Guidance Notes for the Completion of Statutory Reports and Returns

These notes are important and should be read before completion of any report or return under section 7 of the Act.

4. Unfit conduct

This section discusses the types of unfit conduct described in Schedule 1 of the CDDA 1986 and states the types of evidence which are needed to support an allegation if put before the Court. This evidence should be viewed in the context of the duties of all directors, which may be summarised as:

• a fiduciary duty to act honestly and for the benefit of the company;

• a duty to act with such a degree of skill as may reasonably be expected of a person with their knowledge and experience; and

• a duty to comply with statutory obligations imposed by the Companies Acts and other relevant legislation.
  

All matters of unfit conduct fall within one of the following more general categories. You may therefore find it easier to use them when identifying unfit conduct:

• Taking unwarranted risks with creditors' or shareholders' money.

• Taking unfair advantage of the position of director.

• Terious failures to comply with statutory duties and company law.

The following information will be required whatever the nature of the unfit conduct:

• Who was responsible?

• When did it happen?

• What are the sums involved?
  

The more frequently encountered matters laid down in Schedule 1 to the CDDA are now discussed. They are not exhaustive, and you must report any other matters which demonstrate unfitness on the part of the directors, bearing in mind, among other matters, Part X of the Companies Act 1985 concerning fair dealing by directors of all companies.

However, you should always consider the "materiality" of matters of unfitness. In particular, you should ask:

• How much damage has been done to creditors', shareholders' or employees' interests?

• How much did the unfit conduct affect the directors' ability to manage the company?

4.1 Schedule 1 CDDA - Matters for determining unfitness of directors

Part I - Matters that apply in all cases

 
Misfeasance or breach of duty

1. In your opinion, have the directors received any money or other consideration from the company (except their proper remuneration) for services provided, which has resulted in a material loss to the company? When did this take place and what was the company's financial
   position at the time?

2. Has the director authorised any payments or other dispositions of property to himself (or to connected persons) as in (a) above, including any amounts paid to the directors for personal expenses?

3. Has the director been responsible for the non-disclosure to the company of any contracts, dealings or other transactions in which the company's assets or property (including goodwill) were used and which resulted in a material loss to the company?

4. Has the director been responsible for any material loss to the company through the sale, assignment, transfer or other disposal of any company assets or property, except in the normal course of business?

If the answer is yes to any of the above questions, please quantify the loss, supply details of evidence available, and provide any explanations given by the director for their actions. If proceedings for recovery have been, or are to be, taken against the director(s), then you should give details in answer to question 20 at section 7 of the D1 (see "Other proceedings" in section 3.2 ).

Breach of duty can cover many matters of unfit conduct. Examples might be failing to pay over pension contributions deducted from employees, or allowing the company to make loans for which it received no benefit. The allegation effectively covers any conduct by a director which you consider was not in the proper interests of the company or generally worked to the detriment of creditors, employees or members.

Misapplication or retention of company money or property

Has the director retained or misapplied (or been responsible for the retention or misapplication of) any money or other company property resulting in:

• an obligation to account which has not been fulfilled?
  
  Or

• a trading, capital or other loss?

If so, please provide full details.

Transactions defrauding creditors

Matters which you should consider under this heading include:

• Disposal of any of the company's property, assets or undertaking by transfer, gift or at a significant undervalue for the purpose of placing such assets beyond the reach of the company, its members or creditors.

The director's responsibility for this and explanations given should be set out.

• Selling goods which are the property of third parties. Matters for consideration include:

• Who was responsible, and what was the value of goods disposed of? Is the original agreement available?

• When were the goods sold and what happened to the sale proceeds? Is the sale recorded in the accounting records?

• Has the owner of the assets complained; is a separate action for recovery being taken?

• Did the company continue to make lease or hire purchase payments after the disposal?

Transactions which give you cause to make allegations of misfeasance/breach of duty, misapplication/retention of company money or property, and transactions defrauding creditors are fairly similar to each other and could collectively be described as comprising "breaches of commercial morality". More usually, you will be reporting in respect of companies which are insolvent, so such transactions will come under the heading of "preferences and transactions at an undervalue". The type of evidence needed in relation to such an allegation is discussed in more detail in chapter 4 part II .

In either event, you need not overly concern yourself at the reporting stage with defining the allegation by reference to Schedule 1, Part I or II. Rather, you should describe the transaction and show its adverse effect on the company or its creditors or both.

Failure to comply with the Companies Acts 1985 and 1989

Accounting records

Please confirm that you have formally required the delivery of all accounting records to you and state whether you believe you have all records which were kept. If not, please state why others may still be holding the company's records and what steps you have taken to obtain the remaining records. If the accounting records are not produced or are inadequate, and the deficiency cannot properly be explained (except by a balancing trading losses Figure), you should always ask the directors for explanations. For example:

• Did the company keep accounting records regularly recording its transactions, dealings, assets and liabilities (section 221 CA 1985)?

• If no accounting records were kept, what was the director's responsibility for the default? What explanation has the director given? Was any accountant or bookkeeper employed?
  
  If records were kept:

• were any accounts produced and, if so, were qualifications made in auditors’ or accountants’ reports regarding the adequacy of the records?

• to what date were the accounting records written up?

• are there any material omissions, having regard to the size and nature of the business?

• have the inadequacies hindered your administration, for example, collection of book debts, verification of creditors' claims, identification of assets belonging to the company, and benefits received by the directors?

• would the lack of proper financial information have caused the directors to be unable to inform themselves of the company's financial position, and to manage the company properly?

• have the creditors lost because of the inadequacies?
  

If accounting records have been maintained in a computerised form, you should ensure that you recover both the hard-copy printouts and the relevant source documents from which the accounts have been prepared.

Preservation of accounting records

• For what period did the company preserve its accounting records and where were they kept (section 222 CA85)?

• Were accounting records kept outside Great Britain? If so, were accounts and returns prepared from them and were they regularly sent to Great Britain (section 222 CA 1985)?

• Can you identify any of the accounting records which are missing and give any information as to the circumstances?

Keeping of statutory registers

• Did the company keep the registers required by sections 288, 352 and 353 of the CA 1985?

• If not, what was the director's responsibility for the failures or omissions? The size and nature of the company's business should be taken into account, especially if it is owner-managed.

• Has the lack of any of these records hindered the administration of the company's estate? If so, please give details.

Minute books

Although not specifically referred to within the schedule, the company's minute book can be an important source of information. Often it provides clear evidence of what information was available to the directors and what action they took at various points in time.

• Has the minute book been kept and written up?

• Has it been delivered up to you?

Annual returns

• Please provide details of any (material) omissions or deficiencies in respect of the annual returns (sections 363 and 364 CA 1985).

• What was the director's responsibility for any default, omission or delay in the annual returns, and what explanation has he given?

Accounts

1. To what date were audited or statutory accounts last prepared? Or has the company taken advantage of the exemption from audit provisions available to certain small companies?

2. Were any accounts prepared for any period subsequent to the accounts referred to in (a) above?

3. Have the balance sheets to the accounts referred to in (a) above been signed by the company's officers, and were all required documents annexed to them (section 238 CA 1985)? If there was any default, omission or delay in preparation, signing or filing the audited or statutory accounts, what was the director's responsibility for this?

4. Has any failure to file accounts caused particular prejudice to creditors or third parties or both?

5. Concerning the accounts referred to in (a) above, were any auditors' or accountants’ reports qualified in relation to matters other than the quality of records, e.g. reference to fundamental uncertainty concerning the company's financial position.

6. Were the reports to any earlier accounts qualified? If so, please supply copies and state the extent of the director's responsibility for any of the deficiencies disclosed in the auditor's qualification and what explanation the director has given.

Part II - Relevant matters if the company has become insolvent

Causes of failure and insolvency

You should report on the extent of the directors' responsibility for the causes of the company becoming insolvent.

Conduct which can be put before the Court under this heading can be categorised in terms of:

• trading without regard to the interests of creditors (and shareholders) through incompetence or
  negligence to a marked degree; or

• trading without reasonable prospect of paying creditors' claims. These are both dealt with in detail below.
  

As descriptions of types of conduct they are, to an extent, interchangeable. The Courts are reluctant to place responsibility on directors for events leading to a company's failure which could not be foreseen or whose effects could not be mitigated; nor are they prepared to penalise directors for commercial
misjudgement.

Trading without regard to the interests of creditors

• What events caused the company's insolvency?

• In promoting the company, was sufficient regard given to the potential viability of its business?

• Was capital available, except as credit from suppliers, to finance the purchase of necessary plant and equipment and to see the company through its setting-up period?

• In accepting contracts, was proper consideration given to the costs involved or did the customers effectively dictate the price? Were the directors aware whether prices charged covered costs?

• Having regard to the size and nature of its business and their own professional qualification and experience, did the directors have available enough financial information, management accounts, feasibility studies or professional advice, to make effective policy decisions?

• Were audited accounts prepared, and filed, by due dates?

• Was information provided to investors, providers of working capital and creditors? Did they rely on that information and was it accurate?

Trading without reasonable prospect of paying creditors' claims

In addition to those matters set out under the preceding sub-heading, the following are relevant considerations:

1. When did the company first become insolvent?

2. Is that evidenced by accounting information, judgements/claims, threatening letters, dishonoured cheques, distraints, execution, PAYE/VAT/DSS arrears?

3. Could the directors have had any valid reason to believe that the company's fortunes would change sufficiently for it to return to solvency?

4. Was any capital/cash injection expected to be forthcoming and if so was that expectation reasonable? Would it have been adequate?

5. Was professional advice to continue trading (or not to do so) ever received? If so, what was the advice given, when, and by whom, and was it based on accurate information?

6. By what amount did the company's deficiency or debts to various categories of creditors increase after the date identified at (a) above?

7. To what extent was the continuation of the company's trading facilitated by the withholding of Crown money? By its forbearance, has the Crown suffered disproportionately to the creditors generally? Over what period, compared with other creditors, has the Crown debt accrued?

8. With regard to (f) above, what money was introduced directly or indirectly by the directors in the relevant period? If debts have been guaranteed, will those guarantees be honoured? What is the extent of collateral security?

9. Did the directors moderate their remuneration/benefits in the relevant period? Did the amounts drawn remain reasonable in all the circumstances? Indeed, was there any increase?

Crown debts

The Courts have held that debts due to the Crown, for example, VAT or PAYE & NIC not paid over, are not, of themselves, evidence of unfit conduct. The existence of Crown debt can provide evidence of a company's inability to pay its debts as and when due, in addition to money owed to trade creditors, as mentioned above.

To make a specific allegation in relation to Crown debts, it is necessary to demonstrate that:

• the Crown has been treated worse than the General body of trade creditors; or

• that the forbearance of the Crown departments has been abused when, for example, deferred collection arrangements have been agreed but not complied with, to the detriment of the Crown.

It is important to report significant failure to comply with statutory schemes where, for a prolonged period, there has been a failure to submit returns and/or pay over money for which the company is accountable to the Crown. Such conduct may, of itself, give rise to a separate allegation.

The Crown is an involuntary creditor. It relies on compliance to be in a position to assess its debt due from the company. Therefore, the absence of Crown pressure should not be regarded as a mitigating factor because the duty is on the company to comply.

It is important, where possible, for Practitioners to identify those claims which are quantified as opposed to those estimated. You should send copies of any claims you receive, when relevant.

Phoenix companies

You should consider how far the business of the company under consideration was the successor of an earlier failed company. The overriding considerations are the time elapsed between two (or more) failures and how far the same people were responsible for managing each company. Clearly you may be restricted as to how far you can enquire into relevant matters. However, listed below are some of the more important the Unit would like to see.

• What assets were acquired from a previous company or business and in what circumstances? How much was paid (if anything) and what was the source of the money used?

• How similar is any business acquired and continued? For instance, did the successor company continue the same contracts or deal with similar customers? Was the workforce substantially unchanged? Did the successor company use the same or similar trading style (section 216 IA 1986), advertising material etc?

In summary, the central question is how far the directors of the new company could reasonably expect it to be viable. In this context, the length of time between the two failures is crucial, as is your consideration of matters listed under "Trading without reasonable prospect of paying creditors' claims" in chapter 4 part II .
You are also asked to provide details of any 'new' business being managed by the directors in apparent contravention of section 216 of The Insolvency Act 1986.

Consumer prepayments/deposits

The mere fact that a company has taken customer deposits and has then failed to deliver goods or services does not automatically constitute unfit conduct. Neither does the Secretary of State necessarily have to prove that the deposits were taken at a time when the company was insolvent in order to allege unfit conduct.

For the allegation to stand up, there must be some evidence that the failure was not excusable. Although not an exhaustive list, the following factors are relevant:

• Was the company using deposits for its general trading purposes at a time when orders were not being met on time, so that the company was jeopardising deposits without realistic prospect of delivering the goods or services, or being able to repay deposits?

• If it can be shown that a company had neither the intention nor the ability to deliver the goods or services, then the taking of deposits would constitute unfit conduct even if the company is, or was, fully solvent at the time the deposit was taken.

• If the company's treatment of deposit money is in breach of the express terms of a contract, the receipt and handling of such deposits may amount to unfit conduct, even in the absence of fraud or insolvency.

When reporting, you are asked to state, in addition to the above:

• What is the number and aggregate amount of deposits?

• Over what period were the deposits received?

• Were any misleading statements made to customers, and, if so, when and by whom?

• Have depositors been reimbursed under any kind of compensation scheme, or by a credit card issuer?

• Have you received complaints? (Please forward examples.)

• Did the company ever maintain a separate bank account into which deposits were, or should have been, paid?

• What, if any, explanation has been offered by the directors for the failure to supply goods or services, or to give refunds?

Transactions at an undervalue, preferences and dispositions of property

Matters that can be put before the Court are those for which an application has been, or could reasonably be made, for an order of the Court to set aside the transaction under sections 127 or 238 to 240 (in Scotland, section 242 or 243) IA 1986. If the full tests set out in those sections cannot be met, it may still be possible to make out an allegation along these lines. You should highlight any benefit to the director or connected persons, at a time when the company was insolvent or which exacerbated the failure of the company.

Preference/transaction at an undervalue

• When did the transaction take place and who has benefited from it?

• How much was the benefit and what was the full value of the asset transferred?

• Is the transaction recorded in the accounting records?

• Was there a liability in the last accounts to a director or connected person or company where that liability apparently no longer exists?

• What action/decision has been taken over recovery?

Duty to assist the Practitioner and to deliver property

• Has the director failed to deliver to you, when required, any property, books, papers or records of the company (section 234 IA 1986)? If so, please give details.

• Has the director failed to co-operate with you as office-holder, in providing information about the company's affairs (section 235 IA 1986)? If so, provide brief details, including any proceedings taken.

• What explanations have been provided for these defaults?

• What steps have you taken to enforce compliance? Have you verified that the director is at the address where requests for information have gone?

• What actual problems have these defaults caused in the administration of the company's affairs? Can a loss to the creditors be identified?

Showing that the company was insolvent

With many of the matters under Part II of the schedule, it is also necessary to show that at the time of the events to which the allegation relates, the company was insolvent. If so, it is important that you tell the Unit what evidence is available to show that the directors ought to have been aware of the insolvent position.

"Balance sheet" insolvency is not necessarily enough.  To prove the allegations, it must be shown that the directors were aware, or should have been aware, of the insolvent position (for example, by creditor pressure or warnings from advisers), that steps were not taken to remedy the situation, and that continued trading was detrimental to creditors and others.

You should also consider whether there is any evidence, particularly in any records delivered up, which provides justification for the company continuing to trade, even if the directors were aware of the insolvent position. Such evidence might include the existence of potential investors or evidence that the company was currently trading profitably. However, the mere fact that there has been professional advice does not preclude allegations of unfitness. Much depends on the assumptions on which that advice was based, and whether it was acted upon.

[ CONTENTS ] [ PART 1 ] [ PART 2 ] [ PART 3 ] [PART 4] [ PART 5 ] [ PART 6 ] [ APPENDICES ]