Procedure for dissolution

Dissolution is a cheaper, quicker and easier way of removing a company from the Companies House register than liquidation. To dissolve a company, the directors sign and send a form to Companies House, with a £10 fee, and publish a notice of proposed striking-off in the Gazette. If nobody objects for 2 months, the company is then dissolved upon publication of a further notice.

Misuse of dissolution

However, dissolution is only available in specific circumstances; most notably, the company must not have traded in the last 3 months. This means that there is significant potential for it to be misused, whether intentionally or not. Indeed, the Insolvency Service regularly receives complaints about former directors who are alleged to have misused the dissolution process by various practices.

One such practice – known as “Phoenixism” after the famous mythical bird that rose from the ashes – involves dissolving a company to escape its liabilities, such as debts owed, and then setting up a new company in its place, often with the same location and assets. In other cases, directors may dissolve a company simply to avoid the time and expense of liquidation, even though liquidation is more appropriate.

Most recently, the government has raised concern that the dissolution process was being misused as a method of fraudulently avoiding repayment of government-backed loans given to business to support them during the Covid-19 pandemic.

Importantly, companies may be dissolved rather than liquidated because the directors want to avoid a government investigation into their conduct under the Company Directors Disqualification Act 1986 (“CDDA”). As well as granting powers of investigation, the CDDA permits the government to apply for a court order disqualifying a person from serving as a director of a company for up to 15 years.  This is on the basis that their conduct – such as fraudulent behaviour and seeking to deprive creditors of assets – makes them unfit to manage a company.

Shortcomings of existing powers to investigate and disqualify directors

At present, however, the CDDA powers of disqualification do not apply to directors of companies which have been dissolved. In order to get around this, the government currently follows a three-stage process of:

• applying to the Court to restore the dissolved company to the register;
• once the company has been restored to the register, using powers under the Companies Act 1985 to obtain information and documents from the company, so as to investigate the director’s conduct; and
• if appropriate, seeking a disqualification order under CDDA.

This is a costly, time-consuming and cumbersome procedure, which the government believes makes it harder for directors to be held accountable for unfit conduct.

The new Bill

In order to close this loophole, the Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Bill seeks to expand the government’s powers of investigation and disqualification of directors  under CDDA so as to include former directors of dissolved companies, thus avoiding the need to restore them to the register first. In line with the existing rules for insolvent companies, it will also provide that a court order for compensation can be made against a disqualified director whose conduct has caused loss to creditors of a dissolved company.

The Bill is highly likely to become law in unamended form, having passed through all the Commons stages unaltered and with no MPs speaking in opposition. It is now in the Lords, with its second reading scheduled for 26 October 2021.

Conclusion

The new Bill will be of significant interest to providers of Directors’ and Officers’ Liability insurance (“D&O”), as it is likely to lead to an increase in the numbers of investigations into directors of dissolved companies, and in the numbers of disqualification orders made as a result. Depending on the type of cover provided, a D&O policy may respond to cover the director’s costs of dealing with the investigation.

Moreover, directors of companies who are at risk of insolvency, and are considering whether to opt for dissolution or liquidation, should also take note of the risks of inadvertently misusing the dissolution procedure.  It is as important as ever for directors to take appropriate legal advice before deciding whether to dissolve the company.