Orr Litchfield
Solicitors and Business Lawyers
Solicitors and Business Lawyers
Introduction
Covid-19 is affecting individuals and businesses on a local, national and global scale. An enormous number of businesses are facing sudden, unexpected economic and other business-related pressures (particularly, in the retail, restaurant, hospitality and travel sectors). Reductions in work or sales and increasing numbers of late (or no) payment from customers, without any significant decrease in business costs, have combined to create substantial cashflow problems for many businesses. Numerous businesses have either already closed or gone into liquidation or administration or are close to being forced into doing so.
This article is intended to assist business owners, directors and managers to understand some of the business and personal risks relating to insolvency and to help them to manage and mitigate those risks so that their business can survive the coronavirus outbreak or, where that is not possible, to successfully manage the closure of their business without personal liability.
Current position on Government Assistance
At the time of writing, the UK Government has announced and/or implemented numerous measures in order to try to assist businesses, business owners and employees. Several of these involve the temporary removal, reduction or deferral of business costs and others involve the direct underwriting of the costs of retaining employees.
What steps should directors be taking?
Business and continuity planning is essential. However, when there is a financial or other crisis affecting your business, it is likely to become more important than ever. You need to objectively assess the short-term, medium-term and long-term future of your business, with a particular focus on short-term continuity planning to enable your business to be successfully navigated through the period of the coronavirus outbreak.
This is likely to involve regularly undertaking 5 steps - collating relevant information and documentation; reviewing it in detail; assessing it; determining what actions are required and when; and implementing them. The mantra to follow is: COLLATE/REVIEW/ASSESS/DECIDE/IMPLEMENT/REPEAT!
When should directors be taking these steps?
These steps should be carried out immediately. They should be repeated regularly throughout the period of the coronavirus outbreak and afterwards until your business has stabilised. Inevitably, some steps will need to be repeated less often than others, depending on their rate of change and the nature of your business. In any event, a regular collation, assessment, review, decision-making and implementation process is likely to help make your business more efficient and effective and, therefore, more profitable.
How should directors be taking these steps?
You are likely to be able to carry out most steps without external assistance. Where appropriate, you may require the assistance of external professionals (for example, solicitors, accountants or insolvency practitioners) to assist you.
How each business carries out its business and continuity planning and what it includes is likely to vary significantly from business to business. However, it may include some or all of the items referred to below.
The collation and assessment phase may include matters such as:
1. Government measures and assistance – The UK Government has announced a variety of measures to assist businesses, business owners and individuals through the coronavirus outbreak. You should ensure that you are aware of and understand those measures, which may assist your business. It is usually possible to set up automatic alerts so that you are kept up to date.
2. General business and market sector information - You should ensure that you are aware of general and sector specific business information and developments, which may assist your business. Again, it may be possible to set up automatic alerts so that you are kept up to date.
3. Company financial information – You will need accurate and up to date management accounts, cash-flow statements and projections.
4. Inventory of stock, equipment and materials – You should ensure that you have an accurate and up to date list of your current levels of stock, equipment and materials and make a realistic forecast of your short-term requirements.
5. Suppliers – You need to identify any weaknesses in your supply chain and among your service providers. Your suppliers and service providers may be facing similar problems to you. They may be prepared to accept temporary changes to arrangements in order to maintain customers and minimise their own disruption (for example, reduced prices, increased credit or improved payment terms).
6. Customers– You need to identify any weaknesses among your customers and fulfilment agents. Again, they may be facing similar problems to you. You need to ensure that you fulfil contracts with customers and that your customers can and do pay you. If there are any signs that your customers may become insolvent, try to adjust your contracts and, in particular, your security and credit terms. If there are any signs that your fulfilment agents may become insolvent, try to identify alternatives.
7. Banks, lenders and other creditors – You need to review your existing financial arrangements and, in particular, the terms of any loan or other funding agreements in order to assess matters such as available funding, the risk of breaching financial or other covenants and the risks of failing to meet any scheduled repayments. Your bank may be prepared to vary the existing arrangements by granting a repayment holiday, agreeing a short extension to your facility or overdraft or restructuring payments. If your existing bank is not willing to assist you, an alternative lender may be willing to do so or it may be possible to raise additional equity finance from existing or new shareholders to bridge cash flow constraints. At the time of writing, the UK Government has announced various measures relating to borrowing including the Coronavirus Business Interruption Loan Scheme.
8. Contracts – Review your contracts in order to assess which ones you wish to retain and whether there is any scope for permanently or temporarily adjusting them, where appropriate. Ensure that you can comply with those contracts that you wish to retain. If there are contracts, which you no longer require, you will need to assess whether it may be possible to terminate them at no or no significant cost.
9. Property – You may own or occupy property as a freeholder, leaseholder or licensee. In the latter 2 cases, your landlord may be willing to consider temporarily reducing the rent for an agreed period or granting a payment holiday. If you are a freeholder, you may have the reverse problem to deal with. If you are a licensee, there may be scope to reduce the size of your premises and, consequently, your costs. At the time of writing, the UK Government has announced various measures relating to property including a business rates holiday for retail, hospitality and leisure businesses in England for the 2020 to 2021 tax year.
10. Employees – You should assess your staffing requirements. In particular, you may need to consider making redundancies. However, there are numerous alternatives to redundancy, which may enable businesses and the relevant staff to survive the coronavirus together. At the time of writing, the UK Government has announced various measures relating to the protection of staff including the Coronavirus Job Retention Scheme pursuant to which the state will pay to employers 80% of a retained employee’s wages, up to a monthly cap of £2,500.
11. Insurance – You should identify what insurance cover you have and read through the relevant parts of the policies in order to assess whether they may assist you. Typical types of insurance cover that may be relevant include business interruption, keyman, employer’s liability, crisis management, mitigation, and reputational insurance. You may wish to seek assistance and guidance from your insurance broker.
12. Litigation –In relation to any existing or potential litigation, there may be a risk that your opponent becomes insolvent. The uncertainty created by the coronavirus outbreak is likely to encourage the resolution of disputes as parties seek certainty of outcome, wish to avoid wasted time and costs and prefer to focus on other issues. Where there is no resolution, parties may wish to consider how they can obtain security from the opponent (for example, via a payment into court or security for costs).
The review and decision-making process may include matters such as:
1. Departmental reviews, meetings and reports – Depending on the size and structure of your business, your initial review and internal reporting may be carried out departmentally. These will need to deal with the information and documentation obtained during the collation and assessment phase.
2. Assessing your current financial status – You will need to assess the financial information and documentation obtained during the collation and assessment phase. It is likely that you will need to do so more regularly than usual.
3. Solvency and risk of insolvency - You will need to determine from your financial and other information whether you are insolvent or if there is a risk that you may become so. It may be that you will need to make this assessment regularly until there is greater stability.
4. Revising your business plan and budget – You should review and, where appropriate, adjust your business plan and budget to reflect the impact and predicted effects of the coronavirus outbreak. This should assist you (a) to determine what steps you need to take in order to continue trading, and (b) in your discussions with your bank (or other funders), creditors, customers and suppliers.
5. Board meetings – You should hold regular full board meetings in order to discuss the up to date financial and other information and documentation, which has been collated (and, perhaps, provisionally assessed at departmental level). Informed decisions can then be made on a collective basis. Depending on the financial status of your business, it may be necessary to hold these meetings more regularly than usual - weekly or even daily.
6. Advice from external professionals (for example, solicitors, accountants or insolvency practitioners) – Internal and external professionals should be consulted, where appropriate, at an early stage. They may be able to assist you (among other matters) to understand issues, identify potential solutions and negotiate with other parties. Evidence that you sought and acted upon professional advice may reduce the risk of any personal liability.
7. Maintaining records – It is vital that you prepare and maintain detailed board minutes of all meetings setting out the matters discussed, decisions made and the reasons for those decisions. Clearly written board minutes reduce the risk of later misinterpretation of Board decisions and, where relevant, may reduce the risk of any personal liability. They may also assist you in ensuring that you fully consider relevant issues when making decisions.
The implementation phase is likely to require a significant amount of co-ordinated communication in order to ensure that is takes place as efficiently, effectively and smoothly as possible. It may include matters such as renegotiating existing contracts, focussing on cash collection, cutting costs (for example, making employees redundant) or resolving disputes. Whatever it is, it should be monitored closely until it is concluded.
Why should directors be taking these steps?
These steps are important because there may be a risk of personal liability for directors if their company becomes insolvent and subsequently enters into liquidation (or a similar procedure). In particular, directors will wish to avoid being accused of wrongful trading, fraudulent trading or any similar breaches of their duties. They will also wish to avoid being disqualified as a director.
What is a director?
It includes executive and non-executive directors, (who have been properly appointed by the company), de facto directors (being any person who has assumed the status and functions of a company director even though he has not been properly appointed) and shadow directors (being any person in accordance with whose directions or instructions the directors of the company are accustomed to act – excluding advice in a professional capacity).
What are directors’ duties?
Section 172 of the Companies Act 2006 imposes a general duty on every director to act in a way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders as a whole – this may vary significantly depending on the objectives of the company.
In making decisions and choices, directors must also consider (among other matters) the company's business relationships with suppliers, customers and others; the interests of its employees; and the likely consequences of any decision in the long term. Directors also have a general duty to exercise reasonable care, skill and diligence, which is tested on an objective and subjective basis. The objective test relates to the general knowledge, skill and experience that may be reasonably expected of a person carrying out the functions carried out by a director. The subjective test relates to the general knowledge, skill and experience of that particular director.
What is the risk of breaching the statutory duty?
The risk of a director breaching his statutory duty under Section 172 of the Companies Act 2006, as a consequence of actions arising from the coronavirus outbreak, is low. If the directors make poor commercial decisions, the Court is unlikely to interfere provided that they make them honestly and in good faith.
What are Directors’ duties when their company is insolvent?
When a company is insolvent or is likely to become insolvent, the main duty of the directors changes from promoting the success of the company for the benefit of its shareholders as a whole to a duty to protect the interests of creditors.
The rapid onset and severe impact of the coronavirus outbreak, combined with the Governments continuing attempts to respond to it by introducing measures to protect businesses, business owners and employees, may make it particularly difficult to determine whether a business is likely to become insolvent or survive any temporary technical insolvency. In these circumstances, it is particularly important that the directors take (and document that they have taken) appropriate steps by collating, reviewing and assessing up to date information and documentation; before making and implementing decisions based on that information and documentation.
When is a company Insolvent?
There is no definition of ‘insolvent’ in the Insolvency Act 1986 (‘IA1986’). However, the two main tests of insolvency are the ‘cashflow’ test (set out in section 123(1)(e) IA1986) and the ‘balance sheet’ test (set out in section 123(2) IA1986).
(a) The cashflow test - The company cannot pay its debts as they fall due. This test is primarily directed at short-term and medium-term liquidity.
(b) The balance sheet test - The liabilities of the company (including contingent and prospective liabilities) are in excess of its assets. This test is primarily directed at long-term capital structure.
Can your company trade whilst Insolvent?
The short answer is ‘Yes’. There is no offence of trading whilst insolvent. However, directors will need to be aware of the rules relating to wrongful trading, fraudulent trading, misfeasance, transactions at an undervalue, preferences, disqualification from acting as a director and related risks. In these circumstances, it is particularly important that the directors take (and document that they have taken) appropriate steps, in case the company enters into insolvency proceedings at a later date.
What is Wrongful Trading?
It is defined in section 214 IA1986. It applies in relation to a person who was a director of the company at the relevant time, if the company has gone into insolvent liquidation and at some time before the commencement of the winding up of the company, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation. In those circumstances, the court may (on the application of the liquidator) declare that a director is liable to make a contribution to the company’s assets.
In general terms, any contribution from directors is likely to be limited to the amount of any increase in losses to creditors during the period commencing on the date on which the company became insolvent (or knew or ought to have concluded that it could not be avoided) and ending on the date on which formal insolvency proceedings started.
A claim is only likely arise if it is shown that the company is worse off as a result of the continuation of trading. If the company’s net asset position has not become worse during the relevant period then a claim against the directors is unlikely to be pursued.
It is important to note that a company may improve the position of its creditors, even if insolvent liquidation or insolvent administration is unavoidable, by taking steps such as collecting in debts or completing contracts. Conversely, a company may worsen the position of its creditors by failing to take such steps.
What is Fraudulent Trading?
It is defined in section 213 IA1986. It applies where it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person, or for any fraudulent purpose.
The court may (on the application of the liquidator) declare that any persons who were knowingly parties to the carrying on of the business in this manner make such contributions (if any) to the company’s assets as the court thinks proper. It requires some form of dishonesty on the part of the relevant person. It is also is a criminal offence.
Other potential risks arising from Insolvency
In addition to wrongful and fraudulent trading, an insolvency practitioner appointed in connection with the winding up of a company will investigate the company’s affairs in order to determine whether any other breaches of conduct or offences have occurred. These may include:
(a) Misfeasance or breach of fiduciary duty – Under section 214 IA1986, the Court has the power to order a director (or certain other persons) to repay, restore or account for money or property together with interest or contribute to the company’s assets by way of compensation where the director has misapplied or retained or become accountable for any money or other property of the company or been guilty of any misfeasance or breach of fiduciary duty in relation to the company.
(b) Unlawful dividends – A director who authorises the payment of a dividend (cash or non-cash) that contravenes the provisions of the Companies Act 2006 may be in breach of his duty. If so, he may be required to repay the company for any loss suffered, even if he is not a recipient of the dividend (for example, where he is not a shareholder or the relevant category of shareholder). A recipient of an unlawful dividend may also be required to repay any unlawful element of the dividend, which he received if he had knowledge it was unlawful.
(c) Transaction at an undervalue – Under section 238 IA1986, a transaction with another person will be at an undervalue if either (i) the company makes a gift to that person or that person provides no consideration or; (ii) the value of the consideration received by the company (in money or money’s worth) is significantly less than the value of the consideration given by the company.
Any transaction at an undervalue, which took place within two years of the commencement of insolvency will be open to challenge if it took place at a time the company was insolvent or the company became insolvent as a result of the transaction. It is important to note that a transaction cannot be challenged where (i) it was done in good faith for the purpose of carrying on the company’s business and (ii) the directors had reasonable grounds for believing that it would benefit the company.
(d) Preferences - Under section 239 IA1986, where a company gives another person a preference, the court may make an order restoring the position to what it would have been if the company had not given that preference.
A company gives a preference to a person where (i) that person is one of the company’s creditors (or a surety or guarantor for any of the company’s debts or other liabilities), and (ii) as a consequence of the action (or inaction) of the company, that person is placed into a better position in the event of the company going into insolvent liquidation, than the position he would have been in if that the action (or inaction) had not occurred.
A preference is open to challenge if it occurred within 6 months of the commencement of insolvency but that period is extended to 2 years where the recipient of the preference is a connected person. Where a transaction is challenged, it will be necessary to establish that the company was influenced by a desire to give the other person a preference. Where the other person is a connected person, the desire to prefer is presumed. However, it may be rebutted by evidence.
(e) Directors’ Remuneration, Expenses and Employees – The payment of these (and, in particular, any arrears) should be considered carefully where other unconnected creditors are not being paid. However, where the continued payment of key employees (including relevant directors) is critical to ensure that the company is managed through a period of financial distress, ongoing payments of remuneration and expenses may well be justified where it is in the best interests of the creditors.
(f) Director’s disqualification - If a company enters into formal insolvency, the insolvency practitioner appointed to deal with the company has a duty to report to the Secretary of State on the conduct of each of the directors and former directors of the company. Where a liquidator concludes that a director’s conduct was inappropriate, and makes him unfit to be a director, then that will be included in the report. A director may then face director’s disqualification proceedings pursuant to which a person may be disqualified from acting as a director (or in the promotion, formation or management) of any company on the grounds of unfitness for a period between 2 to 15 years.
Need to talk?
Whatever stage you or your business has reached, we can help you to understand the different legal and related issues arising from the coronavirus outbreak, continuity planning and insolvency and the risk of personal liability so that you can choose the option that is right for you and/or your business.
Contact us
If you would like more information about the coronavirus outbreak, continuity planning or insolvency or would like to discuss a potential or existing issue, please contact us by telephone on +44 (0)20 3126 4520 or +45 38 88 16 00 or by email at enquiries@orrlitchfield.com
Disclaimer
This information is for guidance purposes only and should not be regarded as a substitute for taking legal advice. Please refer to the full Legal Notices on our website.
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