Can a failed company director really keep the Bentley, give staff zilch, and just set up a new business?

Okay, did that headline do its job and get your attention!?

Then I’m guessing it may well have reminded you of that old acquaintance, friend, neighbour or even someone your heard down the pub who mentioned their failed limited company only to proclaim, in the very next breath (while simultaneously ordering another pint): “But I’ve simply gone and set up another business. And you know what; it’s going great!”

I am also assuming you might have pondered, in response to this person: ‘Surely that’s not on, or allowed?’ Or ‘How can that possibly be legit?!’

Company closures, the sober reality…

 Despite how things sometimes sound (and in fairness to headline-writers they wouldn’t be doing their job if they weren’t sensationalist or made you click); the truth on company failures, by comparison, is often rather boring, writes Richard Hunt, a director at SFP Group.

So what is the truth; can failed company directors really keep the Bentley, give staff zilch, and just set up a new biz? Is there some strange loophole in the law allowing errant directors the ability to drop one company and ‘go again,’ potentially leaving in their wake a large number of unsettled creditors?

The CDDA and Wrongful Trading rules: introduction

Let me explain by first saying that the UK’s insolvency legislation has intentionally been constructed to allow a director of one failed limited company the ability – with certain safeguards provided for under the Insolvency Act and Rules 1986 (‘the Act’) -- to set up the same business again.

That might not be what hard-working, rule-abiding limited company contractors quite want to hear!

But to reassure you -- the same legislation (mostly contained in the Company Directors Disqualification Act 1986, ‘CDDA’), has also been designed to capture directors who have breached their fiduciary duties. I’m talking about those directors whose priority, at the time it was obvious the company would fail, should have been on protecting stakeholders' interests especially company creditors, as held under the Wrongful Trading rules (also part of the Act).

When are company director duties breached?

This question can be a little trickier to answer.  But to get close to an answer; let me give you both extremes in two examples which are easy to follow. And to warn you; only then can we look at the huge grey area that depends on numerous factors!

Example 1: Bill, a director acting in accordance with his duties

Director Bill loses his major customer and cannot continue trading as his company is technically insolvent

The definition of ‘technically insolvent’ is the company either has more liabilities than assets or cannot pay its debts as they fall due. Or both!

Bill speaks to his accountant who refers him to an Insolvency Practitioner (IP). The IP forms a ‘wind down strategy’ with Bill working within the parameters of the law, which can include his ability to purchase the business and assets for market value.

(N.B If the insolvent company were placed into liquidation and Bill was successful in buying the business and assets, the Act and Rules would allow Bill to start a new company to trade under the same or similar name as the insolvent one, provided that statutory notices had been sent to the insolvent company's creditors and gazetted or where Bill had been given the court's permission.  Alternatively, the purchase could be via a pre-pack Administration, which carries its own regulatory requirements to ensure the process is not abused.

There is a limit, though. The Finance Act 2020 enables HMRC in some circumstances to issue joint and several liability notices on directors who are repeatedly behind companies that go into an insolvency process while owing HMRC money).

Example 2: Dan, acting in breach of his duties

Dan loses his major customer and cannot continue trading as the company is technically insolvent. Dan decides to set up another company (without seeking any professional advice) and transfers the remaining business into that new company, without any consideration. Then, left with a shell full of liabilities, Dan approaches an IP to liquidate the ‘old’ company or tries to dissolve the company himself!

Example 3: Amy, acting on what she feels is appropriate

Amy loses her major customer and cannot continue trading as the company is technically insolvent. Amy remains optimistic, however, and has a number of potential new clients which will replace the lost turnover. In the meantime, Amy continues to trade in the hope of securing new business to cover that lost income.

Bill and Dan should hopefully need no further comment other than to say with Dan (Example 2,) his actions open himself up for potential criminal and personal proceedings and liability, mainly from the liquidator but also potentially from The Insolvency Service too.

Example 3, Amy, is the grey area I warned you about! Here, for Amy, it all depends on what happens next!

So if she secures those new clients, and turns her company around then any exposure is gone -- regardless of her business previously being technically insolvent.

However, if Amy were to carry on trading with the liabilities increasing, her carrying on could open up a number of claims against her, if her company subsequently enters into administration and / or liquidation.

Seek advice early (and seek advice early) if your company starts to falter

Are you an ‘Amy,’ feeling around for what’s appropriate when your limited company is clearly on the ropes? If you are, your best way out of this corner is rather simple -- seek advice early, and seek advice early. Did I say that twice? Yes, I did -- because it bears repeating!

Working with a licensed insolvency practitioner as soon as the company becomes technically insolvent (i.e. as soon as you lose that major customer in our example), can provide an element of protection. It can even help as a defence against any allegation of director wrongdoing, such as wrongful trading under the Act or disqualification proceedings under the CDDA, even if the company does end up in an insolvency process.

Finally, be like Bill, and don’t do a Dan!

So, can failed company directors really keep the Bentley, give staff zilch, and just set up a new biz?!

Bill, who was working with a professional adviser and within the parameters of the law in Example 1, doesn’t really deserve to be seen as that pantomime villain, regardless of going through an insolvency process and starting up the same business again. Be like Bill!

Dan in Example 2? Well, that’s a totally different story and certainly deserves you spitting out your beer in objection. And if you get his shoes wet in the process? Maybe that’s deserved.  Don’t do a Dan!

From what we’re seeing, despite company insolvencies still being historically high, genuine cases of the dodgy director running off with the riches, paying staff nothing and forming a company afresh (to potentially do it all over again!) are a rarity. If it doesn’t feel rare to you, remember headline-writers would be in shtook of their own, if they wrote the rather drab:

‘Company fails, director takes sound advice and buys business back legitimately for market value.’

Yep, I probably wouldn’t read that story either!

Coming up next...

But as a headline, how about, ‘Should I close my limited company or make it dormant?’ Hopefully you would at least glance at that article as we’ll be back shortly to answer this often-asked question by contractors, exclusively on ContractorUK.

Find out more about SFP Group here.