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With the pandemic largely behind us, business owners now find themselves having to repay their Bounce Back Loans or Business Interruption Loans at a time of high inflation and whilst they are trying to re-build their ‘pre-Covid’ turnover levels.
Many diligent company directors are seeking advice as to whether they should be continuing to trade at all but, in most cases, the advice is that they can proceed – just with caution. Common concerns which are raised are as follows:
A period of loss making can cause directors a lot of anxiety. When a company becomes insolvent on a balance sheet basis, the duties of the Board switch to being owed to creditors rather than shareholders, which means that transactions can potentially come under greater scrutiny should the company ultimately fail.
However, if the company still has some reserves and is meeting its liabilities as they fall due, then there is no need to factor in contingent liabilities when deciding if the company is insolvent. These might include redundancy costs or costs relating to the termination of a lease, which might crystallise if the company did cease trading. If the intention is for the business to improve its finances and retain its current work force then the Board can make decisions on that basis, provided the company is solvent.
A recurring theme when a Board is concerned about the future of the company is that discussions and decisions should be recorded so that the Board have a note of their thought processes at the time.
Whilst company shareholders are under no obligation to provide funding to cover a company’s losses, they may well wish to do so with a view to returning the company back to profitability and preserving what they have managed to build up. The shareholders should ensure that they have the most accurate management information in order that they can assess the risk of potentially not seeing a return on the money. If the additional funds are put into the company as a loan, then shareholders will need to be mindful that their debt will be ranked as unsecured in the event that the company doesn’t survive.
Investors might consider whether the company is able to grant security to the lender over its assets in respect of new funding. A lawyer would be able to advise on how that might legitimately be achieved.
If a company reaches a stage where it is unable to meet all of its obligations as they fall due then the Board need to think carefully about which payments are prioritised. If certain creditors are paid at the expense of others and the company subsequently fails, then a Liquidator could look to overturn the transactions or pursue personal claims against the directors.
For such a claim to be successful, a Liquidator would need to show that the directors had a desire to prefer the particular creditor rather than the motivation being a legitimate business need – for example to precure an essential supply of goods. As before, the best defence that directors can have against potential scrutiny of such transactions is a contemporaneous note recording the Board’s decision making process at the time of making payments.
Personal claims against directors could arise where additional debts are incurred when there is no reasonable prospect of the company avoiding an insolvency. If the Board are continuing to trade on the basis of future funding being obtained then they should carefully record minutes of discussions and decisions to set out a record of why trading continued and why that was expected to improve the position of the creditors of the company.
The Board are not expected to be able to see into the future but they should be able to explain their motivation should the funding not ultimately materialise, which might leave the company unable to pay its debts.
In conclusion, there are three key lessons here:
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