Directors’ Duties: Companies in Financial Difficulties

Our newsletters over the last few months have been about planning for your exit, which most of us hope will mean retirement on a sale of your company.

With the economy picking up you may be thinking about how to plan for that retirement. But, as we come out of recession, there is the risk of over trading: your business being short of the working capital it needs to grow as stock and work in progress are funded.

In the next two months newsletters we cover the topic of the duties of a Director when your company is in financial difficulties.  This month in Part One we cover the importance of good independent objective advice and cover the different types of insolvency procedure.  Next month we will cover personal liability and risks.

If you know of someone who you think would like to read this newsletter do forward them a copy.

James Hunt and the team at
Everyman Legal

The First Step:  find a good independent adviser                    

Cash flow pressures can make life difficult for any business, whether they are the result of long-term (such as increased competition) or short-term negative factors, or the need to raise cash to provide working capital for new contracts.

Because this is a commonplace problem there are a number of business advisers who specialise in helping people in this situation. Approaching an accountant, insolvency practitioner or a solicitor is probably the first step that you should take. However, your adviser will need the full picture, so be prepared to take the time to brief them properly.

If you do not already have a trusted adviser be wary of unregulated advisers who may not have your interests at heart. Look for personal recommendations and ask for references.

What is insolvency?

There are two sorts of insolvency:

Balance sheet insolvency is where the company’s liabilities exceed its assets. Cash flow insolvency is where a company is unable to pay its debts as they fall due. Cash flow insolvency may lead to balance sheet insolvency if the company cannot pay its bills. For instance, if there is a forced sale and the company’s assets are written down instead of being shown at going concern value.

Many companies that are balance sheet insolvent can continue to trade provided they have the support of key creditors, such as their bank.

Insolvency procedures

Several procedures can be used to save a company so it is important to understand the options available.

Administration

This procedure provides the company with protection from its creditors. Finance houses cannot repossess vehicles and machinery and landlords and HM Revenue and Customs cannot take possession of plant or stock (known as distraint).

An insolvency practitioner (licensed by a professional body and appointed by the company or a bank) takes responsibility for the business. This means that directors lose their powers, but on the positive side the administrator’s duty is to save the business as a going concern, if possible.

Corporate Voluntary Arrangement

This procedure needs to be supervised (but not controlled by) an insolvency practitioner.  It can be used to compromise (or settle) creditor claims so that, for example, creditors receive a delayed payment or a reduced payment of so many pence in the pound, through an informal but binding agreement.

The procedure involves the preparation of a proposal and the convening of a creditors’ meeting vote on the proposal.  A 75% vote (by value of debt held) of the creditors is needed for the proposal to be passed.  It is then binding on all creditors.

This can be a powerful procedure for a company running a business that has suffered an unexpected problem but is otherwise viable (e.g. a major bad debt).

Compulsory Winding Up

This is the procedure taken by a creditor who is owed at least £750. It involves the appointment of a liquidator who is normally the Official Receiver. His role is to collect in the assets and pay off the debts of the company and distribute any surplus to those entitled to it.

Members’ Voluntary Liquidation

This procedure is initiated by a 75% vote of the shareholders of the company in favour of appointing a liquidator. There are two types:

Creditors’ Voluntary Liquidation (CVL)

This applies where the directors are unable to make a declaration of solvency. The liquidator is usually an insolvency practitioner chosen by the directors but it can be the Official Receiver.

Members’ Voluntary Liquidation

This is the same as for the CVL but it is preceded by a Directors’ declaration of solvency and there is no need for a creditors’ committee.

The role of the liquidator in either case is to collect the assets and pay off the liabilities. He also has the power to give up certain heavy liabilities such as an unprofitable contract or lease.

Hints and Tips

Take advice at an early stage from an independent business adviser;

Beware of unregulated advisers who may be unscrupulous.

Ask for references and take advantage of initial free advice;

Take the time to fully brief your chosen adviser.