What are my duties as a director, and do these duties change in a time of economic crisis?
Company directors are subject to a wide range of statutory and common law duties. A key duty is the duty to promote the success of the company for the benefit of its members (section 172 Companies Act 2006). In fulfilling this duty, a director must have regard to a number of factors which reflect expectations of reasonable business behaviour. One of these is the likely consequences of any decision in the long term; others include the interests of employees and the need to foster business relationships with suppliers, customers and others.
In these unsettling times, many companies find themselves facing a sudden total or partial collapse in demand and/or inability to trade. Governments across the world have hurried to announce unprecedented business support to try and prevent businesses experiencing a cash flow crisis. However, for some companies this may not be enough and the impact of the crisis may be such as to threaten the solvency of the company. The duty to promote the success of the company is not generally owed directly to creditors of the company. Importantly, however, when directors know or ought to know that their company is or is likely to become insolvent, the focus of their duties shifts and they must then consider or act in the interests of the company's creditors.
What are the implications of the strain on cash flow that my company is experiencing?
If the company is unable to meet creditor demands, whether from employees, landlords, suppliers or HMRC, as they fall due, the company may be 'insolvent' on a cash flow basis.
If my company is 'insolvent' on this basis should it cease operations?
As noted above, when the company is in this situation, the director's overriding duty is to act in the best interests of the creditors as a whole. However, immediate cessation of business may be extremely damaging to creditors. Instead, the directors should seek advice on planning and implementing a turnaround strategy, whilst constantly asking and assessing whether there is a reasonable prospect of the company avoiding administration or liquidation.
What exactly is wrongful trading?
Wrongful trading happens when a director keeps on trading when they know the business is unable to pay its debts. It is a civil offence under the Insolvency Act 1986 and the Companies Act 2006. The tests are that the company continues to trade when:
- the director knew, or ought to have concluded, that there was no reasonable prospect of the company avoiding insolvent liquidation; and
- they did not take every step they could to minimise the potential loss to the company's creditors.
Do I face potential personal liability as a director in this situation?
As noted above, the director of a company will be liable for wrongful trading, and will thus expose themselves to liability for the company's debts, if the company goes into insolvent liquidation and the director either knew or ought to have concluded that there was no reasonable prospect of the company avoiding administration or liquidation. In the light of the pandemic, a new measure was enacted to protect directors of companies who pay staff and suppliers even if there are fears that the company may become insolvent. Under this new measure, the wrongful trading provisions were temporarily suspended. However, the suspension ends on 30 September 2020 and is not being extended. It will therefore be more important than ever for directors to take the steps set out below.
What steps can I take to protect my position?
The directors will need to take appropriate steps both to protect the position of the company and to minimise the potential loss to its creditors so as to reduce the risk of incurring liability for wrongful trading. Steps which the directors ought generally to be considering include:
- convening regular board meetings to review the position of the company (taking full advantage of any ability under the company's articles to hold such meetings by electronic means)
- making appropriate enquiries of the management team
- making sure the directors are regularly getting full and up-to-date details of the company's trading and financial position
- taking appropriate advice – legal, financial and insolvency
- exploring whether debt financing is available to ease cash-flow problems
- talking to the company's creditors, to understand their commercial position and seek whether each can 'share some pain'
- keeping up-to-date with the all the business support being offered by the Government and considering whether the company can use it, including any time-to-pay arrangements offered by HMRC.
The strategy for directors could be summarised as:
- Act fairly as between all business stakeholders, act honestly and in the best interests of creditors; and
- Plan and implement a strategic course of action that will deal with creditors, making the situation better not worse.
Can my business maximise cash collection or limit payments out by setting off debts owed to the business?
The ability to set off debts and potential claims against one another will be pertinent to the challenges facing businesses. Where both parties claim that sums are due to them by the other, a form of set-off would seem a logical approach and will be attractive to the party facing the larger claim. However, the availability of set-off is dependent upon the way in which the debts have arisen and what has been agreed between the parties.
Broadly speaking the circumstances in which set off will be available are as follows:
- Where payments are due from both parties and the parties had agreed that instead of making separate payments, the party due to make the larger payment would pay the difference between the two amounts due. This is known as contractual set-off.
- Where the sums arise from the same transaction (or are very closely connected) and are either due and payable or, in the case of unliquidated damages, are a reasonable assessment of the loss made in good faith. This is known as equitable or transactional set-off.
- Where a claim and a counterclaim in a court action are both liquidated sums, or ascertainable with certainty, and are both due and payable at the commencement of the action. The two claims do not have to arise from the same transaction or closely connected transactions. This is known as legal set-off.
It is also possible, however, for the parties to a contract to exclude the right to set-off. Whether you are seeking to enforce your right to set-off or are faced with a party who is wishing to do so, it is important to review the terms agreed between you to check this point.
Has my business already taken all the relevant self-help steps available to maximise available cash flow and lessen the effect of a lack of liquidity?
If you haven't already done so, consider the following steps as a matter of urgency:
- If your business cannot be adjusted to the current short-term demands, consider postponing any conventional plans or projects for expansion acquisition or recruitment that contemplate enhanced expenditure.
- Consider negotiating with "establishment" creditors to "smooth out" spikes in expenditure like the payment of rent. Landlords may be amenable to varying the obligation to pay rent from a quarterly in advance basis to a basis that sees rent paid monthly in arrears. Some responsible landlords may even be amenable to a complete rental holiday.
- Consider negotiating extended credit terms with trade creditors. Be careful however to act fairly and honestly as between creditors. Preferring certain creditors over others may in some circumstances have adverse consequences on those creditors who are considered to have received preferential treatment.
- Consider confirming existing but underused credit facilities or applying for new credit facilities from banks, including where relevant the Covid-19 bailout loans being made available as part of the Government's package of financial support for business.
- Take full advantage of any other available elements of the Government's package of financial support measures. For full details see https://www.gov.uk/government/collections/financial-support-for-businesses-during-coronavirus-covid-19
This is a general summary of the position. For tailored advice on your company's situation, contact Gillian White (gillian.white@howardkennedy.com) or Vernon Dennis (vernon.dennis@howardkennedy.com) or your usual Howard Kennedy LLP contact.
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