Insolvency and Companies Court Judge Prentis has made the first compensation order under section 15A and 15B of the Company Directors Disqualification Act 1986 (“the Act”). In making the order, the court has provided some helpful comments on the background to the compensation order regime and its application in practice.
The compensation order regime was introduced with effect from 1 October 2015, and applies to conduct after that date. It gives the Secretary of State power to apply for a compensation order against a director who is subject to a disqualification order or who has given a disqualification undertaking.
On 14 May 2019, ICCJ Prentis made a disqualification order against Kevin William Eagling (“Mr Eagling”) for the maximum period of 15 years in relation to his conduct as a director of Noble Vintners Limited (“Noble”). The judge continued consideration of the compensation application in order that he could be addressed on the background to the compensation regime and its application in the instant case.
In a judgment handed down on 1 November 2019, ICCJ Prentis ordered Mr Eagling to pay compensation in the sum of £559,484, with £460,067 being paid to the Secretary of State for the benefit of 28 named creditors of Noble, and £99,416 being paid to the liquidator of Noble as a contribution to its assets.
Noble traded as a wine broker, ostensibly targeting high net worth individuals, largely through telemarketing campaigns. The Secretary of State issued disqualification proceedings against Mr Eagling on the basis that he caused Noble to incur obligations, including those generated by its own recommendations to clients to buy and sell wine, which it did not meet. It was alleged that Mr Eagling paid almost all of Noble’s income over the relevant period to a company controlled by him, without any commercial justification for so doing. The sums paid to this company totalled £559,484. These sums included money that Noble had been paid by wine merchants for wines belonging to customers of Noble and sums received from customers of Noble in respect of orders of wine placed.
ICCJ Prentis had no hesitation in finding that Mr Eagling’s conduct was unfit within the terms of the Act. He noted that Mr Eagling’s conduct had a substantial effect on Noble’s creditors. The company was telephoning customers who had already bought wine, advising them it was time to sell that wine. However, when the wine was sold the proceeds vanished. The judge considered that it was a highly aggravated case of unfitness that merited a disqualification order of 15 years.
Compensation order “consternation”
As this was the first case brought by the Secretary of State for a compensation order, the judge took the opportunity to address some of the “consternation” that the regime had caused within the insolvency profession. In particular, the judge identified the inter-relationship between the regime and the routes to recovery available to an insolvency practitioner under the Insolvency Act 1986 (the “Insolvency Act”). The judge was also keen to be addressed on the potential disruption to the priorities of distribution, and the long established principle of ‘pari passu’ distribution (under which creditors are paid pro rata in accordance with the amount of each of their claims).
New free standing regime
It was noted that the intention of the 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. The regime had been introduced to give the disqualification regime more “bite” and to provide a remedy to creditors where these were not available under the Insolvency Act.
The judge was careful to highlight that one of the main differences between the compensation regime and the recovery routes under the Insolvency Act was that with the former, liability is not based on the loss to the relevant company, but rather loss to individual creditors. ICCJ Prentis noted that the regime was “a new, free-standing, regime, and must be interpreted as such.”
The judge carefully examined the preconditions in section 15A(3)(b) of the Act, in particular that the conduct for which the person is subject to the disqualification order must have “caused loss to one or more creditors of an insolvent company of which the person has at any time been a director”.
Importantly, the Act did not address directly what was meant by causation. In the absence of any statutory guidance, the judge thought the conduct need not be the predominant cause of loss, however mere “but for” causality might not provide a sufficient connection between the misconduct and the loss. The example given by the judge in this regards was an allegation of failure to keep proper accounting records. ICCJ Prentis suggested a “middle road” in which “using hindsight and common sense but without considering foreseeability, the court must be satisfied that the misconduct has caused loss within the meaning of the Act to a creditor of a relevant insolvent company”.
Amount of compensation
It was noted that section 15B gives the court discretion in relation to both the amount of any compensation order and to whom it was payable. In determining the amount, the court must have regard to the amount of the loss caused, the nature of the misconduct and what other financial contribution the person has made in recompense for the misconduct.
In considering what other financial contribution the person had made, the judge addressed concerns that some might have regarding double recovery. It was acknowledged that in many situations there will be overlap between the facts founding the compensation regime and those founding claims within a liquidation or administration, with the culpable person being the same. However, the judge was clear that any court would bear in mind 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.
ICCJ Prentis also dismissed the criticism that the compensation regime could potentially harm the relationship between it and the insolvency regime. The Insolvency Service’s internal guidance and the opportunity for the court to have the fullest information before it when deciding whether and in what amount to make an order, meant that it was a regime with checks and balances at every stage. It was noted that there could be situations where the insolvency practitioner and the Secretary of State are competing for sums from the same pot and this would also be something that the court would take account of in making an order.
Distribution to creditors
The court, with the benefit of all the information available to it, will also be able to decide whether any compensation order should be paid to the insolvent company or to the Secretary of State for the benefit of creditors or a class of creditors, or some combination. It was noted, in particular, 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.”
In this case, the judge was prepared to adhere to the Secretary of State’s suggestion of who should benefit from the compensation order. The 28 creditors identified by the Secretary of State had either had their wine sold by Noble without being paid the proceeds, or had paid Noble for wine it had not purchased. The judge was satisfied that these creditors had suffered the most direct loss and it would be unfair if payments they made, or ought to have received were attributed to payment of those who had already suffered losses.
In situations where the Secretary of State is ordered to distribute to creditors, it was noted that the legislation did not specify any particular mode of distribution, or ascertainment. The issue being that there was no direct means for any creditor to challenge their inclusion or exclusion from a particular class of creditors. It was thought any such issues could be resolved by way of an application to the court.
The judgment in this case brings some much-needed clarification on how the courts will apply the provisions of the compensation order regime. Hopefully, it will provide some comfort to those insolvency practitioners who feared that the regime might be used to usurp the role of the insolvency practitioner and prevent recoveries being made under the routes available in the Insolvency Act.
While there might be overlap in some cases, the compensation regime is a new, free-standing regime that seeks to redress losses suffered by individual creditors caused by the director’s misconduct, rather than losses to the insolvent company. In the court’s mind, there are sufficient checks and balances within the legislation, and particularly given the role of the court, to ensure that there is no disruption to the priorities of distribution.
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 are going to have to be even more aware of the Secretary of State’s power to seek an award of compensation following an order/undertaking.
It should be noted, however, that while the Secretary of State 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 Secretary of State does say 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.
Andrew Scott is a Senior Associate in Shepherd and Wedderburn’s commercial dispute resolution team. For more information, you can contact Andrew on 0131-473 5709 or at firstname.lastname@example.org.