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R3 have published the findings of some interesting research on 'dodgy directors." This brought to mind some of the legislative policy that sat behind the Insolvency Act 1986 and the Enterprise Act 2002 administration reforms, and indeed earlier Corkian ideas, that early redress to administration would help found a defence for directors against allegations of s.214 Insolvency Act 1986 wrongful trading and ultimately s.6 Company Directors Disqualification Act 1986 unfitness. Did this sort of defence incentive ever actually influence directors though? Do directors seek early redress so as to afford themselves with a defence against accusations of wrongful trading or unfit conduct? Evidence seems to suggest that these 'punitive' provisions do not in fact exercise the minds of directors who are considering insolvency options.
Back to the R3 work. The R3 report notes that the number of directors disqualified by the government for misconduct, such as fraud, has failed to keep pace with an increased number of reports of potential misconduct. R3 notes,
"The percentage of reports taken forward by the Insolvency Service (i.e. disqualifications) has halved from 40% in 2003/4 to 20% in 2009/10. Fraudulent activity is known to increase during tough economic times. In 2009/10, insolvency practitioners submitted 7,030 reports on directors' behaviour which they believed warranted further investigation. However, in that year, only 1,387 cases were concluded by the Insolvency Service."
R3's President Steven Law commented:
"This mechanism is in place to protect the general public and other businesses from dishonest directors. Not punishing directors who are blameworthy sends out a dangerous message to others."
The most common reasons for insolvency practitioners reporting directors are: failure to pay tax debts (35%); obtaining personal benefits from the company (28%) and appropriation of assets to other companies (24%).
"These are serious infringements that damage the reputation and success of UK plc", continued Steven Law. "Furthermore, R3 would like to assist the Insolvency Service in implementing an effective system which ensures that it is not just the easier cases that are pursued. It is important that the more serious offences are punished appropriately."
The report contains some interesting evidence garnered from IPs and in particular it highlights cases when directors have not been disqualified despite the insolvency practitioner reporting obvious misconduct:
"A company working in the airline industry, based in South East England.
Aspects of the director’s conduct which the IP believed warranted a report to the IS: attempted concealment of assets. The IP stated: “£250,000 was sent to a German company with no details… [this was] clearly a scam to remove money from the company to be paid back to the director.”
An electrical company, located in London.
Aspects of the director’s conduct which the IP believed warranted a report to the IS: appropriation of assets, preferential payments, personal benefits obtained by directors, overvaluing assets in accounts for the purpose of obtaining loans, or other financial accommodation, or to mislead creditors, loans to directors in making share purchases and dishonoured cheques. The IP stated that: “Funds were diverted to an associated company….which ran off with the money”.
A manufacturing company, located in the South Midlands.
Aspects of the director’s conduct which the IP believed warranted a report to the IS: attempted concealment of assets, phoenix operations, appropriation of assets to other companies, preferential payments, overvaluing assets in accounts for the purpose of obtaining loans, or other financial accommodation, or to mislead creditors, use of delaying tactics and non-payment of Crown debts to finance trading. The IP stated that this was: “probably the most clear cut case I have ever made a submission on”.
That are two main points that can be made in relation to the R3 work. First, Professor Sir Otto Kahn-Freund QC's seminal MLR article on creditor protection and limited liability abuse provides an historic piece of authority for the arguments that Mr Law outlines. Kahn-Feund's article (Kahn-Freund, O. Some Reflections on Company Law Reform (1945) 7 MLR, page 54) identified the kind of miscreant conduct that Mr Law draws our attention to highlighting the adage that plus ça change, plus c'est la même chose. Secondly, I think R3's call for mandatory director education following disqualification is eminently sensible.
"This is the ultimate statement of where the law on IVAs is to be found in our great common law...