You are a director whose company is struggling to cope with the economic downturn. You may be struggling with the monthly wage bill; having to seek longer payment terms or just starting to notice a downturn in sales.
Directors of UK companies need to navigate a legal minefield when deciding whether their company is fundamentally strong enough to survive. The substantive decision to carry on trading may depend on a range of factors such as interest rates, availability of funding, strength of the competition, domestic and foreign demand for the product etc. The procedures they follow in reaching an answer to this decision, is also key.
We set out below 10 practical tips for directors:
1. Do not ignore the problem
The ostrich in the sand approach does not work when an individual puts a final reminder in a drawer. It certainly should not be adopted if your company is in financial difficulty. Recognising that the business is in difficulties and resolving to do something about it, is probably the most important stage in the process.
Taking action, sooner rather than later, could make the difference in saving the business. Even if it cannot be saved, action at an earlier stage may reduce the risk of a director subsequently being personally liable for the debts of the company. Known as wrongful trading, this is where the company is trading and taking on liabilities, when the directors should have concluded there was no reasonable possibility of saving the company. Wrongful trading is more likely if the directors are ignoring the problems.
2. Take proper advice
Once a problem has been identified, directors should assess whether they need outside help. If the company is in receipt of statutory demands, events of default notices etc, it is fairly obvious that specialist legal/insolvency advice is needed.
However, even if the company has not reached the default stage, the board should still consider whether it has the necessary knowledge and skill sets to turn the company around. Bringing in turnaround experts is an option which should be considered as they have a proven track record of saving companies.
Legal advice, particularly on the duties that directors owe, should also be considered.. Generalising, when a company is solvent, the directors owe duties to their shareholders. When insolvency is a possibility, the duties are owed to the creditors as a whole. The dual threat of disqualification as a director and personal liability for the debts, means that the director should take proper advice on their legal position.
3. Establish procedures and stick to them
Hindsight is always 20:20. A decision, for example, taken by the Board to continue to trade may subsequently prove to have been wrong. However if there is evidence to document the thought process behind it (board minutes, evidence of advice taken, consideration of creditors’ position etc), it is unlikely that the directors will be open to legal redress. If the company is in financial difficulties, the directors should consider implementing procedures such as the:
(a) production of detailed, accurate and up-to-date management accounts;
(b) review of such management accounts and all other relevant trading/financial information at regular minuted board meetings where directors are encouraged to raise any specific concerns;
(c) formulation of specific areas of responsibility for each director;
(d) review of the position of the company’s creditors; and
(e) expediate the collections of debts. Once rumours get out that a company is in trouble, it will become harder to collect.
4. Stay with the ship
As Captain Smith tragically proved on the Titanic, a Captain is supposed to go down with his ship. Directors of troubled companies are supposed to have the interests of the creditor at the forefront of everything they do. It is difficult to see how they can protect their creditors’ interests if they are out of office.
The main time when a resignation may be appropriate is if (a) a Board is refusing to acknowledge the problem and (b) by a director resigning, it forces the spotlight onto the company and requires them to take action. A subsequently appointed insolvency official can review the conduct of former directors, so resignation does not get the director off the hook in any event.
5. Beware the legal pitfalls
Decisions taken at this troubled time are often fraught with legal difficulties. For example, if it is decided that employee numbers should be cut, the redundancy process in the UK should be handled with great care. Get it wrong and you are only adding to the company’s woes with unfair dismissal claims.
Decisions to cancel orders should be checked to make sure that there are no penalty clauses being triggered.
It is also wise to check bank covenants to make sure you are not inadvertently triggering a breach by say, quickly disposing of certain assets.
6. Consider the stakeholders in the business
To have any chance of survival it is imperative to keep key players, such as the bank/landlord/employees, on side.
Often, the bank will be far more sympathetic if it is involved in the process from the start rather than notified at the last minute of a problem. Often it is a good idea to have one point of contact such as the finance director that is in regular discussions with the bank/landlord.
A landlord given notice of a future default may be prepared to agree a rent reduction/holiday to keep the tenant paying rent in the long term.
7. Think the unthinkable
If the company is in difficulties every possible solution should be on the table (another reason why bringing in a turnaround expert is often a good idea).
Often there is no point in just looking to reduce cost at the edges. The whole rationale of each business unit should be re-examined. Every line of costs should be reviewed as well as consideration being given to proposals such as invoice discounting/factoring, stock reduction, out sourcing etc.
It is also not just a case of trading (and continuing to run the risk of wrongful trading) or throwing in the towel by liquidating the company at the first sign of trouble. A company voluntary arrangement or administration process should also be considered.
8. Do not prefer
A liquidator has the ability to review the actions of a company for a period of up to two years prior to the insolvency (longer if there is evidence that steps were deliberately taken to put assets outside the reach of creditors).
It is surprising how often key assets are transferred out to connected companies or dividends/bonuses are paid, just as the company is about to fail. If there is no commercial justification for such transactions, they will be looked at and may be subject to legal challenge.
9. Consider the priority
If the company is in difficulties, the directors should have one eye on the payment order for creditors if the company goes into insolvency. For example, if the bank has full security, there is more justification in meeting term loan repayments than paying in full unsecured creditors.
The law acknowledges that the directors should be allowed to pay for proper advice.. However the intention behind payment orders may also be looked at. For example, directors are often tempted to pay liabilities where they have given personal guarantees. This decision could be attacked as a preference.
10. Do not lose too much sleep!
It is going to be interesting to see how the credit crunch affects the Department for Business, Enterprise and Regulatory Reform’s previously published position about encouraging a culture of entrepreneurship and responsible risk taking.
In the US it is almost expected that a successful businessman will have one or two previous business failures on his CV. The Government does not want to see directors being sued or barred from future management of companies if there is a legitimate business failure.
As such, the insolvency service will generally only instigate disqualification proceedings when there is genuine evidence of serious negligence/fraudulent conduct. Also liquidators will only bring claims for wrongful trading if they are in funds and there is evidence of conduct well below the standard required. In the current climate, many business will fail and the previous stigma attached to a director of a failed company will hopefully reduce.
Fox Williams LLP is a business law firm based in the City of London. We are dedicated to providing clients with the highest quality of legal service.
Please contact Paul Taylor if you would like to know more about any of the matters mentioned in this article or simply to discuss our particular approach to your legal needs. Paul is a partner in our Corporate department and advises clients on a broad range of business areas, including mergers and acquisitions, joint ventures, private equity, banking and insolvency.
Telephone: 0207 614 2512