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COVID-19 and insolvency FAQs

This page contains frequently asked questions we have received regarding insolvency as a result of COVID-19

My company placed me on furlough leave and I agreed to receive wages whilst furloughed at the reduced level guaranteed by the government. However, now they have entered a formal insolvency process and I have been made redundant. How will my redundancy pay be calculated and how do I get paid?

Owing to your employer company’s insolvency, you will need to complete an RP1 form following the appointment of an Insolvency Practitioner as administrator or liquidator, in order to claim for redundancy from the Redundancy Payments Office (‘RPO’). Redundancy payments are generally only available if you are a qualifying employee with over two years’ service with your employer.

On 30 July 2020 the government announced that furloughed employees will be entitled to receive redundancy payments at their normal rate of pay, rather than the reduced furloughed rate (if applicable). These new regulations came into force with immediate effect on 31 July 2020; any redundancy claims made prior to this date will unfortunately not be covered by these new rules, although for earlier claims which have not yet been processed, it is still in principle arguable that the full rate should be applied.

The appointed Insolvency Practitioner (IP) or their staff will also assist you in calculating any claims you may have in respect of unpaid wages, outstanding holiday pay, and pay in lieu of notice. You will receive the statutory minima of each of these claims in addition to your statutory redundancy pay – calculated using your weekly pay figure (currently capped at £538 per week), length of service and age – directly from the RPO. We know of several IPs who have assisted staff to process applications based on the normal rate notwithstanding that their actual wages were reduced prior to insolvency due to furlough arrangements, even before the regulations were changed to confirm this.

Any sum you are owed over and above these statutory minima will be a claim in the liquidation or administration. Unpaid wages and outstanding holiday pay will be classified as an ordinary preferential claim, and redundancy and pay in lieu of notice will be an unsecured claim. Depending on whether there are any realisations during the course of the administration or liquidation, you may also receive a dividend payment in due course.

Can my company defer payment of VAT to HMRC during the crisis? What are the consequences of doing so?

Yes, as at 31 March 2020 the government had applied a deferral for VAT payments from 20 March 2020 until 30 June 2020. All UK businesses are eligible, as are non-established businesses registered for VAT in the UK. This will generally mean the deferral of one quarter’s VAT, so the payment due on 7 April, May or June 2020 or the monthly payments due on each of these dates. Payments on account that were due to be paid on 31 March, 30 April, 31 May and 30 June can be deferred. Businesses wishing to avail themselves of this deferral will need to cancel their direct debits and diarise to reinstate their direct debit mandate once the deferral is over. Taxpayers have until 31 March 2021 to pay any liabilities that accumulate during the deferral period and will need to make arrangements to pay the accumulated VAT. VAT refunds and reclaims will be paid by HMRC as normal and businesses should continue to file their VAT returns by the due date.

The second part of this enquiry is, in part, also an insolvency law question. We are hearing from our contacts amongst qualified insolvency practitioner clients that many businesses who could have chosen to defer accounting for tax when offered this concession by government instead chose not to. The reasons given are varied, but one recurring one seems to be that none of us know quite what additional, or perhaps short term, pressures may have hit our business cash flow at the end of any given deferral period. If we know we have to clear a much heftier tax bill than we are used to at that time it risks at the very least suggesting to funders and potential investors down the line that there was a cash flow problem and/or that the point at which the tax then catches up is a regular seasonal pinch point. In a distressed scenario, whilst the law against ‘wrongful trading’ is shortly to be suspended with (retrospective) effect from 1 March 2020, this is only relevant for those companies who should have known they could not avoid insolvent liquidation. For the vast majority of companies nowhere near that point, the concern will be that the decision they take may not be in the best interests of the company and its stakeholders (shareholders, investors, creditors). Such decisions are actually much more likely to lead to a risk of personal liabilities for directors than wrongful trading is.

The mistake that is often made when people defer tax is that they fail to adequately provide for the liability they know is coming, and in an insolvency setting an office holder may then ask why those funds were not paid or carefully ring-fenced, particularly if directors drew anything from the company during the same period other than their PAYE salary. If you are going to draw a ring around such funds so you cannot on the face of it dip into them for general trading, would it not simply be better to pay the tax and get on with the next quarter? Of course, the answer to that will vary depending on the circumstances of the business, but if in doubt about what you should do at any given point, we would strongly recommend that you consult with your accountants and ask for assistance with your cash flow analysis and create a clear paper trail to show you have taken bespoke, professional advice and furnished the professional with the information they need to advise. Many insolvency practitioner accountants (whose services you might not think of going to first if you are not even contemplating insolvency) are offering assistance with cash flow projection work to support strategic management decisions, including new loan applications, by adding the credibility of their experience.

Some of our business suppliers are threatening to sue us for non-payment of invoices or to issue a winding up petition. We accept we will probably have to pay but we don’t yet know if we will have the funds to cover all invoices currently due, or which will become due. What should we do?

The starting point is that getting involved in litigation and/or having to work your way out from under a winding up petition – no matter how ill conceived – is expensive and dangerous for any business. At the current time it sounds like your business can ill afford to be taking on additional cost and risk. The absolute worst thing you can do in these circumstances, therefore, is bury your head in the sand and hope these threats will go away. Contrary to some reports, the courts are working (remotely obviously), and winding up petitions are still currently being issued (even if not by HMRC for the moment) and heard (generally by Skype).

If there is any doubt in your mind as to whether the invoice has been properly raised, accords with the terms of your contract, or whether you have a valid counter claim which could extinguish the invoice, we would suggest in the first instance that you acknowledge the invoice / chaser for payment but say you are taking legal advice and will revert to them further within a suitable, short timescale (not less than 5 business days but probably no more than 28 days in total). It may be possible to reference one or more evolving government initiatives or a relevant moratorium on creditor action depending on when this is happening, but if you are taking legal advice you may choose to leave that aspect to your solicitors. You should definitely avoid the temptation to admit the underlying debt as this will almost never improve the position for your business; such concessions are more usefully made in connection with agreeing a structured payment plan but it very much depends on the circumstances. Do not assume either that just because you head your emails ‘without prejudice’ this cannot be taken as a valid admission. Of course, having said you will be taking legal advice, you must then be true to your word and do so, promptly. Seeking advice from solicitors (remotely of course) need not be an unduly expensive affair, particularly if you are able to pull all your relevant documents together first and can present them to the solicitor with a coherent, narrative story by reference to relevant dates. Of course if cash really is tight you will need to ask your solicitors for a budget, based on what you have shown them and you will need to make provision in your accounts for that budget or to pay that sum to your solicitors on account of their advice, so the funds are clearly ring-fenced for that purpose. This will avoid potentially hidden exposure in due course for the board; such expenditure is entirely justified and will not be regarded as an unlawful preference or transaction at an undervalue.

If, however, you are absolutely certain a debt is payable and that there is no prospect of a counterclaim which would even come close to wiping out that debt, we would suggest you open a different form of dialogue along the lines that you are working on your cash flow projections and hope to revert to them shortly when you have been able to schedule the required payment or payments. You should then – before offering payment terms – be speaking with your own accountants and, preferably, a suitable qualified insolvency practitioner accountant (to whom your accountants and/or your solicitors should be able to introduce you, or you could visit resources such as the R3 website, which has a searchable list of members). Objectively speaking this is generally the responsible thing to do. In normal circumstances, it is tempting to pay the creditors who shout loudest first, or whose ongoing supplies are most essential to your business, and the law does recognise genuine commercial pressure as a justification for doing so. However, these are not normal times and if the company does need to enter into an insolvency procedure in the future (even if the cause of that is not even on your radar at the moment), you can expect to be asked why you chose to put that particular creditor ahead of others. If you were influenced in so doing by a ‘desire to prefer’ that creditor in the event of a future insolvent liquidation (especially if one or more of your directors have personally guaranteed that debt) you may find that other, unpaid creditors – including HMRC – are aggrieved by that decision and the whole board can expect to be placed under scrutiny for that decision, even if it was within the delegated authority of one director. Taking early, professional advice is anything but an admission of defeat; it is a way of maximising the company’s options in a way which is likely not only to avoid a much worse state of affairs, but which will also afford much better legal protection for your directors, in the event that insolvency follows, despite everyone’s best efforts.

Under the Corporate Insolvency and Governance Act 2020, there is a general prohibition (subject to exceptions) on winding up petitions based on the non-payment of invoices due to financial difficulties caused directly by COVID19, currently until 30 September 2020. Each threat of petition should be looked at closely on its merits and you should seek legal advice as soon as possible if you receive a winding up petition. You should not simply assume you are safe from the possibility of a winding up petition, but likewise you should not threaten such action if the action itself would likely be unlawful.

Part of our company’s business has been (temporarily we hope) wiped out by COVID-19 restrictions, whilst other product and/or service lines are actually doing much better as a result of key worker contracts, online order fulfilment, etc. What we would like to do is move the profitable business to a new company, hire more staff there and look at insolvency or mothballing options for the existing company. Can we?

In principle yes, but this is something which would have to be undertaken with the utmost care, and only following early input from a qualified insolvency practitioner accountant (to whom your accountants and/or solicitors should be able to introduce you). Just as the financial crisis in 2008-9 had a very long, very flat insolvency curve due to heavy government intervention, we do not expect to see a huge number of formal insolvencies in the short term, but we do expect them to come as government support is relaxed in due course. We can therefore expect everything we are doing now, no matter how well intentioned to preserve essential services and retain employment prospects which can be retained, to come under a level of scrutiny in the not too distant future. The suspension of the ‘wrongful trading’ provisions, which applies retrospectively from 1 March to 30 September under the new Corporate Insolvency and Governance Act 2020, does not mean that you are completely protected in whatever you choose to do – you still owe your duties to the company and its creditors under the existing directors’ duties. 

The proposed relaxation of ‘wrongful trading’ laws offer no tangible protection in this context. Clearly your experience will not be unique, but it will be unusual to the economic circumstances of today. Generally businesses with multiple divisions will have more time to see a drop off in one aspect of the business coming, and to react accordingly to scale back that aspect or to restructure the business generally so as to separate the functions. If this has to be done on an accelerated basis, for example to make best use of government backed funding and support which is only available for a short period and/or to address creditor pressure (eg. CBILS or bounce back loans), the same considerations apply but must be implemented much more urgently.

First and foremost, the board of the existing business need to give serious thought to (and to be seen to be giving serious thought to) its overall viability. With the current boost in other aspects of the business and by accessing available sources of funding and creditor deferral, might the existing company be able to weather the storm and discharge all creditors in full, or at agreed, reduced levels over time? If so, would that be in the best interests of its current creditors (remembering that if a company is actually or prospectively insolvent, its directors’ duties transfer from shareholders to creditors)? Read our blog on directors duties for more information.

Only by seeking information and advice can the directors fully explore all options so they can document making the right (or at least a wholly defensible) choice between the available options. If the advice is that the existing company is properly able to access an insolvency procedure with a view to preserving the profitable aspects of its business by transferring goodwill, staff and contracts to a new entity, then you will need an IP willing and able to oversee the process, to work with you to properly value (perhaps with the benefit of a limited marketing exercise) the assets being transferred and to make it all happen as swiftly and painlessly as possible. If the existing company is to enter a liquidation procedure, you will need to take early legal advice as well to ensure that you and the IP understand any employment law or other relevant legal implications (e.g. transferability of existing contracts) and that the new company is able to re-use any required trading styles / company names (even if those names or trading styles are only similar to the existing company set up). You will need to ensure that the professional advice requirements are costed into and funded through the option taken because directors should not properly acquire services for a company if it does not have the ability to pay. It will also invariably be counter productive to set up a new company with a similar name even before you have taken this advice, or to seek to divert contracts and/or staff to the new company without looking at the wider picture first and to avoid a conflict of interests the new company might well need to take separate legal advice so that any common directors can best understand how to reconcile the different ‘hats’ that they are wearing.

If my company looks like it might be insolvent as a result of COVID-19, when should I make contact with an insolvency practitioner?

It is important to remember that any IP – whether ultimately appointed by the directors themselves, a lender, one or more creditors, or the court – is bound by their own legal duties to investigate and pursue (or to sell to a third party where appropriate for the benefit of creditors) any proper claims against directors. The Secretary of State has a similar duty to pursue disqualification and/ or creditor compensation orders where it is observed that the director’s conduct fell below expected standards.

This means that there is everything in fact to be gained by directors consulting with their own choice of IP at an early stage, i.e. before the cash starts running out. The first thing the IP will do is take a health check on the company, which will help inform the directors’ decision making, and they will then explore all available options to hopefully ensure that the company does not need to enter an insolvency procedure at all. If their advice, however, is that a formal insolvency procedure cannot reasonably be avoided, they can help you to choose the right one, and to ensure that the directors do not fall foul of the sort of pitfalls along the way which might suggest that claims should be brought against them after the event. In being aware of their duties (for more information see our FAQ “What legal duties do I owe as a director which I need to be aware of during the Covid-19 Crisis”), seeking professional advice where needed, and maintaining clear records of their board decisions, directors keep themselves firmly on the right side of the line, and should have nothing to fear therefore if, in the end, the company itself cannot be rescued.

The very worst thing that directors can do during a crisis is to fail to recognise and address the issues that their business is facing and to put a misplaced trust in their ability to simply fold the company at the last minute when all the money has already run out. IPs are there to assist where they can. They are heavily regulated, specialist accountants who are trained to respond positively to a crisis. They add a huge amount of value to the economy through their work, which often preserves any value in a company’s underlying business which can be recycled and recirculated to save or create jobs and productivity. Directors should never, therefore, regard the consultation of an IP as an admission of defeat. It is something to be welcomed, and may be just what directors need to help them in these unprecedented times.

Should you or any of your contacts require any guidance with any of the issues highlighted in this FAQ, please get in touch with any of our CR&I team who have a wealth of connections with a variety of IPs and financial advisors, and we would be glad to assist you with putting you in touch with the right individuals for your business needs.

What legal duties do I owe as a director which I need to be aware of during the COVID-19 economic crisis?

Many directors will of course be very familiar with their legal duties, however, most directors who were trading businesses which were wholly profitable before the crisis will likely not have needed to concern themselves with such matters too much. Until now.

We thought it would be helpful to highlight some of the most important duties which – amongst others – become even more relevant when the long-term security of a business is starting to be called into doubt.

1. Act within your powers

Every director must act in accordance with the company’s constitution (broadly speaking, the Articles of Association) and only exercise their powers for the purposes for which they are conferred. This is an exercise in knowing your company. If you are not familiar with your constitutional documents, read them. If you do not understand them, or you realise they do not reflect the way you do business or will need to do business in the future, take advice on them, and if necessary change them with shareholder approval as appropriate. You may wish to review your trading terms and conditions at the same time.

2. Promote the success of the company

In general terms this duty requires directors to act in a way which they believe is most likely to promote the company’s success for the benefit of its shareholders as a whole. Directors should consider, among other things, the following:

  • the long-term consequences of any given decision;
  • the interests of the company’s employees;
  • the need to maintain the company’s business relationships with suppliers and customers;
  • the likely impact of the decision on the community and the environment;
  • the desirability of maintaining a reputation for high standards of business conduct; and
  • the need to act fairly as between shareholders of the company.

When a company approaches insolvency, however, this duty to promote success transforms by degrees from a duty to the shareholders into a duty to the company’s creditors. At its lowest, the duty will require you to do all you reasonably can to minimise any shortfall which the creditors might suffer if and when the company does fail.

In trying to meet this duty, the Insolvency Act steps in to remind directors that treating one creditor more favourably than another (particularly if the favoured creditor is connected to a director in some way), transferring company assets (including contracts and new business) to another party at an undervalue and paying yourself an income in the form of share dividends when there are no profits to justify it, are all expressly forbidden. If you do any of these things and the company finds its way into an insolvency procedure, you (and potentially anyone else who has benefited from this sort of conduct) can expect to be on the receiving end of claims.

Likewise, directors must not simply bury their heads in the sand and continue trading in exactly the same way if they are reasonably aware that the company is in difficulty (‘wrongful trading’). In the particular circumstances of the pandemic, it is likely that this duty would extend to a positive duty upon you to take such professional advice as you may need in order to challenge (if properly arguable) and/or negotiate down any contract clauses which place a burden on the company to do something which simply could not be done owing to the virus and/or the lockdown. On the flip side of this, if you are banking on the fulfilment of a contractual obligation to your company, you may be expected to take advice as to whether there is now a legal exposure for the company, e.g. because the other party might be released by law from that obligation. 

Although under the new Corporate Insolvency and Governance Act 2020, the wrongful trading provisions have been temporarily suspended retrospectively from 1 March to 30 September 2020. During this period, the court is to assume that a director is not responsible for any worsening of the financial position of the company or its creditors. Whilst this was intended to provide you with some ‘breathing space’, your actions may still be in breach of your other duties to the company and its creditors, meaning you could still be held personally liable, especially once the suspension has lifted after 30 September.

By taking early advice and/or renegotiating contractual terms on the basis of such advice, you might gain valuable information and/ or mitigation which helps you justify a decision to either continue to trade as you are, make changes to your trading practices, or to shut up shop (for more information, please see our blog on directors duties).

3. Exercise independent judgement

Every director should exercise their own personal judgement when taking decisions for the company; the law does not allow you to abdicate or contract out of your general duties This duty does not prevent delegation to others with particular expertise provided such delegation is authorised constitutionally, independent judgement is exercised when deciding to delegate and the delegating director maintains oversight. A marketing director would, for example, be entitled to rely on the advice and opinion of the finance director when considering financial matters but would have an obligation to scrutinise and exercise independent judgement when following such advice.

A director should not (except in exceptional circumstances that are outside the scope of this note), enter into an agreement with another person to vote in a particular way at a board meeting. If in doubt about how you should vote at a board meeting, talk it out, insist that the board takes external advice, or ask for an adjournment so that you can take your own.

4. Exercise due care, skill, and diligence

Directors are not expected to be able to see the future, nor are they expected only to take decisions which bring the company unbridled success. They are allowed to make mistakes. Whether those mistakes are ultimately culpable, however, will be judged by the standards to be expected of a reasonably diligent person carrying out the functions of a director. All directors will be held to the same minimum standard of competence when making company decisions, regardless of whether they kept quiet during the decision process or chose to take no part in those decisions. Directors will also be held to the standard of the knowledge, skill, and experience they themselves possess. This means that if a director is also a qualified lawyer or accountant, for example, they may be held to a higher standard than directors who do not possess such specialised skills or training.

5. Avoid conflicts of interest and declare any personal interests in proposed transactions

Every director must avoid situations likely to give rise to a conflict of interests. Generally speaking, a director should not vote in a decision in which they have an interest but a conflict may be authorised by shareholders or (in certain circumstances) by other directors. As such, directors must declare the nature and extent of any direct or indirect interest they may have in a proposed or existing transaction or arrangement and this should be reflected in the minutes of the board meeting. Depending on the company’s Articles of Association, a director may be authorised to vote in relation to a proposed or existing transaction or arrangement provided such interests are declared but if in doubt, advice should be taken on this point to ensure that any decision has been taken with sufficient board authority. This is particularly important if, for example, the directors decide that the best thing they can do for the company’s creditors is to transfer some of its business to another company with which they are also involved.

6. Not to accept third party benefits

Directors must not, as a rule, accept benefits from third parties gained through their position or through a decision they take as a director. In the event of the future insolvency of the company, any pecuniary benefit derived by the director personally is likely to ring loud alarm bells both in terms of director conduct reporting and liability.

To a certain extent, compliance with the above duties is a matter of common sense. In practice, however, directors should ensure that they understand their duties in light of the applicable circumstances and record their decision making processes together with any professional advice obtained (for more information, please see our FAQ “If my company looks like it might be insolvent as a result of COVID-19, when should I make contact with an insolvency practitioner ?”) in order to evidence that they have considered their duties and acted properly.

Should you or any of your contacts require any guidance with any of the issues highlighted in this FAQ, please get in touch with any of our CR&I team.

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