What are the key responsibilities of directors? What do they need to look out for when insolvency looms?
Nitin Joshi, one of our partners, has worked in insolvency for over 40 years and in that time, he has seen pretty much everything you can in the world of insolvency. In this article he answers the questions that directors of insolvent companies (or about to become insolvent) should be asking, details what their key responsibilities are and puts right a few misconceptions too.
1. It’s my company, right?
No, not right. You may be a director, you may be a shareholder or more then likely, you will be both, but a limited liability company has its own distinct life, it is an entity in its own right, a body corporate. Unlike the much-fabled Norwegian Blue of Monty Python fame, it is perfectly alive and breathing. And a little like a sourdough starter, the company not only needs constant attention and feeding but great care is needed, from the directors, who have many responsibilities.
2. So, what is a director?
Under the Companies Act 2006, you are responsible (or potentially) for a company even if:
- You’re not active in your role as director
- Someone else tells you what to do
- You act as a director but have not been formally appointed
- You control a board of directors without being on it
3. What about filing with Companies House?
You will be responsible for filing these things which are normally left to the company’s accountant but it’s your job to make sure it’s done:
- Confirmation statement
- Annual accounts
- Change to your company’s registered office
- Allotment of shares
- Registration of charges
- Any change in your company’s people with significant control
4. The Big Seven. What are my general duties?
Under the Companies Act 2006, all directors must:
- Act within powers – i.e. in accordance with the company’s constitution
- Promote the success of the company
- Exercise independent judgement
- Exercise reasonable care, skill and diligence
- Avoid conflicts of interest
- Not accept Third Party benefits
- Declare interest in proposed or existing transactions with the company
5. As a director, what’s the real story when a company is insolvent?
Insolvency is a specific event and much depends on the directors’ ability to identify a point in time when they believe their company is insolvent. So, what is insolvency? Simply, it’s one of these three things, and any one of them will do:
- The company’s liabilities exceed its assets
- The company cannot pay a Statutory Demand (a 21-day demand, a statutory form). There is no minimum amount for a statutory demand – a creditor can serve one for a very low amount, but this is very rare, however, usually it is no lower than £750. The minimum for a petition for winding up is £750.
- The company is cash flow insolvent, meaning it cannot pay creditors as and when they fall due.
This definition is helpful and useful because this is what insolvency looks like at the sharp end of waking up in the middle of a cold night, firefighting in the office, making sure customers pay, making sure the debit balance only kisses the overdraft limit which is personally guaranteed by the directors, making sure the ageing on the creditors’ list doesn’t look like a shoppers queue on day one of Covid-19 outside Tesco, before finally returning home for a late supper and ending the day with an excellent impression of insomnia.
It’s worth noting here that it’s not just knowing about your actual creditors, right now, but contingent and prospective creditors too. So, if you think there will be creditors coming out of the woodwork anytime soon with a (probably) undisputed claim that the company will not be able to meet then this needs to be taken account in your appraisal of the company’s solvency.
If, for example, it’s likely that taxes will become due which the company will not be able to settle, then the company is insolvent and directors need to take steps now, failing which they may be trading the company whilst insolvent. A common argument by HMRC and rating authorities is, why did you allow the company to trade when it was, or was soon going to be, insolvent?
6. What is expected of a director? It’s your responsibility to know whether your company is insolvent or solvent, and no one else’s
As Donald Rumsfeld said, it’s about knowing the knowns and the unknowns. You are expected to know whether your company is solvent or insolvent, and that appraisal is not something you can delegate to your advisors. Yes, they will help you come to a conclusion, but it’s your responsibility to determine the status of your company. The buck stops with you. Worrying, sure. But you have to know the unknowns, too, as it’s no defence for directors to say I didn’t know we owed them money or potentially owed them.
7. What about Director Disqualification?
Insolvency law is a minefield for directors. Not taking proper advice can result in claims against directors personally for fraudulent trading, or at a lower threshold wrongful trading, and can result in disqualification from being a director for up to 15 years. To add to this the Government’s Insolvency Service may apply for a Compensation Order to go along with disqualification.
The Insolvency Service will investigate directors for a potential disqualification if there has been widespread neglect, deceit, wrongful trading, serial insolvency, large and aged tax liabilities and, of course, highly suspect transactions including self-preferred payments, and asset disposals pre-liquidation at under or no value.
8. What about Covid Loans?
Today, there is an enormous James Webb sized telescope on Directors who have misused the Government’s financial support post-Covid, particularly CBILs and Bounce Back Loans. This is a big area and needs case specific advice. The short version is that this funding was supposed to fund ongoing company trading and not to support the directors personally. All too often, the latter has been the case.
9. I can simply Phoenix my Company, can’t I?
A temptation for small companies, where the directors have embarked on an informal self-liquidation, with both eyes on a new company rising from the ashes – the infamous Phoenix – is that they’ve made sure all mission critical suppliers are fully paid (because their goodwill is required for the new company), leaving a couple of very larger creditors including the tax man high and dry. Sorry, think again. This will be majorly wrong on many levels with serious consequences.
Some points for directors to consider when the company is insolvent or likely to become so
Fiduciary duty. A complex area ordinarily in company law and here too. Essentially, when a company is insolvent, the tables are turned and now the directors’ general duty is to creditors not shareholders.
This means there’s a microscope on directors to make sure that on the cusp of formal insolvency, and possibly for some time prior to that, they conducted themselves with creditors’ interests to mind. So, against human nature, the fire-fighting director now has to operate in the interests of the creditors. From now it is a full on Hitchcockian nightmare about who can be paid and why (is it in the interest of creditors?), how much, will I increase liabilities if I carry on, and shall I chase that elusive big deal because that will sort everything?
With classic wrongful trading scenarios, a Liquidator mounts a claim against a director (actually all of a company’s directors) and that claim could be for that additional debt incurred, from the date (subjective but not too difficult) when the company should have been wound up but continued to trade incurring further debt.
Against this, clearly, there will be focus on what, if anything, did the directors do to remedy the situation faced with insolvency. For example, were fixed costs, like salaries, reduced and were dividends ceased?
Don’t forget that even if an insolvent company had no assets and a Liquidator has no fighting fund, it will not stop a claim against directors being launched, particularly as these days there’s a wide range of litigation funders. Also, lawyers who are experts in this area are often retained in a no fee no recovery basis.
Where a Liquidator armed with lawyers thinks that the directors are worth ‘powder and shot,’ a claim is probable.
So, you are faced with an insolvent company, what can you do, what are the options for directors?
For companies, there are three options:
Administration
The Administration procedure, first introduced in the Insolvency Act 1986 and subsequently revised by the Enterprise Act 2002, is designed to hold a business together while plans are formed either to put in place a financial restructuring to rescue the company, or to sell the business and assets to produce a better result for creditors than a liquidation.
Who appoints an Administrator?
A company can go into Administration in a number of ways. The company, directors, or one or more secured or unsecured creditors, can make an application to the court for an Administration. The majority though are a result of the company’s own application.
Generally, Administrations apply to larger businesses, at least where there is discernibly a business that can exist cohesively and can be salvaged and potentially sold for the benefit of creditors.
What happens after the appointment of Administrators?
The Administrators, who will be insolvency practitioners, take over the day-to-day control and management of the company.
What happens to the Company at the end of an Administration?
The Administrator is able to have the Company dissolved if all assets worth realisation have been realised and distributed to creditors. An Administrator needs the consent of the Court to make a distribution to unsecured creditors. Otherwise, the exit route from Administration is for the company to go into Company Voluntary Arrangement (CVA) (or scheme of arrangement) or a Creditors’ Voluntary Liquidation (CVL) or Compulsory Liquidation.
The result of a successful CVA is the rescue of the company with control being handed back to the directors. The end result of a CVL, compulsory liquidation or unsuccessful CVA is that the company is dissolved.
CVAs – What is a Company Voluntary Arrangement?
A CVA is effectively a ‘deal’ between a company and its creditors for repaying in full, or in part, the liabilities of that company. It is a formal insolvency procedure.
The offer of a deal requires the approval of 75% of creditors present and voting at a meeting summoned to approve the proposals. Secured creditors are not bound by the CVA unless they have expressly agreed to the arrangement.
A CVA is typically offered by companies which are challenged but which have a sound underlying business. Once a CVA has been approved, creditors are unable to take any alternative action to recover their debt in full. It is also binding on creditors who rejected the proposals.
When is a CVA used?
A CVA can be used in a number of situations, namely:
a) To rescue a company as a going concern
b) To effect an orderly wind-down of a company (without the company first being put into liquidation)
c) Following on from an Administration
The directors of the company, a Liquidator or an Administrator of a company may all propose a CVA.
We have supervised many successful CVAs. Take a look at some of them.
Why do CVAs sometimes fail?
When a CVA fails, it usually does so because:
- Directors are not incentivised. They realise they’ll need to carry on trading for a lengthy period, possibly up to 5 years, with probably no benefit to them, simply paying back to creditors.
- Suppliers are unlikely to extend trade credit to the company post-approval of the CVA. So, pro forma trading or money up-front isn’t viable for most businesses particularly if trading with limited overdraft facility.
CVLs – Who appoints Liquidators?
In a Creditors’ Voluntary Liquidation (CVL) the shareholders (referred to as the members) pass a shareholders’ resolution (75% majority required) to wind up the company and appoint a Liquidator who must be a licensed insolvency practitioner. The creditors than meet and either confirm the Liquidator’s appointment or appoint another one of their choosing. Voting is by a majority (by value) of creditors.
- Powers of a Liquidator
A Liquidator has wide ranging powers, exercising those effectively whilst standing in the shoes of former directors but with the benefit of hindsight in dealing with the conduct of directors and investigating prior transactions.
- Main role of a Liquidator
The Liquidator’s main role is to realise company assets and distribute those funds to creditors. Whilst doing this, there will be a statutory requirement to carry out investigations into director conduct and scrutinise historical transactions.
- Main problems directors face when a Liquidator is appointed
So, often, directors complain to their advisors that a Liquidator “chosen” by them has turned nasty. Why? Simply, there are some common reasons:
1) There is an overdrawn director’s loan account, meaning directors owe money to the company. They are, therefore, debtors and the Liquidator is required to call it in and, usually, negotiate a settlement.
2) Illegal dividends. This means that shareholders (usually the directors) were paid dividends not from distributable profits but essentially when the company was making losses and probably on a cash flow basis was insolvent. The common complaint against the director will be that they were paid to the detriment of other, external creditors. The directors, therefore, made preferred payments to themselves.
In these cases, a Liquidator may seek to recover these dividend payments from the directors.
As always, however, the claim by a Liquidator may not be a slam dunk. It is possible to promote arguments as to why such dividends are legal.
Liquidation. Could this be the beginning, or the beginning of the end?
On the contrary, it is often a new beginning. Often, an insolvent liquidation is the only step that directors can take when there simply is no other option. Indeed, by not taking decisive action, directors may become personally liable.
Providing the directors have conducted themselves properly, have not wrongfully or fraudulently traded the company, have not paid associated companies or themselves (instead of third-party creditors), not siphoned off company assets and not paid for them, have paid almost everyone except the tax man and so on, a liquidation does not mean that directors will be automatically disqualified.
In a large number of cases, in small to medium CVLs, the directors end up buying the business, including trading name, websites, tangible assets and customer base from the Liquidator. This is commonplace; however, the directors need to show that they have bought “substantially all the assets” from the Liquidator, paid for it, at market valuation, evidenced by an invoice, and to comply with “Phoenix” provisions under S216 of the Insolvency Act, and obtained their necessary clearance, usually relatively cheaply with a lawyer familiar with the process.
This is a potentially complex area and professional advice must be sought.
The punchline, finally…..
Being a director can be hazardous for your health. As soon as you enter choppy waters, it is crucially important the right steps are taken. We are here to help you navigate those waters, so you arrive at the shore safely. Take a look at some of our testimonials.
(*Please note, this is not legal advice and if you want to know more, please get in contact with us.)
