Compensation orders against disqualified directors: High Court confirms they are not limited to cases of fraud

In only the second reported decision on compensation orders against disqualified directors under section 15A of the Company Directors Disqualification Act 1986 (CDDA 1986), the High Court confirmed that compensation orders are not limited to cases of fraud but can be made in cases of negligence or recklessness causing identifiable loss: Secretary of State For Business and Trade v Barnsby (Re Pure Zanzibar Ltd) [2023] EWHC 2284 (Ch).

This unwelcome development for directors is somewhat offset by the court's suggestion that questions of foreseeability may be relevant in determining whether the director caused the alleged losses, though it is likely to depend on the precise unfit conduct giving rise to the disqualification order. Ultimately, further clarity on the test for causation of losses needs to be provided by future judgments as the judge's comments were not only obiter dicta but were made without the issue being properly argued before her.

The court also considered the relevance of a disqualified director's impecuniosity in relation to the making of a compensation order. The decision suggests that, while a director's resources (or lack thereof) may be a factor to take into account in exercising the court's discretion, the court will be slow to view financial difficulties as a sufficient factor to justify not making the order.

Background

The defendant, Mr Barnsby, was the sole director of a travel company, Pure Zanzibar Ltd, which held an Air Travel Organisers Licence (ATOL) issued by the Civil Aviation Authority (CAA). ATOLs seek to ensure customers of tour operators have financial protection in the event flights are no longer available. Selling air travel tickets, amongst other activities, without a valid ATOL is a criminal offence under the Civil Aviation (Air Travel Organisers' Licensing) Regulations 2012.

Pure Zanzibar's ATOL expired on 31 March 2017. From that point on, the CAA informed Pure Zanzibar on four separate occasions that its loss of ATOL meant that it was no longer able to take new licensable bookings or accept payments for existing licensable bookings.

Pure Zanzibar nonetheless took payments and new bookings from four new customers. Its booking forms used the ATOL logo even though it no longer had an ATOL and was prohibited from taking new bookings.

Pure Zanzibar entered creditors' voluntary liquidation on 19 December 2017 and none of its customers received their holidays or a refund. The company was subsequently dissolved and the Secretary of State for Business and Trade (the "SoS") (previously known as the Secretary of State for Business, Energy and Industrial Strategy) brought disqualification proceedings against Mr Barnsby under section 6 of CDDA 1986.

ICC Judge Barber disqualified Mr Barnsby from being a director for a period of seven years due to his “woefully reckless and incompetent conduct" in continuing to operate Pure Zanzibar without an ATOL and therefore putting "customers' money at significant risk" ([2022] EWHC 971 (Ch)).

The SoS sought a compensation order under section 15A of CDDA 1986 for the creditors’ (ie customers') total loss of deposits of £81,405 (plus interest).

Sections 15A to 15C of CDDA 1986, containing the statutory regime for compensation orders, were introduced by the Small Business, Enterprise and Employment Act 2015. Section 15A provides (insofar as material) that the court may make a compensation order against an individual on the application of the SoS where: (1) the individual is subject to a disqualification order or disqualification undertaking pursuant to CDDA 1986; and (2) conduct for which the person is subject to the disqualification order or undertaking has caused loss to one or more creditors of an insolvent company of which the person has at any time been a director. In effect, the provision circumvents the company's separate legal personality (the so-called "corporate veil") by allowing the creditors to recover the losses caused by the company from the disqualified director.

Decision

The High Court (ICC Judge Barber) granted the compensation order sought.

Causation

ICC Judge Barber held that, no matter the standard of causation applied, Mr Barnsby caused the losses of the creditors by causing Pure Zanzibar to trade without an ATOL, the purpose of which was to protect the customers (who became creditors of Pure Zanzibar) from losing their deposits.  However, in reaching this conclusion ICC Judge Barber made a series of obiter comments on causation that may be of relevance to future cases.

The discussion focussed on the only previous reported case on compensation orders, Re Noble Vintners Ltd [2019] EWHC 2806 (Ch). In that case, the defendant was a sole director who misappropriated the company's funds and ICC Judge Prentis held that causation in the context of a compensation order should be assessed using "hindsight and common sense but without considering foreseeability". ICC Judge Barber noted that Noble Vintners involved "a flagrant breach of a fiduciary duty" and said it was therefore unsurprising that the court had applied the same approach to causation as that applied in respect of equitable compensation (which is the usual remedy for breach of a fiduciary duty).

However, ICC Judge Barber questioned whether the Noble Vintners approach to causation was appropriate in all directors’ disqualification compensation cases, regardless of the nature of the unfit conduct giving rise to the disqualification order. She commented that if the unfit conduct was negligence-based or related to a breach of section 174 of the Companies Act 2006 (duty to exercise reasonable care, skill and diligence), then it was difficult to see why foreseeability could not be used as part of the test for causation. ICC Judge Barber referred to an extract from Mithani on Directors' Disqualification, a key practitioners' text in the area, which raised the possibility of common law principles of remoteness being applicable to compensation order applications.

Ultimately, ICC Judge Barber concluded that a detailed consideration of the approach to causation in respect of compensation orders was not necessary to decide the case, though there may be other cases in the future which warrant fuller debate on the topic. ICC Judge Barber also cautioned that the issue was not properly argued before her as Mr Barnsby was not legally represented at the hearing.

Discretion

ICC Judge Barber made two salient points as to how she exercised her discretion to make a compensation order.

First, in response to Mr Barnsby's submission that the court should only make a compensation order in the circumstances of fraud, ICC Judge Barber held that it "was clearly the intention of Parliament that the compensation order regime would cover cases of negligence or recklessness causing identifiable loss as well".

Second, ICC Judge Barber considered how Mr Barnsby's impecuniosity should affect her discretion to make a compensation order, another point which Mr Barnsby raised. She confirmed that a director's lack of resources, in principle, is a relevant factor to take into account when considering whether to make a compensation order. However, "mere impecuniosity will rarely weigh heavily" in the court's assessment of whether to grant an order and "the court should be slow to allow mere impecuniosity, of itself, to dictate the outcome of a s15A application; particularly where, as here, that impecuniosity is, in part at least, a result of lifestyle choices freely adopted".