Insolvent Companies - Advising the Directors
Directors of Insolvent Companies rely on their professional advisors to guide them through the perils of Reckless Trading, Directors' Restriction, Directors' Disqualification, personal liabilities for the debts of the company, personal guarantees, employment legislation, breaching contracts and other issues. The purpose of this article is to set out a framework for advising Directors of Insolvent Companies.
RESCUE CULTURE The passing of the Company Law Enforcement Act 2001, with its strong measures on Restriction of Directors, has changed the insolvency landscape in Ireland. Prior to the passing of the Act, it was too easy for Directors to liquidate their companies and avoid being Restricted / Disqualified.
The establishment of the Office of the Director of Corporate Enforcement has now ensured that the conduct of all Directors in every insolvent liquidation is now closely examined.
This background has encouraged Directors to be more pro-active in trying to rescue their companies from Liquidation. This “rescue culture” has encouraged more Directors to walk the tightrope of trading whilst insolvent. If a Director “falls off the tightrope” he may be exposed to personal liability and to Restriction / Disqualification.
If a company is insolvent, and the Directors decide to continue trading, then they may be held personally liable if they are knowingly a party to the carrying on of the business in a reckless manner. A Director may be deemed to be reckless where: -Having regard to the general knowledge, skill and experience that might reasonably be expected of a person in that position, he ought to have known that his actions or those of the company would cause loss to the creditors; or
-If the Director was party to the company contracting a debt and did not honestly believe on reasonable grounds that the company would be able to repay the debt.
If it is found that a Director has not acted “honestly and responsibly”, then he may be Restricted / Disqualified by the High Court.
Given the risks facing Directors of companies which are trading whilst insolvent, it is clear that they need pragmatic advice.
IS THE COMPANY INSOLVENT? A quick review should be carried out to determine if the company is insolvent. The key test of insolvency is whether a company can meet its liabilities as they fall due for payment. A key step in this review is the preparation of detailed cash flow projections. If this review shows that the difficulties are only short term, and that they will be rectified in the short/medium term, then the Directors should have little concern, provided the longer term also looks positive. However, if the review shows that the cash flow difficulties will not be resolved in the short/medium term, then a corporate recovery action plan will have to be considered.
IS THE BUSINESS VIABLE? Before a corporate recovery action plan can be developed, a key step is to determine whether the underlying business of the company is viable or not. The viability of a business depends on many factors, including the company's market share and the state of the market itself. Indicators of a non - viable business are as follows: -Industry over capacity -Competitor price cutting -Market collapse -High fixed cost base -Long-term loss making contracts If the company is not viable, and cannot be made viable, then the Directors should be advised to place the company into orderly Liquidation or, if the company's bankers have a Debenture, invite the bank to appoint a Receiver. An orderly Liquidation does not necessarily mean making all staff redundant immediately, and convening a creditors meeting for ten days time. It may mean that certain staff are made redundant immediately, and that advance Notice of Redundancy is given to other employees while they finish certain key contracts which will produce profits for the company, and improve the prospects of a dividend for the creditors. Providing advance Notice of Redundancy will help to reduce claims for Minimum Notice. Directors would also need advice as to whether they could sell existing stock which may be subject to Retention of Title claims and, if the company's existing bank accounts are overdrawn, where to deposit cheques received from debtors.
Sometimes it will be found that the underlying business of the company is viable, but that the overhang of debt derived from accumulated losses is too large. If the company is unable to implement a Scheme of Arrangement, then the company cannot continue trading. In such cases, the Directors should consider selling the viable business, together with its Goodwill, for the benefit of the creditors. Alternatively, the Directors could decide to preserve the Goodwill of the business by operating the business in a scaled down capacity until a Liquidator is appointed, and allow the Liquidator to sell the business as a going concern.
Just because liquidation is the easy option, it does not mean it is the best option. I find it disappointing when I attend creditors meetings, on behalf of creditors, and see that a perfectly viable business has been destroyed by liquidation, which, with some creativity and flair, could have been restructured to produce a better dividend to creditors.
CAN THE COMPANY ACCEPT / ENCOURAGE CUSTOMER DEPOSITS? Some businesses, such as furniture retailers, travel agents and conservatory installers, rely on customers paying deposits to maintain cash flow. Up until recently, the traditional advice to Directors of insolvent companies has been that such deposits should be placed in a separate “client type” account, so that if the company did go into liquidation, that the deposits could be refunded. However, such advice could actually trigger the company being placed into liquidation, as its cash flow would dry up. The recent case of World of Leather in the UK may be of some assistance to such cases. World of Leather were UK retailers of furniture who traded from 39 stores. Customers paid a deposit when they placed an order and the balance on delivery.
The Directors realised that the company was in financial difficulty, but continued to trade for about four months while investigating possibilities for restructuring the business. The reconstruction efforts were unsuccessful, and the company was placed into administration on 15 March 2000. During the four month period the Directors continued to accept customer deposits, even though they knew the company was in serious financial difficulty. Indeed, customers were encouraged to pay in full to qualify for substantial discounts or early delivery of the furniture they ordered. The collapse of World of Leather led to a public outcry in the UK, and the Secretary of State initiated proceedings of Disqualification against the Directors.
The Directors defended their position by claiming that by continuing to accept customers' deposits that they improved the cash flow of the business in line with a viable rescue plan which, if successful, would have enabled the company to avoid liquidation. The Directors produced evidence that they had sought professional advice on the difficulties facing the company, and had followed that advice.
The UK Court's Judgment, dated 30 April 2004, held that the Directors were not guilty of Wrongful Trading (the UK equivalent to Reckless Trading) and therefore should not be disqualified from acting as Directors. The Judge commended the Directors' decision to obtain full legal and professional advice before continuing to trade. With this advice they were able to demonstrate that there was a reasonable prospect of finding a solution, and achieving a satisfactory outcome for all of the company's creditors. The Judge stated that the company's Directors did not have a duty to segregate customers' deposits into separate accounts once a company was in financial difficulty.
DEVISING A RECOVERY STRATEGY If it is determined that there is a business worth saving, then the next step is to develop an appropriate recovery strategy. Typical recovery strategies include the immediate introduction of iron fisted financial controls, organisational changes, product/market re-orientation, improved marketing, changes to product pricing, boosting cash flow by selling fixed assets and reducing stocks and reducing debtors, cost reduction, and tackling overhead costs.
SCHEMES OF ARRANGEMENT In some cases it will be necessary for some form of financial reconstructing to be implemented. This may call for unsecured creditors to agree to reduce their debts by, say, 40%. Larger cases may be suitable for Examinership. Smaller cases might be suitable for an informal scheme of arrangement, whereby creditors informally agree to write off a proportion of their debt, on the basis that they would be guaranteed some level of dividend, which in a liquidation they would not get.
STEPS DIRECTORS SHOULD TAKE TO PROTECT THEIR PERSONAL POSITION The Directors should meet regularly to discuss current events and keep proper minutes of their meetings, and record the fact that they have relied on advice provided by professional advisors. The decision to continue trading should be reviewed on a frequent basis. Following the High Court decision in Tralee Beef and Lamb Limited, it is important that all Directors actively participate in all Board meetings, and regularly review the company's financial performance.
While the World of Leather case, and other cases, show that reliance on professional advice can be a mitigating factor in determining whether a Restriction / Disqualification order should be made, such reliance is not a complete panacea. The advisors must be competent and the advice reasonable. Directors cannot discharge their responsibilities entirely by relying unquestioningly on professional advice.
Occasionally, individual Directors may be best advised to resign their Directorships immediately. If a Director resigns more then 12 months before the company is placed into liquidation, then he cannot be subject to Restriction proceedings.
TAX RETURNS The Directors should be advised to submit all tax returns on a timely basis.
PROPER ACCOUNTS As Directors can be held personally liable for some or all of the debts of a company which is in liquidation and has not kept proper books of account, the Directors should take reasonable steps to ensure proper books of account are kept.
RETURNS TO CRO Annual Returns to the Companies Registration Office should be filed on time. Sometimes Directors may make a deliberate decision not to file returns, so as to avoid publicising their difficulties to creditors, particularly if the creditors are providing credit on the strength of credit insurance. Credit insurers closely monitor the debts which they have insured, and may withdraw cover if the accounts show a weak financial position. Obviously, for Directors not to file accounts in these circumstances increases the risk of them being Restricted.
MAJOR CREDITORS In certain circumstances major creditors should be kept informed of the issues facing the company. In practice, the more money a creditor is owed, the more receptive he is to positive proposals.
SHADOW DIRECTORS A potential pitfall for advisors to insolvent companies is that they may be deemed to be shadow directors. If the Directors of a company are accustomed to acting in accordance with the direction or instructions of another person, that person may be deemed to be a shadow director and therefore subject to many of the statutory obligations imposed on directors generally. Accordingly, professional advisors should be careful how they present their advice to such companies.
Jim Stafford, FCA, is Principal of Friel Stafford. www.liquidations.ie
4/6/2009 1:28:39 PM
I am particularly interested in the current state of busness affairs of Jim Langan Furniture as I was employed by this company
7/4/2008 3:28:35 PM
hi, thank you for the article, question for you.
What happens when a franchisor goes into insolvency, without asking or declaring to his business partners his intention.
How does one put a case forward to the court to advise of gross fraud and misconduct.
4/29/2008 5:15:53 PM
A director of two companies one goes insolvent what happens to other directorship?