Positive vibes, as we look ahead to our own business prospects after a possibly tough year, are a great feeling. They promote energy and, to a certain extent, can help fulfil our hopes of generating new revenue to lift our businesses out of the danger zone. If they are wildly unrealistic, however, and ignore pressing problems right under our noses, the same feelings might amount to delusion and even official scrutiny, should things ultimately go wrong.
The number of company insolvencies in November 2023 was 21% higher than the number in November 2022, reaching 2,466 registrations, according to the latest figures. Again, the hike was driven by Creditors’ Voluntary Liquidations (CVLs) – directors throwing in the towel while the decision was still theirs. Others will have left it far too late to act.
Recent cases of directors being sanctioned by the Insolvency Service have been mainly related to the abuse of Bounce Back Loans obtained for their businesses during the Covid pandemic. Beyond the BBL issue, the still relatively recent (October 2022) Supreme Court ruling in BTI v. Sequana on directors’ fiduciary duties in a looming insolvency provides a further sobering reminder. When a company is “insolvent or bordering on insolvency”, or an insolvent liquidation or administration is probable, the directors’ duty to act in good faith in the interests of the company should be understood as including the interests of its creditors as a whole (the creditor duty).
While a “real risk of insolvency” is not sufficient to trigger this duty – and in Sequana, the creditor duty was not engaged, because insolvency was not even probable at the relevant time – as a general principle, the greater the company’s financial difficulties, the more the directors should prioritise creditors’ interests. Where an insolvent liquidation or administration is inevitable, creditors’ interests become paramount as the shareholders cease to retain any valuable interest in the company.
In today’s difficult trading conditions, many companies will face issues with cash flow, higher costs of doing business, and lower demand. All of these, individually or together, are existential threats leaving a company only a step away from insolvency. The moment managers think their business might be facing ultimate collapse, expert advice must be urgently sought for the protection of the company, its creditors and directors.
The first tests are straightforward: balance sheet insolvency, where liabilities exceed assets; or cashflow insolvency, where liabilities, other debts and overheads cannot be met when they are due. Companies may fail one of both of these definitions. Directors have a legal duty not to take on additional credit or accept deposits for goods and services that are unlikely to be delivered. In other cases, the correct decision may be to cease trading immediately.
Unsurprisingly, the regulations around insolvency are complex. Where there is a possibility to trade while technically insolvent, the decision should be taken by a licensed Insolvency Practitioner formally engaged by the company, not by the directors themselves. ‘Wrongful trading’ may leave directors personally liable for company debts, with the additional risk of disqualification for two to fifteen years. “Fraudulent trading” moves the misery to the next level, adding a criminal element to civil action if a clear intention to defraud creditors is determined.
Government investigators and appointed Liquidators will pick apart a company’s financial record in the run-up to insolvency, so stricken directors – even the most optimistic – must pull their heads out of the sand before it’s too late: look for the warning signs in current trading; keep close tabs on the company’s financial position; avoid large transactions at questionable valuations; and, most important, seek early professional advice on insolvency.
Written by Runita Kholia, Senior Analyst at Buchler Phillips, a UK based independent boutique firm with an impeccable Mayfair heritage, specialising in corporate recovery, turnaround, restructuring and insolvency.