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

Seema Malhotra Excerpts

Committee stage
Tuesday 6th July 2021 Public Bill Committees

[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.

[Peter Grant]

Q Good morning, Mr Pegge. You have described the loophole of company directors being able to dissolve the company in order to avoid their liabilities. Another way that directors can act is to set up two or three companies, transfer all the assets out of a company, dissolve the company with the debts and retain the companies with the assets. Is that a loophole that will still exist, even if the Bill goes through? If that loophole continues, is there a danger that that then becomes the route of choice for dodgy directors to avoid their liabilities?

Stephen Pegge: I think the practice you are describing is sometimes called phoenixing—setting up a company in the same location with the same assets purporting to be the same business with the same directors. It has certainly been a matter of concern for some time. Putting in place these measures should help to discourage and mitigate the risks of phoenixing: I do not think it entirely removes it. As you say, it is possible, even without these additional powers of investigation, for that to take place, but certainly where there is evidence of abuse, the fact that the Insolvency Service will have powers under the discretion delegated by the Secretary of State to investigate the directors, take action against them in terms of disqualification more generally, and seek compensation from them personally for losses suffered will discourage the practice of phoenixing, which I know is a concern. As I say, I do not think that it entirely removes it, but it certainly will discourage it, and to some extent remove some of the possibilities of it taking place.

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[The Chair]

Q We will now hear oral evidence from David Kerr, a fellow at the Chartered Institute of Credit Management. We have until 11 for this session. Could the witness please introduce himself for the record and make a few remarks about the Bill? Thank you.

David Kerr: Good morning, and thank you for the invitation to join the proceedings today. My name is David Kerr. I am a fellow of the Chartered Institute of Credit Management, the largest such body for credit managers. It was formed approximately 80 years ago and provides professional support, training and representation for credit managers and the creditor community.

The CICM contributed to the 2018 consultation and broadly supported the proposed measure in relation to director disqualification. Creditors have often raised concerns about directors leaving behind unpaid debts; whereas in a formal insolvency process, there will be some inquiry by an insolvency practitioner, when a company is dissolved ordinarily there is not. As we have heard, at present, the Insolvency Service will rarely look at those cases because it would potentially involve the cost of restoring a company to the register. The Bill therefore plugs an important gap, as others have commented.

It is probably important to make the point that this was first considered as a suitable measure and had support back in 2018, and while the urgency to bring it in now is understood, this measure is not solely for the purposes of chasing after directors and recouping funds in relation to covid debts but potentially has wider implications as well. There has been reference to the fact that 2,000 or 2,500 companies with unpaid bounce back loans may have been dissolved over the last year or so. I do not think there is any suggestion that every one of those will be investigated, but presumably the Insolvency Service will apply the same public interest criteria as it has hitherto in relation to insolvent companies. That would certainly give it the power to investigate those companies where directors have left behind debts, whether they are bank or Government debts or any other. That should act as a deterrent, one would hope, to directors using this route to avoid liabilities, and will perhaps also restore some confidence in the creditor community, provided that the action taken is publicised and therefore serves its purpose, both in the compensation orders that might be made and the deterrent factor. Broadly, the CICM supports the Bill. With that, I will be happy to take any questions that Committee members may have.

[Seema Malhotra]

Q Thank you for giving evidence today, Mr Kerr. You talked about restoring confidence to the creditor community. Would you say that there has been a loss of confidence in the creditor community? In relation to the 2,000 or 2,500 dissolved companies that you mentioned as having received covid-related loans, would you say that a high proportion of those may require investigation? Based on your experience of the creditor community, do you think that there was the means to repay those loans that those companies then tried to avoid?

David Kerr: In relation to confidence, I would not go as far as to say that there is a lack of confidence in the system, but in order to enhance confidence this is a suitable measure. It removes one source of frustration among creditors, which is where they can see directors who are not taking steps to put their companies through a formal insolvency process and instead are seeking to avoid debts by using the dissolution route.

In terms of numbers, I have not made any inquiry into the 2,000 to 2,500 companies that have been mentioned, but there has to be a sense of realism about the extent to which any Government agency can inquire into their circumstances. A percentage of them, based on creditor inquiries, complaints or other information that may come into the hands of the Insolvency Service, would trigger some investigation.

In relation to insolvent companies, although perhaps insolvency practitioners and creditors may be frustrated from time to time about the number of cases that result in disqualification proceedings, again there needs to be a sense of realism around the extent to which that can be done. That will happen in cases where, despite all the information, there is also a public interest test that is passed to pursue those actions.

[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.

[Seema Malhotra]

If you change your mind you can always let us know.

[Peter Grant]

Q Good morning, Mr Kerr. May I come back to the retrospective nature of parts of the legislation? The three-year period will be permitted because that is what the current timescale is. Given the notorious complexity of a lot of financial misconduct cases and the fact that they are long drawn-out processes, is there an argument for that three-year period to be extended in cases where there is an indication that there is not only misconduct, but potentially criminal fraud? I am thinking about cases in which the potential fraud runs into the tens of millions of pounds. Is there an argument that in those cases, there should be no hiding place for criminals of that scale, simply because of the length of time they have managed to get away with it?

David Kerr: That is a fair point. I suppose the statute of limitations could be considered a relevant backstop, but I will come back to my previous point that we have a three-year limit in relation to investigations into directors’ conduct in insolvent situations, and that has been with us for 35 years. I have not heard any suggestion from the Insolvency Service that that has proved to be inadequate. This is effectively an extension of the same power into dissolved company circumstances. I have not seen or heard any evidence to suggest that it is an inadequate period.

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[Paul Scully]

Q Finally, in terms of your role in credit management, what do you think this will do for the confidence of lenders and supply chains, in particular SMEs in those supply chains?

David Kerr: Generally, if the system is seen to be working well and those who abuse it are brought to account, then it helps enhance the confidence of those engaged in providing credit, whether it is through loans, trade credit or anything else. In that sense, it is a welcome provision that, if resourced and used as intended, should have the desired effect.

[Seema Malhotra]

Q To follow up on a couple of points, there have been critics of the proposals in this small piece of legislation. From your experience and that of your members, how long can it take for companies that have been dissolved to be restored to the register? In 2019, over half a million UK companies were dissolved but only 33 restored. In terms of the time it takes in practice, what could that look like?

David Kerr: I think the cost issue is the bigger disincentive for creditors that previously might have wanted to take steps to try and get somebody appointed to investigate. The service itself has made the point that there are legal costs and other costs associated with that process, and it would not be practical for creditors to mount that kind of action alone or, in many case, at all, given the amounts of their own debts.

The bigger disincentive is probably the cost and this avoids that. You are right in the sense that if there is a lengthy time process and if it takes several months, that eats into the three-year time limit that we have talked about, so that could be a problem. I think here, with this measure, we avoid that because the Department can have the ability to make appropriate inquiries and take action, without the need to go through that process.

[Seema Malhotra]

Q How much could it cost? What sort of range of costs could creditors see?

David Kerr: I do not have those figures in front of me but I have seen the fees involved. They amount to a few hundred pounds, but that does not include the cost of a solicitor to spend the time doing the necessary work. I would imagine that it would be a few hundred running into a thousand or more pounds to get a company restored, but I could not give you any exact figures.

[Seema Malhotra]

Q May I probe you a little further on the three year issue? You are right that within legislation there is provision for courts to make disqualification orders within three years after a company has been dissolved. This legislation extends that in line with that current time limit. In light of the fact that we have very unusual circumstances at the moment, with potentially thousands of companies that could require investigation, do you think that with that increased workload for the Insolvency Service, the question about available resources and the court backlogs, there could be a particular issue with directors effectively being culpable but the Government running out of time for courts to issue disqualification orders against them?

David Kerr: We might have touched on this slightly previously. First, there is no suggestion, as far as I am aware, that the whole of the 2,500 companies that have been mentioned would be the subject of an investigation. We are talking about dissolutions in the last 15 months or thereabouts. The time limit is relevant, obviously, because the service has to work to that, but the previous witness made the point, which we should bear in mind, that the majority of the cases that it takes do not necessarily involve court proceedings. In a lot of cases, having presented the evidence to the directors and with the threat of court proceedings available to the service if necessary, many are resolved by the director giving an undertaking, which has the same effect as an order, so a lot of them will not involve court proceedings and that helps the service to achieve what it is seeking to do within that timeframe. Many of the cases in these instances of dissolved companies, I imagine, would result similarly in a relatively high proportion of those being concluded by undertaking.

[Simon Baynes (Clwyd South) (Con)]

Q Thank you, Mr Kerr, for your evidence. I have two questions. These measures clearly have widespread support. Can you give us a feel for the scale of the problem with dissolved companies? We have discussed quite a lot of different figures this morning, but do you feel this is a very significant problem, or a manageable problem, just to get some more idea anecdotally on that?

Secondly, clause 2 allows “easier investigation”. Can you give us some idea of the way in which the Bill improves that process of investigation?

David Kerr: I will deal with the second point first. We know that this provision means that we do not have to go through the process of restoring a company and instead the Department can commence an investigation in circumstances where it deems it appropriate without any barriers to doing that. In that sense it makes the process easier to commence the work it needs to do.

Many companies are dissolved every year, but I do not think there is any suggestion that all those, or even the majority, involve any misconduct by directors and by those who have opposed or supported the measure. I do not think there is any suggestion among those who proposed or supported the measure that that process should be removed as an option for companies in appropriate circumstances. The question is really how many of those represent some form of misconduct or where misconduct might be hidden, or where there is some abuse. I have not seen any statistics on that and do not know if anybody would know for certain. Again, it comes back to the point that the service would have the power to investigate in circumstances where something was brought to its attention, suggesting a need for investigation. In that sense, it is a welcome provision.

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[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.

[The Chair]

Thank you, Dr Tribe. Peter Grant next.