One of the main reasons that an individual may have for creating a limited company is to trade with the benefit of limited liability.

Should it become insolvent, then only the assets of the limited company will be used to liquidate the liabilities. This is compared with an individual, trading either as a sole trader or in their capacity as a member of a partnership, who places all of their assets in jeopardy.

Limited liability is therefore, in one view, an insurance policy in relation to the individual's personal assets.

But what happens when it all goes wrong and a company is placed into liquidation?

If there has been any unfit conduct on the part of the directors, then the liquidator or official receiver has a duty to send the Secretary of State for Trade and Industry a report on the conduct of all directors who were in office for the last three years of the company's trading.

The Secretary of State has then to decide whether it is in the public interest to seek a disqualification order against a director.

The Insolvency Service informs the director that an action is planned. In reality, directors usually have an inkling that proceedings may be brought against them long before the Insolvency Service letter, as the liquidator will usually have asked a number of detailed and relevant questions about the circumstances that led to the company's liquidation.

But just because the Insolvency Service has commenced this course of action does not mean that it is a foregone conclusion. It does not always follow that the director is completely at fault and should be disqualified.

A "commercial misjudgment", for example, is not enough to base an action on. The DTI has to show that the directors were negligent, incompetent or acted improperly.

Even if the Insolvency Service finds fault, it is possible that a deal can be negotiated.

A process exists whereby directors can consent to an order resulting in disqualification on the basis of a statement of facts agreed by both parties, known as an undertaking.

As an incentive to the director to accept the undertaking, a discount to the period of disqualification is offered, normally in the region of one or two years.

Also, the Insolvency Service may not seek to recover any costs and there are no court proceedings.

Once an undertaking is accepted, the director's name is placed on a public register at Companies House and the DTI will issue a press release local to the company's place of business.

Good advice and negotiation can affect the length of any Disqualification Order, which can be between two and 15 years.

Its effect is that the recipient cannot be involved in the management of the company, nor can he be a liquidator or administrator. Ignoring the order and acting as a shadow director runs the risk of being held personally liable for the new company's debts, a fine and a two-year prison sentence.

* David Birks is a specialist company insolvency and director disqualification litigator at Blackett, Hart & Pratt in Darlington. For more information, contact him on (01325) 466794.

Published: 23/05/2006