First ever disqualifications of directors of a credit union

Here’s a link to a news article that recently appeared on the government’s website, gov.uk about what I believe to be the first disqualifications of directors of a credit union – The Enterprise The Business Credit Union Ltd T/A DotcomUnity Credit Union (EBCU).

So how did we get to the stage where directors of credit unions can be banned?  Let’s look at the background behind the law we have today…

In the Mid 1980s, at a time of massive change in insolvency legislation, the Company Directors Disqualification Act (CDDA) was brought in so that the government could hold directors of limited companies and similar to account for shortcomings in their conduct – the previous law did not make this an easy task, the CDDA made it so.  You see the CDDA made it easier for the authorities, then the DTI, to get disqualifications through the courts at first but later by mutual agreement (an undertaking by the director).  But credit unions were not covered by the CDDA.  It took until 2010 for the government to put forward an act of parliament, the Co-operative and Community Benefit Societies and Credit Unions Act 2010, to make it possible for the first time for directors of credit unions to be held to account in a similar fashion to the directors of limited companies.  The Act became law 3 years later, in early December 2013.  The credit union that was the subject of this disqualification failed a year and a half later.

Why the delay in bringing in this legislation?

We can only guess, but I suspect the reason was few credit unions failed until the 2010s, so there was simply no need to extend the legislation.  But now that more credit unions are failing and with pressure for continuing improvements in standards across the wider financial and banking sector, the attention turned to the credit unions, where some thought a more professional approach to management was needed.

So we now have a law whereby we, as insolvency practitioners, have a duty to report on the conduct of directors of an insolvent credit union we are liquidating or administering, which report might lead to their disqualification.  And that report covers all directors whether or not they work in the business on a day to day basis or act in a non executive capacity, and whether they get paid or not for their services.

This raises the question of how the standards expected of the individual members of the board of a credit union should be measured, after all they are often quite a mixed bunch.  For example would a non exec be measured in the same way as the exec director(s)?  What standard would be required of a non exec with 30 years experience as a captain of British industry and now brought in to bring some commercial acumen compare to that expected of a retired housewife who simply sat on the board because of her interest in supporting the local community but had no specific managerial skills?  What standards would be required of an accountant who sits on the board to oversee the finances, or a lawyer to help on its legals?

The answer is, in broad terms the standard by which they will be judged will be the higher of:

  1. The actual skills the person has ie what professional qualifications they have and what business experience they have
  2. The skill that you would expect a person to have in such a position of a credit union of that size and complexity.

Therefore…

A higher standard would be expected of directors of bigger more complex credit unions than small ones.

A higher standard would be expected of the former captain of British industry, even if he is unpaid and a NED, and a professionally qualified accountant or solicitor who sits on the board than the retired lady who works a collection point but also sits on the board.

The point is there are no certain standards set in stone, every instance is different as it depends on the circumstances, it’s a matter for the courts to assess what that standard should be and whether the person failed to meet it.  Of course, in some instances it’s easy, blatant fraud or personal profiteering renders the person liable to be banned and attacked for the recovery of money, but not all cases are so straight forward.  What of the lawyer, accountant or captain of British industry who was supposed to be overseeing this particular aspect of the credit union’s affairs but somehow didn’t do all they could – are they always liable?

There is a major point here… where there are different standards required of different members of the board there is a potential for major conflict within the board.  The actions and inaction of the more professionally qualified members of the board will come under more scrutiny, and they could be held to account more so than others.  Put simply, some are at more risk than others, and this is likely to reflect in their actions and decisions.  And the opportunity for conflict within the board tends to heighten when credit unions come under increasing financial pressure and pressure from the regulator.  One option would be for the board to engage an insolvency practitioner or lawyer (provided both have relevant credit union experience) to support them in these difficult times – taking, relying on and acting in accordance with an insolvency practitioner’s advice can often provide a shield against or a defence in any attack, because they are both independent and an expert.

So let’s look at the Bournemouth credit union disqualifications…

Here’s the link again to the government website’s press release – LINK.

I’ve read the article several times.  Maybe it’s just poorly written, but to me it doesn’t explain properly why these directors should have been banned. (I find that government press releases often lack clarity or balance, this one is as clear as mud)

Let’s pick it apart…

There’s a focus right from the very start on a figure of £7.3m, the total estimated creditor claims.  The way the article is written sends out a message that this was a big finsolvency where the reader is led by the nose to assume that creditors lost the entire £7.3m.  It’s not until much further down the article that there’s a mention that the deficiency is £1.5m.  It’s only by deducting one from the other that we get to calculate there were £5.8m of expected assets.  The assets, even though they are very large indeed, are conveniently ignored. (why do the government do this?  If we were to merely focus on the fact the UK government has over a trillion pounds of debt and ignored the UK’s assets, politicians and civil servants would be pilloring us, why shouldn’t we do the same to them here?)

So let’s talk about the assets… it’s worthwhile pointing out that in any credit union insolvency a good proportion of the members will do their level best not to repay the loans they have been granted.  This means a large provision is required against the book value of the members’ loans, arising purely as a result of the formal insolvency.  With the £5.8m representing the level of estimated realisable assets after a provision for loan debt write offs (and any other asset provisions that might be required), undoubtedly the financial position of the credit union prior to the withdrawal of approvals would have showed a far smaller a deficiency than £1.5m.  Yet there was no mention of book values or the position shown in the financial information on which the directors had relied and acted.  The focus was simply on the credit union owing £7m…this was done for effect…to send out the wrong message.

Turning now to the issue of inter-company billing… Here a figure close to £0.4m was mentioned for ‘additional billing’, the article quotes the figure in an effort to suggest to the reader that the director(s) somehow got away a big sum of money himself.  Nowhere was there mention of a figure by which the director(s) might have profited – so that figure could be anything between a mere £1 and £0.4m.  The article lacks balance, the focus is on the big figure for effect and not on the relevant figure.  Sure the directors could and should indeed have communicated the contract terms to the board formally, and got its approval to them, but that does not address all the points.  Would the government have sought the disqualifications if the directors’ costs in the associated company had been £1m and they had lost £0.6m on the work? Presumably no, the size of any ‘secret profit’ is highly relevant.  So why was it not reported?

Sure, they appear to  have failed to get proper board approval, but sometimes things get missed in the heat of the day because a lot is going on, when all are under pressure.

Isn’t it interesting that the ‘active doers’ on the board, rather than the non executive ‘supporters and watchers’ got taken to task for something they didn’t do?  Doesn’t bode well for boards working together as a cohesive unit all going in the one direction does it?

Let’s talk again about the associated company … Why was the name of that company not reported?  Was it to stop people like me who don’t take any form of ‘news’ from any party, especially as the government, at face value?  By not giving us the name we are prevented from checking up on the story, yet it’s a vital fact, one that’s conveniently not given to us… Let’s remember there are hundreds of other disqualification press releases where the government are more than happy to report the associated company’s name, so why not here?  The failure to give the name is a departure from the government’s standard practice.  Why is that?

Turning now to the submission of incorrect accounts to the PRA… Perhaps this is where the directors might be culpable (possibly the only area?) … The press release suggests that the credit union’s net assets were overstated because a provision for fees paid/payable to the associated company had been understated by £150k.  It actually looks like they have explained the government’s views properly!  But I’d still like to see more evidence because frankly the government have not covered themselves with glory here in all other places!

I would point out that throughout that period back in 2015 and even now there are numerous credit unions who were/are years in arrears with lodging their accounts, and the authorities then and now did and still do absolutely nothing about it.  Yet credit unions deal with the public, they take money from them.  Isn’t one of the main planks of UK insolvency law that where anyone dealing with the public through an organisation with limited liability there should be a high level of accountability, including the lodging of accounts so the public can at least in theory assess the financial strength of who they are dealing with?  And companies get fined thousands of pounds for failing to lodge their accounts, why not credit unions?

(why also is it that anyone enquiring as to a credit union’s finances has to pay £12 for each and every set of  accounts, administrators’ and liquidators’ reports etc when all these documents for limited companies and almost all other organisations are available free of charge to all on the Companies House website? ).   In Bournemouth’s case I would like to have seen the accounts, the administrators’ and liquidators’ reports without having to pay for each document.  No one is going to go to all that expense to check a press report.  When you consider everything about this case, isn’t it all too very convenient?

Let’s look again at the point the press release raises over the billing of fees payable to the associated company in the latter period of trading – the press release almost suggests  the board’s plan for repairing the credit union’s financial position included the associated company foregoing fees, and reporting that none had been billed when a good amount had.

This aspect is skated over again.  Was it looking for funding elsewhere to meet its running costs? – local authorities and ‘angel investors’ often provide such support.  Where was it on getting any such funding?  Would receipt of that funding have enabled it to repay the fees billed?  Were the directors of the credit union aware of the situation and working on the assumption that funding would be coming into the credit union albeit indirectly?  How was this reported to the regulator? – all regulators and government officials like standard forms, on which there is often no space for detailed explanations making the form incredibly unreliable.  Were the other members of the board aware of the turnaround plan that was reported and in agreement with it?  Why have the entire board of directors not been held accountable for any misreporting to the regulator?

Put another way, having read what I can from the release, I believe that here we have a case here of government officials acting like the worst possible journalists – not letting the facts get in the way of a good story – they have purposely gone out of their way to manage our perception of the credit union’s financial position and the directors’ actions.  They have done nothing to properly explain the true position.  I understand that press releases have to be short by definition, but this release is incredibly misleading, to the extent that, in my opinion, the Insolvency Service did not prove any part of its case for disqualification.  It would be incredibly dangerous for you as a board member of a credit union to consider the themes of this case when deciding how to manage your credit union’s position.

Let me ask you a question…  How would you and the rest of your board feel if the government adopted the same conniving approach with you should your credit union go into administration or liquidation?  I can only guess how these 3 directors who were banned feel.

The next, and a major, point I’d like to raise is the fact that the disqualifications did not pass through the courts, they were just agreed between the directors and the government.  Put another way, the directors’ guilt – if there was any – was never tested in a court of law.  The government acted as judge, jury and executioner simply because the law enables them to be so.

I have found over the years that the Insolvency Service are frankly like school playground bullies – they have the full financial backing of the government (they pay out huge sums to some of the most expensive lawyers in the country) while the directors often have little or no funds to pay lawyers to defend themselves.  It’s an uneven fight, so many directors simply capitulate and accept a ban just to avoid the substantial legal costs they would be incurring defending themselves.

Yet the article is written in matter of fact terms – nowhere does it say ‘the Insolvency Service took the view that…; conversely the directors argued that…; it was expedient in everyone’s interest to agree a compromise and one was agreed whereby a ban of x years was accepted without the directors accepting liability’.  Now imagine yourself arguing with someone over any issue where you agree a compromise – how is that compromise worded?  That’s right, without an admission of liability or guilt.   Let’s remember, this has not been tested in any court in any way, so to me it’s pretty incredible the Insolvency Service can say what they have said, and with so many obvious holes, with such certainty.  Of course the directors are never asked to comment on the wording of the press release, they’ve had no say at all in its drafting.  There’s nothing they can do to get the Insolvency service to amend or withdraw it.  How would you like it if anyone anywhere said what they liked about you without there being any checks or balances and you could do nothing about it either at the time or retrospectively?

There’s another thing worth taking on board.  Directors who fail to take, or take but choose to ignore, professional advice taken at the right time from the right people; who fail to take advice from their auditors and solicitors about such things as the inter-company billing referred to in the press release; who fail to take advice from a licensed insolvency practitioner in the lead up to insolvency; often have little defence to the DTI’s disqualification efforts.  Ignorance is no excuse, ever.  The authorities expect you, someone who probably has no prior experience of such difficulties or issues to find the right help and follow it, not somehow muddle through yourself trusting to luck or taking advice and doing what you want to anyway (especially if doing so profits you).  Credit unions often muddle through without professional support because they can’t afford it or they choose local accountants/IPs with little credit union experience.  The point is this puts the board at risk, more so its ‘professional’ members.  There no mention in the press release about the advice the directors took, or might have taken.  Another omission.

Going back to the agreement of disqualifications, the undertaking, typically often directors who are relatively advanced in years in employment terms (each here was in their 5os, and we do live in an ageist society in terms of work) have problems finding decent employment after a business failure.  Their income earning capacity is at best reduced, sometimes it’s disappeared completely.  They also only have a limited time before retirement, they don’t have tens of years of potential future employment or engagement in business to protect.  The upshot of this is they are vulnerable, and will often throw the towel in to best protect their worsening financial position in the lead up to retirement.  It’s often a matter of the director taking the rap in order to best protect their family. I’d like to see the Insolvency Service taken to the courts to see whether their approach generally on getting undertakings is an abuse of a person’s human rights, especially in the case of middle aged and older directors.

Interestingly, only 3 directors were subject to disqualification undertakings.  The FSA website lists 25 directors, although I don’t know when each acted as a director.  The point is the other directors appear to have walked away scot-free.  With probably more getting away than being taken to task there is massive opportunity for conflicts within boards – consider my comment above.  Why the others were not included in the disqualification proceedings is unclear, it was not explained why these 3 were the focus of attention while others were not… you see doing nothing, not addressing the affairs of a struggling entity, turning a blind eye to what’s going on, failing to exercise close financial control and thus facilitating another’s withdrawal of cash and assets have all opened up directors of limited companies to personal attack, both in terms of being banned and financially compensating the company for the losses the creditors suffered.  So why not here? Perhaps it’s an oversight?  Perhaps the government went only for the easy targets only, the people who could not fight back?

My take on all this, in overview?

The Bournemouth experience does not set much of a precedent.  It shows that the government are committed to sending out a message they will be cracking down on the directors of insolvent credit unions.  But I get the feel that these 3 were nowhere near as culpable as the government would have us believe.  What is clear is that directors of credit unions are at risk of personal attack and being banned whether executive, non-executive, paid or voluntary, some more so than others – the execs and professional directors more so. You would be wise to do what you can to try to ensure it’s not you who comes within the Insolvency Service’s gaze and that conflicts with the board are managed.   You might just need my help to ensure that…

 

 

 

 

Customer deposits and insolvency

As a licensed insolvency practitioner I am often asked to advise directors who are in a very dark place – whose company is on the brink of liquidation. I guess you might be in such a place?

 

Insolvency law requires that when a company is insolvent, and even when its solvency is in doubt, its directors have a duty to place the interests of creditors above those of themselves and the shareholders. The law looks at it this way – you’ve been given the privilege of limited liability; a cost of that privilege is that you have to do the right thing at the right time for those innocent third parties you might hurt by your actions.  Pretty much common sense, but can be difficult to implement in the real world.

If you don’t place the interests of the creditors above yours or the company’s, you as a director expose yourself to being disqualified for 7-10 years, and could see you personally paying compensation for your ‘wrongdoing’.  You could even be forced into personal bankruptcy.  And in the most severe cases, where a lot of the public’s money is lost and you continue to take money long after a judge thinks you should have known you would not be able to supply the goods or services that have been paid for, you could even go to prison.

The penalties for getting it wrong are severe so it’s vital, if you normally take deposits or payment for goods or services up front, especially from the public, that you get advice from an insolvency expert.  Take that advice at the earliest possible opportunity.  And then follow it. Be aware that turning a blind eye or ignorance is no excuse, this is something you’d be a fool not to address.

When I get involved with companies in this position the first thing I have to do is explore with the directors whether they should allow the company to continue to trade at all or whether they shut simply shut up shop.  This may sound harsh to you, especially as it’s your business and you have sunk so much time, money and effort into it, but all the other questions that follow on depend on it.  If you have come to me for advice early and you have forecasts showing that things are likely to get better, the answer is often that you can allow the company to continue trading. Often though the forecasts show a worsening position or are not certain to be achieved – in either case you should think seriously about protecting customer deposits, ring-fencing them so the customer gets their money back if things don’t go to plan.

The safest way to do this is either to stop accepting deposits.  The next safest is pay them into a trust bank account and only release the cash into your company’s own account as and when the goods or service are delivered. Both of these options make an already tight cash position worse and could make your turnaround plans unworkable.   Either way you have to manage your cash position.   If you choose not to do either of these and continue to accept deposits, you need hard evidence supporting that decision. And you should continue to revise that information and monitor the decision. This is an area where you might need my help.

How important is it you take and follow professional advice?

It’s vital. You see taking customer deposits can expose you to a wrongful trading and/or a fraudulent trading action – the first civil, the second civil and criminal action.  Case law has determined that ignorance, a lack of knowledge, skill or experience, and a failure to take all possible steps to minimise deposit creditors’ losses once the company is past the point of no return is no excuse. And that’s why you need my help.

Let’s now look into a real life case … a few years ago but the principles remain true today…

Uno plc and its subsidiary World of Leather were large retailers of furniture to the public. Furniture was bought in from manufacturers after a customer order had been placed. Customers paid a deposit when they placed the order and paid the balance on delivery.

They got into financial difficulties. Their directors allowed the companies to continue to trade for four months while investigating options for restructuring the businesses. During this time they held discussions with venture capitalists and competitors, none of which were successful and the companies were placed into administration. By then, the deposit creditors were owed £26 million. Unsecured creditors would receive nothing.

The companies had continued to accept customer deposits during that four-month period. Those deposits were not placed in a separate trust account, even though the directors knew that the company was having problems. In fact during that four-month period, the company actively sought to take more cash deposits from customers as part of a strategy to increase the money in the companies to prevent them from going under. Unsuspecting customers were encouraged to pay in full for their furniture in order to qualify for a substantial discount or early delivery.

Were the directors liable to repay those deposits?   Were the directors unfit to be involved in the management of a company?

In their defence, the directors argued two things:

• While they were investigating options for restructuring there was a reasonable prospect that the companies could avoid insolvent liquidation and
• After they became aware that the company had no such prospects, they took every step to minimise potential losses to creditors.

In particular, they claimed that by continuing to accept customer deposits— in fact, increasing them—they improved the cash flows of the business in line with a viable rescue plan that, if successful, would have enabled the companies to avoid liquidation.

The directors produced evidence of their plan which was based on accurate, timely financial information. They also showed that they had taken, and acted in accordance with, appropriate professional insolvency advice throughout.   In summary, they had made informed decisions.

The court decided that the directors were not guilty of wrongful trading and should not be disqualified. The judge explained that a director is not unfit and will not disqualified merely because he knowingly allowed a company to trade and take customer deposits while insolvent.

Key to the case were the following:

1. The directors had continued access to reliable financial information as to the existing financial position and forecasts demonstrating the proposed rescue plan.
2. The directors obtained and followed full legal and professional advice in allowing the companies to continue to trade and take deposits.
3. There was a huge amount of documentation and written evidence that supported and evidenced the directors’ decisions.
4. The directors not only kept their major creditors informed of the companies’ situation, they told them of their strategy to restructure the business, and got them to buy in to the plan. The point is they were not just trusting to luck. Not every business can do this – it’s particularly difficult for a small business to do.
5. The judge said that company directors have no duty to segregate customer deposits once a company gets in financial difficulty. Continuing to pay monies into the general company account is not on its own a reason to disqualify a director, it is not irrefutable evidence of improper or dishonest conduct, a lack of probity or incompetence.
6. Based on the legal and professional advice they received, the directors formed a reasonable belief that there was a reasonable prospect of finding a satisfactory outcome for the creditors. They held this belief properly and honestly based on hard written evidence and professional advice.
7. The directors made no effort to shirk their responsibilities, no one resigned. They were just trying to work their way through a very difficult position.

The case gives some useful guidance on what you as a director need to do to avoid personal liability. The directors weren’t flying blind. No one ran away. A proper comparison was made of the effect on creditors of closing down and continuing the business. The figures justified their restructuring plan and decision to carry on accepting deposits and paying them into the companies’ normal bank accounts. The decisions were made on the basis of prudent management, accurate financial information, and legal and professional advice. A professional analysis of the situation and comprehensive reporting are vital. Evidence is key – minute all decisions, retain all the financial documents. Get independent professional advice from the right insolvency specialist.

Here are some questions for you to ask yourself:

1. Is the company insolvent or at risk of insolvency?
2. Should you continue to accept customer deposits?
3. What do you tell major creditors, if anything?
4. What steps should you take to protect your personal position?
5. Can you resign if you don’t like what is going on?
6. Do you have all the evidence you need to justify your decisions?
7. Are you taking the right professional advice?