To identify an insolvency situation
Directors must continually review the financial performance of their company. They need to be able to recognise when the company is in financial difficulty. Indicators of financial difficulty include the following:
- the company has many unpaid creditors who are putting the company under increasing pressure to pay its bills; and
- the company cannot use its overdraft facility for temporary relief as the facility is fully drawn and the bank is refusing to extend further credit.
It is the directors who need to decide what action to take on behalf of the company. In making that decision, the directors will need advice on their duties, responsibilities and liabilities under the IA 1986 and general law and their options under the IA 1986 and CIGA 2020 for resolving their companies’ financial difficulties and the exposure of creditors to losses.
Can the directors ignore financial difficulties and simply keep a company trading?
Doing nothing to address a company’s financial difficulties is not an option. If the company enters into an insolvent liquidation or administration, directors can be made personally liable to contribute to the company’s assets under the provisions of the IA 1986 dealing with wrongful or fraudulent trading. In addition, in an insolvency situation, a director’s duty to promote the success of the company under s.172 CA 2006 is subject to any enactment or rule of law requiring directors to consider or act in the interests of creditors of the company (see s.172(3) CA 2006). This refers to the preservation of the common law rule that once the company is facing the prospect of insolvency, the directors’ duty to promote the success of the company switches to protecting the interests of the creditors. A director’s breach of this duty can make him or her liable to pay damages to the company under s. 212 IA 1986 which deals with misfeasance.
The directors also risk disqualification under the Company Directors Disqualification Act 1986.
There is, therefore, an obligation on the directors to recognise when a company risks becoming insolvent and to take appropriate action.
Should the directors try to save the company or its business?
Faced with a company in financial difficulty, the directors have several options. The first decision of the board is whether to aim for the survival of the company (either with or without the aid of a formal insolvency procedure) or whether the company’s financial predicament is so great that at best, only the company’s business can be rescued (e.g. by the sale of the business and assets as a going concern to a buyer). If the latter option is the only viable one available, it is very likely the company will have to enter into a formal insolvency procedure to achieve it.
If the directors wish to try to aim to preserve the survival of the company, there are various turnaround strategies. These include restructuring the company’s debts perhaps by obtaining a pre-insolvency moratorium to achieve a consensual contractual arrangement with some or all creditors or through a company voluntary arrangement (‘CVA’), a restructuring plan or a scheme of arrangement (as discussed below). As part of this process, the company may also need to bring in new management and/or replace existing directors. The directors may appoint turnaround specialists (sometimes called company doctors) or specialist financial advisors, both of whom offer independent, informed advice. Turnaround is a growing specialism within business and the law and can be cost effective and successful if approached in the right way.
A turnaround specialist or financial advisor will act quickly to carry out an appraisal of the company’s situation and, if it is possible to rescue the company, establish an action plan.
If the directors, assisted by their advisors, conclude that it is not possible to turn around the fortunes of the company so as to preserve the company’s survival, then there are various insolvency procedures available to deal with the company’s predicament. This Chapter will examine the various procedures available to financially struggling companies.