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Holding Directors to account - a tougher stance by the Insolvency Service?

  • United Kingdom
  • Financial services disputes and investigations
  • Litigation and dispute management
  • Pensions disputes

18-02-2021

In the wake of a number of high profile corporate collapses there have been renewed calls for a tougher stance to be taken against the directors of failed companies.

The recent case The Secretary of State for Business Energy and Industrial Strategy v Paul Martin Evans, Nigel Arthur William Basset Evans [2020] EWHC 3519 (Ch) is a timely reminder of the high threshold that must be met before the Court will make disqualification orders.

Background

Brooklands was the trustee company of a SIPP with 5,500 members and £650million of assets.  In 2009, Brooklands entered into an agreement with a Cypriot company, FCP Insurance Consultants Limited (“FCP”) under which FCP would introduce customers to it. FCP approached UK-resident customers, proposing that they invest in the Brooklands SIPP and/or in an unregulated fund called the LM Managed Performance Fund which invested in property developments in Australia.  The unregulated fund ran into difficulties and  administrators were appointed in 2013.  Subsequently, the Financial Ombudsman Service (FOS) received over 1000 complaints against Brooklands. The FOS upheld complaints and this led to Brooklands entering administration and the Financial Services Compensation Scheme paying out significant sums to customers.

The Secretary of State applied for disqualification orders against the Defendants, who were the managing director and finance director of Brooklands, on the basis that Brooklands had insufficient regard to the regulatory framework in which it carried on its business in relation to the 20 UK customers introduced to Brooklands through FCP. The complaints were that the company failed to undertake sufficient due diligence in accepting business from FCP with the consequence being that Brooklands allowed these customers’ pensions to be invested in a high risk unregulated fund which was not suitable for them.

Criteria for disqualification order

Section 6 of the Company Directors Disqualification Act 1986 (the “Act”) provides that three conditions must be satisfied in order for a disqualification order to be made, namely that:

1.    the company has at any time become insolvent within the meaning of section 6 of the Act

2.    the defendant was a director of the company

3.    the defendant's conduct as a director was such as to make them "unfit to be concerned in the management of a company"

The only point in contention was 3. The Court had to determine whether the conduct amounted to misconduct (which could be incompetence or dishonesty) and if so whether the misconduct warranted a finding of unfitness. The factors which the court will take account of are set out in Schedule 1 to the Act and include the extent of the directors’ responsibility for breaches/contraventions and the company’s insolvency; the  pervasiveness of the conduct; and the nature and extent of potential or actual loss or harm. The Court accepted that not all misconduct warrants a finding of unfitness but was also clear that it is not necessary to identify and demonstrate a breach of a duty or obligation as a prerequisite for finding misconduct. This was important in the context of the failings alleged against the directors of Brooklands which, in many instances, related to regulatory guidance or recommendations contained in thematic reviews. The Judge’s view was that:

“a director of a company which carries on a business that is a profession or is regulated must have regard to the overarching principles governing his or her profession or the service his or her company is providing and to what is regarded by the relevant regulator as good practice, and that a serious or pervasive failure to do so must be misconduct”. 

The Court considered that the directors of Brooklands has been incompetent in respect of the relationship with FCP and therefore were guilty of misconduct. However, the Judge then had to determine if the misconduct was of such a degree that it meant the directors were unfit to hold that office. On the authorities, this required incompetence in a very marked degree, really gross incompetence or incompetence of a very high degree. The Court found this threshold had not been met. The Judge pointed out that the FCA had carried out monitoring of Brooklands on three occasions and concluded that the company’s systems were adequate. He also noted that the application for disqualification was based on the relationship with one introducer, FCP, and the customers that invested through FCP represented a very small proportion of the company’s business.

Conclusion

The Judge made it clear that this was a case decided on its own facts. It is, however, a reminder that incompetence or negligence alone will not be enough for the court to make a disqualification order.

With political pressure growing for directors of failed companies to be more accountable, disqualification proceedings may not be  seen as a particularly effective tool to achieving that. The long awaited BEIS white paper on financial reporting expected to be published imminently is likely to contain proposals that seek to address more directly concerns about director accountability.