Compensation orders against disqualified directors – four years in the making

United Kingdom

Background

The aim of the compensation order regime, to make directors financially account for the consequences of their unfit conduct, applies to directors’ conduct after 1 October 2015 and gives the Secretary of State (“SoS”) the power to apply for a compensation order against a director who is either subject to a disqualification order or who has given a disqualification undertaking and the conduct of that person has caused loss to one or more creditors of the insolvent company.

The court has the discretion to order the director to pay an amount (a) to the SoS for the benefit of a creditor/creditors specified in the order or a class/classes of creditors, and/or (b) a contribution to the assets of the company, as it sees fit.  In making the application for the compensation order and considering whether it is in the public interest to do so, the SoS must have regard to the amount of loss caused, the nature of the conduct and whether a person has already made a financial contribution in recompense for the conduct.

On 1 November 2019, ICC Judge Prentis handed down the first compensation order under the Company Directors Disqualification Act 1986 (the “Act”), as explained further below.

Facts

Noble Vintners Limited (the “Company”) traded as a wine broker on behalf of high net worth individuals who wished to acquire expensive wine, usually for investment purposes. The Company was incorporated in June 2011 and in May 2015, Mr Eagling, who had been a manager of the Company, became sole shareholder and director. On 22 June 2017, the Company entered creditors’ voluntary liquidation with an estimated deficiency of approximately £1.7 million.

It was alleged that between 2 November 2015 and 18 October 2016, Mr Eagling caused the misappropriation of company funds totalling £559,484 from the Company. Specifically, Mr Eagling was alleged to have recommended that customers purchase wine, but that wine was never received and similarly, recommended that customers sell wine but did not receive the proceeds of the sale. 

In December 2018, the SoS issued proceedings against Mr Eagling, seeking both his disqualification under section 6 of the Act and a compensation order in the amount of £559,484

In May 2019, ICC Judge Prentis found against Mr Eagling on the basis that by 2 November 2015, the Company had very little prospect of meeting its substantial debts, yet continued to incur obligations. Further, Mr Eagling chose to pay almost all of the Company’s income to his own personal company, without any commercial or legitimate justification for doing so. Mr Eagling was disqualified for the maximum period of 15 years.

Decision

The Judge ordered Mr Eagling to pay compensation in the full amount, namely sum of £559,484 on the basis that Mr Eagling’s misconduct was of the “most serious sort” and the removal of the sums from the Company caused a loss to its creditors in the same amount. ICC Judge Prentis also expressly stated that Mr Eagling had made no other recompense and was very unlikely to do so, on the basis that the liquidator of the Company had not sought to make any representations, nor did he have any funds to pursue Mr Eagling under the provisions of the Insolvency Act 1986 (“IA 86”).

As to the question of division, the Judge agreed that £460,067 ought properly to be paid to the SoS for the benefit of 28 named creditors of the Company whose debts had accrued after 2 November 2015. Whilst these creditors had no priority over the treatment of earlier (unsecured) creditors, they had suffered the most direct loss. The remainder (£99,416) was to be paid to the liquidator of the Company as a contribution to the Company’s assets.

Commentary

In making the order, the court has provided some helpful comments on the application of the compensation order regime and how it might inter-play with the existing provisions of the IA 1986. This has given rise to concerns about potential double recovery and the fact that this regime may hamper office-holders in (or preclude them from) bringing their “own” set of claims. 

Arguably, the regime also goes against the principle of pari passu as between unsecured creditors, which has long been an established principle of UK insolvency law.

On these points, the Judge made it clear that:

  • no statute should be interpreted so as to impose a double liability, and the fact that a court needs to take into account any financial contribution made by the director or is at risk of having to make, means that this matter will be at the forefront of the court's mind when making a compensation order; and
  • the intention of the compensation regime was to enhance the protective aspect of the disqualification regime, by giving monetary redress to creditors who had lost out as a result of a director's misconduct. It was a free-standing regime, where liability is based on loss to individual creditors, as opposed to the company (compare the recovery routes under the IA 86). Since 1986, there have been very few reported cases of claims for wrongful trading, preferences and transactions at an undervalue. However, the Judge also made clear – and this will provide some comfort to IPs – that the court has a wide discretion and that there are “sufficient checks and balances at every stage” which mean that the court will bear in mind the appropriateness of allocating proceeds to particular creditors rather than to creditors generally. 

In assessing the division of the compensation payable, the court has the discretion to determine whether any compensation order should be paid to the insolvent company or to the SoS for the benefit of identified creditors, or some combination. On this and again, of comfort to IPs, it was noted that the court would "have to consider the public interest in insolvency practitioners being remunerated, what the relevant practitioners have done in order to allow the disqualification and compensation claims to be made, and how they are to be remunerated if not through the compensation order; and how monies would be distributed were they to be within the insolvent company".

Finally, the Judge did recognise that the compensation regime could result in fewer disqualification cases settling by undertaking. Now that the first order has been made, directors will need to be mindful of the SoS's power to seek an award of compensation following an order/undertaking.  It should be noted, however, that while the SoS is not going to rule out the possibility of applying for a compensation order if further information should come to light, when notifying a director of its intention to issue disqualification proceedings, the SoS ought to confirm whether they consider a compensation order would be appropriate or not. That should give directors some assurance that if they were to give an undertaking they would not be immediately subject to proceedings for a compensation order.

Given that this is the first compensation order in 4 years since its implementation, it will be interesting to see whether more follow. What does seem clear however, is that the regime may well offer greater options for recovery where the requirements for antecedent transactions are not made out, there is insufficient funding in the insolvent estate to bring a claim and/or a particular creditor or class of creditors have been affected.