New bill aims to close legal loophole in the dissolution process

A new bill has been put before Parliament proposing new powers to investigate directors of companies that have been dissolved, closing a legal loophole to deter against the misuse of the dissolution process.

The pandemic has been tough for everyone. And while some businesses are starting to operate at some level of normality others, despite Government assistance, will simply not be able to recover from the effects of Covid-19 and be forced to close.

What options are open to businesses that find themselves no longer able to operate? And what will the Government’s new legislation mean for them?

Dissolution of a company

Dissolution of the company is just one of the options available when looking to bring a company to an end. This is where a company applies to be struck off from the register and the company ceases to exist. Dissolution is not necessarily a bad thing, many will naturally come to an end if they cease trading or for other reasons such as retirement. If a business has no debt or has sufficient funds to settle its liabilities, then dissolution is the appropriate way to end the company.

There are rules to be aware of if you choose to go down this route.

For example, a company cannot apply for dissolution if any formal insolvency procedure has been started against it. Dissolution is only available if, in the 3 months prior to applying, the company has not:

• Engaged in trade, including the disposal of stock;
• Changed its name; or
• Disposed of its assets including property and land.

Voluntary Liquidation

An alternative option is for the company to be wound up via a liquidation. There are different types of liquidation:

• Creditors’ voluntary liquidation – where the company cannot pay its debts and the directors and creditors are involved in the winding up.
• Compulsory liquidation – where the company cannot pay its debts and the creditors apply to the courts to force the winding up.
• Members’ voluntary liquidation – where the company can pay its debts, but the members want to close the company and distribute its assets in accordance with its constitution.

Liquidation is different from dissolution as it involves the realisation of assets and distribution of funds to creditors and shareholders in accordance with a statutory order of priority.

Bad practice

Although dissolution should only be used where a company is solvent and has repaid its liabilities, many companies use the process as a way of avoiding creditors.

Directors may quietly start the dissolution process without having repaid the liabilities of the company in the hope that creditors do not find out until it is too late and avoid their conduct coming under any scrutiny as it would in an insolvent liquidation. A creditor can apply to restore the company to the register in order to attempt to recover money it’s owed, but the reality is that the costs of doing so are likely to outweigh the chances of recovering what is owed.

In light of the volume of government-backed loans that have been made available to businesses during the Covid-19 pandemic, it’s no surprise that Government is keen to avoid directors inappropriately dissolving companies and walking away without having made any repayments.

New measures

It’s this loophole that the Government is looking to tackle with The Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Bill (Bill). If passed it will give the Insolvency Service new powers to investigate directors of dissolved companies. The measures will be retrospective, allowing the Insolvency Service to investigate the circumstances of historic dissolutions.

Directors who are found to have been involved in malpractice or wrongdoing may be given fines and will be subject to a disqualification order for up to 15 years.

Comment

A recent surge in applications may well be a result of Companies House lifting their temporary suspension of voluntary strike-off action, and no doubt many will involve no wrongdoing. However, the proposed new measures will cast a worrying shadow over those directors who’ve taken their chances with a risky dissolution, possibly with a view to avoiding repayment of its debts instead of a fairer method of closing down their business.

Although it remains to be seen, lenders who’ve provided government back loans could be required to fully exercise their rights before they’re able to recover any losses under the government guarantee. Directors need to be aware that this may include restoring a dissolved company to the register.

Get in touch

If you’re thinking about closing a company or would just like some advice on the new legislation contact the Banking and Finance team.