Court imposes compensation order on disqualified director

28 September 2023

The court orders a disqualified director of an insolvent company to pay personal compensation to creditors.

This is only the second time the courts have considered a personal compensation order against a disqualified director since their introduction in 2015.

What happened?

Secretary of State v Barnsby [2023] EWHC 2284 (Ch) concerned an individual who was the sole director and majority shareholder of a company that sold package holidays.

For this purpose, the company held an Air Travel Organiser’s Licence (ATOL), which it required to lawfully sell package holidays.

The company’s ATOL expired on 31 March 2017. However, the company continued (illegally) to take bookings and payments from four customers after that date. It also retained a deposit paid by a fifth customer after its ATOL expired when it could not lawfully provide the relevant holiday package.

The company’s business struggled and, on 19 December 2017, it entered creditors’ voluntary liquidation. At the time it entered liquidation, it had an estimate deficit of just over £500,000, insufficient to satisfy its creditors’ claims.

When the liquidation was finally concluded in July 2019, total receipts in the liquidation stood at just over £200, whereas unsecured creditors’ claims (including claims by the five customers above) stood at just over £350,000. As a result, the five customers received no refund.

In April 2022, the High Court made an order against the director under the Company Directors Disqualification Act 1986 (the CDDA), prohibiting him from acting as a company director for seven years. For more information on director disqualification orders, see the box “What is a director disqualification order?” below.

What is a director disqualification order?

Under the CDDA, the court can make a disqualification order against a company director in various circumstances.

A disqualification order prohibits an individual from being a director of a company. It also prevents the individual from being involved in promoting, forming or managing a company. The prohibitions apply to any company and not just companies of which the individual was a director when the order was made.

The circumstances that can trigger a disqualification are varied and include:

  • where the director has been convicted of an indictable (i.e. a more serious) criminal offence, has breached competition law or persistently breached certain provisions of companies law, has acted fraudulently or participated in wrongful trading; or
  • where the director was a director of an insolvent company and the court considers them unfit to be involved in managing a company.

In addition, the Economic Crime and Corporate Transparency Bill (which is currently making its way through Parliament) will amend the CDDA and other legislation to allow the Government (acting through the Office of Financial Sanctions Implementation) effectively to impose disqualification on a sanctioned individual.

The Act sets out a list of factors the court must consider when deciding whether an individual is unfit to be involved in managing a company. These include breaching legislative requirements, misfeasance and breach of duty. But the list is not exhaustive and the court can take into account any other factors it considers relevant.

Breach of a disqualification order is a criminal offence.

In some cases, a director may offer a disqualification undertaking, in which case a formal disqualification order can be avoided.

A disqualification order or undertaking does not, in and of itself, terminate a director’s appointment. A company’s articles will normally state that a person ceases to be a director automatically if it becomes unlawful for them to act as a director. However, if the articles are silent, in theory, a director’s appointment continues notwithstanding a disqualification order or undertaking.

Likewise, a person can, in theory, be appointed as a company director even if they are disqualified (although they will be committing a criminal offence).

However, under changes to be made by the Economic Crime and Corporate Transparency Bill, a director’s appointment will terminate automatically if they become subject to a disqualification order. The Bill will also introduce new checks to ensure that an individual cannot form a company or be appointed as a director if they are disqualified.

Following this, the Secretary of State brought further proceedings to obtain a compensation order against the director, seeking to claim back the amounts paid by the five customers.

Compensation orders, introduced in 2015, are a relatively new feature of director disqualifications. They are designed to compensate creditors who suffer loss as a result of culpable behaviour by directors but are unable to recover in a company’s liquidation.

Only the Secretary of State can apply to the court for a compensation order, and this is only the second claim for such an order since their introduction. For more information on compensation orders, see the box “What is a compensation order?” below.

What is a compensation order?

Compensation orders were introduced in 2015. If certain conditions are met, the Secretary of State, acting through The Insolvency Service, can apply to the court for an order requiring a disqualified individual, or a person who has given a disqualification undertaking, to pay compensation.

The court can make a compensation order against an individual only if:

  • the conduct that prompted the disqualification order or undertaking caused loss to one or more creditors of an insolvent company (or a solvent company that has been dissolved); and
  • the individual was or had been a director of that company at any time.

The Secretary of State can, in certain circumstances, accept a compensation undertaking in place of a compensation order.

The Secretary of State has two years from the date of disqualification to apply for a compensation order. If the order is granted, the individual must pay an amount of compensation to the Secretary of State to hold for one or more creditors or classes of creditor of the company in question, or alternatively to contribute to the assets of that company.

The CDDA sets out certain factors the court must consider when calculating the compensation payable under the compensation order, including the amount of the creditors’ loss and the nature of the individual’s conduct. However, it does not set out any formula for calculating compensation, leaving this exercise open to the court on a case-by-case basis.

Importantly, unlike actions open to a liquidator or administrator under the Insolvency Act 1986, which can be used to recover money or assets for an insolvent company, compensation under a compensation order can be payable direct to creditors. In fact, there is no need to show that the insolvent company itself actually suffered any loss as a result of the director’s conduct.

In this respect, compensation orders are a new power that are completely separate from the powers of a liquidator or administrator, designed to compensate creditors who cannot recover fully through a formal insolvency process and to “remove the perception that wrongdoers are not held to account”.

Despite having been available for eight years, there have now been only two applications to court for a compensation order.

What did the court say?

The court granted the compensation order.

In deciding whether to grant the order, the court had to wrestle with the question of calculation.

The only other application for a compensation order to date (Re Noble Vintners Ltd [2019] EWHC 2806 (Ch)) concerned a breach of director’s duty.

For most kinds of breach of director’s duty, such as a failure to promote the company’s success, a failure to exercise independent judgment or profiting from a conflict of interest, compensation is traditionally calculated on an “equitable basis”.

However, where (as in this case) an individual’s conduct amounts to negligence or a breach of a director’s duty to exercise reasonable care, skill and diligence, compensation is traditionally calculated using common law principles.

The key difference is between these two methods is that, when calculating according to common law principles, loss is only recoverable if it was foreseeable at the time of the breach and is not too remote. This means that events that happened after the breach cannot be taken into account.

By contrast, under equitable principles, the court is entitled to use hindsight to decide how much to award by way of compensation, taking all matters it considers appropriate into account.

Unfortunately, the court in this case did not provide definitive guidance on this point, noting merely that, whichever approach were adopted, the result and compensation would have been the same.

The court therefore awarded compensation equal to the amount the creditors had paid to the company before it went insolvent, namely the deposits for their holidays (albeit with a few small adjustments).

The defendant advanced various arguments why the amount of compensation should be lowered, including that he was in a difficult financial position and may be driven to bankruptcy by a substantial compensation order.

The court was not persuaded. The director was a “relatively young” man and had a job. It was reasonable to expect that he might earn enough in the future to satisfy a compensation order. Moreover, the legislation states that a compensation order was a provable debt in an individual’s bankruptcy, suggesting that it already contemplates an order tipping an individual into bankruptcy.

What does this mean for me?

Compensation orders and compensation undertakings have so far been a little-used means of enabling creditors of companies that have entered formal insolvency proceedings to recover compensation from those companies’ directors.

This is no doubt in part due to the fact that, unlike claims under the Insolvency Act 1986, which can be brought by a liquidator or administrator, only the Secretary of State can apply to court for a compensation order or request a compensation undertaking.

But, as the two cases so far on compensation orders show, it is a potentially useful remedy where a liquidation or administration yields little in the way of recovery and creditors remain uncompensated.

Creditors who are unlikely to recover in the insolvency proceedings might consider pursuing this remedy as an alternative route where one or more of the directors has been disqualified as a result of their conduct.

However, to do so, creditors will need to persuade the Insolvency Service to take the case. The Insolvency Service is unlikely to do this if an insolvency practitioner 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 insolvency proceedings to compensate for their conduct.

Given the propensity for liquidators and administrators to pursue actions against directors, particularly for breaches of duty, this may well rule out the CDDA compensation regime in many instances.

However, in other cases, it remains a potential avenue of remedy. In particular, given the difficulties that liquidators and administrators now face in bringing successful wrongful trading claims against directors, many practitioners predict that the CDDA compensation regime will become more commonly used in their place.

The CDDA compensation regime also offers creditors another important advantage – directors can be required to compensate individual creditors directly. By contrast, where a liquidator or administrator successfully pursues a claim under the Insolvency Act 1986, the proceeds of that claim are required to be divided among all unpaid creditors.

Before asking the Secretary of State to apply for a compensation order against a director, a person will need to show that various conditions are satisfied.

  • The person is a creditor of an insolvent company and has not been adequately compensated in the company’s liquidation or administration.
  • The individual against whom the order is sought was, at some point, a director of the insolvent company.
  • That individual is subject to a disqualification order or has given a disqualification undertaking.
  • The individual’s conduct that led to the order or undertaking has caused the creditor some loss.
  • The liquidator or administrator of the insolvent company has not brought, or is not bringing, proceedings against the individual in respect of that conduct.
  • The individual has not contributed to the assets of the insolvent company during formal insolvency proceedings.

Read the judgment in Secretary of State for Business and Trade v Barnsby [2023] EWHC 2284 (Ch)