In the latest of our Difficult Truths episodes of the MAP Room Podcast , we sat down with Jimmy Fish, a Licenced Insolvency Practitioner, to hear more about the often misunderstood world of insolvency.
What is an insolvency practitioner?
An Insolvency Practitioner is an officer of the court who is licensed by an authorised regulatory body to undertake formal insolvency appointments within the United Kingdom.
Only licensed insolvency practitioners are authorised to act on behalf of companies, and individuals, when they are facing insolvency or financial distress. An insolvency practitioner’s decisions about what to do with an insolvent company or individual will be based on what process results in the best return for creditors.
In its simplest form, an insolvency practitioner realises assets and distributes the proceeds to creditors. Insolvency practitioners are licensed and regulated, and their fees are agreed with creditors or the courts. Transparency is at the heart of any process and the Insolvency practitioners’ fees and reports about their cases are filed with Companies House and are publicly available.
What is the legal definition of insolvency?
A company is insolvent if it has insufficient assets to discharge its debts and liabilities. There are different tests to determine insolvency, depending on the context in which the expression is used.
Section 123 of the Insolvency Act 1986 defines the tests of insolvency as : –
- Balance sheet test = liabilities outweigh assets
- Cash flow test = cannot pay debts as and when due
Does insolvency still hold a taboo status and if so, why?
There is no taboo in admitting financial distress or admitting an insolvency. Often it is the fear of failure that stops entrepreneurs from seeking help, and most of the time when an entrepreneur does decide to reach out for experts’ assistance, it is at a very late stage.
The earlier someone seeks advice the better, as the problem can be more easily solved and there will be more options available to the Company to overcome the issue(s). Accountants and Insolvency Practitioners offer a helping hand to entrepreneurs to ensure that seeking help is not a taboo anymore.
What are the responsibilities of the company director in this matter?
Directors are responsible for the day-to-day management of their companies. Their role is set out in company law, the company’s constitution (Articles of Association) and, if they have employees, their employment contracts.
Directors owe legal duties, such as the duty to promote the success of the company for the benefit of its shareholders. But when a company is in financial difficulty and there is a risk of insolvency, directors owe a primary duty of care to creditors to minimise their losses.
What are the 3 most common errors / issues that lead to insolvency?
The mix of poor financial management and a consistent lack of appropriate cash levels is one of the biggest causes of insolvency. Most small business owners are good at their craft, as a designer or a web engineer for example, but they are not accountants and can find it difficult to stay on top of the books and figures, which results in a lack of reliable, up to date, financial information.
Budgeting plays a big part in effective financial management in that a solid budget can often predict the highs and lows of the business cycle and so allow you to make better decisions in areas such as spending and cash collection. Also in the smaller business, we often see the owner / directors failing to separate business and personal accounts, running personal expenses through the business.
If your business is laden with too much debt, then this is always a challenge. The same is true if you don’t have an effective debt recovery procedure in place to make sure you get your money when it is owed.
But the biggest mistake we see is not taking advice sooner and battling on too long. Burying their head in the sand only further increases the chances of insolvency and facing any financial hardship head on may open up your options and help you steady the ship before it’s too late!
Where do you see companies continue to trade insolvently, not knowing or understanding?
One area that is often entered into with the best of intentions, is where the proverbial carrot gets dangled on a new contract and the business rushes to increase resource and their own costs.
Complex projects also must have a clear and understood payment schedule within them, so the supplier is not holding all that cost without payment until the last possible moment.
It is also important to remember that we simply don’t know what we don’t know and all too often it is hard for the directors to recognise the signs or worse have denial, where we see directors pumping personal money into companies, to stop them having to make what are difficult decisions.
What are the process options?
Company Voluntary Arrangement – CVA
This is a formal agreement with creditors to repay debt over time. This maybe at a discount, or sometimes written off, depending on the agreement of all the secured and preferential creditors plus at least 75% of unsecured creditors.
One of the attractions of a CVA is that the company remains as a going concern.
Administration
We can see a good business with contracts and employees to preserve, but too much debt and creditor pressure is making life difficult, if not impossible. Here the IP files for a period of moratorium to relieve creditor pressure whilst the business and assets are marketed for sale, once an independent valuation of the business and assets is made.
The best bits are sold to a new limited company and the creditors are left behind with the old company, where the creditors seek to share any cash realisations after costs. Under this process employees will often transfer with the business under TUPE regulations, and so administration can be the preferred route for employees.
The business is sold to the highest bidder, which may be a competitor, but can also be the old directors, known as a connected party, subject to high level of scrutiny and reporting requirements.
Creditors’ Voluntary Liquidation (CVL)
CVL is where directors voluntarily decide to close their business down because it has become insolvent and therefore cannot legally continue trading. Often as result of a terminal insolvency event, such as the loss of a major contract or client.
The business ceases to trade as it is no longer viable, and the company has effectively come to the end of its economic life. Liquidation results in the formal winding up of the company and the redundancies of all staff who can claim against the government Redundancy Payments Services. There is no salvaging of the business, and any assets are sold at auction.
The directors can purchase the assets at fair value and can set up again post liquidation, but will be automatically prohibited from using a name similar to that of the previous company that is in liquidation. Again, an independent valuation of the assets is key to this strategy.
Compulsory Liquidation
The process that is out of the hands of the company is when the company is wound up by the Court, resulting in investigations by the Insolvency Service.
What does life look like for the directors involved following insolvency?
Putting aside the significant disappointment and maybe embarrassment associated, there is not as much effect as many believe. If you wish to continue in the same line as the old business, then you may struggle getting credit from a supplier, sometimes having to pay higher process or pay on a pro-forma basis.
Existing contracts may also be at risk, as there is often an insolvency clause of a supply contract that allows the buyer to cancel any agreement.
On a personal level for the director of a limited company there is limited liability, where the debts fall away with company unless any personal guarantees exist. And a company failure has no impact on personal credit ratings etc as the public record is against the company and not against their name.
Where personal liability can occur is when the IP is obliged to investigate the conduct of directors and identifies any areas of misconduct that could result in claims to be pursued for the benefit of all creditors.
Here the insolvency practitioner has a number of powers available to them to track down missing assets, reverse pre-insolvency transactions, and investigate wrongdoing by individuals and company directors.
What leads to a director’s ban?
Director disqualification proceedings can be launched if it is believed that a director has been involved in (or has allowed others to be involved in) unfit conduct.
‘Unfit conduct’ includes:
- Allowing a company to continue trading when it can’t pay its debts
- Not keeping proper company accounting records
- Not sending accounts and returns to Companies House
- Not paying tax owed by the company
- Using company money or assets for personal benefit
- Taking deposits for services they knew wouldn’t be supplied / worsening the position of creditor(s)
Serious Misconduct occurs where a loss to creditors exists due to theft, preference payments, transactions at an undervalue, wrongful trading or excessive remuneration. This can lead onto criminal investigation.
Section 212 of the Insolvency Act 1986 addresses the legal concept of misfeasance and makes a director personally accountable to pay back to the company the amount of the loss caused by any misfeasance to the extent that the court so orders.
I certainly hope that this situation does not come into your business, but it is important to understand how to recognise the signs early and then how you can reach out for help and support.
Many issues I see are simply down to ignorance….But ignorance is not a defence!
