WHAT NOT TO DO WHEN YOU FIND YOURSELF IN A PIT!

When we first leave school and start work, it’s usually for another person and the Boss, who is a Partner or Director of the business, can seem like a demi-god, often driving around in a big flash car, owning a small stately home and exuding wealth and well-being from every pore.?The more ambitious of us quickly aspire to have what he/she has and strive for a level of success that will bring those rich rewards and all that goes with it.

As our career develops and we take on more responsibility, it becomes more obvious that it isn’t that easy to attain our goals and when we reach that happy day of being made-up to Partner level or an executive role, it quickly dawns upon us that success comes with a price.?Responsibility brings with it an enormous amount of baggage in the shape of regulation, obligations towards employees and sleepless nights thinking about where the next job’s coming from, what can be billed and how cash flow will stand-up for the next month/year.?It’s not quite the Shangri-La we expected.

Those who rather than climbing the greasy ladder decide to set-up their own business, usually come to this realisation a bit sooner.

Now, as an Insolvency Practitioner, I admit that I do tend to be a bit cynical, having seen thirty-six years’ worth of other people’s business failures.?These have been for a variety of different reasons, but can easily be summarised in three classes. Bad luck, incompetence or just plain villainy.

The first of these probably occurs most frequently, when something happens outside the control of the business owner which may be insurmountable, such as a large bad debt (or a pandemic).?The second one may simply be due to the fact that there is very little to prevent people from starting-up a business, there are no minimum requirements to demonstrate competence before so doing.?Anyone can assume the mantle of company director, simply by buying a company off the shelf for a few pounds.?It is perhaps small wonder that so many business start-ups don’t last longer than a couple of years.?The third one speaks for itself.

The past year and a bit has been extraordinary, in so far as the stultification of trading within many sectors has not seen a concomitant amount of business failure.?This is, of course, mainly due to the rafts of government measures put in place which have enabled businesses to survive, but not to thrive.?Moratoria on statutory demands, bankruptcy and winding-up petitions, coupled with the job protection scheme, government backed loans free of personal liability for company directors, protection from wrongful trading actions and general creditor leniency, have combined to enable owners to effectively hibernate their businesses for the duration.

However, sooner of later all good things must come to an end.?

The beginning of July has seen the start of winding-down of the furlough scheme.?Decisions will have to be made as to whether the workforce can be brought back or whether redundancies will have to be made.?Government backed loans will start to be collected and creditor pressure will increase in relation to the deferments allowed during lock-down.?Protection against wrongful trading has not been extended, meaning that directors must ensure that whatever actions they now take do not run foul of that section of the Insolvency Act.

Wrongful Trading is where a director causes a business to continue to trade after the point when a he knew, or ought to have concluded, that insolvent liquidation was unavoidable.?Unlike Fraudulent Trading, which is a criminal offence, Wrongful Trading is a civil offence with a lower burden of proof. If found guilty, a director may be punished by disqualification and may be made personally liable for any liabilities which arose as a results of his actions.

There is always a temptation for business owners to start thinking of ways to protect not only their business, but also to avoid putting their own personal assets at risk. This is where many pitfalls and bear-traps can catch-out the unwary and is where taking proper advice becomes so important and establishing what not to do is every bit as important as what to do.?If there is any chance that the business is, or may become, insolvent then the importance of avoiding these traps is so important.?The test for insolvency will be whether the businesses liabilities outweigh the assets or if it is unable to pay its debts as and when they fall due.

As businesses come back to life, many will find that cash flow is tight and there will inevitably be a temptation to start repaying those creditors who are felt to be more deserving.?If matters become untenable and the business becomes insolvent, then such payments may be seen as voidable-preferences, which may later be overturned by a liquidator.?If the payment is to a connected party (e.g. family or friends or a connected business) then there is a statutory presumption that it is a preference and a director will have to prove that he was not influenced by a desire to prefer, in a reversal of the usual burden of proof.?The transaction itself may be set-aside by a court, but for the director it may constitute a breach of duty (misfeasance).?Misfeasance carries a penalty of possible disqualification from being a director of a limited company and/or a fine.

One of the most frequent pitfalls encountered is where a director, who has personally guaranteed the company’s bank account, ensures that money is paid-in against the overdraft or loan, but at the expense of not paying other creditors.?As a result of the personal guarantee, not only is the bank effectively preferred, but he/she will also have preferred himself/herself.?Directors who are creditors by virtue of having a director’s loan account must avoid the temptation of causing the company to repay that loan account ahead of other creditors.

?In a similar vein, directors (or sole traders) facing possible insolvency may sell assets in order to generate funds, but may do so at an undervalue.?They may even transfer assets away from the business with the intention of keeping them out of reach of creditors.?If this is done with a connected party, then again, the burden of proof is effectively reversed and the court can make a restitutionary order and the director/business owner will again face sanctions under the Insolvency Act 1986 and the Company Directors Disqualification Act 1986.

The above is but a small sample of the pitfalls that can befall unwary directors and business owners.?They can easily catch-out the unwary, which is why it is going to be so important, as we slowly resume business as usual, that proper planning and forethought is undertaken.?As the old adage goes, if you find yourself in a pit, it’s time to stop digging.

The first port of call for assistance should always be the business’s accountants, but the team at John Harlow Insolvency & Corporate Recovery are always on hand for free confidential initial advice if difficulties are encountered.?If you wish to discuss any matter please contact us at mail@harlowinsolvency.co.uk or call on 0116 275 5021.