Insolvency: Making the most of a bad situation

Tania Clench
- Leadership - Dec 20, 2019

A renewed light is being shone on the behaviour of company directors during insolvency situations and their actions are being scrutinised more than ever before. Tania Clench, Legal Director and insolvency specialist at law firm, Shakespeare Martineau, says that it’s now more important than ever for Board members to be clear about their duties, especially in the event of an insolvency. This includes ensuring bookkeeping is up-to-date, keeping up to speed with tax liabilities and seeking help quickly when things begin turning sour, instead of burying their heads in the sand.

Over the past 12 months, the UK has seen a raft of high-profile collapses, some of which have truly rocked the business world. In recent years, the sheer volume of high street casualties has forced the retail sector into the spotlight. However, whether from failure to adapt to increased demands or the pressure of high rental costs, businesses across the UK have been feeling the strain. 

According to the Office of National Statistics (ONS), the number of company administrations in Q3 2019 was the highest since Q1 2014. With insolvencies now so common, a renewed light is being shone on the behaviour of directors during these difficult situations and more than ever, their actions and decisions are being scrutinised. It is vital for Board members to be clear about their duties, especially when insolvency is looming.

In large corporate organisations, directors are often akin to ‘super employees’, in terms of their specialism and control over the business. They are more risk adverse and will often have the benefit of D&O cover. For mid-tier firms and SMEs, however, the role of a single director can be far more influential, extending to include shouldering the burden of maintaining the business’ reputation and financial prosperity. These directors are likely to take more personal risk and their concerns will differ from directors of PLCs, in that they will worry about personal liability arising from making bad business decisions (e.g. breach of directors’ duties), personal liability arising from the failure to pay creditors, the fear of letting people down, loss of income and damage to reputation. Not only do directors need to be keeping an eye on their area of expertise, they also need to have a keen awareness of the company’s financial situation.

From the outset, the company’s directors must understand that they have a duty to the company and an obligation to act in its best interests. Whilst it is acceptable for there to be a division and delegation of tasks for different aspects of a company’s management, directors still have inescapable personal responsibilities, including informing themselves of the company’s affairs and supervising these with their fellow directors. Furthermore, directors cannot passively allow others to manage their company while abrogating their personal responsibility and allowing their independent judgment to be compromised. Instead, directors must supervise the actions taken for their companies and form independent opinions as to whether the actions are in the best interests of the company. However, there are occasions when directors may reasonably defer to the views of their fellow directors or the company accountant, for example.

When a company is on the verge of insolvency, the director’s duty to promote the success of the company becomes a duty to act in the best interest of creditors as a whole. Where the directors know or ought to have known that the company could not avoid insolvent liquidation or administration, and they allow the company to continue to trade and/or incur losses, they risk personal liability for the company’s debts.

These duties are not diluted by virtue of an officer being ‘only’ a non-executive director – so NEDs – beware! A lack of awareness means they are not properly able to discharge their duties and will not provide them with any defence in any claim for breach of duty.

When an organisation goes into insolvency, it is the office holder’s (administrator or liquidator) job to investigate the affairs of the company, as well as the directors’ conduct. In any corporate insolvency there may be concerns regarding the way in which the business was conducted, how trading was controlled, whether proper decisions were made at the time, and whether assets have been sold at an under-value or otherwise dissipated.

An office holder may conclude that there are matters (for example, the conduct of management, prior transactions susceptible to challenge, or the consequences of possible criminal offences) that require early investigation, either as a matter of public policy or because there are real prospects of recoveries for the estate. It is for the office holder to decide whether investigation and subsequent legal action should proceed as quickly as possible; this could include disqualification or breach of duty claims. If these proceedings are taken and the director is found personally liable, this could mean the loss of their home.

In order to ensure that the position of director is taken seriously, there needs to be more awareness around the director’s role and the duties and responsibilities that flow from this. This can be achieved by increased training before taking up a position and whilst in post. By introducing a basic training programme for future directors and Board members, upcoming directors can be ‘trained’ and developed within their roles and learn to react at the earliest signs of trouble.

The age-old saying “desperate times call for desperate measures” is so commonplace that no one is quite sure about its origin, however, it can be applied to today’s business environment. When threatened with insolvency, directors may be tempted to use company money that is otherwise owed to the Crown for PAYE/NIC, etc, as working capital in a bid to help keep the business afloat. However, a short-term fix such as this can have dramatic repercussions and cause serious issues down the line. Individuals who are in leadership positions within a company must make sure they are not making financial decisions and bad choices out of desperation, in any case.

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For a greater level of management and security going forward, a high level of scrutiny is essential. For example, should a company dissolve and be left to fall off the company register, there is the facility to restore it to the register so that investigations can be made into where it all went wrong. Office holders require in-depth information from the Board, for example, the steps taken to minimise losses or preserve assets, meeting minutes, and documents in relation to the payment of creditors setting out the reasons for any such decisions. Directors should ensure that the books and records are complete and up-to-date and that they are broadly aware of the company’s financial position.

Whilst the rate of company insolvency shows no signs of slowing, there are steps Board members can take to mitigate the damage, should the business start to fail. Instead of burying their heads in the sand, company directors must adopt a proactive approach to successfully navigate the organisation through rough waters and come out the other side. No director should ever regret having taken advice early.

 

About Tania Clench

An experienced member of the restructuring, recovery and insolvency team at Shakespeare Martineau, Tania advises corporates and individuals in financial distress and provides innovative solutions, whether by way of litigation or via an out of court process. Tania’s wide client base extends to acting for insolvency practitioners, company directors and individuals, in both personal and corporate insolvency matters.

Tania has enviable expertise in the ‘director protection’ arena, having acted for DBIS in relation to disqualification proceedings for 10 years; she now acts for directors in a range of proceedings, as well as advising them on their duties.

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