The Government has put in place substantial measures that are intended to help mitigate the devastating effect of Covid-19 on the UK economy. Many businesses are now facing their toughest test in living memory. Yet even as the UK endures extraordinary lockdown measures, and with some 3.9 billion people in global isolation, directors of UK companies must continue to try and keep their businesses out of insolvency.
In times of global economic downturn, it is prudent for company directors to stay abreast of the government’s measures, as well as their own obligations to the company. Directors of UK companies need to navigate a legal minefield when deciding whether their company is fundamentally strong enough to survive. The decision to carry on in business may normally depend on a range of factors such as interest rates, the availability of funding, the strength of the competition and domestic and foreign demand for product and service. However, increasingly the number one consideration will be, “how long is the lockdown going to continue for?”.
Our top 10 tips for company directors provide guidance to ensure you err on the right side of your duties throughout this testing period. We provide more detail below. Essentially, directors should remember:
This article covers the following top 10 points:
1. Wrongful trading provisions suspended, but directors must still fulfil their duties properly
Section 214 of the Insolvency Act 1986 enables a liquidator of a company to apply to the Court to seek contribution orders from directors and/or ex-directors. The liquidator must show that before the commencement of the winding-up, the company carried on incurring liabilities when the defendant “knew, or ought to have concluded, that there was no reasonable prospect of the company avoiding an insolvent liquidation”.
Due to the Covid-19 crisis, it was announced that the Government would suspend the wrongful trading provisions under s.214 in respect of actions taken after 1 March for an initial period of three months. However, this encourages directors to seek advice from an insolvency expert, and insolvency bodies such as R3 (which represents the insolvency and restructuring profession) have already raised concerns about suspending provisions designed to protect creditors, at a time when companies are most in financial distress.
Does this change mean that directors should act differently from before? Almost certainly not. According to the Government statement “all of the other checks and balances that help to ensure directors fulfil their duties properly will remain in force”.
The relaxation should not be taken as a get-out-of-jail-free card. Whilst the temporary measures are designed to ensure that directors are not rushing to the insolvency courts, the majority of other checks and balances remain in order to ensure that directors comply with their duties. You must continue to act in the best interests of all creditors and have a reasonable belief that the company can avoid an insolvency process.
2. Consider the stakeholders in the business
It is imperative during this period to keep your key stakeholders on side, including banks and landlords.
Often, the bank will be far more sympathetic if it is involved in discussions from the start, rather than being notified at the last minute of a problem. It is a good idea to have one point of contact, such as the finance director, in regular discussions with the bank or landlord.
A landlord given notice of a future default may be prepared to agree a rent reduction or holiday to keep the tenant paying rent in the long term. Our article detailing practical points for commercial landlords provides further advice on this topic.
3. Establish procedures and stick to them
A decision taken by the Board to continue to trade when economic conditions are tough may subsequently prove to have been ill-founded. However, if there is evidence to document the process behind such a decision, it is unlikely that the directors will be subject to legal redress.
When a company is in financial difficulty, directors should consider implementing, amongst other things, the following procedures:
(a) produce and review detailed, accurate and up-to-date management accounts;
(b) review historic management accounts and all other relevant trading/ financial information at regular, minuted board meetings, where directors are encouraged to raise any specific concerns;
(c) designate specific areas of responsibility for each director and avoid conflicts of interest;
(d) review the position of the company’s creditors
(e) expedite the collection of debts – once rumours get out that a company is in trouble, debts will become harder to collect.
The Government has offered a significant aid package to help companies avoid redundancies during the Covid-19 pandemic by offering such measures as furlough schemes, loan guarantee schemes, business rates holidays, reductions in rent and loan/ grant entitlement for struggling companies.
Decisions taken at this time remain fraught with legal difficulties. While furlough may be flavour of the month, it is a process to be handled carefully with care in order to avoid potential claims in the future. See our latest article on furlough leave, here. Likewise, decisions to cancel orders should be checked to make sure that penalty clauses will not be triggered. It is also wise to check bank covenants to make sure you are not inadvertently triggering a breach by, for example, quickly disposing of certain assets.
For a full picture of the Government’s measures to minimise business disruption, please see our article 10 tips for SME business owners during the COVID-19 pandemic.
Struggling companies often consider selling assets when finances become tight to alleviate cash flow problems. It is equally tempting for companies to seek to buy knockdown priced assets from other struggling companies. However, if insolvency follows, both buyer and seller risk such transactions being set aside by insolvency practitioners as transfers at an undervalue. Seeking legal advice and gathering independent valuation of asset purchases or disposals is good evidence to indicate that a director has sought to comply with its duties.
If the company is in financial difficulty, every available solution should be on the table. If things are looking bad, it may be advisable to enlist the help of a turnaround expert to provide specialist advice on turning the tide of a company’s fortunes.
Instead of looking to reduce cost at the edges, the 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 and outsourcing.
It is also not just a case of trading or throwing in the towel by liquidating the company at the first sign of trouble. A whole variety of arrangements, such as company voluntary arrangements or administration processes, should be considered.
It is equally important to note that in a further response to the virus, a new restructuring regime known as a ‘business rescue moratorium’ has been proposed. This is designed to (i) prevent creditors from taking enforcement action whilst the business seeks a rescue/restructure, and (ii) permit the business to continue to access the supply of goods and services necessary to continue to trade. Further details are still awaited.
7. Consider the payment priorities
If the company is in difficulty, the directors should keep an eye on the payment order for creditors. 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 directors should be allowed to pay for proper advice. However the intention behind payments may also be looked at.
For example, directors are often tempted to pay liabilities where they have given personal guarantees. This decision could be treated as a preference (see below).
A liquidator is able to review the actions of a company for a period of up to two years prior to the insolvency (or even longer if there is evidence that steps were deliberately taken to put assets outside of the reach of creditors).
There may be a temptation to transfer key assets to connected companies/persons, or to pay out dividends and bonuses just as the company is about to fail. Such transactions will be carefully reviewed and, if there is no commercial justification for them, may be subject to legal challenge.
9. Stay with the ship – or is resignation the best course of action?
Just as a captain’s duties lie with their passengers, directors of troubled companies must have the interests of their creditors at the forefront of each decision that they make. While resignation from the Board of a struggling company may seem tempting, it is difficult to see how a director can protect shareholders’ interests if out of office. A subsequently appointed insolvency official can review the conduct of former directors, so resignation does not guarantee that the director is off the hook in any event.
A director’s resignation may be appropriate, however, if a board refuses to acknowledge that the company has a problem. In this situation, the act of resignation by a director shines a spotlight on the company, thus requiring the remaining board directors to take action.
10. Take proper advice and don’t lose too much sleep!
Directors should continue to assess whether they need outside help. If the company is in receipt of statutory demands or default notices, these are clear signs that specialist legal and/or 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 skillsets to turn the company around. Bringing in turnaround experts is an option which should be considered as these specialists have a proven track record of saving companies.
Legal advice, particularly in respect of the duties that directors owe to their creditors, should be considered. Although personal liability under wrongful trading provisions has been suspended, the ongoing threat of disqualification as a director (where the director of an insolvent company is deemed unfit to manage a company) remains alive. However, the Insolvency Service will generally only instigate disqualification proceedings when there is genuine evidence of serious negligence and/or fraudulent conduct.
Since 2008, the stigma attached to a director of a failed company has reduced significantly and in the current climate, many more businesses will fail. In this new reality we find ourselves in an adage comes to mind: it is not the crime but the cover-up that causes the problems.
If you have any questions about these issues in relation to your own organisation, please contact a member of the team or speak with your usual Fox Williams contact.
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