A lot has come out in relation to dealing with the initial impact of COVID-19, the extensive measures which the Chancellor has announced, along with the expected future announcements to supplement the help businesses are receiving in order to continue to trade. Indeed the chancellor mentioned on 17 March that he did not want to see businesses to go bust, and we agree with this position!
However, a director retains duties both under the Companies Act and Insolvency Act when a business is insolvent. While Germany has deferred the obligation to file for protective insolvency proceedings and Spain appears to have followed suit, our regime is different. We do not have strict criteria determining the point at which a director must file for insolvency. Instead the Insolvency Act focuses on a change as to in who’s interests the directors should act in, the shareholders or the creditors, and imposes potential personal liability on the directors for breaches of the Insolvency Act or Companies Act if a company continues to trade while it is insolvent. However, assuming the directors do not commit such breaches then a company can continue to trade despite failing one of the tests for insolvency, if by doing so it is acting in the interests of its creditors.
Indeed the measures announced by the Chancellor, particularly a government backed £5m loan, are specifically designed to deal with businesses short term cash flow problems. The very nature of the crisis we are facing means that large swathes of UK Plc are cashflow insolvent. The aim of the measures announced is to maintain trading until the crisis is over and life returns back to normal.
While the rate relief, grants, SSP cover and loans may resolve the cashflow issue, the loan in particularly may well tip the balance sheet into a net liability position and render the company balance sheet insolvent.
So as an SME director what do I do?
Document, Document, Document!!
Why are you continuing to trade and why is it in the interests of creditors (assuming you are cashflow insolvent today)?
At the point of applying for the loan set out your assumptions for future trade, what will the loan allow you to achieve and why does it secure the medium to long term future of the business?
How will the business pay back the loan, what happens when interest payments become due in six months, what happens when the business rates relief comes to an end? Chances are you will doing multiple things while applying for the loan, adjusting capacity, negotiating with landlords, benefiting from the rates freeze, securing supply chains and assessing your route to market and customer viability. In documenting your decision to continue to trade you should factor in all these issues and any other which may affect your ability to trade out of the current crisis.
If you cannot see a future where you can trade ‘normally’ and generate sufficient profit to repay the loan then taking such a loan may not be acting in the interests of creditors. When in doubt get advice.
The chancellor said that he didn’t want business to go bust and neither do we. However, neither do we want to see hard working directors penalised in six months time for trying to survive but breaching their duties to creditors and being exposed to personal liability.
Going bust should also not be taken as short hand for entering into an insolvency process, which in the right circumstances can provide a positive solution to troubled times, whether in the form of debt relief as part of a CVA, obtaining the protection of the administration moratorium to trade, sell, or restructure the business, or simply to protect and realise assets in a liquidation which can be subsequently used to create value for the purchaser. Directors can be making the right call for the creditors by making the hard call for their business.
We are working on an ‘Options for distressed businesses during COVID – 19’ which will be available shortly. In the meantime please do not hesitate to contact one of the Corporate Restructuring partners or pick up the phone should you need advice.