James Hopkirk, Restructuring Director of Kreston Reeves discusses some of the alternative solutions to putting a company into liquidation and the processes company directors should follow
With the pandemic largely behind us, business owners now find themselves having to repay their Bounce Back Loans or Business Interruption Loans at a time of high inflation, whilst they are trying to re-build their ‘pre-Covid’ turnover levels.
Many diligent company directors are seeking advice as to whether they should be continuing to trade at all but, in most cases, the advice is that they can proceed – just with caution. Common concerns which are raised are as follows:
"We’re making losses and if we had to stop trading now, we wouldn’t be able to cover the costs of redundancies on top of everything else… "
A period of loss making can cause directors a lot of anxiety. When a company becomes insolvent on a balance sheet basis, the duties of the Board switch to being owed to creditors rather than shareholders, which means that transactions can potentially come under greater scrutiny should the company ultimately fail.
However, if the company still has some reserves and is meeting its liabilities as they fall due, then there is no need to factor in contingent liabilities when deciding if the company is insolvent. These might include redundancy costs or costs relating to the termination of a lease, which might crystallise if the company did cease trading. If the intention is for the business to improve its finances and retain its current work force then the Board can make decisions on that basis, provided the company is solvent.
A recurring theme when a Board is concerned about the future of the company is that discussions and decisions should be recorded so that the Board has a note of their thought processes at the time.
"Should I invest more money to keep the company going?"
Whilst company shareholders are under no obligation to provide funding to cover a company’s losses, they may well wish to do so with a view to returning the company back to profitability and preserving what they have managed to build up. The shareholders should ensure that they have the most accurate management information in order that they can assess the risk of potentially not seeing a return on the money. If the additional funds are put into the company as a loan, then shareholders will need to be mindful that their debt will be ranked as unsecured in the event that the company doesn’t survive.
Investors might consider whether the company is able to grant security to the lender over its assets in respect of new funding. A lawyer would be able to advise on how that might legitimately be achieved.
"Can I prioritise redundancy payments / key suppliers?"
If a company reaches a stage where it is unable to meet all of its obligations as they fall due, then the Board needs to think carefully about which payments are prioritised. If certain creditors are paid at the expense of others and the company subsequently fails, then a Liquidator could look to overturn the transactions or pursue personal claims against the directors.
For such a claim to be successful, a Liquidator would need to show that the directors had a desire to prefer the particular creditor rather than the motivation being a legitimate business need – for example to procure an essential supply of goods. As before, the best defence that directors can have against potential scrutiny of such transactions is a contemporaneous note recording the Board’s decision making process at the time of making payments.
"Cash flow forecasts are showing problems in a couple of months but we’re seeking further funding to address that"
Personal claims against directors could arise where additional debts are incurred when there is no reasonable prospect of the company avoiding an insolvency. If the Board is continuing to trade on the basis of future funding being obtained then it should carefully record minutes of discussions and decisions to set out a record of why trading continued and why that was expected to improve the position of the creditors of the company.
The Board is not expected to be able to see into the future but it should be able to explain its motivation should the funding not ultimately materialise, which might leave the company unable to pay its debts.
In conclusion, there are three key lessons here:
1 Records of decisions – the board should be able to demonstrate that it believed at the time that its actions would be in the best interests of the company and its creditors.
2 Treat creditors fairly – if the company cannot afford to pay all creditors as they fall due, then careful consideration should be taken before prioritising any one creditor.
3 Seek advice – the consequences of acting in an unreasonable way, or a way which the Board cannot demonstrate was reasonable, can be severe, so if a Board of directors is concerned that it may be unable to avoid an insolvency then it should seek advice from its accountant or an Insolvency Practitioner.
If you have any questions and want to achieve optimal results for your business, get in contact with James Hopkirk: