COVID-19 – Insolvency Moratorium
Guest content: Phil Deyes, Director, Leonard Curtis Business Solutions Group
In times of business uncertainty, the questions around a business taking on additional credit, fall in to sharp focus. Many businesses are now taking on credit to manage working capital requirements as opposed taking on credit for the purposes of growth or acquisition. Cash generation from sales is diminished, but the need to meet the fixed costs of the business remain.
To manage any cash shortfalls, business owners may have taken advantage of a BBL or a CBIL. At such low rates of interest and the extended periods over which the loan is repaid, they are a very sensible form of credit. There is no question that such credit is probably the most competitive in the market place.
However, when a company is deemed as insolvent, then a directors responsibility shifts from acting in the best interests of the company, to acting in the best interests of the creditors. This will include acting in the best interests of those you are obtaining credit from. Credit should not be incurred, where a view is formed prior to taking on that credit, that the company has no prospect of repaying the credit taken on. In the same way, you should not be taking in more supplies of good and services, on credit terms, if you do not believe that when the goods or services fall due for payment, the company will not be able to settle that credit.
There are two key points to be drawn from this;
- Knowing when your business may be classified as insolvent, or rendered insolvent by taking on additional credit;
- Understanding how to record and document business decisions regarding taking on credit, during a period where the company’s current and future trading prospects remain uncertain.
The test for insolvency is covered by two definitions. The company only needs to meet one condition to be deemed insolvent. The first is a cash flow test, known as the inability to pay debts as and when they fall due. This could be, for example, being unable to pay Crown debt when due, trade suppliers within normal credit terms, or wages and salaries pay able for hours worked. You can of course, agree alternative repayment terms with your creditors (for example a time to pay arrangement with HMRC). The second is a balance sheet test, which looks at your overall balance sheet position. If your balance sheet is negative, then you can be classified as insolvent.
Many businesses, may feel they fall within these definitions or perceive they may soon be so categorised. Directors must therefore take care when making decisions around taking on credit. The risk to a director, if proven to have recklessly taken on credit, is a potential action that can be brought by a future liquidator, should the company unfortunately proceed in to liquidation. One of the roles of the liquidator, is to investigate the actions taken by directors, in the lead up to liquidation. A liquidator will normally gather evidence to identify when a company was insolvent and then examine the actions taken by the directors from that date to the date of the actual liquidation of the company and this can include decisions around taking on additional credit. If it can be proven that such credit was recklessly incurred, then the liquidator may be able to bring a personal action against the director, for what is known as Wrongful Trading, notwithstanding the limited liability status of the company.
During this current pandemic, the Government has recognised that the risk of a Wrongful Trading action, may inhibit a director from taking on a BBL or CBIL and may instead decide the risk is too great and simply liquidate the business. There is therefore a temporary restriction within the newly enacted Corporate Insolvency and Governance Act 2020, which protects a director from a Wrongful Trading action by a liquidator in relation to credit incurred during the period 1 March to 30 September. This does not represent a ‘free for all credit bonanza’ but does provide a great deal of comfort to directors about the taking on of loans to help manage cash flow during this time of crisis.
When a liquidator is examining the affairs of a liquidated company or the actions of the directors, they are looking back in time, making assessments about the business decisions made by the directors and whether they were fair, reasonable and balanced. If the liquidator has access to the contemporaneous files notes, emails, Board Minutes etc taken at the time a decision around taking on credit was made, the liquidator will be able to easily access the actions taken by reference to facts at the time. It is therefore vitally important that business decisions are recorded, have sanction from all directors and are supported by reference to current and future trading and business forecasts. Also, to document how credit incurred is to be spent and for any overdue credit, what discussions are taking place with the suppliers of such credit to obtain new terms or alternative terms of repayment and/or postponement.
Providing directors act with the interests of creditors as a whole, record those decisions with reference to financial information available at the time, the prospects of a future appointed liquidator to levy sanctions personally against the directors of that company are small.