Companies with financial problems face a number of difficult decisions about the best course of action to take. A company stands a better chance of recovery if it recognises its financial problems at an early stage and takes appropriate measures to resolve them before creditors take matters into their own hands. If a company enters into a particular insolvency procedure, directors also become a subject of specific duties. In this article, I will focus on what a director’s responsibilities are in relation to corporate insolvency. I will then outline a number of informal solutions to prevent insolvency as well as some of the formal insolvency procedures.
Can directors be personally liable on company insolvency?
A company which finds itself in financial difficulty will have a number of options. The course of action which is undertaken will depend on how serious its financial difficulties are, how co-operative its creditors are and what it actually aims to achieve.
Company’s directors are a subject of specific duties and their main responsibility is to minimise potential loss to the company’s creditors in the event of insolvency. Once the company is of ‘doubtful solvency’, their priority is to put creditors’ interests first. As well as the various solutions to the company’s financial problems, the principal issues that directors should consider are as follows:
• Should the company cease trading?
• Have the directors’ actions given rise to any criminal liabilities?
• Have the directors’ actions contributed to the company’s assets or any of its debts?
• What are the company’s obligations towards its employees?
• Should any of the directors resign?
Directors must remember that they are personally liable for their conduct. If they don’t take the appropriate actions to prevent corporate insolvency, they may be disqualified. They can also be found liable for the offences of wrongful/ fraudulent trading or misfeasance (e.g. the misapplication of the company’s money).
Directors will usually find that their conduct is scrutinised prior to the insolvency. This is because taking action against the directors for breach of duty (i.e. if they have not acted in the best interest of the company) is a good way to increase the company’s assets for distribution to the creditors. Therefore, it is advisable for directors to keep record of all commercial decisions (e.g. board minutes) in order to prove that all relevant interests have been considered appropriately and all relevant issues have been discussed.
What are the informal solutions to prevent insolvency?
Before considering the formal insolvency procedures, a company should look at potential informal solutions such as:
• Making the business more efficient
• Selling off part or all of the business
• Obtaining further funding
• Coming to an informal agreement with creditors
• Ceasing to trade
It is possible to make a business more profitable by putting more efficient management procedures in place or by closing certain parts of the business down. If the company has more serious financial difficulties, however, it may need to sell part of its business/assets in order to pay off its debts. For example, if a particular division of the business is unprofitable, it could be closed down and its assets sold off.
If the business is generally profitable, but is currently suffering from a temporary cash flow problem, the company may obtain additional funding. The most common way in which companies obtain new finance is through debt with the lender often requiring some form of security for repayment. There is a whole range of types of security – from direct security over assets to third party guarantees. Another common type of financing is through offering an issue of new shares to an investor in return for monetary value, which is known as ‘equity finance’.
In some cases, a company that has enough assets to cover all of its liabilities may cease to trade and pay its debts itself. Once the creditors have been paid off, any surplus may be distributed among the shareholders. When the company has no assets left, it can then apply to be struck off. An informal winding up is a viable option only when the company’s assets exceed its liabilities. Otherwise, a formal liquidation will be required.
What are the formal insolvency procedures?
There are four main insolvency procedures – liquidation, administration, receivership and voluntary arrangements.
• Liquidation is a procedure in which the company’s assets are sold off and the proceeds are thus used to pay off its creditors. Any surplus funds will be paid to its shareholders. Eventually the company will be dissolved and will cease to exist. Liquidation is used when the company is in serious financial difficulties and has no other options to cover its debts. Liquidation, especially compulsory one, is highly regulated and aims to deal with all creditors fairly. Nonetheless, it is very unlikely that any of them will be paid in full.
• Administration’s aim is to rescue the business from its financial troubles. It is thus focused on companies, which have good prospect of trading successfully once the administration is over. Generally speaking, the administrator takes over the company’s business for a particular period of time, taking the necessary actions to achieve the purpose of the administration. The process is highly regulated and usually more cost effective than liquidation.
• Receivership is a method in which a receiver is appointed to take control of the secured assets and realise them in order to discharge the secured debt. It is generally used when the company has defaulted on its repayments. This method differentiates itself from the others as the receivership is conducted for the benefit of the specific security holder rather than the company’s creditors. It can be extremely detrimental to the company, mainly because the receiver damages the company’s goodwill while realising its key assets and makes it difficult for the business to carry on trading afterwards.
• Voluntary arrangement is an agreement between the company and its creditors, where the creditors grant the company a period of time to repay its debts to the extent agreed. The aim is to save the business from its financial difficulties so that it can carry on trading afterwards. This is an option only if the business has good prospects of recovery.
It is important to know that in the event of a company facing financial difficulties, professional advice from an accountant, which we will be happy to provide, should be sought at an earliest opportunity.
If you have any questions or queries related to company insolvency or company formations in general, we are available for a live chat or you can leave a message on our Support & Contact web page and we will get back to you.