Director disqualification – lessons to be learned from the Kids Company decision

Following the compulsory liquidation of Kids Company (the background to which we outline in our article here), the Official Receiver (OR) alleged that the charity trustees and the CEO were unfit to be involved in the management of a company because they caused or allowed the charity to operate an unsustainable business model.

In common with the practice of many charities, Kids Company had a board of trustees who were its registered directors (all of whom were unpaid non-executives), and a CEO who was not a registered director (who was paid and had an executive role running the charity on a day-to-day basis).

Disqualification was sought against the charity trustees, and the CEO, who was neither a trustee nor a director, on the basis of the OR’s assertion she was a de facto director. The period of disqualification sought ranged from 2½ years to 6 years.

The basis for the disqualification was the OR’s single allegation of unfitness on the basis the trustees and the CEO caused or allowed Kids Company to operate an unsustainable business model, set out in reports of some 600 pages with 18,000 pages of exhibits.

The judge, Mrs Justice Falk, found that Kids Company’s CEO, Camila Batmanghelidjh, was not a de facto director of the charity.  We discuss the court’s considerations in our article here.

She also found that the trustees as a group were highly impressive and dedicated individuals from whom the public did not need any protection – the primary purpose of a disqualification order. The decisions they made were matters of honest judgment, made in difficult circumstances in what they thought were the best interests of the charity. The OR had not demonstrated that decisions that the trustees took, or failed to take, in the factual context were outside a range of reasonable decision-making, and in the judge’s view, the trustees’ conduct did not amount to incompetence of a high degree.

Considerations for directors

With the potential for disqualification a concern for many directors seeking insolvency advice, the decision provides a timely reminder of a number of points, including:

• The disqualification regime applies equally to de facto (and shadow) directors as it does to de jure directors
• Whether a person is a de facto director will depend on a variety of factors, including the corporate governance structure of the company
• For disqualification proceedings to succeed:
  • the OR must prove allegations about a director’s conduct; and
  • the Court must be satisfied that the conduct complained of, insofar as it is proven, justifies a finding of unfitness
• Unfitness (with no allegation of dishonesty) means incompetence of a high degree
• The burden of proof on the OR is a heavy one, given the serious nature of a disqualification order
• The charitable status of a company is relevant – the judge stated that “incompetent conduct which might merit a finding of unfitness in a director of a commercial company would not necessarily lead to the same conclusion in a different, charitable, context”

Bringing disqualification cases

Due to concerns raised during the trial about a lack of balance in the investigation and presentation of the case, and the experience of the particular individuals (at the Insolvency Service) in the relation to charities in particular, the judge made several recommendations as to how the Insolvency Service should proceed in future disqualification cases.

• Allegations should be clearly framed
• The OR should place more emphasis on the requirements of balance and fairness in assembling reports
• The OR should be mindful of the length and structure of reports and exhibits, with excessive length having the potential to amount to oppression, given the costs implications for defendants
• In proceedings against joint defendants, care should be given to the position of each individual director
• For charities, the primary means of regulating director/trustees’ behaviour in practice should be via the standards set by, and the enforcement powers of, the Charity Commission, being the regulator with the most appropriate expertise.

Comment

While public policy dictates that Official Receivers will continue to bring disqualification proceedings against directors they assert are unfit, this judgment will undoubtedly give the Insolvency Service pause for thought in its approach to investigations and proceedings.  More clarification of its allegations, for example, should allow for directors to address the case put against them more readily, and in appropriate cases to consider agreeing disqualification undertakings, avoiding the need for a lengthy and costly trial.

Additionally, the charitable sector has welcomed the very clear judgment reflecting the importance of not dissuading capable individuals from taking charity trustee roles, particularly the recommendation that the Charity Commission is best placed to enforce the standards of trustee competence and behaviour.

For more information on this article or connected issues, please contact David Pomeroy our Restructuring & Insolvency Team.