Compensation Orders - What directors need to know
Many directors will be aware that if a company, which is struggling financially, subsequently enters into administration or liquidation, the conduct of any person who was a director of the insolvent company will be subject to review. In some cases, this could lead to an investigation by the Insolvency Service.
However, company directors should also be aware that there are circumstances in which the Insolvency Service can apply to Court for a compensation order.
What is a Compensation Order?
The Insolvency Service can apply for a compensation order, if:
a director is subject to a disqualification order or undertaking; and
their conduct has caused a loss to one or more creditors of the insolvent company.
The purpose of any compensation order is to make director(s) financially accountable for unfit conduct. This option is available under the Small Business, Enterprise and Employment Act 2015, which came into effect on 1 October 2015 and an application must be made within two years of the disqualification or undertaking.
If the Insolvency Service has made the decision to seek a compensation order, the relevant director will be notified by post (to their last known address). If proceedings are then issued the director will be formally served with notice of the proceedings.
At the Court hearing, a director has the opportunity to respond to the allegations made and offer an explanation for losses incurred.
At this stage of the process the Court, may:
agree that a compensation order should be awarded;
disagree that a compensation order should be awarded;
agree or amend the quantity awarded;
agree on who the compensation should benefit.
However, you should also be aware that if the Court agrees that a compensation order should be made, the order usually includes an order to pay the costs and expenses of the Secretary of State, which could be significant.
As an alternative, any director, who receives notice that the Insolvency Service will be seeking a Compensation order, could provide undertaking to pay. This avoids all the costs associated with potentially lengthy legal proceedings and saves time and worry.
Once accepted by the Secretary of State, the undertaking has the same effect as a court order and can only be amended by the court.
Potentially, the most significant benefit to a director of providing an undertaking is that it allows him / her to come to an agreement as to the amount of the compensation, and how it is paid. This could be invaluable if your affordability to pay the compensation is hindered, or you need time in which to raise the funds.
Directors of a company which is facing financial difficulty could be at greater risk of being held liable to make a contribution to company assets. Accountability for your actions as a director is no longer limited to a disqualification order, or disqualification undertaking, with no financial implications.
Cautious directors should document their decisions, and the rationale behind each one. Most importantly, if your company is experiencing financial difficulty it is important to seek early advice from a fully licensed Insolvency Practitioner.
At LMS we provide free and transparent advice to any director looking to close their company. We also provide advice to directors who have already closed their company and find themselves subject to allegations of poor conduct. If you require any further information please do not hesitate to contact us for a no obligation assessment.