Dealing with business failure can be traumatic, but it’s important to be aware of the key issues and to make objective decisions.
Most responsible directors of companies will recognise the warning signs when a business begins to struggle. When the pressure is on, cash is the most important commodity and close monitoring and forecasting of the cash position is critical.
As a director of a limited company you need to be sure that you are not carrying on trading when the company is insolvent. Two tests need to be applied:
• do the company’s assets exceed its liabilities, and
• can the company pay its creditors as debts fall due?
If the answer is no, then it is probably time to stop trading. To fail to do so could result in a director incurring personal liabilities for the company’s debts. If there are good reasons to believe that the company will come through a rough patch, then there may be a justification for carrying on. If so, it is very helpful to clearly document the thought process and to show that expert professional advice has been sought. These actions will help demonstrate that a reasonable decision was made by a prudent director having regard to all the circumstances.
Care also needs to be taken in how creditors are managed prior to a potential business failure. Any attempt to “prefer” certain creditors over others (especially if they are parties connected to the company or its directors) may well be challenged in any insolvency. That being said, there may be justifiable reasons to pay down certain debts in the interests of the creditors as a whole.
The important thing to remember is that the relevant law is designed to be helpful in case of genuine business failures, but there are penalties where there is fraud or recklessness.
Bringing in a solicitor
Once it is clear that a business can’t carry on, there should be an urgent review with a solicitor or insolvency practitioner to agree the way forward. There may be a way of quite legitimately continuing the business in a new company and discontinuing activity in the original company. Where there are strong underlying revenues, but the original company has major debt/overhead issues this could be a good solution. The nature and size of the company’s creditors will be important factors in deciding what is possible. This would be the case if a Company Voluntary Arrangement (CVA) was proposed, where a majority of creditors would have to agree to accept an offer of so many pence in the pound over the CVA period. Once this is paid off the company can come out of CVA and continue trading.
There are also practical issues to consider if the business is to continue trading in a new entity or through a CVA. Can customers, suppliers, key employees, landlords, banks and other stakeholders be kept sufficiently onside to give the business a chance to bounce back? Communication with all these stakeholders is important, even if it is not easy in the circumstances.
Once the decision is taken to formally wind up a company, the prospective liquidator will convene a creditors’ meeting. He will also ask all creditors to “prove” in the liquidation, that is confirm how much they are owed. When it comes to confirming the appointment of the liquidator this is done on a vote of creditors with reference to how much they are owed. The biggest creditors will therefore have the biggest say. This can be helpful as the directors themselves may be the biggest creditors.
Once appointed the liquidator will then collect in any monies owing and seek to realise the assets of the company for the best price possible. After deducting the expenses of the liquidation a pro rata distribution of the balance (if any) will be made to creditors.
As mentioned at the beginning of this article, the process can be very traumatic, but if the right decisions are made and professional advice is sought early on damage can be minimised and opportunities preserved.