Contractors' guide to insolvency, Part Two

(Continued from Part One)

Protecting positions – pride comes before a fall

Ordinarily when a business is performing well, the first duty of a director is towards the company shareholders. When things are going wrong the duty moves over towards protecting the creditors. The defence to an accusation of wrongful trading (which can enable the “veil of incorporation” to be lifted and company liabilities to be passed on to the directors personally) is that they took “every step possible to minimise losses to creditors”.

Not all directors realise that the protection of a limited liability company can be lifted. However, when a director allows a company to continue to trade after the time when they knew, or ought to have known, that there was no reasonable prospect of avoiding insolvent liquidation, they can be held personally liable for the debts incurred after that date.

This is why, when things start to go wrong directors should maintain a good documentation trail. What they are doing, and why, may seem obvious at the time; however, things may look very different when reflected on. A liquidator will have the benefit of hindsight and, without a contemporaneous note, detailing their thinking behind their actions, directors may find themselves at the wrong end of a disqualification hearing or worse – personal liability.

No creditors’ position should be allowed to get materially worse by virtue of the business struggling on. This also means avoiding pitfalls such as entering into transactions at undervalue or preferring one creditor to others. By the same token directors in trouble cannot just abandon ship – they should take stock, establish their position and determine which they think is the best way forward. To resign from office is seldom likely to be considered taking every step possible to minimise losses to creditors.

Who is going to help you through the turmoil that surrounds you at this time? Your family and friends will undoubtedly be on your side and will want to support you. A description of lenders during the recent banking crisis was “the three F’s” – Friends, Family and Fools. What you actually need is a critical friend. Someone who will test and challenge your assumptions and, if necessary, tell you that ‘Yes, your bum does look big in that!’ A pat on the shoulder and a soothing ‘there there, it’ll be all right’ won’t do. A sticking plaster on an arterial wound will never be sufficient.  Get in touch with someone who has been there, done that and, preferably, comes recommended. 

And ostriches prevail. It takes a lot of guts to admit to anyone that your entrepreneurial zeal has come to nought. You’d told everyone about your venture and your hopes and dreams for it. Now you are having to face reality. Probably on your own. Maybe you are at the stage of making sure you are the first to the letterbox in the morning in order that loved-ones don’t see the stream of threatening letters landing on the mat. The earlier the likes of me are spoken with, the wider the range of options likely to be available. Picking up the phone to, or walking through the doors of an insolvency practitioner does take courage. But rarely are the realities as bad as the imaginings.

What next?

There are a number of forms of insolvency. For companies, the main ones are administration, which has largely replaced administrative receivership, other forms of receivership, liquidation (solvent members voluntary liquidation, insolvent creditors voluntary liquidation and compulsory liquidations - generally started by a creditor through the courts) and company voluntary arrangements (CVA). In addition there are procedures for partnership and individuals as well as for limited liability partnerships and unincorporated businesses. Some processes can lead to others (you may exit an administration via a CVA or liquidation), but all liquidations lead, eventually to a company being struck off the company register – liquidation is simply the winding-up of the affairs of a company prior to its dissolution.

Having discovered the problem, gone through a creditors meeting, you will finish that process and find yourself wondering ‘what next?’ If the meeting was to consider an administrator’s proposal you may still have work to do; if it’s a CVA then you will have to make the proposal work and see it through.

For the purposes of this article let us assume that you have just concluded creditors’ voluntary liquidation meetings and the IP is now your company’s liquidator. The IP isn’t working ‘for’ you now. They are acting for the creditors and might not even be from the firm you initially instructed; creditors determine who is to be liquidator based upon the total value (not number) of creditor claims they represent. But for the majority of run-of-the-mill meetings no creditors attend or are represented, and the votes are cast by proxy vote with the creditor instructing the chairman (by post) in whose favour their vote should be cast.

Possible disqualification

Soon after the meeting of creditors you are likely to receive a letter from the liquidator containing a Company Directors Disqualification Act 1986 (CDDA) questionnaire. In addition you may receive a copy of a circular to creditors which, in addition to telling them how to download the report to creditors and minutes of the meeting, will also ask them for “any evidence of wrongdoing by the directors in their conduct of the company which matters ought properly to be brought to the attention of the Secretary of State (SoS) for the purposes of the CDDA.”

This is standard and does not mean that anyone thinks you have done anything wrong. Every IP has to ask you questions about how you managed the business and to invite observations from those who have suffered as a result of the failure – your creditors. Within six months of appointment the IP should report, confidentially, to the SoS their findings and it is for the SoS to determine whether or not proceedings should be taken against you to prevent or restrict you from being “involved or concerned in the promotion, formation or management of a limited company” – disqualifications can be for between two and 15 years.

Additionally you are likely to receive demands under any personal guarantees you may have given. If you guaranteed to a bank they are likely to have already made their demand immediately upon receiving notice of the meeting of creditors. This is, as much as anything else, simply their way of ensuring that they secure the earliest date possible from which additional interest, fees and charges can also be claimed against you, the guarantor. However, and this might be seen as good news, none of the people having guarantees are likely to want to see you declare yourself bankrupt. Those going bankrupt may lose a lot but their debts too will be written off by virtue of the bankruptcy; dividends of more than a few pence in the pound are rare.

In closing...

Whether the life of your company is coming to an end for good reasons or bad, you want to plan your exit with the assistance of professionals who have travelled along this path before. In the case of solvent liquidations timing can be crucial – especially where tax year-end is approaching and there are merits to making distributions either side of the tax year-end. When things have NOT gone to plan, you want to know that what you are doing will keep you out of trouble; not risk your personal assets and ensure that you have a better than fair chance of being able to remain a company director, if that is your preference, in the future.

This is the second part of a two-part guide, exclusively for ContractorUK, by Peter Windatt. He is an accountant and licensed insolvency practitioner with BRI (Business Recovery and Insolvency). He has previously chaired the Joint Insolvency Examinations Board (the exams that all IPs must take to qualify), and currently chairs the Insolvency Committee at the Association of Chartered Certified Accountants.

Editor's Note: Beacon LLP provide contractors with a specialist insolvency service. With Beacon LLP contractors can close down their limited company in as little as 24 hours with no upfront or hidden costs, for more information please click here. 

Related Reading –

Seven mistakes limited company directors make

Contractors’ Questions: Will I be disqualified as a company director?

Two freelancers, one conman and a doubling in fees

Closing a Company - MVL

Wednesday 18th February 2015