Bench, Joe Bloggs, and East have all entered into administration in 2018. New Look and Select have both entered into Company Voluntary Arrangements (CVAs). House of Fraser is next up. This article highlights the duties of directors if insolvency threatens.
Directors need to navigate a legal minefield when deciding whether their company is fundamentally strong enough to survive. The decision to carry on trading may depend on a range of factors such as interest rates, availability of funding, strength of the competition, and domestic and foreign demand for the brand. The procedures they follow in reaching an answer to this decision is also key.
Directors duties and potential insolvency
Directors have a raft of statutory duties. When a company is solvent, these duties are generally owed to the shareholders.
But the duty to promote the success of the company for the benefit of its shareholders will reduce and be overtaken by an obligation to have regard to the interests of creditors as a whole as a company nears insolvency.
As a general rule, as a company’s financial position worsens, the interest of the company’s creditors generally should become of paramount importance. The dual threat of personal liability or disqualification as a director means that directors ignore at their peril the interests of creditors.
Steps which the directors should be taking
These threats apply mainly in respect of the period where there is no reasonable prospect of avoiding an insolvent winding up. A good example of the need to be careful when approaching insolvency is the public criticism of the ex-directors of Carillion. Controls should, therefore, be established to minimise the risk of wrongful trading. These should include:
- the production of detailed, accurate, and up-to-date management accounts;
- the production of detailed cash flow statements that reconcile to the P&L account and balance sheet (profit does not equal cash and solvency!);
- the production of board minutes detailing rationale for decisions;
- obtaining valuations for asset disposals;
- reviewing all relevant trading information at regular board meetings where directors are encouraged to raise any specific concerns;
- formulating specific areas of responsibility for each director and avoiding conflicts;
- reviewing the position of the creditors generally. In particular, directors should be very careful about favouring one creditor over another (particularly if connected to the company or some incentive to pay him, e.g. he holds personal guarantees from directors);
- considering your own financial position. For example, whether it is appropriate a director to be paid any promised bonus; and
- taking professional advice.
It is in the interests of each director to ensure that all deliberations of the Board are fully minuted, so ensuring that any subsequently appointed liquidator can establish the efforts taken, not only by the board, but by each individual director to protect the company’s creditors.
The fact that a director obtains professional advice in this area is likely to be a helpful factor. By contrast, directors who have been required by liquidators to complete an extremely detailed questionnaire as to their conduct prior to an insolvency, often state that they wished that they had kept better records, including full notes of their attempts to protect the interests of the creditors.
Resignation is very much a last resort and should only be contemplated if a director’s concerns are being ignored and departure would draw attention to the company’s plight.
If a director believes that the company cannot continue trading, there are several options available at this stage. The first one is to bring in the so-called “turnaround experts”. As in the case of AlixPartners and Jaeger, these experts are typically engaged with a view to informally turning around the company. This can involve selling off key assets, restructuring or closing failing stores.
However, if this does not work, or it is believed that the situation is already terminal, then it is time to start talking to an Insolvency Practitioner. These practitioners will typically set out a number of options, including a CVA, Administration or Liquidation.
A CVA allows companies to come to an informal yet binding form of agreement or compromise with the company’s creditors and so avoid or supplement other, more formal, types of insolvency proceedings (such as administration). One example of such a CVA is New Look, which entered into a CVA on 21 March 2018 resulting in 980 jobs lost and 60 stores being closed.
A CVA involves a meeting between the shareholders and creditors of the company, who will vote on approving any proposals as to how their debt is to be paid. For example, creditors may agree to accept 75p for every £1 owed in an effort to save the company. These proposals must be approved by a simple majority in value of the members and 75% in value of the company’s creditors present and voting.
Unlike an administration, a CVA does not automatically result in a statutory moratorium which protects the company from creditors taking action to recover their debts. However, small companies (with fewer than 50 employees, turnover of less than £5.6m and balance sheet assets of less than £2.8m) can elect for a 28 day moratorium, which ends on the day the members’ and creditors’ meetings are held (or on the expiry of 28 days).
Another option for a company that is under threat of insolvency is to launch the process of administration.
This enables a company to be rescued or reorganised, or its assets realised, under the protection of a statutory moratorium.
Routes into administration
An administration can be commenced by way of:
- a petition to court (a shareholder, director or creditor may petition). A qualifying floating charge holder may intervene in the application by nominating an alternative administrator or blocking the appointment altogether; or
- through an out-of-court route. The out-of-court route was introduced as a quicker, cheaper and less bureaucratic route.
When a company is in administration a full moratorium on insolvency proceedings and other legal process applies to the company. A moratorium is effectively a freeze on creditors taking action against the company and means that the administrator can get on with the business of restoring the company to profitability without having to deal continuously with the attempts of secured creditors trying to enforce their rights.
The role and functions of an administrator
The administrator (who must be a licensed insolvency practitioner) is given wide powers to carry on the company’s business and realise its assets. The three key functions of an administrator are to:
- Secure control of the company’s assets;
- Prepare proposals for approval of the creditors; and
- Carry out those proposals.
There are three different types of liquidation:
- members’ voluntary winding up;
- creditors’ voluntary winding up; and
- compulsory winding up.
A members voluntary winding up can only be done if the company is solvent and a compulsory winding up is not a decision of the company, so neither are discussed here.
The very real prospect of liquidation is well demonstrated by that of Cammac Venture Limited (the fashion label of reality television star Millie Mackintosh). This was despite being the biggest-selling brand on Asos (excluding Asos’ own labels).
A creditors’ voluntary winding up begins when the directors decide that it cannot by reason of its liabilities continue its business and it is therefore advisable to wind the company up. The directors then call a shareholders meeting where the shareholders must pass a special resolution determining that the company should be wound up.
Within 14 days of this meeting, the company must convene a meeting of the creditors, where the appointment of a nominated liquidator must be confirmed. It is common to hold the shareholder and creditor meeting on the same day, with the shareholder meeting being held first.
After the liquidator is appointed, they will carry out their work in the usual way, by selling off assets and making redundancies to cut costs and realise assets for the purpose of distributing funds to creditors.
The downside to this form of liquidation is that the liquidator’s fees are typically quite high. They may even ask for an indemnity from the shareholders if they believe they will not be able to pay their fees from the value of the company’s assets.
So, who ya gonna call?