Blockquote icon
Once the line is crossed, directors face the risk of significant personal liability for wrongful trading
John Nugent

Introduction

Covid-19 economic disruption means you as a company director must think differently, particularly if your company enters the “twilight zone” of potential insolvency. If it does, your conduct as a director could later be closely scrutinised.

Risk Umbrella

The “twilight zone”

The “twilight zone” is generally thought to occur when a company encounters financial difficulties – cash flow problems, tightening of credit terms by suppliers, and pressure from lenders about existing and new facilities. If you’re in the twilight zone, you must think primarily about your creditors and treat their interests as paramount. A company moves out of the twilight zone and into insolvency when the directors know, or should know, there is no reasonable prospect of the company avoiding insolvent liquidation. Ask yourself – can I pay my creditors? Should I be incurring new debt? Once the line is crossed, the directors face the risk of significant personal liability for wrongful trading.

As a consequence of Covid-19, the wrongful trading rules were suspended from 1 March. Does this mean directors should act differently from before? Almost certainly not. According to the related Government statement “all of the other checks and balances that help to ensure directors fulfil their duties properly will remain in force”. The relaxation should not be taken as a get-out-of-jail-free card.

The temporary measures are designed to ensure directors aren’t rushing to put their companies into administration, but the majority of other checks and balances remain in place to ensure directors comply with their duties. You must continue to act in the best interests of all creditors and have a reasonable belief that the company can avoid being insolvent.

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Blockquote icon
The temporary measures are designed to ensure directors aren’t rushing to put their companies into administration
John Nugent

What can you do?

Examine the company’s financial position and assess likely outcomes. If the position deteriorates, seek advice from an insolvency practitioner to ensure that any decisions taken can withstand scrutiny.

Although counter intuitive, it might be that the company should continue to trade even if it’s likely that insolvent liquidation can’t be avoided. If the company owns valuable intellectual property rights or other assets which will achieve a much higher value if sold on a going concern basis, and lose that value on insolvency, it may well lead to a better outcome for creditors if the company is traded for a further short period to allow those rights to be marketed and sold. The difficulty will be judging how long to keep trading if a buyer can’t quickly be found.

Overall, ask yourself:

  • Is there sufficient cash to pay debts as they fall due and for as long as necessary to enable the company to deal with balance sheet issues or finalise any restructuring process?
  • If the company can’t pay its debts as they fall due, is there a realistic prospect of it being able to do so in the near future, and before any creditor takes steps to commence winding-up proceedings?
  • Does the company have net assets or net liabilities on its balance sheet? Pay attention to contingent liabilities, which may not appear on the balance sheet at present, but which the company may have to meet in future.
  • Are there any critical dates on which events might occur that will change the company’s circumstances, for better or worse?
  • Is there any prospect of external funding?
  • Is there interest in buying the company’s business?
  • Could the company’s debts and liabilities be restructured?

Provided you carefully monitor the financial position (which includes considering cashflow forecasts and compliance with financial covenants), hold and minute regular board meetings and take professional advice early on, you should be okay.

John Nugent Author Photo

Written by John Nugent
RD for South East and Principal at My Inhouse Lawyer

One of our values (Growth) is, in many ways, all about cultivating a growth mindset. We are passionate about learning, improving and evolving. We learn from each other, use the best know-how tools in the market and constantly look for ways to simplify. Lawskool is our way of sharing with you. It isn’t intended to be legal advice, rather to enlighten you to make smart business decisions day to day with the benefit of some of our insight. We hope you enjoy the experience. There are some really good ideas and tips coming from some of the best inhouse lawyers. Easy to read and practical. If there’s something you’d like us to write about or some feedback you wish to share, feel free to drop us a note. Equally, if it’s legal advice you’re after, then just give us a call on 0207 939 3959.

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