What happens during an Insolvency Service investigation and how it may affect the company’s directors

Jon Munnery, a business liquidation specialist from UK Liquidators, and James Robbins, solicitor and insolvency specialist from Harrison Drury, explain how an Insolvency Service investigation is conducted and how company directors may find themselves at risk of director disqualification if they’re caught in the crossfire.

An Insolvency Service investigation is part and parcel of a company liquidation and administration procedure. The aim is to investigate events leading to the demise of the company, including director conduct.

Directors of limited companies typically benefit from a limited liability status and are protected from being found personally liable for the actions and debts of the company. However, if evidence of wrongdoing or unfit behaviour is found on the part of the company directors, particularly when the company is insolvent, or close to insolvency, such protection will subside.

Company directors may be exposed to serious repercussions, such as personal liability to repay some or all the company’s debts, disqualification from being able to act as a director in the future and in some serious cases, prosecution for criminal offences.

Who conducts an insolvency service investigation?

An Insolvency Service investigation is conducted by the office holder, who is either the Official Receiver or an appointed insolvency practitioner. Any evidence of misconduct found by the office holder must be reported to The Insolvency Service. The investigation can quickly transition from a civil investigation to a criminal investigation if there are signs of serious wrongdoing, such as fraud.

The Insolvency Service investigation timeline

During an Insolvency Service investigation, the office holder will set out to establish how the business came to fail and assess whether the conduct of the company directors was adequate and whether the directors committed any wrongdoing whilst in office. The investigation begins with fact-finding, exploring company records, and conducting interviews with company directors, shadow directors, employees, and external stakeholders.

• Fact-finding – Company directors must provide an account of the events leading up to the collapse of the company through a combination of questionnaires and interviews. This stage is dedicated to exploring the circumstances surrounding the company liquidation or administration.
• Company records – A look at the financial records of the company will help corroborate director claims and illustrate how the business may have taken a turn for the worse.
• External interviews – Interviews with external stakeholders may be arranged to help substantiate director claims, seek additional insight, and shed an unbiased view on the matter.

Any notable findings can be used by the office holder and will be compiled in a report for The Insolvency Service.

What is classed as director wrongdoing?

Director wrongdoing can take many forms and the consequences will vary based on the severity of the wrongdoing. Some of the most notable examples of wrongdoing are listed below.

• Misuse of Bounce Back Loans – During the coronavirus pandemic, the government provided businesses with emergency access to finance through a series of loan schemes, such as the Bounce Back Loan Scheme. Bounce Back Loans were provided on the condition that they would be used to provide an economic benefit to the company’s business. If a Bounce Back Loan was misused, such as for a director’s personal benefit, that director could be disqualified, and may even be required to repay the outstanding loan sum.
• Transactions at an undervalue – A director can be found to have entered a transaction at an undervalue if assets of the company were gifted or sold to the director (or any third parties for that matter), in return for money or money’s worth, which is significantly less than the actual value of the assets. A transaction at an undervalue puts the company’s creditors at a disadvantage, as there are fewer assets in the company to distribute to creditors.
• Preferential payments – As part of the process in an administration or liquidation, any returns are distributed to creditors in an order of priority as set out in the Insolvency Act, 1986. If payment or preferred treatment is made to a creditor that would put them in a better position than they otherwise would have been in, this can amount to a preference which puts other creditors waiting in line at a disadvantage.
• Wrongful trading – Like many of the offences listed above, this is a civil offence and is committed when a director is aware or should be aware that the company cannot avoid insolvency but continues trading.
• Fraudulent trading – A director can be found liable where it appears that they have carried on any business of the company with an intent to defraud creditors or for any fraudulent purpose. Like wrongful trading, fraudulent trading is a civil offence, but it differs in that it can also constitute criminal one. Allegations of fraudulent trading are therefore very serious and directors must ensure that they act honestly at all times and do not attempt to put company assets out of the reach of creditors.
• Unlawful dividends – This is when a shareholder takes or receives dividends when there are insufficient profits in the company. Clearly, this will prejudice any creditors in an insolvent scenario as the company is agreeing to pay out of profits that it does not have.

What are the consequences of director misconduct?

If a director is found to have committed any of the above offences, they may be required to personally compensate the company so that their own funds can be applied in the insolvency. If allegations of fraudulent behaviour are founded, a director can even be fined or face a prison sentence if criminal proceedings are brought against them.

Any liability owed to the company arising from any of the above offences will also be separate from any personal guarantees the director may have in place.

Additionally, if an office holder suspects any improper or unfit behaviour on the part of a director, they are under a duty to provide a report to the Secretary of State for Business, Energy and Industrial Strategy on the conduct of all directors in office in the last three years of the company’s trading. The Secretary of State (via The Insolvency Service) then considers whether to seek a disqualification order against a director(s).

A disqualification order under the Company Directors Disqualification Act (CDDA) 1986 can result in the disqualification of a company director for a period between two and 15 years.

• Disqualification for reckless or negligent conduct as a director (two – five years)
• Disqualification for serious misconduct which is more detrimental to the public interest (six – 10 years)
• Disqualification for the most severe breaches. For example, fraudulent or serious criminal behaviour (11 – 15 years)

While disqualified, an individual cannot be a director of any company registered in, or connected with, the UK or be involved in forming, marketing, or management of such a company.

The state of director disqualifications

Official statistics published by The Insolvency Service on enforcement outcomes provides a summary of the state of director disqualifications, including the total number of director disqualifications and average length of director disqualification orders.

• During 2022/23, 932 directors were disqualified under the CDDA, a 16 per cent increase compared to 2021/22. Before the coronavirus pandemic, the number of disqualifications had been stable at between 1,200 and 1,300 between 2013/14 and 2019/20.
• The mean average length of director disqualifications in 2022/23 was seven years and four months. In each of the previous 10 financial years, the average length had been between five years and five months, and six years.

To provide some context to these figures, the reason for the lower number of disqualification orders made under CDDA in the past three years appears to be down to the lower number of company insolvencies during the coronavirus pandemic, along with the time gap between insolvency and the completion of investigations and subsequent proceedings.

One reason to explain the recent increase in the length of disqualification orders being made is due to the increase in the number of disqualifications relating to coronavirus financial support scheme abuse, which to date, have tended to result in longer than average disqualification periods.

Written by insolvency expert Jon Munnery, UK Liquidators, part of Begbies Traynor Group. Jon is a highly experienced company liquidation specialist with over 30 years’ experience in supporting company directors with company closures. He is a member of the Insolvency Practitioners Association MIPA and is a Member of The Association of Business Recovery Professionals MABRP.

Co-authored by James Robbins, partner at Harrison Drury and a Legal 500 recommended solicitor in insolvency and restructuring. James specialises in insolvency law and is also dual qualified as an insolvency practitioner. He has significant experience of advising insolvency practitioners, creditors, distressed companies and company directors with a range of insolvency matters.

For further support and advice regarding Insolvency Service investigations and the responsibility of company directors, contact Harrison Drury on 01772 258321 or email James.Robbins@harrison-drury.com