Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Bill (First sitting)

Jeff Smith Excerpts

Committee stage
Tuesday 6th July 2021 Public Bill Committees

[The Chair]

Thank you, Mr Pegge. We will now take questions from members of the Committee, if you would be so kind as to answer. The Opposition traditionally go first, so I call Jeff Smith.

[Jeff Smith (Manchester, Withington) (Lab)]

Q Hi, and thanks for coming to give evidence. I am just trying to get a picture of the scale of the problem. To what extent do you think this is a problem? Are the measures in this legislation adequate to deal with the scale of the problem that you think is out there?

Stephen Pegge: To put it in context, the Insolvency Service estimates that there is currently evidence of misconduct or misuse of dissolution process in only 1% of cases. Given that there are something like 500,000 dissolutions a year, that might amount to only about 5,000 cases. There is some evidence that it is a rising problem and, given that the average company that is dissolved might have a loan of say £200,000, even 5,000 cases could amount to a risk to creditors of up to £1 billion. It is significant in scale because of the large number of companies, even if it is not currently a high level of risk in proportionate terms. I would emphasise that the vast majority of businesses are honest and straightforward and are not abusing this scheme.

The other factor that members of the Committee may be interested in is that quite clearly over the last year, during the covid crisis, there have been a significant number of companies that have taken finance. Given that the Government, through the British Business Bank, have provided guarantees, there would be an impact on the taxpayer if those loans were not repaid and a claim for repayment were made. Again, that is relevant to consideration.

[Seema Malhotra (Feltham and Heston) (Lab/Co-op)]

Q Thank you for your evidence today, Mr Pegge. I understand that you helped to establish the covid-19 lending schemes. The Government have suggested that some companies have been dissolved to avoid paying back Government loans given as coronavirus support. Have you seen any evidence of that? If these measures go through, do you believe, from your experience and what you have seen, that the Insolvency Service is adequately resourced to deal with the expansion of powers it would have through the Bill?

Stephen Pegge: Yes, we have seen instances of this practice being used to try and avoid liability under bounce back loans. Back in May 2020, UK Finance with the British Business Bank established the bounce bank loan fraud collaboration group. It involves attendees from the Cabinet Office; CIFAS, the UK fraud prevention service; the Treasury; BEIS; and the National Investigation Service—NATIS. The aim is for intelligence to be shared, good practice to be developed and a threat log to be maintained and fed into the National Crime Agency and the National Economic Crime Centre. In fact, this was one of the practices which had been identified through that and has led to some efforts more recently to try to intervene and intercept these cases of dissolved companies involving Companies House and BEIS.

In the meantime, it is always possible that these cases may well have got through and there is some evidence—again, reported by the Insolvency Service—that there could be around 2,000 such cases which are dissolved and where currently the powers to investigate do not exist, so it is a real problem. If it were to become a more popular route for fraud, while there are mechanisms to deal with it and creditors can object when they get notice through alerts when these situations are gazetted, unscrupulous individuals can still get through and it is important that it is closed as a loophole.

As regards the resources of the Insolvency Service, we have all been conscious that, while the number of insolvencies has been low during a period of suspension and the generous support that has been provided to businesses through public agencies and the finance industry, we would expect that to rise significantly in this next period. There is already some evidence that it will do so. It is important that the Insolvency Service is resourced sufficiently to be able to deal with this. The evidence at the moment is that they have been involved in disqualification of directors in something like 1,000 or so cases across the last year, so it is quite possible that there might be a rise in the amount of work that they will need to do. We would certainly support any investigation into what additional resources might be necessary.

[Mick Whitley (Birkenhead) (Lab)]

Q Welcome, Mr Pegge. Do the Government proposals address all the problems that have been identified with the dissolution process in relation to liabilities and directors’ conduct?

Stephen Pegge: This is certainly a very important contribution to addressing major issues, and it is the one that we have been most concerned about recently. We have seen, as I mentioned, real evidence of dissolution being used as an attempt to avoid liability, but I stress that in many cases dissolution is an efficient and appropriate way for companies to be removed from the register where there is no money owing and that business is ceasing, without going through the time and cost of liquidation, which obviously is available as an alternative—for solvent businesses through members’ voluntary liquidation, or in insolvent situations through creditors’ voluntary or compulsory liquidation. I am not aware of significant other means by which we need to deal with abuse of dissolution. This is the one that has been most to the fore in the evidence that we have seen of abuse, certainly through the fraud group.

[Jeff Smith]

Q I am trying to get a picture of the scale of the issue. You mentioned that the Insolvency Service was involved in about 1,0000 cases in the last year. I appreciate that you said that that is a low number for the year. Then you said that there may be around 2,000 cases where the powers to investigate currently do not exist. That sounds like a significant increase in work for the Insolvency Service, and I wonder whether you think that it will be able to cope.

Stephen Pegge: I am not close enough to its work and resource. One thing that I would say is that the Insolvency Service has very good experience in these sorts of investigations. I would also say that the other element of work, if it has found problems that meet the threshold of evidence and it takes action to disqualify a director, does not necessarily need to involve a court process. In most cases, the Insolvency Service will be successful in getting an undertaking from the director involved to be disqualified. It then has the powers to put that into effect, but certainly people may want to consider whether the resources are sufficient to deal with the case.

The other point is that these are situations where dissolution has been successful. We are also looking to these measures to act, to a certain extent, as a deterrent, in order to make it less attractive for those looking to abuse the system to try it on, as it were. So it may be that this event becomes less frequent in due course.

In fact, one of the processes that is clearly available is for creditors to object to an application for dissolution—and, indeed, the Insolvency Service at the moment is also able to object—on the basis of complaints at that earlier stage, where they have evidence of doing so. And because of evidence of significant numbers of attempts here, those objections have been done on a mass basis.

[Ms Marie Rimmer (St Helens South and Whiston) (Lab)]

Q Good morning, Mr Pegge. Clause 2(14) states that the provisions

“have effect in relation to conduct…occurring, and in relation to companies dissolved, at any time before, as well as after, the passing of this Act.”

Do you support making these provisions retrospective and, if so, how should the Insolvency Service make use of these retrospective powers?

Stephen Pegge: As I understand it, the support for this measure was confirmed as early as 2018 and it has really been a lack of parliamentary time that has made it difficult for it to be put in place. Given that we are aware of abuse that has happened in the meantime, I support this measure being retrospective. I appreciate that that retrospectivity is not often applied to such Bills, but we are talking about a fairly high evidence threshold and about situations where natural justice would support this measure being made with retrospective effect.

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[Seema Malhotra]

Q If a case passes the public interest test, do you think there should be the resources to deal with that? There is concern that the Insolvency Service may not have the resources, and therefore the ability to follow up on the expansion of powers in the Bill in the public interest. Has your experience been that the Insolvency Service has been able to resource any investigations that might be needed? What tools should the Government use to pursue directors of dissolved companies that they identify as culpable? Do you have a view on that?

David Kerr: In terms of resources and the ability to pursue all the cases that the Insolvency Service might wish to pursue, I guess that is probably a question for the Department. Not all the cases that are investigated will pass the public interest threshold. To the extent that there are cases that pass the test but cannot be pursued for resource reasons, I am sure the Insolvency Service would welcome any additional resources that can be made available to it. From the point of view of creditors, if actions are pursued in relation to covid-related debts and not others, perhaps the measure works against them a bit.

That comes to the second part of your question. There are two elements to this. First, there is the potential disqualification of individuals who are proven to have acted inappropriately. Secondly, and on the back of that to some extent, there is the possibility of compensation orders against those individuals, with a view to putting money back into the hands of creditors. Again, I am sure CICM creditors would wish that to be as effective for its members as for any Government debt.

[Jeff Smith]

Q Mr Kerr, you said that the CICM is broadly supportive. Do you have any particular concerns about the Bill? Is there anything that you think is missing from it, or could it be improved?

David Kerr: I think the point has been made about resource. I have heard comments from others on Second Reading and elsewhere about that. It would be unfortunate if the emphasis were entirely on dealing with bounce back loan fraud and if that took resources away from other directors’ conduct investigation cases. That point is not, I suppose, directly relevant to the provisions in the Bill; it is more a question of how it is implemented and taken forward. There have also been some comments about the retrospective element; the previous witness touched on that. I think these cases have to be taken within three years of the relevant date—the date of insolvency or the date of dissolution. I do not think the Department would be able to go back before 2018 in any event, and that was the date on which the consultation was conducted, so I suppose one could argue that directors have had notice of the intended provisions for the relevant period.

Those were probably the only points where there might be concerns to a limited extent, but generally I think the provision is a sensible one that gives the service powers that it does not have currently and which can only be helpful, I would have thought, to trust and confidence in the insolvency regime.

[Jeff Smith]

Q That is very helpful. On the three-year cut-off, are you concerned that that is likely to have implications on other investigations that the Insolvency Service carries out if it is not funded properly?

David Kerr: I was referring partly to the point that had been made by the Committee to the previous witness about whether there would be any issues around natural justice if the retrospective provisions pre-dated the consultation. I do not think that, in practice, that would happen. Going forward, the compensation laws that might be sought can be obtained after the disqualification order or undertaking, so there may be more than three years available to the service from the date of dissolution. There has to be a cut-off. I do not think there is any suggestion that the provisions of the disqualification have to be changed in that respect, merely that they would be applied to these circumstances. They have proved to be satisfactory since 1986 in relation to director disqualification in the insolvency proceedings, so I have no reason to believe that, going forward, those time limits will not be effective in relation to dissolved companies.

[Seema Malhotra]

Q Are any sanctions that are currently available to use against directors who may have dissolved companies to avoid liabilities not being used as much as they could be?

David Kerr: None that I can think of immediately.

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[The Chair]

Thank you, Dr Tribe. We will now take some questions from Committee members.

[Jeff Smith]

Q Thank you Dr Tribe, that was a very helpful overview, and pretty unqualified support for the principle of the Bill. It did seem that your main concern is about resourcing it. You said that until appropriate funding is handed out to the Insolvency Service, the Bill will, at least, be a deterrent. Do you have a view as to the nature of the problem, and the funding that the Insolvency service would need to actually make this work?

Dr Tribe: It is my impression that this new work to deal with directors of dissolved companies who have potentially behaved in an unfit manner would be subsumed into the general run of business of the disqualification unit at the Insolvency Service. They prioritise the most egregious cases, or those that help send out a public protection signal to the public. In the interim, I think this kind of work would fall into that part of their function. My point about hammering out or ensuring funding is in place is partly in response to some comments on funding made on Second Reading of the Bill. Since the Companies Act 1928, and perhaps most famously in the Cork report of 1982, this question of whether the disqualification regime is properly funded has always existed. Its lack of efficacy between 1928 and 1982 was put down to a lack of resourcing.

That point is very important, because in essence this is the system that protects the limited liability form, the engine of capitalism that drives through our commercial activities. Unless the Insolvency Service is able to properly resource and ensure that this work is undertaken, we have a problem when we try to pursue those who are responsible for the loss of between £16 billion and £27 billion. This potentially unknown—we will find out when the PwC report comes in—and potentially large gap will need to be addressed in terms of where the money went and who was responsible for causing that money to be dissipated.

[Jeff Smith]

Q Thank you, that is helpful. Just as a follow-up, are you concerned that there might be a focus on making use of these new powers at the expense of current work on other insolvent companies?

Dr Tribe: Not necessarily. Going back to my prioritisation point, the Insolvency Service obviously has finite resources that it needs to deploy in the best way possible—I suppose that is a problem for many public bodies— if other types of abuse manifest over time. The most obvious and recent problem is the bounce back loan phoenixism problem, but in due course other things might come about that require us to tinker with our corporate and insolvency law so that we have an effective system that maintains trust and confidence in it. What the Insolvency Service wants to do in terms of prioritising threats to the system will depend on its internal guidance.

[Seema Malhotra]

Q Dr Tribe, I want to ask first whether you have a view about the existing sanctions that are available to use against directors who may be abusing the dissolution process—perhaps powers that are currently available but are not used as extensively as they might be. That is one of the challenges that critics of this legislation may make.

Secondly, are there any other more general problems with the dissolution of companies that are important to discuss at this time while changes are being made? Should changes be made to the eligibility criteria on dissolutions? What steps need to be taken prior to dissolution?

Dr Tribe: I will take the first question first. I think you are drawing attention to the compensation order regime, and you did so on Second Reading, too. There is some interesting research by Dr Williams at Cambridge in 2014, who looked—he sort of future-gazed—at how successful the compensation system might be. In that research, he highlighted that some of the directors in small closely held companies, which he argues the regime mainly targets, might end up being adjudicated bankrupt—they might go through the bankruptcy process, I should say—in due course. That would mean, of course, that any pursuit of those individuals would run into another layer of difficulty in trying to get to the value that might be there for the insolvent estate of the company or dissolved company that we are dealing with. His work future-gazed in that way at some of these issues.

It is true to say that, on the compensation regime, we saw one case in 2019, the Noble Vintners case, where insolvency and companies court Judge Prentis made a 15-year disqualification order. That is right at the top of what we call the Sevenoaks scale, after the case in which Lord Justice Dillon set out the various types of malpractice and where they fall on the scale, from two years up to 15. In the Noble Vintners case, it was the most unfit behaviour on the facts of that case that you could have —up at the 15-year period. Then, of course, that was followed by a compensation order that recouped for creditors just over half a million pounds—£559,000.

There has been some success with the compensation scheme. It is in its early days, in a certain sense. Although the reforms came in in 2015, there was a delay in implementation. You are right to say that we should pause for thought and mull over how effective that is. That takes us back to the resourcing and funding point, for one thing. Secondly, it takes us to the idea of that prioritisation agenda and how fruitful a claim that you are going to bring might be to get compensation. It is a power that exists and should exist. It goes some way—as you can see from the case of Noble Vintners—to getting value back into the insolvent estate for the creditors. It is a positive thing for creditors, and something that the disqualification regime did not do until that reform in 2015. Of course, it provided a protection mechanism, but in terms of getting value back into the estate, that is a good reform. That is your first question.

Your second question was on dissolution problems. I think you might be driving at the process of dissolution and how the registrar at Companies House deals with dissolution. After the directors have signed their form, made their declaration, paid the £10 and noted that there is going to be a striking off and that is published in the London Gazette, there is a period of two months where all the parties that should be informed—shareholders, creditors, employees and pension managers, for example—might know of this potential dissolution and should then, therefore, perhaps act on it as creditors. Some of the witnesses who have gone before me may have addressed this, particularly those from the credit community. In due course, as part of a wider analysis of what Companies House and its function is, that step in dissolution may be looked at.

As I said earlier, there are approximately half a million dissolutions per year, and many of those are for very good reasons in terms of, as I have said, maintaining the integrity of the register and getting rid of companies that have been through the insolvency processes but then get dissolved as well. The guidance for the Bill and some other sources note that among those half a million dissolutions, there could be about 5,000 that are potentially problematic that we would want the Insolvency Service to be able to investigate. Obviously, 5,000 is a lot more than the current levels of disqualification under the current provisions. Over the past decade or so, there have been about 1,200 a year, so you can see there is quite a significant upshift in the work that the Insolvency Service might have to do.

A Companies House review perhaps in due course mulling on what its function is—is it a regulator, is it a repository of information?—might look to dissolution, but in the short term I think you have this £17 billion to £26 billion problem, and there seems to be a loophole that needs to be closed.

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[Paul Scully]

Q It was about the fact that Carillion obviously has a large supply chain within it, and you have been dealing with and writing about cases with complex supply chains. What confidence can this measure to close that loophole give to SMEs in particular?

Dr Tribe: Thanks for that clarification. If we can ensure that any vehicle that is used in any form of creditor relationship with different entities has an individual put-off effect by going down this dissolution route that we have identified, it will hopefully increase confidence in the way people use the corporate form. The more loopholes we can close down that have caused us to think the form is being used inappropriately, the better.

Unfortunately, phoenixing, as we have discussed, has been going on for literally decades, and perhaps in the future we might be back here again with some other problem that has arisen because of nefarious activity.

[Jeff Smith]

Q I will just ask one final question. We have had some written evidence suggesting that the current regime is adequate. If you do not mind my quoting from it, it says:

“Applying the current controls properly, putting dissolved companies into liquidation and publicising that new policy will be a far more effective deterrent...That requires no new legislation at all.”

Do you have a view on that?

Dr Tribe: The trouble is that to get to that liquidation point, you have to go through the restoration stage. I think that submission might have also talked about the idea of restoring an entity to the register and then going through that insolvency route. I think the Insolvency Service did 33 of those in 2019—pre the bounce back loan issue and pre corona, obviously. Each one of those 33 will have cost it court fees, process fees at Companies House and so on, which means there is this extra layer of procedure that it has to get through before it can ultimately investigate the unfitness activity. I think the dissolution reform in this legislation ensures that that extra layer of bureaucracy—getting the companies back on the register, through restoration, then going through the insolvency processes—is cleared out, and we move straight to the enforcement section.

The other problem with restoration is that you perhaps undermine the integrity of the register itself if you take 33 companies off it, but you then want to put them back on because you need to go through the steps that we want for enforcement and so on. It is an interesting point, but I think you have a quicker public protection mechanism process that you can do now that gets you to a less costly enforcement outcome.

[Jeff Smith]

Thanks.

[The Chair]

If there are no further questions, I thank you, Dr Tribe, for giving evidence this morning. It is much appreciated. I thank all the witnesses for appearing this morning.

Ordered, That further consideration be now adjourned. —(Paul Scully.)