Disqualification as a Director - everything you need to know

You may be banned as a director for up to 15 years if you don't meet your legal responsibilities. This process is known as director disqualification.

In this detailed guide, we cover the consequences of being disqualified, the stages of investigation, and your options for moving forward. 

There are many ways a director can be disqualified. In most cases, it will be initiated by the Insolvency Service, which has the power to investigate the conduct of directors of insolvent companies. 

Alternatively, a court can initiate a ban, usually for fraudulent or wrongful trading cases. Sometimes, a director may voluntarily agree to disqualification to avoid court proceedings, which is called a voluntary undertaking. 

Consequences of director disqualification

The consequences of being banned as a director are far-reaching. They will not only be prohibited from acting as a director or participating in a company's management, but they will also face several other restrictions on other business activities.

Breaching a disqualification order is a criminal offence that can result in a fine, imprisonment or both.

Effects of disqualification

During the period of a disqualification order or undertaking, you cannot act as a director and cannot take part, directly or indirectly, in the formation, promotion, and management of a company or limited liability partnership. 

But the broader impact of being banned as a director should be considered. The personal consequences are far-reaching and include:

• Effecting current employment and business interests.
• Restrictions on future employment.
• Criminal penalties if a disqualification order or undertaking is breached.
• Compensation orders.
• Other financial penalties – e.g., personal liability for company debts if a disqualification order or undertaking is breached.
• Professional and personal embarrassment.
• Potential claims by the liquidator/administrator of the company.

In addition to the above consequences, many organisations seek to apply restrictions on those who have been disqualified to include the following:

• Charities
• Schools
• Pension trustees
• Police and police authorities
• Registered social landlords
• Health boards and social care bodies
• Solicitors, barristers, accountants and other professionals

Unfit conduct: types of misconduct

Disqualification claims will only be issued if the Insolvency Service investigations support allegations of misconduct by a director.

Where a company has become insolvent, a director's misconduct need not be deliberately fraudulent or criminal and will often include actions taken by directors innocently, in error or as a result of a negligent omission.

Whilst not an exhaustive list, below are some of the common examples of misconduct that will give rise to a disqualification: 

• Non-payment of HMRC and/or failure to submit returns.
• Acting whilst disqualified.
• Acting contrary to the public interest.
• Abuse of directors' loan account.
• Drawing illegal dividends.
• Acting in breach of financial service regulations.
• Trading whilst insolvent.
• Trading to the detriment of creditors.
• Failure to prepare and file accounts or make returns to Companies House.
• Hiding or disposing of assets.
• Failure to keep proper accounting records.
• Failure to cooperate with an insolvency practitioner or office holder.
• Fraudulent bounce-back loan applications.
• Misapplication of bounce-back loan monies.

The process of disqualification

The majority of disqualifications occur after a company has entered into a formal insolvency process (e.g. liquidation or administration). As a matter of statutory requirement, the liquidator, administrator or official receiver will submit a report to the Insolvency Service on the conduct of all directors in office during the previous three trading years.

The report aims for the liquidator or administrator to flag any behaviour or conduct they consider potentially warrants a disqualification.  

The Insolvency Service, acting on behalf of the Secretary of State for Business, Energy and Industrial Strategy, will decide whether it is in the public interest to investigate the matter further and, ultimately, whether a disqualification order should be pursued. 

Generally speaking, the Insolvency Service investigation will take the following format. 

• Section 16 stage – the Insolvency Service will formally notify a director that it intends to pursue a ban through a 'section 16 letter'. The letter will set out the allegations against the director, the period of the ban sought, and whether a compensation order will be pursued. Even at this stage, the director can try to persuade the Insolvency Service that it is not in the public interest to continue with the threatened proceedings. 
• The investigation stage – the Insolvency Service will use the investigation stage as a fact-gathering opportunity, often asking the director to attend an interview and complete a questionnaire. The director's responses will determine if the Insolvency Service recommends pursuing a ban. 
• Issuing proceedings – if the director's explanations do not persuade the Insolvency Service, court proceedings will be issued against the director. The director can either defend the proceedings, negotiate a voluntary ban or allow a disqualification order to be made on a contested basis. 

The investigation stage

Dealing with initial enquiries from the Insolvency Service

The Insolvency Service will write to the directors, asking them to complete an initial questionnaire or attend an interview to provide details about the company and the areas of concern.

These early enquiries are the cornerstone for the Insolvency Service in deciding whether to initiate a full-blown investigation. Getting the correct responses to those early enquiries is vital.

Section 16 letters

A section 16 letter is formal notice that disqualification proceedings will be issued against you. 

You must act immediately if you have received a section 16 letter from the Insolvency Service. Failure to respond could result in disqualification proceedings being issued against you.

The section 16 letter sets out the allegations of unfit conduct and the period of disqualification sought and allows you to offer a voluntary disqualification undertaking to avoid proceedings being issued.

Although the letter informs you of the proposed proceedings, all is not lost. There is a window of opportunity to persuade the Insolvency Service to drop the investigation or to negotiate the terms and period of a voluntary undertaking.

Disqualification undertakings

Agreeing to accept a voluntary disqualification undertaking has the same practical effect as a disqualification order.

If you do not wish to remain a director or don't intend to act as a director in the future, then accepting a disqualification undertaking can be a cost-effective and sensible approach to avoiding proceedings being issued against you.

We can advise you on minimising the period of disqualification and the framing of allegations of unfit conduct against you. This is vitally important as the liquidator/administrator of the company can rely on the admissions made in the undertaking to pursue civil recovery claims against you. 

The introduction of the Small Business, Enterprise and Employment Act 2015 and Compensation Orders means directors can now be held liable to compensate the company for losses caused by the director's misconduct. It is, therefore, vital that you seek specialist legal advice before signing an undertaking.

Negotiating the terms of an undertaking is often done in conjunction with making an application to the court for permission to act as a director, notwithstanding the voluntary undertaking. Permission is sought when there is little hope of defeating the misconduct allegations but when there is a genuine need for you to continue acting as a director of a specific company.

Compensation orders

A compensation order can be one of the effects of disqualification; it allows the Insolvency Service to recover monies from a director whose misconduct has caused the company loss in the run-up to insolvency. The Insolvency Service will confirm in the Section 16 Letter if it intends to pursue a compensation order.

Much like a disqualification undertaking, it is open for a director to offer a compensation undertaking, thereby avoiding the issuance of proceedings.

Reinstatement and appeals

Even when a disqualification ban is inevitable, all is not lost. 

If you have been disqualified either by court order or by way of a voluntary undertaking, it is possible to obtain court permission to act as a director, notwithstanding a ban, thereby allowing you to preserve your current business interests and safeguard your other directorships.

Section 17 of the Company Directors Disqualification Act 1986 allows a director to apply to the court for leave to act as a director or manage a company. Indeed, by the time the ban comes into force, the director may have started a new company, and that company's success requires the director's ongoing involvement. In those circumstances, it is possible to apply to the court for permission to act as a director without breaching the ban. 

We can work with you to prepare your application and supporting evidence and ensure that your application is determined as soon as possible to minimise the disruption to your business. 

Since breaching a ban is a criminal offence, it is always wise to obtain permission to avoid an inadvertent breach. 

Permission to act

If you are already disqualified or threatened with disqualification, obtaining court permission to act as a director is possible, notwithstanding a ban. A disqualification aims to protect the public from a repeat of the misconduct that led to the company's failure.

Section 17 of the Company Directors Disqualification Act 1986 allows a director to apply to the court for leave to act as a director or manage a company. By the time the ban comes into force, the director may have started a new company or learned from his previous failures; in those circumstances, it is open to you as a director to apply to the court for permission.

Why should I apply for permission?

A disqualification order or undertaking prevents you from being appointed as a director and from being involved in a company's formation, promotion, and management. The word 'management' is extremely wide, and without a set definition of what constitutes management, it is too easy to breach a ban inadvertently. Given the criminal and civil penalties, it is always wise to seek permission.

When should I apply?

Permission or 'section 17' applications, as they are known, should be made as soon as possible. If you are considering offering a disqualification undertaking, we can work with you to ensure minimal disruption by preparing your application swiftly and avoiding the need to resign from your current directorship.

You will need to demonstrate to the court that there is a genuine need for you to be involved in the company's management and that adequate safeguards are in place to protect the public from any reoccurrence of the misconduct that gave rise to the original company failure.

Breaching a disqualification order

Breaching an undertaking or order, deliberately or inadvertently, is a criminal offence. A director who breaches an undertaking or order could be sentenced to up to 2 years imprisonment and receive a fine. In addition, the director will be personally liable for the company's debts.

And it's not just the disqualified person who should be worried about potential breaches. Anyone who carries out company business on the instructions of someone disqualified can be prosecuted and become personally liable for the company's debts.

The implications of breaching an order or undertaking, even unknowingly, are severe. If you are considering offering an undertaking or are already disqualified, contact our dedicated director disqualification team immediately for advice on how to avoid unwittingly overstepping a ban and for advice on applying for permission to act whilst disqualified.