As we march inexorably towards the rather grim milestone of a full year under various forms of COVID-related legal business restrictions, having at the same time faced the consequences of the end of the Brexit transition period, it is hardly surprising that a large number of limited liability businesses are looking toward the end of government support measures and/or the resumption of creditor enforcement measures during 2021 with some trepidation.
Leaving aside for the moment the SME company directors for whom these restrictions resulted in a total loss of income with (as yet) no government support to speak of, a vast number of entirely viable and successful limited liability businesses will still have availed themselves of tax deferrals, furlough payments, government backed loans and/or similar options in the expectation that we would, by now, have been free from these restrictions. At the time, most of us would have thought we would by now be trading if not normally, then as close to normality as makes little difference to the bottom line.
Many businesses will, of course, have fared much better than merely surviving this period, finding new opportunities and efficiencies they would not have dreamed possible only 12 months ago. Others will be at a point where they are tempted – or even already planning – to throw in the towel as they watch their profit margins and/or currently available cash reserves starting to disappear, without any clear visibility as to when they might be restored.
Wherever our businesses fall in this spectrum, however, almost all of us will have made sweeping adaptations to the way we do business and in the face of such critical changes there are certain common considerations which the law expects of us, as fiduciaries and guardians of our businesses. If we forget or fall short of these expectations we risk – despite the limited liability status of our businesses and regardless of their economic strength today – being held personally liable and/or disqualified for if, in the future, we are unable (in spite our best efforts) to keep our businesses out of a formal insolvency process. The days when any of us could legitimately boast that our businesses were too big, too well run, too well respected to ever fail are long behind us. If nothing else, 2020 should have taught us that we never know what is around the corner, and that any business which is fighting fit today could in principle be vulnerable tomorrow.
This note explores how we think the actions of today’s directors and limited liability partners (who are treated very much like company directors for these purposes) are likely to be judged by the standards of tomorrow’s aggrieved creditor, liquidator and/or Secretary of State (responsible for disqualification actions). It is not a detailed examination of director duties as a company approaches possible insolvency (for which see our Blog of 15 May 2020 regarding directors’ duties), but rather a short list of pointers and good habits which it would be beneficial for us to keep well in mind, and more importantly to be seen to have had in mind, as we navigate the coming months:
It may seem overly cautious in a successful business, but it is never too soon to adopt this discipline, particularly when taking key business decisions such as acquisitions, disposals, taking loans, instigating funding rounds, moving trading locations, reorganisations and connected party transactions. Your current and future creditors are regarded in law as key stakeholders in your business, and if you get into the habit of actively considering their interests now and at every turn, this will stand you in the best possible stead in the event that the unthinkable happens.
All too often we find, where liquidators or litigation funders are pursuing claims against the former management of an insolvent business, that the defendant individuals regret that years before an insolvent event occurred they had overlooked basic steps, such as might be required in the constitution of the company, partnership agreement, Companies Act and/or Insolvency Act. It may be something as simple as not keeping the minute book up to date. If the interests of creditors had been at the front of everyone’s mind, it is much less likely that they would have made such mistakes. Part of this discipline requires an acknowledgment that, in law, fiduciaries are typically liable for any collective breach of their duties jointly and severally: it is not enough to say that someone else was responsible for the finances, or that you were never shown the books or whatever. We must all take responsibility and if you are a director or LLP partner (especially if you are also in that role a charity trustee) and you are being excluded from information which you need in order to understand how a decision could impact on creditors, you need to consider your position.
In a comfortably solvent company the interests of shareholders and creditors will invariably be aligned, so in reality it is no great imposition to record in your board minutes and internal correspondence (all of which would be deliverable and/or disclosable to a liquidator or the Secretary of State) that you have considered creditor interests as part of your general impact assessment, just as you might consider the impact of a decision on your workforce, against your diversity policy or upon the environment. If your decision could impact substantially on cashflow and/or could prejudice their interests, be sure you have discussed the matter carefully, called for the production of a cashflow projection or similar analysis, and that you agree that you have good and sufficient commercial reasons for proceeding, i.e. that you are promoting the success of the company. If in doubt, consider taking external advice, and if you decide that this input is not necessary, at least be clear on why you reached that conclusion.
In our experience, the single most common reason (excluding personal guarantees, which are obviously to be avoided wherever possible) why limited liability business owners face personal liabilities and/or disqualification following the failure of their business is that they failed to record why they did what they did, when they did it. Consequently, they are unable to prove their innocence when the blame for a company’s insolvency is laid at their door.
Getting into the discipline of keeping regular records of decision making will both improve the quality of the decision making itself and ensure that the reasons for that decision stand the test of time. Such records will record for posterity what information was (or was not) available to management at the time, ensuring you will not be judged with the benefit of hindsight.
How far you go in this regard probably depends as much as anything upon the nature of your business and of the decision being taken. It is obviously not necessary to keep records of every small decision in the ordinary course of business, but if, for example, your business has been seriously affected or interrupted by circumstances beyond management control, you should keep records as to your attempts to make any appropriate insurance claims and to instigate any contractual clauses which would reduce the business’ liabilities. You should also ensure that creditors are kept in the loop, in writing, and essential supplies safeguarded. Likewise, if you take government-backed loans for the purposes of supporting your business or enter into some sort of tax deferral arrangement, you should record very carefully the basis upon which you concluded that the business would be able to pay these within agreed timescales, and what steps you have taken to ensure that funds brought into the business are used only for appropriate purposes.
If your business needs to sell assets, including interests in other businesses, you should record your steps to carefully secure market value for those assets, or if they have to be sold more cheaply in a hurry, your reasons for concluding that this was in the best interests of the business and its creditors. The valuation and marketing of assets is likely to require input from a professional and appropriate asset valuer. Sales of business interests against an accountant’s valuation only will not have tested the available market and will not usually be accepted as good evidence by a liquidator or by the Secretary of State.
Time and again we become aware of instances where management has refused – sometimes despite the protestations of one or more directors or partners, or advice from trusted advisors such as the company’s accountants or solicitors – to even speak to an insolvency practitioner, even after a business has already started to fail. The commonest excuses we see for such behaviour suggest that management who take this view regard having a consultation with an insolvency practitioner to be some sort of admission of defeat, and / or that they have been through the numbers carefully themselves and concluded that the business is not insolvent. The worst excuse we have heard is that the business cannot afford to consult with an insolvency practitioner, based on an assumption that their input would be expensive. None of these is true, so they cannot be a good reason for fiduciaries to shun such freely available advice.
In fact we would go further, and suggest that even businesses which from time to time may be doing very well should keep under review whether a consultation with an insolvency professional would still benefit the fitness of the business. Qualified, licensed insolvency practitioner accountants (IPs) are the only professionals truly equipped to advise management whether a company is either already or prospectively insolvent, but more importantly on the range of options which the business may have to ensure that it reverses an existing insolvency, avoids insolvency altogether, or accepts its insolvency but resolves it in the best available manner.
In a recent Financial Times interview, an IP was described as something of a cardiac consultant assessing the ‘beating heart’ of the business. It could be that they pronounce the patient to be healthy, they might instead prescribe a course of exercise or lifestyle changes, or they might need to recommend more invasive procedures (at worst a transplant). The sooner the patient sees the consultant, the more options they will have. None of us have to seek out or act upon medical advice, but closing our ears entirely to freely available health information is illogical and can be self-destructive.
Typically, an insolvency practitioner – particularly one who is introduced to management via their existing professional advisors – will not charge for an initial consultation, and if they recommend that options be explored, those would be carefully costed out and the implications for any existing funding arrangements explained, so that management might take an informed decision before proceeding with any of those options. Moreover, taking and following advice from a reputable IP who has been furnished with appropriate business data upon their request will very often insulate management from later criticism and personal liability for any acts or omissions which follow as a result of that advice. Whilst IP advice to the business is disclosable in the event of a formal insolvency procedure in the future, this is no different to advice from the business accountants or solicitors, both of whose files become the property of the appointed office holder in the event of the formal insolvency of the business.
The question we often put to management who somehow fear the involvement of an IP at an early stage, therefore, is ‘what have you got to lose’?
Clearly none of us know quite how 2021 is going to pan out in our respective markets, or even how government policy will change over time as the world hopefully begins to get a grip on the pandemic and the country adjusts to the more disruptive effects of Brexit. What we do know, however, is that the businesses which come out of these crises best will likely be those who have been mindful of the risks, adjusted their practices to address those risks, and taken appropriate action to mitigate them. By following the above practical tips, we hope that at least some businesses may find these processes slightly less daunting.
Paris Smith LLP offers a full range of legal services and we are able to connect clients with other professional services appropriate to their needs. Insolvency professionals come in various shapes and sizes, with different sector specialisms, professional associations and relationships with applicable regulators. There are many unregulated advisors who advertise on the internet and whose input we would no more recommend than we would recommend someone to an unlicensed medical practitioner. By seeking a referral from specialist insolvency solicitors, you should be able to ensure that you meet a fully qualified IP who is right for you and your business.
If you would like to discuss any aspect of the above, or any matter arising from your consideration of the above, please do not hesitate to get in touch with your usual Paris Smith contact, or with the writer, Mike Pavitt or any member of our Corporate Restructuring & Insolvency team.
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ABOUT THE AUTHOR:
Mike Pavitt is an LLP Partner and Head of Corporate Restructuring & Insolvency at Paris Smith LLP. He has specialised in insolvency matters for more than 20 years and is a former Chair of the Southern Committee of the Association of Business Recovery Professionals (R3). He is also a Fellow of R3 and a current member of the Insolvency Lawyers Association. Paris Smith LLP’s Corporate Restructuring & Insolvency team frequently advise companies, LLPs, directors, partners, secured and unsecured lenders, litigation funders, private individuals and insolvency practitioner accountants in matters relating to actual or prospective insolvency and to insolvency risk.