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The Kids Company Insolvency & Director Disqualification - What Trustees Need to Know

on Thursday, 21 January 2021.

The collapse of notable children's charity, Kids Company, in 2015, and the subsequent investigation by the Insolvency Service into the conduct of its directors prior to formal insolvency has been well documented in the press.

In Autumn 2020, the trial in respect of directors' disqualification proceedings for the majority of the directors of Kids Company commenced, and is anticipated to run for 10 weeks.

At the time of writing this article, judgment has not yet been handed down, although we expect a decision on this case imminently. In the meantime, it may be helpful to remind charity trustees of both the grounds for, and the implications of, disqualification as a director.

Directors Disqualification - The Background

The Director Disqualification regime is set out in the Company Directors Disqualification Act 1986 (CDDA). The CDDA is designed to restrict abuse of the limited liability company structure in England and Wales, and applies to directors and trustees of charitable companies, as well as standard commercial companies.

The aim of Director Disqualification is to protect the public from those individuals who may seek to abuse their positions of trust, or erode confidence (as representatives of the company or charity in question) in the charity itself.

Whilst disqualification can be granted for a period of up to 15 years, in the case of Kids Company, the Insolvency Service is seeking that the trustees are disqualified for periods of between two to six years, depending on the extent of the misconduct.

Of particular note in the case of the Kids Company, is that, as well as bringing action against the registered trustees of the charity, the Insolvency Service has also instituted disqualification proceedings against former Chief Executive, Camila Batmanghelidjh, despite her not being registered as a director of the charity at Companies House at the time of the insolvency. The Insolvency Service's position is that disqualification proceedings can be bought against Ms Batmanghelidjh as she is deemed to be a de facto director, that is, an individual who acts as director even if not formally appointed or registered as such.

This stance taken by the Insolvency Service will be of interest to the many charities that have appointed chief executives and other senior managers to deal with the day to day running of the charity's affairs.

Most trustees of charities that employ staff are provided with regular updates by the CEO (or the senior employee whatever her job title may be) but it may be that the CEO has more control over the charity's affairs than originally envisaged. The limits of the CEO's authority are not always clearly recorded and reflected accurately in meeting minutes and other records of decision making. In light of the Insolvency Service's argument in Kids Company, charities should be aware that in situations where conduct is seen to be unfit, both the Chief Executive and the Board of Trustees could be held accountable.

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What Are the Grounds for Disqualification?

When, as in this case, a charitable company is placed into any form of formal insolvency, including compulsory liquidation, voluntary liquidation or administration, the Official Receiver or Licensed Insolvency Practitioner appointed over the insolvency will undertake a review of the conduct of all trustees and all other individuals acting in a director capacity in the period leading up to insolvency.

These investigations will seek to identify whether the conduct of trustees has been unfit and if so, whether those trustees should be disqualified with the intention that the chance of the same behaviour occurring again is prevented, and thereby the public are protected.

Misconduct by individuals can cover a wide range of situations including:

  • failure to comply with statutory requirements within the Companies Act 2006 or Insolvency Act 1986
  • failure to file tax returns and/or pay taxes
  • using company money or assets for personal benefit
  • not keeping adequate records
  • continuing the operation of the charity whilst it is insolvent
  • attempting to deprive creditors with regards to assets
  • fraudulent or criminal activity

The misconduct does not necessarily have to be deliberate in nature. Negligence or carelessness could also lead to disqualification proceedings being brought. Trustees who are disorganised or uninterested in the affairs of the charity may also find themselves at risk of being disqualified.

In the case of Kids Company, the Insolvency Service's main ground for disqualification is based on the fact that the charity appeared to be operating an unsustainable business model and did not plan for or hold sufficient reserves.

The disqualification proceedings are likely to examine whether the trustees knew, or ought to have known, that the charity was not capable of achieving its objectives and did not have a viable future and following that, whether the trustees took sufficient steps to protect the position of the charity's creditors.

Reports suggest that allegations of breaches of fiduciary duties by the trustees, and the trustees allowing preference payments to be made to some of the charity's creditors were also uncovered during the Insolvency Service's investigations. However, those allegations appear to have been introduced into proceedings too late to allow proper consideration of them in the context of disqualification. Notwithstanding this, trustees of charities should be aware of the range and scope of conduct which could be brought to the court's attention as part of disqualification proceedings.

What Are the Implications of Disqualification?

Being disqualified as a director can impact on many parts of a trustee's life. An individual who is disqualified will not be able to be the director of any company without the prior consent of the court, (which has to expressly be applied for) or be directly or indirectly involved with the setting up, management or promotion of a company or a limited liability partnership. Disqualification will mean that an individual will have to step down from existing roles.

Furthermore, an individual who is disqualified is unable to act as a trustee of any charity, including unincorporated charities, without the leave of the court or the permission of the Charity Commission.

Whilst a disqualified director can continue to run a business as a sole trader, or be a partner in a traditional partnership, many other aspects of life may also be affected. There are restrictions on being a trustee of occupational pension schemes without the Pension Regulator's permission and professional and regulatory bodies would need to be notified and may prevent you from holding certain positions. Schools might remove disqualified directors as governors.  

Anyone who acts in breach of their disqualification could be liable for criminal sanction, as could be any individual who acts on the instructions of a disqualified director in a management capacity.

Trustees should also be aware of the Charity Commission's additional automatic disqualification guidelines, which fall out of the scope of this article.

A further concern for disqualified individuals is the ability of the Insolvency Service to apply for a Compensation Order, requiring disqualified directors to make a personal contribution for the losses suffered by creditors of the insolvent company. Although the ability to apply for Compensation Orders has been in existence since 2015, very few Compensation Orders have been granted to date.

How Can Trustees Protect Themselves?

It should be noted that the vast majority of individuals in a director's position are never disqualified from acting as a Director, even if the charitable company in question is unable to avoid insolvency. Where individuals are disqualified, they most commonly have been found guilty of misconduct in the management of the charity in question, or are considered not to be competent enough to retain a position of trust.

To avoid the chances of disqualification proceedings being bought against them, trustees should act responsibly and take all reasonable steps to ensure that their conduct and the operation of the charity cannot be criticised. Trustees should take care to be aware of and then act in accordance with their fiduciary duties and all statutory and regulatory obligations.

In times of financial distress, trustees should regularly and continually monitor the financial health and future prospects of the charity, place particular emphasis on assessing whether the charity has adequate reserves, and take prompt action if insolvency is inevitable.

Trustees of all charities are reminded at this time that (regardless of their charity's current financial position) they would be well advised to undertake a review of the charity to ensure that the corporate governance procedures are adequate. Trustees may also want to consider the various insurance policies which may be available to cover officer conduct issues.

Where allegations are made in respect of a trustee's conduct, acting promptly and taking professional advice can assist a trustee in defending those allegations and any future disqualification proceedings. In many cases we can assist an individual in avoiding disqualification, reducing the term of any disqualification proposed, or securing leave to act or continue to act as Director or Trustee of specific organisations despite a general disqualification.

Should you have any queries about the matters raised in this article, please do not hesitate to contact Ambuja Bose in our Charity Law team on 07469 850886, or complete the form below.

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