Directors' duties - a practical guide for directors of companies facing financial stress

This is inevitably a challenging time for many company directors throughout Northern Ireland and beyond. Businesses have been faced with a quite unprecedented set of social and economic circumstances due to the Covid-19 pandemic and now, as lockdown has eased and restrictions begin to be lifted, the focus turns to how those businesses that have been most severely impacted by this crisis will evolve. Directors are no doubt busy strategising how to best ensure their company’s immediate short term stability and in time their longer term growth and prosperity.

According to the latest Quarterly Economic Survey published by the Northern Ireland Chamber of Commerce and Industry and BDO earlier this month around 77% of members confirmed that they had furloughed staff and 12% have had to make redundancies. Furthermore, just over half of members highlighted their intention to reduce staff levels post Covid-19 and the implication from almost 1 in 5 members was that they felt their business was ultimately unlikely to survive.

Similarly, the PMI report recently released by Ulster Bank for June 2020 claims that “Companies remained pessimistic regarding the 12-month outlook for output amid concerns about the long-term impacts of Covid-19.” The stark reality of the impact of the pandemic on the private sector is evidenced in the further reported reductions in output, new orders and employment.

During this slow emergence towards regaining economic activity it is imperative that directors of limited companies tread carefully through the legal minefield of their duties and obligations and avoid common pitfalls associated with insolvency such as wrongful trading and preference payments which could lead to disqualification and personal liability.

A director is normally under a duty to act in the best interests of the company and its shareholders. However, this is the position when the solvency of the company and its long term future is not in question. The position changes dramatically when the company becomes insolvent or enters the zone of insolvency.
Below are some practical tips that may serve as a useful reference framework for guiding directors through this difficult period and hopefully towards a successful return to trading.

In simple terms a company is deemed to be insolvent if either the value of its liabilities exceeds the value of its assets, commonly known as the ‘Balance Sheet Test’, or if it is unable to discharge its liabilities as they fall due, commonly referred to as the ‘Cash Flow Test.’ If a company satisfies either of these tests then it is technically insolvent however it is not uncommon for a financially distressed company to satisfy both tests at the same time.

A period of insolvency can sometimes be a fleeting or temporary event where the company can ride out the financial difficulty and continue trading healthily into the future. Directors therefore have to be extremely vigilant at identifying when their company’s financial problems are more than just a minor bump in the commercial road.

The following is by no means a complete list but directors should consider the following:

Carry out a financial assessment of the company as it currently stands and map out clearly the plans for the company going forward. Does the company have a realistic prospect of trading its way out of its current difficulty? If the answer is yes, then record the assumptions or basis for reaching that decision but then frequently revisit whether those assumptions remain valid and record any changes and whether that affects the overall assessment of the company’s future prospects. These discussions should include all of the directors and the full contemporaneous records of those meetings including the rationale behind the decisions reached should be carefully retained for future reference.
The financial position of the company, to include reviewing the previous assessments of the company’s financial position with a view to determining whether same is improving or worsening, should become a standing agenda item for the board of directors.
The directors should review how often they currently meet and judge whether that remains sufficient or whether more frequent meetings would be appropriate, even for an agreed short term period.
Embrace technology and the ability to meet and share information among the directors in a more efficient and convenient manner than perhaps has gone before. Electronic transmission of large documents and video calls have proved invaluable to the business community during recent months.
Keep abreast of the local business, legislative and economic news. What are other companies similar to yours doing? Have you taken advantage of all available financial support packages?
Engage with your creditors, do not ignore them. Explore the possibility of payment holidays, more preferable payment terms, return of surplus stock. Remember that there is an existing commercial relationship that both parties will normally want to continue with into the future.
One of the primary pieces of advice is to be careful not to do anything to worsen the company’s financial position, especially in terms of its ability to make a return to its creditors. Do not deplete the company’s assets, do not increase the company’s liabilities or grant favourable security to the company’s creditors. All creditors should be treated in the same manner and be aware that any payment to a creditor that is deemed to be a preference payment, which is a payment designed to put that particular creditor in a better position in the event of a liquidation than the other creditors, can be ultimately challenged and overturned if the company ends up in liquidation. This normally means that the Court will order that particular creditor to repay to a liquidator the full extent of the preference payment that they previously received. This could potentially lead to separate insolvency consequences for that particular creditor if it was unable at that stage to repay the monies in full.

It has never been more important for directors to avail of early professional advice to ensure that they are informed and supported in making those difficult and delicate decisions in relation to their company. The earlier advice is sought, the more options are normally available to you and the more time you will have to fully explore those options.

TLT have a team of insolvency and restructuring experts with the experience to support local businesses in finding the right solutions by providing clear and practical advice.

If you would like to arrange a consultation with a member of our team please get in touch.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at July 2020. Specific advice should be sought for specific cases. For more information see our terms & conditions.