concluded. Similarly, if it becomes apparent that disqualification proceedings are being contemplated, it is important to take proactive preparatory steps. This may firstly prevent any application proceeding and, if not, ensure that you are in the best possible position to respond.