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An overview of Compensation Orders and how they work

If a company, which is struggling financially, ends up in either administration or liquidation then the directors of the company will all be susceptible to an investigation by the Insolvency Service, following the initial investigation by the liquidator or administrator. This could lead to proceedings being considered by the Insolvency Service.

If you are a not interested in remaining as a director, or being involved in multiple companies in the future, then taking up the Insolvency Service on the offered Director Disqualification Undertaking can be a sensible and commercial approach as it stops the proceedings, meaning that you don’t have to go through the whole process, and in doing so means that you do not need to incur further legal costs.

However, the Small Business, Enterprise and Employment Act 2015 (the “2015 Act”), which came into effect in October 2015, changed this approach and meant that the directors’ easy option of giving a Director Disqualification Undertaking is no longer the safe and easy option that it once was. This is because as part of the 2015 Act the director can now be found to be liable to provide compensation to the Company, in a payment made to the Insolvency Service, for the loss that has been suffered as a result of the director’s misconduct in the lead up to insolvency.

The impact on the Director and his choices

The first indication a director will receive of the intention, or not, to move forward with potential director disqualification proceedings may be a Section 16 letter. This is a letter, sent out by the Insolvency Service, as a requirement under the rules of the Company Directors Disqualification Act 1986 which signifies the intent and the grounds that they intend to rely upon for seeking a disqualification order.

Ordinarily, the advice – we would recommend that advice was immediately sought – would be to consider the grounds of misconduct then either to send a letter of representation to the Insolvency Service with the aim of them dropping the proceedings or, if you have no real wish to remain as a director, consider signing a Director Disqualification Undertaking.

The issues that the director now faces, with the introduction of the 2105 Act, is that there is a possibility that if the conduct that the Insolvency Service is considering, took place after October 2015, then the Insolvency Service may consider that the case is appropriate for a Compensation Order.

Compensation Orders (and Compensation Undertakings) – the details

The purpose of the Compensation Order was set out in the 2015 Act. It allows, where the Insolvency Service considers it appropriate, for the Insolvency Service to seek to recover monies from a former director for the benefit of the creditors as a result of their misconduct that caused the loss in the first place.

The major issue that comes with the Compensation order is that there is no, or little, room to challenge the order as the grounds for bringing it have already been established.

The largest number of Director Disqualification come from none payment of monies owed to HMRC, which means for those ultimately subject to Compensation orders that they will be personally required to pay monies to HMRC as a result of their usually being the single largest creditor if the company has ended in insolvency.

As a result of the implications of a Compensation Order and how it can impact on the giving of a Disqualification Undertaking, the director – we would recommend – takes specific, detailed and expert advice.

If you come to see us for that advice, having received a Section 16 letter (or indeed any other correspondence) from the Insolvency Service then we will in the first instance ask you what you’re concerns are and what you are trying to achieve in dealing with the potential Directors Disqualification proceedings.

Usually, the responses that we get from those initial questions are focused around the director trying to understand the impact that it will have on the company that they are currently focused on, how much detail and information that the Insolvency Service have had access to in order to consider these proceedings, and in order for their investigators to understand everything that happened in the run up to the company failing, will they be able to do what they are saying they are planning to do and, finally, how much will it cost me to fight if they do bring proceedings?

In our experience the first and last questions raise the biggest concerns for directors and, the answers that we can give them, will end up shaping how they choose to proceed in respect of the proposed Director Disqualification proceedings.

It is perfectly possible that, having discussed it with one of our experts, that you may decide on the basis of our advice to not contest the proceedings because you do not need to be a director or be involved in the management of the new company. If this is the case then there will be no point in incurring further unnecessary costs and you would, on that basis, prefer to an offer to sign a Disqualification Undertaking.

However, with the advent of the new Compensation order or Compensation Undertaking process, signing a Director Disqualification Undertaking will, whist appearing to save costs, actually be likely to start a process that leads to further costs and payments, unless you have received an assurance from the Insolvency Service that they will not be seeking a Compensation Order.

It is clear then that there may need to be consideration given to defending the proceedings, where in the past a Disqualification Undertaking would have been offered early in the process, because to not to do so will lead to a more costly consequence than the costs of the proceedings.

Whilst the introduction of the legislation that brought with it the concept of the Compensation order may therefore seem to have a draconian impact on the way that a director deals with the proposed Director Disqualification proceedings there is, of course, a way to simplify the process in a way that simply replicates the Disqualification process.

It is open to a director, who receives confirmation that the Insolvency Service will be seeking a Compensation order in their Section 16 letter, to offer to accept a Compensation Undertaking. In doing so the director will, as with the Disqualification proceedings, avoid all the costs associated with potentially lengthy proceedings and allow them to move forward with their current businesses.

The advantages of a Compensation Undertaking

The change, bought in by the 2015 Act led to a corresponding change within the Company Directors Disqualification Act 1986, seeing Sections 15A-15C added in order to deal with Compensation Order, their applications, and Compensation Undertakings.

The new sections within the Disqualification Act provide you with a positive option – to sign a Compensation Undertaking – rather than contesting, through litigation, a Compensation Order where, as you will find if you agree to a Disqualification Undertakings, a director in offering to provide the Undertaking will agree to pay a specified amount, in compensation to creditors, and in doing so will bring the proceedings to an end.

The other significant benefit, to the director, of providing a Compensation Undertaking is that it puts the director back in charge of the process and allows them to come to an agreement as to the amount of the payment and how it is paid. This compares to the Court imposed Compensation order where you, as the director, are in the hands of the court in respect of the amount that will be ordered and also over how much time you will get to make the payment.

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