As lockdown is once again gradually eased for what will hopefully be the last time, businesses must look to the future and important decisions will have to be made about the size and shape of the business going forward.
Many businesses will face the challenge of generating sufficient turnover to fund ongoing trading in addition to repaying government-backed loans and accrued rent arrears. Forecasting turnover will be extremely challenging when it remains uncertain whether customer confidence will return in the retail and hospitality sectors, working habits will have changed leading to reduced footfall in city centres and many businesses are also still grappling with the effects of Brexit.
Undoubtedly there will be many instances where such things as the inclusion of government-backed loans and rental arrears on the balance sheet will have rendered companies insolvent and in these circumstances directors must be mindful of their duties to creditors. Where a company is, or is likely to become, insolvent directors owe a primary duty to act in the best interests of creditors. Should directors fail in that duty, and where the business is ultimately placed into a formal insolvency process, directors could face personal liability.
The government introduced a raft of measures over a year ago to protect businesses from the immediate effects of the pandemic, including restrictions on forfeiture of leases, commercial rent arrears recovery, winding up petitions and of course the furlough scheme. These measures have been extremely successful in preventing businesses being forced into formal insolvency processes. Although the furlough scheme has been extended until 30 September 2021, the other measures are due to come to an end on 30 June 2021 and it is therefore vital that businesses plan now for what this will mean financially and directors ensure that they are not putting themselves at risk of personal liability.
Directors can be found liable for wrongful trading if a company continues to trade after a point at which the directors should have known that the company could not avoid insolvent liquidation and in doing so additional losses are incurred by creditors. Temporary changes were made to the relevant legislation last year (and subsequently extended) which meant that no director could be found liable for wrongful trading as a result of decisions taken between 1 March 2020 and 30 June 2021. However, with the removal of the temporary restrictions on that date, very careful forecasting is now essential to ensure that liability does not accrue as a result of a business trading beyond that date.
We also consider that if some form of restructuring process is going to be required in order for an otherwise viable business to prosper as the lockdown is eased, it would be prudent for that to take place before the restrictions on such things as forfeiture of leases and winding up petitions are lifted.
It is also important to emphasise that, apart from the temporary suspension of wrongful trading liability, throughout the pandemic none of the temporary legislation has removed or diminished any other directors’ duties. These include a duty to promote the success of the company, a duty to exercise independent judgment, a duty to exercise reasonable skill, care and diligence and a duty to avoid conflicts of interest. When a company enters a formal insolvency process, the insolvency office holder has a duty to scrutinise the conduct of the directors in the period leading up to the commencement of insolvency and therefore decisions taken now as businesses start to reopen are likely to be examined closely in the event of a subsequent formal insolvency.
What can businesses do to mitigate the risk of failure?
The following is a non-exhaustive list of steps businesses can take to mitigate the risk of a business failure and potential personal liability for directors.
- Create a business plan and a cashflow forecast. These documents should be reviewed and updated frequently as they may need to be relied upon in support of decisions taken to continue trading.
- Hold regular board meetings, carefully document all decisions and the reasoning behind them and make a note of any dissent.
- Where rent has not been paid during lockdown, negotiate with the landlord regarding the timing and payment of any arrears and future rent. Consider the pros and cons of a further deferral of rent leading to a debt on the balance sheet, versus the cashflow implications of monthly/quarterly payments. Consider asking the landlord to apply the rent deposit against any arrears without seeking a top up. Remember, the landlord is unlikely to want the premises back at this point.
- Consider carefully future staffing requirements. Realistically the business is likely to have a reduced turnover and may not require all its existing staff so the sooner redundancy consultation begins the sooner the business can move forward in a slimmed down form.
- Cash is king so all outgoings should be minimised and contracts with suppliers and customers should be reviewed. Customer payment terms should be shortened and strictly adhered to. Consider extending supplier payment terms but in doing so be careful not to incur debt that the business cannot subsequently discharge.
- Avoid using accrued crown debt as working capital. Whilst HMRC have temporarily deferred payment of VAT and extended “time to pay” arrangements, this position will not last forever.
- If at any point you have reason to believe that the company is insolvent on a cashflow or balance sheet basis, seek advice from an insolvency professional at the earliest opportunity. Taking and acting upon such advice will assist in deflecting any accusation that you failed to act in the interests of the company’s creditors.
What restructuring processes are available if needed?
If it appears unlikely that the business will be able to continue it may be possible to put together a restructuring plan or a company voluntary arrangement (CVA) if, but for accrued debt, the business, or part of it, is thought to be viable. The Corporate Insolvency and Governance Act 2020 has introduced a new Moratorium process for businesses in this position. This provides an initial breathing space of 20 days (which can be extended) during which no enforcement action can be taken against the company whilst it explores a range of rescue options.
The Association of Business Recovery Professionals has published a precedent CVA proposal for use by businesses affected by the pandemic which includes a breathing space to allow a business to restructure without fear of creditor action, a further introductory period during which no contributions need be made if the company has not resumed trading, and the ability to suspend contributions in the event of another lockdown.
Administration is another option and also has the effect of putting in place a moratorium. The moratorium prevents any creditor enforcing its rights during the course of the administration and the administrator then seeks to achieve one of three prescribed statutory purposes. These are:
- Rescuing the company as a going concern;
- Achieving a better result for creditors as a whole than would be likely in a liquidation; and
- Realising property in order to make a distribution to one or more secured or preferential creditors.
Unlike liquidation which results in an immediate cessation of trade, an administrator will sometimes continue to trade the company whilst he seeks to achieve one of the above purposes.
There are therefore a range of options available to businesses that have suffered financially as a result of the pandemic and, therefore, to avoid criticism and potential personal liability it is essential that directors take the steps identified above and both seek and act upon professional advice.