When a company begins to struggle financially, oftentimes the directors will neglect the book-keeping and spend their time firefighting and trying to work things out. While that's understandable, it's also potentially one of the worst things you can do: the moment a company is deemed to be insolvent, a director's responsibility to act in the best interests of the company and it's shareholders changes, and he or she is then under a duty to act in the best interests of the company's creditors.
I don't think many directors know this.
What should directors be doing then?
Once a company has become insolvent, but there hasn't been an actual insolvency event, how a director should act will therefore need to change. As a general rule, the following advice should be followed:
- Always maintain accurate and up-to-date books and records, including detailed minutes of company meetings to document the decisions made
- Establish the reasons for the financial difficulties and consider the future strategy of the company.
- Do not continue to trade unless you realistically believe that the company can trade it's way back to solvency or secure funding. Again, document decisions.
- Do not take deposits or advance payments for orders that the company won't be able to fulfil
- Do not show preference to one creditor to the detriment of the others, not even the bank or HMRC
- Do not incur further credit if there is little or no prospect that you can honour these commitments
- Ensure you receive the true market value for any company assets you dispose of
But how do I know if my company is insolvent?
A company becomes insolvent if it's liabilities exceed it's assets (Balance Sheet insolvent), or if it's unable to pay it's debts and financial obligations as and when they fall due (Cash Flow insolvent). If you don't have accurate and up-to-date accounting information, you can't know with certainty if your company is Balance Sheet insolvent, but it's fairly obvious when a company becomes cash flow insolvent. Some of the red flags are:
- Constant pressure on the bank overdraft
- Difficulty paying HMRC on time
- Losing customers or experiencing declining markets
- Increasing creditor levels
- Difficulty making payroll on time
If a company continues to trade while insolvent, but the directors do not know that the company is insolvent, the directors may be acting inappropriately. As we have said above, directors of an insolvent company should be acting in the interest of the creditors, not the company itself. Failure to discharge their directors' duties appropriately can have personal financial implications for the directors.
I don't think many directors know this, either.
Early action is essential
Sticking your head in the sand, while tempting, and understandable, is not an option. If you want to avoid as much of the negative consequences - compulsory liquidation; personal responsibility of corporate debt; director's disqualification amongst others - then getting out in front of a distressed situation is important. First things first: establish an accurate financial picture. Until you know what you're dealing with, you can't really put a plan in place. If this feels overwhelming, we suggest contacting Acumenica immediately. We can assess the situation, identify your personal exposure and put together a plan of action. This may involve the appointment of an insolvency practitioner if the situation is irretrievable, but until we can establish whether there is a chance of trading out of the difficult position, we will have no way of knowing.
Remember though, even at this early stage, even if you only suspect your company may be insolvent, it is best to act as though it is. That means acting in the best interest of the creditors: protect the company's assets; don't incur any additional credit; don't take advance payments if you can't fulfil order; don't show preference to any creditor.
And remember, document every decision you make, including the reasons.
That's one very good reason why, even in times of financial stress, maintaining strong and accurate accounting records is extremely important.
If you think you may need some help, please contact Acumenica for a free consultation. We will discuss your options in an entirely confidential, non-judgmental, pragmatic, friendly way.
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