Company Insolvency and Directors’ Duties
Goodwill and community spirit have been greatly in evidence throughout the lockdown so far, government support has been significant and many businesses have shown admirable ability to adapt. The blunt fact remains however that many businesses are not turning a profit and are facing significant financial difficulties.
The Corporate Governance and Insolvency Act 2020 (CIGA) recently passed has given companies some protection from insolvency proceedings by effectively preventing the use of statutory demands and winding up petitions where the inability to pay arises from coronavirus. Directors have some protection from the same act in that their responsibility for any worsening of the company’s position or the position of creditors is effectively waived from 1 March 2020 to the end of September 2020.
Beyond the short term however, businesses will undoubtedly be facing insolvency. What are the options for a limited company to address insolvency and what duties do directors have to address matters?
What is insolvency?
Insolvency is most often defined as an inability to pay debts as they fall due. There is also a “balance sheet” test: if a company has liabilities outweighing assets it may be insolvent, notwithstanding that no debt is due for payment at that moment. Contingent and future liabilities can also factor into the balance sheet test.
What duties do directors have in relation to insolvency?
Directors’ duties are focused for the most part on their duties to the company, but if and when directors become aware that the company may be insolvent, they also have a duty to creditors. Under the Insolvency (Northern Ireland) Order 1989, if directors allow the company to continue trading when there is no reasonable prospect of paying debts, the directors may become personally liable for what is known as “wrongful trading”. Even if there is no personal liability, a director can be disqualified from acting as a director for a period of years if the court decides that their conduct makes them unfit to act as a director. This includes wrongful trading.
Under the CIGA, the court is to assume that a director is not responsible for any worsening of the financial position of the company or its creditors that occurs during the period between 1 March 2020-30 September 2020. This gives some reasonable cover, but the end of September 2020 fast approaches and if directors fail to deal with matters in good time at that stage, they may not find the courts sympathetic. It should also be noted that this protection is in relation to wrongful trading. There remain other possible offences by directors, including fraudulent trading or breach of fiduciary duty.
What are the options if your company is facing insolvency?
· Member’s Voluntary Liquidation
If a company is solvent but the directors consider that its longer term prospects are poor, the shareholders may pass a resolution placing the company into an MVL. A liquidator is appointed to settle debts owed by the company, to distribute any surplus and to dissolve the company.
· Company Voluntary Arrangement
The Company Voluntary Arrangement (CVA) is a formal arrangement by which a company agrees with its unsecured creditors to pay them less than the full sum owed, usually on the basis that the sum paid under the CVA would be greater than the sum which would be obtained in a liquidation. If sufficient creditors approve the proposal, it is binding on all unsecured creditors. The process is supervised by an Insolvency Practitioner.
The directors or shareholders of an insolvent company may place the company into administration by way of an application to Court. Administration may also be initiated by lenders in certain circumstances. A company in administration is protected from legal action for debts owed by it whilst an administrator is appointed to run the company. The administrator will attempt to preserve or sell the business as a going concern and if this is not possible, will seek to realise assets to pay creditors, with the company then being wound up.
· Creditors’ Voluntary Liquidation
The members of a company may pass a resolution to appoint a liquidator, chosen by creditors. The liquidator manages and realises the company’s assets in order to pay creditors and the company is then dissolved.
· Compulsory Liquidation
If a winding up petition is presented against a company by a creditor, the Court may make an order that the company be wound up. A liquidator is appointed and again manages and realises assets in order to pay creditors and the company is then dissolved.
Under the Corporate Insolvency and Governance Act 2020 companies can enter into a moratorium for a period of 20 business days (extendable in certain circumstances). The moratorium protects the company from action by creditors and involves an Insolvency Practitioner acting a monitor of the company. The monitor must be willing to make a statement that the company is likely to survive as a going concern.
· Scheme of Arrangement
A scheme of arrangement is a statutory process under which a company reaches a binding compromise agreement with its members and/or creditors, or any class of them (including secured creditors). It is generally more expensive and complex than a CVA and as such will usually not suit SMEs, but might well suit larger companies with cash reserves who are seeking to restructure.
All directors who are concerned that their company may be facing insolvency should seek appropriate professional advice as soon as possible. If you wish to discuss issues affecting your company, please contact Philip Gordon at firstname.lastname@example.org