In general terms, section 110 of the Small Business, Enterprise and Employment Act 2015 (the 2015 Act) amends the provisions of the Company Director Disqualification Act 1986 (the CDDA 1986) in relation to directors’ disqualification.
One of the changes introduced is that the Secretary of State will be able to apply to the court for a compensation order against a director who has been disqualified where creditors have suffered identifiable losses from the director’s misconduct1.
A “compensation order” is an order requiring the person against whom it is made to pay an amount to the Secretary of State for the benefit of creditor(s) or a class of creditor(s) as a contribution to the assets of company (amended section 15B(a) of the CDDA 1986).
The Secretary of State can apply for the compensation order within 2 years of a disqualification order being made against a director (amended section 15A(5) of the CDDA 1986).
Factors to be taken into account in determining the amount to be paid under a compensation order are:
- The amount of the loss caused.
- The nature of the director’s conduct.
- Whether the director has made any other financial contribution in recompense for the conduct.
Alternatively, the Secretary of State may accept a “compensation undertaking” from the relevant director instead of applying for a compensation order (amended section 15A(2) of the CDDA 1986). A “compensation undertaking” is an undertaking to pay an amount specified in the undertaking to the Secretary of State for the benefit of a creditor or class of creditors as a contribution to the assets of the relevant company (amended section 15B(2) of the CDDA 1986).
Comparison with the Insolvency Act 1986
Prima facie, the compensation orders introduced by the 2015 Act appear remarkably similar to sections 212 to 214 of the Insolvency Act 1986 (IA 1986), which allow liquidators to apply to the court for an order that directors contribute to the assets of the insolvent company:
- IA 1986 at section 212 provides that an action may be brought against someone who “is or has been an officer” of the company, if the company in which they held office is wound up. In these circumstances, a liquidator, shareholder or creditor can bring an action if that individual has “misapplied or retained, or become accountable for, any money or other property of the company or been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company”.
- IA 1986 at section 213(2) deals with fraudulent trading and provides that on the application of the liquidator, the court may declare that any persons who were knowingly parties to the carrying on of the business fraudulently are liable to make such contributions to the company’s assets as the court thinks proper. “Fraudulent” is defined in section 213(1) as carrying on company business “with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose”.
- IA 1986 at section 214 deals with “wrongful” trading. As with fraudulent trading, the liquidator can apply to the court for a declaration to make a contribution to the company’s assets. The conditions for“wrongful trading” are defined in section 214(2): the company must be in insolvent liquidation and an individual who was a director of the company at that time knew or ought to have known that there was no reasonable prospect that the company would avoid going into insolvent liquidation. There is a defence at section 214(3) if the relevant director “took every step with a view to minimising the potential loss to the company’s creditors”.
The principal difference between the IA 1986 and 2015 Act is that the 2015 Act does not specify that any “wrongful” or “fraudulent” activities are required in order for the application for compensation to be made. It merely requires a person subject to a disqualification order to have caused loss to creditors. Therefore, conduct might warrant disqualification and give rise to a claim for a compensation order under the 2015 Act, even though it might not reach the threshold of sections 213 or 214 in the IA 1986. For instance, disqualification for failure to maintain proper books and records.
However, in practice, it is difficult to imagine many situations where the Secretary of State would apply for a compensation order without an element of wrongful or fraudulent trading having been committed by directors.
The new Insolvency Rules are expected to come into force in April 2016. It is possible that the director compensation orders will be incorporated into these Rules given their similarity to the provisions of the current IA 1986.
What is the potential impact of the new director compensation orders upon D&O insurance?
There is some uncertainty as to coverage of D&O insurance if a director is subject to a compensation order made under the 2015 Act. However, in general terms it may be assumed that:
- In the case of a compensation order for “wrongful” trading (i.e. a section 214 IA 1986 situation), D&O insurance would likely cover the order if it related to merely negligent activity.
- In the case of a compensation order for “fraudulent” trading (i.e. a section 213 IA 1986 situation), D&O insurance would typically exclude fraud and therefore not cover the order.