Suppliers and creditors have often been hung out to dry by company directors deliberately closing down their companies to avoid making payment of their debts. We have represented many clients who have seen a perfectly legitimate debt ‘wiped out’ by a director simply dissolving the company in order to avoid liability. However, Parliament has recently announced proposed new legislation to tackle what can be a significant loophole.

The current law

Many companies are supplied with goods and services in advance. This is not unusual but, of course, it does run the risk that if a company was to close its doors, the creditor may simply see the ability to pay their debt ‘disappear’. This is especially galling when the director of the Oldco reappears with a Newco.

Directors can elect to voluntarily dissolve their companies if they so wish. However, this power should only really be used if the company has not been subject to prior insolvency and has no assets and liabilities and has not been trading. Unfortunately, some directors use this power to close down their business quickly and discreetly and often without even informing the company’s creditors of their actions until they discover the news from Companies House.

This type of behaviour sidesteps the formal insolvency process and any subsequent investigations by an Insolvency Practitioner. The dissolution loophole can be used to mask fraudulent activities by a director, who may (at the same time) seek to set up a new company that will inherit the elements of the dissolved company.

Not only does such behaviour leave creditors with little comeback (unless they are prepared to spend monies on reversing the dissolution and winding up the company themselves), it also has a huge impact on the taxpayer. As you may be aware, in certain circumstances, the Government has to step in to pay the staff their wages and often HMRC is left with a deficit in tax payments.

There are current laws in place for criminal prosecutions to take place if a director knowingly or recklessly provides false or misleading information on a dissolution application. Directors are informed that they must send copies of the dissolution application to notifiable parties (i.e., creditors, employees etc.) within seven days of the application, failing which, they are committing a criminal offence.

Unfortunately, as you may have come to realise, firstly it is difficult to find the relevant organisation that will investigate and prosecute the director for such an offence, and secondly, even when located, there seems a reluctance for such an investigation to take place.

The new legislation

With the Government furlough payments, tax breaks and loans keeping many companies solvent during the pandemic, there have been fears that nefarious directors will pocket the cash, dissolve the company, and with it, any repayments of Government loans will disappear into someone’s back pocket.

The proposed new legislation, which will cover England, Scotland, Wales and Northern Ireland, aims to provide the Insolvency Service with the power to investigate companies and target directors who have inappropriately dissolved their own companies. The measures will also help to prevent directors from setting up phoenix companies after benefitting from a business support scheme such as a HRMC or a COVID Payback Loan.

The extended powers to investigate directors means that there is more likelihood that any wrongdoing will be identified and the directors held to account. If wrongdoing or malpractice is found, directors can face sanctions including a ban for up to 15 years.

Disqualification

In August 2018, the Director’s Disqualification Policy was first announced. A director can be disqualified from being a company director if they fail to meet their legal responsibilities.

However, the Government has confirmed such policy would be updated to deliver measures to combat Bounce Back Loan Fraud as announced in the 2021 Budget.

Dr Roger Barker, Director of Policy and Corporate Governance at the Institute of Directors, said: ‘Company directors fulfil a central role in ensuring that their businesses are well-governed. Although corporate dissolution may be inevitable in some cases, it should only be used as a last resort – after all other realistic avenues for protecting the interests of stakeholders have been exhausted. Using company dissolution as a mechanism for the evasion of a directors’ duties has no place in the governance of a responsible enterprise.’

The future?

The number of dissolutions in Q4 of 2020 increased by 40,212 (33.1%) compared with 2019, and in Q1 of 2021 increased by 34,191 (25.0%) compared with 2020, according to Companies House official statistics. This is perhaps not surprising – we all know the economic effect of lockdowns on certain business types and Companies House are now processing dissolutions again after suspending for a period. However, not all dissolutions have been carried out for proper reasons and the new legislation aims to make directors think twice about trying to avoid debts as they risk the possibility of investigations into their actions.

To support the new legislation, the Government has agreed to provide £1.5bn to ensure the business economy in England is restored in the fastest and fairest way. So it is not all bad news for directors – just those that do not wish to act in line with their fiduciary duties.

Many are hoping the new legislation will act as a strong deterrent against the misuse of the dissolution process and bring such loopholes to an end, which will be good news for businesses providing goods and services on credit terms to SMEs.

The new legislation is expected to become law later this year.

For more information and support with the changes to insolvency legislation, or to arrange a confidential discussion about your debt recovery requirements, please call us on 01332 226 474 or email .