The Pandemic is threatening to cause a financial crisis to equal of even surpass the horrors of The Great Depression almost a century ago. There are few parts of the UK and global economy that aren’t being affected. Right now, there a very few winners and a huge number of losers. Worst of all is the uncertainty as official guidance and the realities of trying to do business are changing moment by moment.

For many business owners, it is uncertainty that is the biggest problem.  Not knowing when lockdown will end, whether customers will still either have the money to spend or want to part with it, how your supply chain has been affected and a multitude of other unknown unknowns makes keeping going so difficult.

This brief guide looks at the practical and legal considerations that will steer the crucial decision about whether to try to fight your way through this crisis, or else accept that your business cannot survive it.

Duties of Company Directors

The Companies Act imposes a duty on directors to act in the most likely to promote the success of the company for the benefit of its shareholders as a whole, or when there is a heightened risk of insolvency, to act instead in the interests of its creditors.

So far, so vague and general. What usually makes directors think seriously about the future of their business is the moment when they realise that they may not be able to keep paying the bills and most particularly, when they know their bank won’t process the next monthly payroll. This is the real time example of one of the two tests set by the insolvency legislation: a company is insolvent if it cannot pay its debts as they fall due (or as they are demanded by creditors).

The other major trigger traditionally has been directors’ fear of being made responsible for some or all of their company’s debts if they are found guilty of Wrongful Trading, which we discuss later in this guide.

The issues facing business owners are illustrated by a recent consultation with a director of a recruitment company, which had several hundred thousand pounds in the bank but suddenly no ongoing revenue because of the crisis and substantial ongoing fixed expenditure. The question posed was simple: how long should they go on trading? The answer was more complicated, but essentially to monitor cash flow like a hawk and not go on past the point when the remaining cash could still pay the costs of closure, such as future rent payments and staff termination costs. This dilemma is haunting entrepreneurs up and down the country and is at the heart of the fiduciary duties of company directors.

Insolvency law changes

The government moved the insolvency goal posts a very long way on 28 March 2020 when it announced that it intended to suspend the Wrongful Trading provisions of the Insolvency Act for three months retrospectively from 1 March 2020. This move was intended to avoid the unnecessary closure of viable businesses, which were only temporarily affected by the crisis. At the same time, it pledged to introduce a new insolvency procedure called a Moratorium to stop aggressive enforcement action by creditors during the crisis. The requisite legislation has yet to be passed by our new virtual Parliament, but should be soon. Only when we see the full details of the new law can we fully understand its implications and the interaction this relaxation may have on other sanctions against errant directors, such as the Company Directors Disqualification Act.

Is irresponsible trading the new wrongful trading?

The fact that the potential sanction for continuing to trade too long before going into a formal insolvency has been suspended does not justify struggling on past the point of no return. Directors may not be personally liable for the time being for the extra losses suffered by creditors because they continued too long, but that doesn’t mean that those losses aren’t harming the viability of those creditors and threatening the livelihood of their staff. If your business does eventually fail, will those creditors trade with you again in a future enterprise, if indeed the write off on your debt does not force them to close too?

Government support schemes

The government has responded to the Pandemic with an almost bewildering array of schemes aimed at helping businesses survive the crisis. Some involve loans, others provide grant, more still provide payment deferrals such on the payment of VAT due for the quarter ended March 2020. Payment deferrals and holidays are also being offered by a broad range of commercial partners, notably some landlords and finance providers.

Taking advantage of a grant from any source is the least problematical, assuming there really are no strings attached with which your business cannot live. Payment holidays are equally helpful, but deferrals are more problematical. Moving a liability further along to the right in your cash flow spreadsheet doesn’t make it go away, so you need to be sure you will have the resources to settle it at that later date before you can use that as a justification for continuing to trade.

The furlough scheme for employees is also very useful as a means of cutting your costs whilst at the same time preserving your work force for when trading activity restarts or returns to nearer pre-virus levels.

The Coronavirus Business Interruption Loan Scheme (CBILS) is the one where SMEs are encountering the most challenges and not just because of the initial problems with its delivery. The issue for many entrepreneurs is that burdening their struggling businesses with debt repayments and interest costs may be the straw that breaks their financial back at some time in the future when the liability to pay clicks in.

Even those prepared to consider taking a loan through CBILS are puzzling over how much extra funding to take on, given the impossibility of predicting future trading. Basing your forecasts on the theory that the lockdown and its worst effects on business being eased after, say three months may or may not be a sensible assumption. Assessing future trading levels is another matter altogether. Whether you are in retail, hospitality, travel or any other consumer facing sector, the indications from other countries already starting to implement their exit strategy suggest that the spending tap will not be turned back on full in a hurry.

The new Moratorium Procdure

We are still waiting for sight of the details of this new anti-creditor enforcement measure, which has been promised as a key means to help embattled businesses get through the crisis. The broad details were set out in the government’s response in 2018 to its public consultation of two years earlier.  A company will be able to put itself under a Moratorium without any prior warning to creditors, subject only to the obtaining the consent of a Monitor, who must be a licensed insolvency practitioner. The effect is to prevent any enforcement action of any type by creditors; furthermore, suppliers are obliged to continue to supply on the same terms as previously. The only proviso is that the company cannot be insolvent, instead it must be ‘in a state of prospective insolvency’. It must also be able to pay all debts falling due during the Moratorium, which lasts for an initial period of 28 days and can be extended for a further 28 days again without consultation with creditors.

The government’s intention with this procedure is to provide breathing space for companies, so that they can either reach a compromise agreement with their creditors or take the necessary steps (such as raising additional funding) to rectify whatever issues are pushing it towards a formal insolvency.  The directors remain in control and this is not to be deemed to be an insolvency event, so that relevant termination or penalty clauses in contracts are not triggered.

But as with the CBILS loans and payment deferral opportunities, directors and business owners must ask themselves if taking advantage of Moratorium protection is an appropriate step for their circumstances, or simply a pointless exercise in delaying the inevitable.

Preferential payments to creditors

Directors must maximise returns for all creditors equally once insolvency is threatened, or they risk falling foul of Section 239 of the Insolvency Act. This establishes the offence of creating a ‘Preference’ whereby a particular creditor is placed in a more beneficial position to the detriment of the remaining creditors in the same class of creditors. For example, repaying a loan from someone connected to the company, such as a director’s relative, or making sure that a creditor is paid simply to encourage an ongoing business relationship post-insolvency. Another case would be where directors have provided a specific lender with a personal guarantee and repay this loan first to protect their personal finances. Preferences include the transfer of assets as well as cash payments. Directors face potential personal liability for some or all of their company’s debts if a Preference is found to have been created. For directors struggling to keep creditors at bay with limited cash resources, this must be a significant factor in deciding whether to carry on trading.

Directors disqualification

Despite the temporary suspension of the Wrongful Trading provisions, continuing to trade ahead of an eventual insolvency has other pitfalls for directors. The insolvency practitioners appointed in every formal insolvency have to report on the conduct of the directors, which in the worse cases of bad behaviour can lead to disqualification orders putting severe restrictions on their future commercial activities for periods up to a maximum of 15 years.  There’s a long list of ‘offences’, including causing customers to lose deposits they have paid for goods or services, failing to pay over amounts due for VAT and PAYE, not keeping proper books and records and other types of reckless behaviour. This is another reason why directors need to think very hard about struggling on in a situation where these sorts of outcomes can occur in the desperate efforts to keep a business afloat.

There’s no harm in taking advice

Deciding to close your business permanently is probably the toughest decision anyone entrepreneur will ever take. The emotional, mental, physical and financial commitment they have made in building up an enterprise makes it virtually impossible to be objective, especially when the margins between continuing and closing are often so slim. The personal consequences can be painful, which is another inhibitor to sound judgment.

This is why we strongly advise any business owner uncertain of what to do in these truly unique circumstances to get input from a range of sources, including trusted business advisers and independent specialists. It will protect you against accusations of recklessness if you decide to continue; it will give you a guiding hand through the process of closure if that it the right way to proceed.