A guide to business-related debt and insolvency
If you have concerns about a business-related debt, or if you’re owed money yourself, our team of specialist commercial and corporate solicitors can provide help and support. Below are some frequently asked questions which will provide initial information about the key issues.
What is insolvency?
There is no statutory definition of ‘insolvent’ although the Insolvency Act 1986, when referring to a state of insolvency, uses the phrase ‘unable to pay its debts’. In practice there are 2 separate tests for insolvency and failure of either might be an indication of insolvency:
- the company cannot pay its debts as they fall due for payment
- the value of its liabilities exceeds the value of its assets
Section 123 of the 1986 act provides that a company is deemed to be unable to pay its debts where:
- the company has not paid, secured or settled a claim for a sum due to a creditor exceeding £750 within 3 months of having been served with a statutory demand
- a creditor has attempted an enforcement process against the company in respect of a debt without success
- it is proven to the satisfaction of the court that the company is unable to pay its debts as they fall due
- it is proven to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account contingent and prospective liabilities
Generally, insolvency law aims to rescue or restructure a business rather than liquidate it. A rescue can maximise the return for creditors and often involves selling a business to another party and using the proceeds of sale to pay its creditors.
What should I be doing as a director if I am worried about insolvency?
- Directors should consider these questions with other board members of their company:
- do we consider the risk of insolvency in our general risk assessment?
- when did we last carry out an insolvency risk assessment?
- are our current assets plus investments less than our current liabilities?
- are our total assets and foreseeable income less than our total liabilities and expected expenditure?
- do we regularly have to go into overdraft because our incoming resources are not enough to meet all of the company’s commitments?
- is there a need to provide additional security for long-term borrowings?
- are we under pressure from creditors who are chasing overdue payments?
- is our company reliant on bank loans with unclear renewal or extension options in order to continue its operations?
- have we adequate financial reporting in place and do the directors fully consider those reports?
- have we breached our banking covenants or exceeded our borrowing facilities with no immediate means of restoring the situation?
- does the company have potential significant contingent liabilities?
What should I do in the period between being concerned to talking action?
Directors should consider budgets including cash projections and business plans. These need to be produced at least monthly and ideally weekly with daily updates in the current situation. Expenditure is often easier to forecast than income. It is important that expenditure predictions take account of all known liabilities and contingencies.
They should also ensure that they have effective internal financial controls in place. These include controls over both expenditure and income and properly understanding and accounting for Value Added Tax (VAT), income tax and National Insurance liabilities through Pay As You Earn (PAYE). These are all statutory liabilities and errors in accounting may result in large and unexpected liabilities and penalties. For information about tax matters visit HM Revenue and Customs (HMRC).
Monitor actual results progress against budget
Directors should review the company’s financial position and its performance against budgets and future projections at least every month. Proper analysis of financial trends and changes in budget predictions may help to assist early identification of financial problems.
Analyse the company’s sources of income and expenditure
Risks of insolvency are reduced by having diverse sources of income and a core of secure funding, avoiding over-dependence on any one source. Possible problems such as uncertainty over taxation and VAT and penalty clauses within contracts will need to be identified.
Ensure that you have robust risk policies in place and review them on a regular basis
Identifying risk is an important part of the planning and budgetary process.
Seek professional advice
Ask an expert for advice before entering transactions which may give rise to significant future financial commitments. These might include building contracts, lease arrangements and borrowings. The directors should satisfy themselves as far as possible that they will be able to meet such commitments in full.
What should I do as director if insolvency cannot be avoided?
If the directors consider that their company might not be able to continue to operate due to its financial situation, they should:
- contact the company’s auditor or accountant, insolvency practitioner or other professional adviser to discuss the options open to them and seek their help and advice – directors should take a careful note of what advice they have been given, and the reasons for any of their decisions made as a consequence of that advice
- draw up a complete list of all the assets and liabilities of the company to determine whether the company is solvent or not – this needs to take into account the additional costs of closure which might include:
- fees for legal and financial advice
- redundancy/holiday/maternity pay
- rent for the remaining period of the lease on equipment or premises
- any extra costs involved in withdrawing from leases
- pension obligations
What does the Government’s announcement about the wrongful trading provisions under the Insolvency Act mean for me?
On March 28 the UK business secretary Alok Sharma announced that the wrongful trading laws would be suspended for 3 months to allow companies “to emerge intact on the other side of the Covid 19 pandemic”.
The law to implement this announcement has not yet been brought into effect but will be rushed through and will apply retrospectively from 1 March.
Make no bones, this is a significant measure. When advising clients, the “wrongful trading” provisions, which were introduced by the 1986 Insolvency Act are the ones that require a director to act to put a company into insolvency when they know or ought to have concluded that the company could not avoid insolvent liquidation and creates personal liability for failing to do so.
So what does the Government announcement mean in terms of director conduct now? One of the key points to remember is that when a company is insolvent (as that expression is explained above) the directors duties are owed not to the shareholders but to the creditors. This means that the directors have to act fairly as between the creditors and specifically they should not be paying one creditor with the intention of preferring that creditor unless that is absolutely necessary to do so (for instance to secure future supplies). Nor should they be selling assets at an undervalue.
It does mean that directors have to carry on acting responsibly in other words and they will run the risk of disqualification of they do not do so, but it does also mean that they have one less risk to worry about, namely personal liability if they allow things to go on past what turns out to be the point of no return.
If dealing with shortages of incoming resources the directors should:
- carry out a review of commitments to see whether they are legally binding or discretionary – even where contractual agreements exist there may be scope for renegotiation
- discuss the company’s situation with its bank, particularly where loans are secured against the property of the company
- review existing borrowing or loan facilities
- check government grants and aid packages
- seek new facilities to provide a bridging facility until sufficient income is received
This course of action should only be taken if it is certain that such income will actually be received. Borrowing is only normally appropriate as a temporary measure – there are costs attached (arrangement fees and interest) and directors will need to check their borrowing powers in the company’s governing document. In addition, in some circumstances it may be difficult to get a loan at all.
Don’t forget to communicate with stakeholders or members who may be able to offer help which will enable a company to get through a period of financial difficulty. Are there other means to cut or curtail planned expenditure to try and bring the level of outgoings below the level of receipts?
Can we help you? To contact our specialist corporate and commercial solicitors in Bristol or London please call 0117 906 9400 or email email@example.com