New legislation has been proposed which closes the ‘legal loophole’ that prevents the Insolvency Service from investigating former directors of companies which have been dissolved. Provisions in The Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Bill have been recommended to deter directors from exploiting the dissolution process, and investigate those who do so.
The Insolvency Service has powers of enforcement, including disqualification, against directors where there is evidence of misconduct. An ability to disqualify is generally considered to be fundamental, necessary to maintain trust and confidence in the UK market, so that those operating in business environments do so safe in the knowledge that those who break the rules and act dishonestly will (or at least, can) be held to account.
Generally speaking, under the current rules, the Insolvency Service only has powers of investigation against former directors of a company that has entered a formal liquidation process. ‘Dissolution’ is not defined as a formal liquidation process and thus there have been an increasing number of cases where directors have taken advantage of this loophole to bypass the scrutiny of the Insolvency Service. Further, although already an offence under existing legislation, the Impact Assessments considering the Bill also cite evidence of so-called ‘phoenix companies’, whereby a company is dissolved without paying its creditors, and subsequently another company is set up in the same line of business with the same directors (often also with a similar name). This points to a trend in certain directors using dissolution to avoid paying company debts.
The proposed legislation will give the Insolvency Service powers to investigate former directors of dissolved companies, and their enforcement powers will mirror those currently in force, including disqualification from being a company director for up to 15 years. The proposed legislation will also have the effect of preventing directors from setting up new companies similar to those previously dissolved, leaving creditors unpaid, thereby theoretically eliminating the possibility of ‘phoenix companies’.
Crucially, if made into law, the legislation will be retrospective. This will enable the Government to clamp down on fraudulent directors, and tackle the many instances of ‘bounce back loan’ fraud, whereby directors have simply dissolved their companies in order to avoid repayment of Covid-19 Bounce-Back loans. This is significant because any director of a dissolved company now has the potential to be investigated by the Insolvency Service and sanctioned if any evidence is uncovered of malpractice or fraud.
Whilst the Government remains assured that in the long run, this reform will increase efficiency and accountability for UK companies, there will undoubtedly be a large increase in case investigations for the Insolvency Service if the Bill is made law. Coupled with the recent surge in dissolutions as a result of the Covid-19 pandemic, there is also the possibility that the Insolvency Service’s resources will be stretched, thereby undermining the effectiveness of its investigations. Ultimately, the rationale proposed is said to be geared to raising standards for corporate governance in the UK and to help ensure continuing confidence and trust in the UK market as it begins to navigate the world stage alone.