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Preparing for insolvency

03 April 2008

If you are director of a company that is in financial difficulty, your focus must shift towards minimising the potential loss to the company's creditors. Solicitors Michael Fiddy and Jonathan Leitch explain

The problem

I own a small group of pubs, but the company is in serious financial straits. Should I carry on trading to try and save the business or would I be better off selling up now?

The law

The chancellor's decision to hike duty on beer and liquor is likely to add to the misery being felt in the pub industry. With the smoking ban, and rising rent and energy costs, it is understandable why many operators are considering quitting.

However, if you have concerns about the solvency of your business, it is vital to understand the legal environment in which you operate and the personal risks of continuing to trade.

The focus of a company's director is to promote the success of the company and, in doing so, maximise returns to its shareholders. However, once the company is at risk of becoming insolvent, limiting any potential shortfall to the creditors becomes paramount. Once a director realises that the company has no reasonable prospect of avoiding insolvent liquidation, he must take every reasonable step to minimise potential loss to the company's creditors. The failure to do this could result in a liquidator pursuing a director personally.

Expert advice

This can be a worrying time for directors faced with unfamiliar circumstances. It is important to seek legal advice from an insolvency expert early on, as this represents one of the best defences to a wrongful trading claim. If your financial records are poor, these should be addressed immediately. If you have bank facilities, you might consider approaching it to discuss what help the bank can offer. It might be worth approaching suppliers to explore whether better terms or discounts can be negotiated. This might improve the near-term trading prospects of the company, and key suppliers might be willing to compromise on their margins to preserve a trading relationship.

If an analysis of the finances determines that the company is insolvent and has no prospects for recovery, you must take immediate action to minimise the potential loss to the company's creditors. At this stage, you should consider approaching an insolvency practitioner or seeking legal advice if you have not done so already.

Check list

  • Assess all the business's debts and liabilities. Is your company able to pay its debts?
  • Consider restructuring bank facilities and agreeing an extension of time for repaying borrowings. A lender will often prefer this to the write-off that might follow in insolvency.
  • Maintain communication with key suppliers and seek improved terms.
  • Enlist the help of an insolvency expert or legal adviser wherever possible to understand your options and the risks of continuing to trade.
  • Consider all possible courses of action open to the company. A director will not be exonerated simply by acting honestly.
  • Do not accept any new credit unless certain this can be repaid.
  • Consider your duty to the creditors of the business. Trading your way out of the problem might involve substantial personal risk, but by obtaining legal advice you should at least be in a position to make an informed decision.

Beware!

If a person is found guilty of wrongful trading, the court has a wide discretion to order them to make a contribution to the company's assets. The court will try to assess when the director should have concluded that the company had no reasonable prospect of avoiding liquidation and then determine what further loss has been suffered as a consequence of the business continuing to trade.

A director could be held liable to make a substantial contribution to the company's assets, and if unable to pay, could face bankruptcy proceedings.

Contacts

  • Michael Fiddy, partner, DLA Piper UK 020 7796 6325
  • Jonathan Leitch, partner, DLA Piper UK 020 7796 6368
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