The fact that more businesses have not failed is the most surprising thing about the Covid-19 pandemic. However, if you look at the fashion retail sector alone, the list of some of the high profile casualties is alarming: Arcadia Group, Bonmarché, Debenhams, DW Sports, Laura Ashley, M&Co, Monsoon, Moss Bros, Oasis and Warehouse, Peacock and Jaeger, TM Lewin and Victoria’s Secret (UK Business)… with more expected.
Many of these businesses had deep rooted problems, which Covid then magnified. In particular, a number owe their demise to their failure to move successfully from bricks to clicks. This was particularly poignantly illustrated by ASOS’ and Boohoo’s respective acquisitions of the non-store parts of the Arcadia and Debenhams groups. But as business life starts to return to normality, what are the legal issues which directors of a business which has been materially impacted by lockdown should be thinking of if there is a risk that the business will not survive in the months ahead?
Covid support
The above businesses all failed when there was an extensive range of Governmental Covid support and moratoriums, see further here.
These support measures are however being gradually withdrawn and businesses will once again be subject to pre-Covid regulations. The re-introduction of wrongful trading risk, alongside the ability of creditors to take meaningful enforcement sanction, are the main likely drivers in forcing boards into action.
Wrongful trading
The onset of the pandemic in March 2020 saw the Government suspend the wrongful trading provisions of the Insolvency Act 1986. Generally a UK company is its own legal entity and directors should not be personally liable for its actions. There are exceptions to this rule (known as piercing the corporate veil) such as for serious health and safety breaches or the failure to file documents at Companies House. One of the biggest risks is wrongful trading, where provisions enable a liquidator of a company, in certain circumstances, to apply to the Court to seek contribution orders from directors and/or ex-directors. The liquidator must show that before the commencement of the winding-up, the company carried on incurring liabilities when the director “knew, or ought to have concluded, that there was no reasonable prospect of the company avoiding an insolvent liquidation”.
From 1 July, we expect this suspension could be lifted. If wrongful trading then becomes a live issue for directors, they may be forced to try and take advantage of statutory defences. But the law sets a high bar for these defences to work. Thought given now and, possibly, action taken by directors may help.
In contrast a resignation from the board will not necessarily save a director from liability!
When giving thought to what this all means, it is worth bearing in mind that:
- If directors take on further debts with no solvent end game in sight, the risk of personal liability is high.
- Recent feedback from liquidators is that few, if any, would be brave enough to bring claims against directors for their handling of business during the pandemic. But from 1 July this may well change.
Statutory demands / winding up petitions
Since March 2020, companies have been able to delay the payment of debts with impunity. Creditors could complain and even obtain court judgments, but enforcement was another matter. Pre-Covid, creditors could threaten a statutory demand and follow up with a liquidation petition. In effect the Covid moratorium gave debtors a “Get out of jail” card if they could show that their failure to pay creditors was due to Covid. Again, this will change on 1 July (in the absence of any extension) and the Courts will be bracing themselves for an influx of winding up petitions.
Options available to directors
Boards and individual directors are increasingly seeking advice about the impending changes and their options, namely:
1. Negotiating with creditors to restructure debts
The above heading could see landlords swapped for creditors.
Businesses which have previously filled office space with 100 plus staff have seen their space requirements reduce by over a half as a result of:
- successive rounds of redundancies; or
- a move to full or part time home working, or
- both.
Unless personal guarantees or large deposits are in play, often tenants can go to landlords and deliver a fairly stark choice. Either (a) agree a substantial rent reduction / surrender of space or (b) prepare to hear from an administrator/liquidator.
Landlords are often in a difficult position as there is hardly a queue of replacement tenants looking for further space. However they will also be reluctant to set a rent reduction/surrender precedent, particularly if there are other co-tenants of the building.
2. Looking for a sale
Whilst many businesses have suffered during Covid, many others (particularly those with a strong online offering) have found themselves cash-rich as sales have soared and expenses have reduced. This could fund an acquisition spree and directors of struggling companies should consider the option of picking up the phone and speaking to competitors, or other potential enquirers, to see if there is any appetite to buy them out.
They may find that such a proposal gathers shareholder support either because it allows them to claim loss relief on EIS type investments or because that they may be able to take advantage of the current CGT rates before the further rises in taxes that is expected to help to pay the national Covid bill.
3. Mothballing
In the second half of 2020, consideration turned to mothballing businesses: costs being taken out of the business with a view to kick starting it again, when calmer trading conditions have returned.
In practice, the proposals only tend to work for businesses holding limited assets such as IP. Mothballing tends to be a non-starter for any businesses with material liabilities (such as office space) or which are dependent on critical employees. Very few staff will agree to put their life on hold and be made redundant with an understanding that they will re-join in the future.
4. Support from directors / shareholders / the Government
2020 saw many businesses turn to their shareholder base, directors, banks and even the Government (Future Fund) for financial support. All these options require legal and accounting / tax input, as there are often many legal obstacles to overcome. For example:
- If you are borrowing from a director and they request a high interest rate/security, should you seek the approval of the shareholders?
- What should your board minutes say and is the lending director entitled to participate in the meeting?
- What further complications are raised if the loan is convertible?
Companies should therefore take professional advice before proceeding with the fund raising/borrowing process. In respect of Government support, the Future Fund was closed to new applicants on 31 January 2021 but bounce back loans will be available to the end of the year.
5. Worst case scenario
Some companies are planning for the changes in respect of statutory demands / winding up petitions on 30 June by looking at, in particular, pre-pack proposals. Again, this is further complicated by changes that were introduced on 30 April, see here.
Boards should be aware that there are a range of options when calling in turnaround expertise. As well as contractual processes such as CVAs, a new moratorium procedure was introduced in 2020 to assist with business rescue. This prevents secured creditors from taking any action against the company. The moratorium initially lasts for up to 28 days, with the ability to extend and be overseen by a ‘moratorium monitor’. There are also new rules preventing key suppliers from refusing to work with financially challenged customers.
We have found that the earlier clients speak to an insolvency practitioner, the better the result. We can certainly help with an introduction to firms that we are very used to working with.
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