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Breach of Corporate Governance puts FCA registered entity on the brink

The breakdown of corporate governance in any organisation can lead to significant problems, financially, operationally and structurally for the business going forward. Often such breaches are associated with financial loss, breach of regulation and loss of trust, both internally and externally. Once such a breach is discovered it is essential that the organisation implements a recovery plan to deal with the legacy issues caused by the breach, and to ensure that no such breach will occur in the future. Left unresolved, a known breakdown of corporate governance leaves directors open to criticism at best, and personal liability, or accusations of collusion at worst.

These issues were brought into particular focus when Mercer & Hole were approached by a director of an FCA regulated business, following the breakdown of a proposed takeover. Financial discrepancies uncovered during the due diligence process had arisen because of a lack of corporate governance.

The Company was an FCA registered entity with circa £100m assets under management. In addition the Company had advisory relationships with clients who had assets under management of several times that amount. As an FCA registered business, any financial discrepancy was under particularly intense scrutiny.

The director’s concerns were heightened when the Company’s auditors confirmed they were unable to sign off going concern accounts without further evidence as to the substance of several significant book debts, as well as identifying that several clients had been invoiced some six months in advance.

The director took the opportunity of his co-director’s absence from the business while on holiday to undertake some limited due diligence. The scale of the problem began to emerge with the Company facing significant cashflow challenges, as well as the auditors highlighting a possible breach of Capital Adequacy requirements. Immediate duress creditors included imminent payroll costs, the landlord, who was pressing for the vacation of the premises, and HM Revenue & Customs, which had intimated its intent to petition for the winding up of the Company. In addition to these issues, the Company’s ability to manage its cashflow was hampered by the advanced invoicing that had occurred.

To put it bluntly, the Company’s future looked bleak.

Mercer & Hole proposed an emergency restructuring plan which would give the Company the prospect of being able to manage itself out of the current predicament. This included managing regulatory concerns, creating cashflow forecasts and monitoring cashflow requirements, negotiating with duress creditors, proposing and helping to implement new governance structures and practices, and realising assets to allow the Company to trade out of its predicament. 

Thirteen week rolling cashflows were drawn up to assess the immediate short term funding requirements, which the director met by the repayment of his small loan account balance. This allowed the director to ensure all duress payments were made and provided the time to undertake a forensic accounting assignment to identify and set out all the issues the firm was facing, and to prepare a proposal to resolve them.

The forensic exercise identified that the other director, who was the Money Laundering Reporting Officer and compliance officer, had wrongly raised in the region of £500,000 of invoices and had overstated client receivables by a further £200,000. Reversing these items completely wiped out the net asset position previously shown on the balance sheet. The forensic work also established that the he owed the Company some £275,000, which needed to be repaid to allow the Company to continue to trade. 

The revised governance structure excluded the debtor director, whilst ensuring that a single party could no longer manipulate the Company’s processes. While it was clear that following a significant career in the City the debtor director was a man of substance and so would be able to repay to the debt due, he was reluctant to do so. He was similarly reluctant to give up his shares, having been close to achieving a lucrative takeover some months earlier. It was therefore necessary to set out clearly to him the financial and potential regulatory issues that had arisen since the collapse of the due diligence and the commercial reality of the situation facing the Company. Further, the Company issued a statutory demand for the repayment of the £275,000 debt, indicating an intention to pursue any non-payment with the issue of bankruptcy proceedings.  The result was repayment of the debt, initially by way of a 50% payment, and then, following a further statutory demand after a missed repayment deadline, the remaining balance.

The former compliance officer was removed from the Company, and the regulatory requirements were managed, with relevant disclosures made to the FCA and improved governance procedures established. The Company’s cashflow had been monitored to ensure that the creditor negotiations, with the landlord and HMRC in particular, avoided third party proceedings being commenced. The auditors were sufficiently satisfied with amended accounts to sign off a going concern opinion. Although the Company still faced a period of rebasing its balance sheet, and had to continue to manage its cashflow closely while the period of forward invoicing was brought back into line with normal trading terms, client assets remained under management, the profitable advisory relationships were maintained, and continued trading was achieved with the minimum of disruption.

The crisis management skills developed during a career of managing businesses in financial and operational distress, allowed Mercer & Hole’s restructuring team to develop and implement a multi-faceted approach to resolve the Company’s governance issues, which had caused financial and regulatory crisis, and nearly led to a cessation of operations.

Directors are urged to seek relevant professional advice wherever they have concerns as to the implementation of corporate governance, or suspected breaches thereof, which will often have a significant impact on the financial performance of their company. This is particularly important where such breaches may lead to the insolvency of the company, given the implications for potential personal liability of the directors in such circumstances.

If you would like us to provide you with any help, guidance or assistance contact the Restructuring & Insolvency team on 020 7236 2601.

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