COVID-19 – a general guide to business survival and restructuring
This article does not provide legal advice nor should it be relied upon by anyone receiving it for the purpose of making decisions in relation to their business or otherwise. This article sets out some general concepts which may be relevant for business owners and managers to consider bearing in mind the current uncertain financial landscape.
Current Issues
As many businesses suffer a dramatic and immediate drop in turnover caused by the Covid 19 outbreak, the Government has already rolled out what is expected to be the first wave of financial support measures.
Whilst further financial support is expected, its availability and the terms on which it will be provided (eg when any loans made are due to be repaid) remain unclear. That may be the case for a few weeks or even longer as government policy is created at an ever-increasing pace to meet this health and economic crisis.
In the first instance, anyone suffering from cashflow or other solvency issues should take professional advice from their accountant as to what support is available.
Options/issues to be aware of
Even with a financial support package, some businesses may struggle to survive in their current form if, for example, they have liabilities that they cannot meet today and will be unable to meet in the future.
If directors reach the conclusion that their company is insolvent (which can be on a balance sheet or cash flow basis), they are under a duty to consider the shareholders and the creditors of the company and to act in the interests of both.
In such circumstances, the directors should take professional advice from an insolvency specialist, not just to identify the best options for the company and its creditors but also to protect themselves from future criticism should the company enter Liquidation.
There two main options to enable a business to continue to trade whilst in financial difficulty: Administration and a Company Voluntary Arrangement.
Administration
Placing a company into Administration effectively places it in a safe harbour from its creditors for a period of 12 months, which can be extended in limited circumstances by another 6 or 12 months. Administrators (i.e. insolvency practitioners) are appointed to manage the affairs of the company whilst continuing to trade. Their primary role is to either enable the company to continue as a going concern or alternatively, to preserve the business that the company operates.
Once a company is placed into Administration, creditors are prevented from taking any action against the company without the consent of the Administrators or the permission of the Court, which will only be granted in exceptional circumstances.
By removing the short-term pressure of creditors taking legal action against the company, the Administrators can attempt to restructure its debt, seek to agree new terms with major creditors, consider whether a redundancy process is required as well as considering other options to make it profitable. Such discussions are often impossible when the directors are fire fighting creditors, who may be threatening Court proceedings or to wind up their company.
Administration is a complex proposition but it is usually an effective route to achieve a balance between the interests of the shareholders and creditors. It can often ensure that the business continues and that jobs are preserved, whilst protecting the directors from any personal claims for breach of duty.
Company Voluntary Arrangement
A CVA is a scheme designed to enable a company to continue to trade by obtaining the approval of its creditors to repay a percentage of the money owed to them over an extended period of time.
A written CVA proposal, which an insolvency practitioner will prepare on behalf of the company, will be approved if 75% of all creditors (and more than 50% of the unconnected creditors voting) vote in favour, at which point it will bind all creditors. Unlike in Administration, control of the company remains with the Board.
The CVA proposal will highlight to creditors that if it is not approved and the company then enters Liquidation, it is likely that they will receive little or no payment of their debt. The proposal will explain how an extended repayment plan often accompanied by the directors personally committing personal loans into the company which would be repayable after the CVA has been completed, will enable continued trading and for a greater percentage of the current debts to be repaid.
A CVA proposal will typically allow for an agreed percentage of the debt to be paid pari passu to each creditor over a 5 year term.
Once a CVA is approved and as long as the proposal terms are met eg the agreed annual dividend to creditors is paid, then the creditors are precluded from bringing proceedings against the company.
Liquidation
In the event that an Administration or a CVA are not viable options, Liquidation is the process by which a company’s trading is brought to an end and the company will, ultimately, cease to exist as a legal entity. The Liquidator will be responsible for realising the assets of the company and making a distribution to creditors from that realisation, after payment of its own costs. Liquidators can pursue claims against errant directors under the Insolvency Act 1986, sharing certain of these powers with Administrators.
Once a company has entered Liquidation, the Liquidator will sell anything that it owns of value. The sale of assets from Liquidations and Administrations can take place after the company’s business or assets have been widely marketed by the office holder or through a pre-packaged sales process. Pre-package sales, which rely upon independent valuations obtained before entering Administration or Liquidation, are designed to minimise disruption to the business.
Wrongful Trading
Directors are responsible to ensure that if their company reaches a tipping point beyond which there is no reasonable prospect of it avoiding an insolvent liquidation, they take steps to ensure that its balance sheet deficiency does not deteriorate. Primarily, this relates to new debts and would not include ongoing liabilities, such as rent.
They key issue here is that once this tipping point has been identified, the directors must seek professional insolvency advice as soon as possible.
If directors fail to obtain and/or follow such advice and the company’s balance sheet deteriorates as a result, then the directors may be required by a Court to contribute to cover that additional loss. For example, if a company should have been liquidated when its balance sheet deficiency was £50,000 but that only takes place when the deficiency was £200,000, the Liquidator can apply to Court for an order that the directors pay £150,000 to the company.
Conclusion
These are unprecedented times. Issues that face businesses today may be overtaken by new challenges next month, next week or even tomorrow. Perfectly rational decisions being made today may be hard to understand in the future and they may need to be subject to scrutiny.
Therefore, it is vital that directors record, whether at Board Meetings or even in email exchanges between them, that they have addressed their minds to any potential insolvency issues. They should set out how they perceive the challenges being faced by the company and explain any course of action that they pursue. Taking insolvency advice is likely to form part of an informed decision-making process.
Teacher Stern regularly advises clients on solvency issues and we work with a range of highly experienced insolvency practitioners to provide pragmatic options to address their concerns.
