There are many ways in which Directors can be made to contribute towards the losses suffered by creditors when a company fails. The best known being Wrongful Trading. Less common are actions for Fraudulent Trading and Misfeasance.

The 2020 Finance Act gave HMRC draconian powers to recover unpaid company tax liabilities from Directors. Directors who have taken illegal dividends and those with overdrawn loan accounts with their companies can be asked to repay these amounts by Liquidators or Administrators.

Now there’s another potential elephant trap for directors of insolvent companies, in the form of Compensation Orders under the Company Directors Disqualification Act 1986 (the CDDA). Earlier this year, the High Court made just such an order against a Director in the Secretary of State v Barnsby case. This involved the deposits lost by five customers of a package holiday business, which continued to trade after its ATOL licence had expired.

This was only the second Compensation Order made since the process was introduced in 2015, but it comes amid predictions within the insolvency profession that they will become much more widely and regularly used to impose financial penalties on errant Directors.

Are all Directors at risk of a Compensation Order?

The answer is no. These orders can only be made against Directors, who have already been disqualified under the CDDA or have given a Disqualification Undertaking under that legislation.

What must the Disqualified Director have done wrong?

Their behaviour must have caused a loss for one or more creditors, which can’t be recovered through the insolvency of the company.

Who can take action to seek a Compensation Order?

This can only be the Secretary of State for Business and Trade, acting through the Insolvency Service and not a Liquidator or Administrator. Normally they will be asked to take action by one or more creditors of the insolvent company.

Persuading the Insolvency Service to seek a Compensation Order

Creditors will have to persuade the Insolvency Service to take on the case. The Insolvency Service is unlikely to do this if the Liquidator or Administrator is already taking action against the Director in respect of the same conduct, or if the Director has already contributed to the company’s assets in the insolvency proceedings as compensation for their conduct.

Is there a time limit for taking action?

The prosecution under the CDDA must be started within two years of the Disqualification Order against the Director being made or the giving of a Disqualification Undertaking by them.

Who can benefit from a Compensation Order?

The Court can order the Director to compensate an individual creditor, a group of creditors, or to pay funds into the insolvent company’s estate. This is a fundamental difference from actions taken as part of an insolvency by a Liquidator or Administrator, where any funds recovered from a Director will be shared between all creditors in accordance with the usual creditor priorities.

Does the company have to have suffered a loss as well as the creditor(s)?

Here’s another feature that differentiates this procedure from actions taken within the insolvency, where it is the company seeking redress for the actions of a Director by acting through its Liquidator or Administrator. With a Compensation Order, it isn’t necessary to prove that the company has suffered detriment, only the creditor(s). An example might be a person who has guaranteed a company debt personally and been called under that guarantee because of the improper actions of the Director. The company is no worse off, but the guarantor is.

Compensation Undertakings

Just as a Director can give a Disqualification Undertaking under the CDDA to avoid full Disqualification proceedings, the Secretary of State can under certain circumstances accept a Compensation Undertaking instead of pursuing legal action and incurring the cost of court proceedings to obtain a Compensation Order.

Compensation orders are a warning to Directors and another recovery route for unpaid creditors

The Barnsby judgment is a salutary warning to Directors that their responsibilities can’t necessarily be ended by putting their company into a formal insolvency procedure and that if their behaviour has been unacceptable, being disqualified under the CDDA opens the door to yet more sanctions.

At the same time, it creates an additional route for creditors to seek recompense for losses incurred as a result of bad behaviour by a Director.

If you are seeking professional advice for your business, Opus is here to help. You can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.