R3 say - "Three in four 'dodgy' directors go unpunished" - defining a 'dodgy director' and is it not the court's function to disqualify directors?

19 OCT 2009

The Association of Business Recovery Professionals (R3) have issued an interesting press release entitled, "Three in four ‘dodgy’ directors go unpunished." The piece raises a number of interesting issues. First, how do you define a 'dodgy director'? Is it someone who has been found s.6 CDDA86 unfit? Secondly, whose responsibility is it to punish directors? The Insolvency Service (IS) or the Courts or even Lord Mandelson? What does the legislation say? Section 6 of the CDDA86 notes that is is the duty of the court to disqualify unfit directors of insolvent companies (section 1). These sorts of issues will certainly be of note to the well paid phoenix four directors of MG Rover. The Lord Mandelson has recently been reported in the Times as preparing to 'ban the phoenix four.' Does he have the power to do this as Secretary of State for BIS, or is it the courts function? Going back to the R3 press release, it notes (with some bold and [square bracketed] insertions by me):

"R3 is calling for the Insolvency Service to be allocated greater resources to pursue more cases referred to them by Insolvency Practitioners (IPs). Last year, out of the 4,752 referrals by IPs, the Insolvency Service disqualified 1,252 directors, or about 26% [surely the court disqualified?] Six years ago 45% of directors were disqualified.

“One in four reports resulting in a disqualification is simply not a high enough strike rate,” says R3 President Peter Sargent. [how many of these referrals went to court and failed there because they directors were not 'unfit' pursuant to section 6, as opposed to the Insolvency Service not pursuing a case due to a lack of funding?"] “Insolvency Practitioners are required by law to report on the conduct of the directors of all businesses when they fail. A particular type of report is required when the conduct of the director appears to the IP to warrant further investigation. The Service does a good job to get the disqualifications it secures but clearly needs additional resources to pursue more cases.” [this is the critical point and I am sure the IS will be pleased to have Mr Sargent's support for further funding. HMRC may also need some further money to cope with any upsurge that results in the IS getting more money.]

Under the Directors Disqualification Act, the Insolvency Service can seek a court order for a director to be barred from taking boardroom posts. Most commonly this is for trading when insolvent and the average disqualification period is six and a half years. R3 has been discussing with Parliamentarians and key stakeholders how best to prevent directors making the same mistakes next time round. Peter Sargent concludes: “We have urged both Government and the opposition to consider introducing compulsory education for disqualified directors. Using a driving analogy, those caught speeding are encouraged to undertake a speed awareness course. Greater publicity for cases the Insolvency Service successfully prosecutes could also act as an additional deterrent, as well as more resources to police those who have been disqualified. Otherwise some ‘dodgy’ directors will simply slip through the net and be allowed to set up shop somewhere else."

The press release contains some interesting extra facts. It notes:

"According to a survey of Insolvency Practitioners published in August 2009, 71% of respondents had received a letter from the Insolvency Service stating their D1 report would not be taken forward. Out of these, a further 70% believed the decision not to proceed was wrong and/or that the director in question should have been disqualified. (IPs appreciate in some instances it is too onerous in terms of costs or not practical to pursue all director disqualification cases.)"

A press release is a very narrow medium that cannot address all the issues that the author might wish to cover in an ideal world. The call by R3 for extra cash for the IS to pursue 'unfit directors' has to be welcomed to ensure that the private limited form, as a legal fiction or concession of Parliament, (going back originally of course to the Joint Stock Companies Act 1844, the Limited Liability Act 1855, and the Joint Stock Companies Act 1856, where the dual qualities of limited liability and registration by incorporation were brought together for the first time) is not abused by miscreant directors who are unfit to use the tool and privilege of limited liability in a responsible manner. We are no longer in the realm of low subjective tests for competency. We now operate in the post Hoffmann Re D'Jan world of s.174 of the Companies Act 2006 as adapted from section 214 of the Insolvency Act 1986 (IA86). A test which was once reserved for the twilight zone now applies to directors from liquidity until s.123 IA is (unfortunately) satisfied. Professor Sir Otto Kahn-Freund QC would perhaps be shocked at the relatively low level of disqualifications that Mr Sargent discusses. The position would only perhaps enforce Kahn-Freund's partnership thesis.

A world of caution must however be raised. In this rush to inspire community confidence in the corporate form and its operation we must however recognise, in a real world sense, that Her Majesty's Court Service (HMCS) is also chronically under funded and that any increase in IS funding must be matched with appropriate funds for the courts so that they might close the circle in the pursuit of 'unfit' directors. Let us make sure the judges have the time and resources they need to exercise the jurisdiction given to them by s.6 of the CDDA86. It is of course with this jurisdiction in mind that we can conclude that neither the Insolvency Service or the Lord Mandelson have the power to disqualify directors. The court is the correct organ to undertake this task.

The idea of director education is interesting. Research I am currently undertaking for the IS (Tribe, J & Blackburn, R & Cocks, L. Phoenixism in Corporate Insolvency – Do Directors learn from insolvent liquidation? Research report funded by the Insolvency Service. Research in progress) indicates that directors are not even aware of their duties pursuant to section 174 of the Companies Act 2006 (and predecessor tests) so 'professionalising' directors in this manner, especially those who have already caused an 'unfit' liquidation to occur, is also to be welcomed. Whether or not the Institute of Directors, and others bodies which represent the interests of the director classes will agree, is of course another matter.

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