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Protecting your business from financial failure

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As businesses embark on the road to recovery, what challenges do company financial directors need to be most aware of and how can they best prepare and protect themselves and their companies? Natalie Todd, partner and committee member of the London Solicitors Litigation Association (LSLA) explains

1.      The grace period and the dangers of trading insolvently/wrongful trading

The UK government has provided a range of protections and support to companies including financial support and temporary halting of insolvency regimes.  Financial directors (FDs) have been given relief for the periods 1 March 2020 to 30 September 2020 and 26 November 2020 to 30 June 2021 from insolvent or wrongful trading duties. In accordance with the Corporate Insolvency & Governance Act 2020, the courts will assume that a FD is not responsible for any worsening of the financial status of the company or its creditors during this six-month period, however, note that this assumption may be capable of being rebutted. FDs should be wary of becoming complacent and continue to follow best practice – this is only a temporary amendment and an FD’s actions can still be challenged on grounds of misfeasance.

In addition, while the government has repeatedly extended the Covid-related property and insolvency restrictions, these relief measures will not last forever. It is becoming increasingly obvious that is almost impossible to predict with any certainty when the various relief will end or whether or not it will be reintroduced given the further waves of infection and further strains of Covid 19. How then can FDs accurately project their cash flow forecasts and/or value their assets? Is this task not becoming almost impossible when finances are such that FDs are in the position of having to question whether a company is solvent or insolvent? The only safe course to adopt in such financial circumstances is to proceed with caution and if in doubt, presume insolvency.  

If there is any doubt about the company’s finances or future, the question to ask again and again is whether there is a reasonable prospect of avoiding insolvent liquidation? If there is, justify that you hold that belief reasonably, having regard to the information available to you and the requisite standards of skill and care expected of you.

Of equal importance in asking this question is to document that you have asked, answered and justified your answer ideally in board minutes with financial information and presentations to the board attached to the minutes. FDs in particular will be expected to take responsibility for this question and also to ensure that they take and document that they take every step possible to minimise creditors suffering additional losses. 

Communicate in writing with your creditors about repayment plans and document any calls/meetings with notes circulated afterward.

Hold board meetings regularly if finances are in question and document all decisions, why and how they are reached. Scrutinise any change or proposed change in finance facilities. Provide for a contingency plan to be drawn up by your advisers. Such actions may be sufficient to amount to a defence to the claim and avoid claims for FDs to contribute personally to the assets of the company if it is found to have traded while insolvent.

2.      Liability for misfeasance

All directors may have to compensate the company for losses caused as a result of a breach of their duty to exercise reasonable care, skill, and diligence that would be exercised by a reasonably diligent person with the general knowledge, skill, and experience that may be reasonably expected of a person carrying out the functions of that director.

This can be especially concerning for FDs who are experienced in financial and legal matters as the actual experience of the FDs is taken into consideration. Ensure you have adequate procedures and compliance manuals in place and kept up to date. Again, all decisions should be documented and full due diligence should be carried out on all transactions.

3.      Liability for preference transactions

If you have cash flow difficulties, consider whether the payment is necessary for the continued operation of the business. Document why some creditors are being paid rather than others. For instance, it may be due to exorbitant interest rates, under a threat of winding up proceedings or a necessity in order to ensure future contracts. 

Get documentary evidence from your creditors and/or follow-up calls with them with notes circulated to your fellow directors and that creditor to try and avoid any discrepancy down the line. Ensure that you have conducted your due diligence on all transactions with unknown counterparts which may transpire to be a connected entity.

Only give personal guarantees if absolutely necessary and exercise extreme caution when paying back creditors to discharge a debt secured by a personal guarantee in preference to other debts.

4.      Liability for transactions at undervalue/transactions defrauding creditors

Document with as much detail as possible why a transaction or service would benefit and is necessary for the company. Ensure that reasonable market value is provided to the company for transactions. You might need to shop around even though you already have your reasons for choosing a certain supplier/provider. In times such as these, query whether any gifts should be made or accepted.  

5.      Repayment of dividends

If there is any suggestion that a dividend could be in excess of available distributable profits, it may be unlawful. Get good accountancy advice before authorising dividend payments if in doubt, otherwise, directors may be acting in breach of their duties and may be personally liable to repay.

6.      General counsels and advisers

Work with your general counsels, CEO, and other directors closely. Establish communication channels between you to ensure that nothing is missed.  Statutory duties require that directors also take into account wider factors including business conduct standards, relationships with suppliers and customers, and any other relevant circumstances.  If in doubt, FDs should seek to rely on legal, restructuring, and accounting advisers. Conduct your day to day to affairs with the foresight that your assumptions may at some stage be reviewed by an insolvency practitioner with the benefit of hindsight.