The coronavirus is a worldwide emergency affecting virtually every person and every business.
In order to protect and save thousands of lives, governments across the world are shutting down non-essential businesses and imposing various forms of social distancing measures and lockdowns on the free movement of people.
It is hard to imagine how the economy and life will ever be the same. Without any warning or anticipation, overnight many businesses and entrepreneurs will have found themselves in financial distress. Overnight directors may be needing to consider cash flow and whether their business is able to survive or not.
This note explores the situation for directors of companies, who face financial problems due to the coronavirus Covid-19.
When does a company become insolvent
Under the Insolvency Act 1986, whilst there is no technical definition of insolvency, there are two tests that the court can apply to determine if a company is unable to pay its debts, and then order the winding up of the company:
Under the “cash flow” test a company may be wound up if it is unable to pay its debts as they fall due. Under the “balance sheet” test a company may be wound up if the value of the company’s assets is less than the number of its liabilities, taking account of its contingent and prospective liabilities.
Both tests will require consideration of present and future liabilities. However, the cash flow test concerns the immediate and short term position, whereas the balance sheet test takes a longer-term view.
Of course, directors can, outside of a creditor or court-based process, voluntarily instigate a winding up of an insolvent company. The process is to convene a general meeting. In a small business, the directors and members may be the same persons. A special resolution (75%) of the members is required to commence a voluntary liquidation.
Wrongful trading
During normal (solvent) trading conditions, director duties are essentially threefold:
- To promote the success of the company for the benefit of the members as a whole;
- To exercise reasonable care, skill and diligence; and
- To exercise independent judgment.
When a company becomes financially distressed, these duties are replaced to a singular duty to act in the interests of creditors as a whole. The means preserving the value of the company in order to maximise the return for creditors.
Wrongful trading is where a director continues to trade a business, where:
- A director knew or ought to have concluded that there was no reasonable prospect that the company would avoid insolvent liquidation or insolvent administration; and
- The director did not take every step with a view to minimising the potential loss to the company’s creditors.
Note, even if a person is not validly appointed as a director of a company at Companies House, these duties can still apply to them if the other appointed directors are accustomed to acting on their instructions. These individuals are known as shadow directors.
A director who is found to have wrongfully traded can be personally liable and be ordered by the courts to reimburse the company for such amount as the court thinks fit.
The coronavirus emergency may lead some directors to take actions that they would not otherwise have taken. But directors should be wary and seek appropriate advice if they are considering taking such actions, as wide powers exist to penalise or disqualify directors responsible for fraudulent trading and misfeasance.
When the duty shifts to protect creditors
There is a so-called “twilight zone”, which may be long or short, when a director’s duty will shift from acting in the interests of the members to acting in the interests of creditors.
Case law tells us that the duty to protect creditors is engaged: “from the point at which directors know or should know that the company is or is likely (in the sense of probable) to become insolvent.”
When to consider insolvency
On 19th March 2020, Borris Johnson has said we can send corona packing in 12 weeks if we follow the rules (self isolation, social distancing and others). Rishi Sunak has also unveiled the largest ever UK government economic interventions to help businesses. However, he has also stated that the UK government won’t be able to save every business.
In the short term, a major influencing factor for directors will be short term cash flow. If cash flow can be managed, even if a business is technically unable to trade, a business may still be able to avoid a liquidation. Directors will need to keep the cash position, and insolvency tests as stated above, under constant review. It may be that a lot of businesses will have time to take advantage of the various government initiatives such as the job retention scheme and corona business continuity loan.
Practical steps
There are a number of practical steps for company directors as follows:
- First of all the challenge from the coronavirus should be assessed. Whilst this is a significant and probably the biggest challenge most directors will have ever faced, each business will have a different level of vulnerability. The vulnerabilities should be analysed and considered. Directors should ensure they are aware of all relevant facts and avoid simply resigning to escape problems. Once the facts are to hand, a plan should be created.
- Consider the cash flow problems, and whether the business can continue with changes? In relation to cash flow problems, can this be managed to continue the business? Is the business really at an end, or is there a way it can continue? For example, will creditors (for example landlords and other suppliers) agree to a short term payment holiday, whilst the immediate impact of the coronavirus problem can be more fully assessed, and there is some understanding when government restrictions may be relaxed to allow more normal life continuing.
- Consider the availability of finance, including the various government initiatives.
- Consider whether the business can be downsized or restructured, or continued in a different form or entity, as opposed to closed and ceased.
- Consider the impact to staff, who may become ill or who need to work from home for extended periods.
- Consider terminating certain contracts and projects. Directors should become familiar with the concepts of frustration, force majeure and review insurance policy documents.
- If appropriate, consider legal and insolvency advice. Note it may be possible to obtain protection from creditors by putting in place or moratorium, known as a company voluntary arrangement (CVA).
If you or your business is affected by the coronavirus then please contact us as follows:
Company and business law advice - Spencer Laymond
Employment law advice - Kaajal Nathwani
Dispute resolution advice - Alan Carter
Wills and probate advice - Anne Stennett
Property advice - Bradley Bernett
Curwens: Your legal team for life.
