Turnaround in business fortunes

Given the current economic climate, some operators may worry about the threat of insolvency. Vernon Dennis, head of corporate recovery and reconstruction at Howard Kennedy Solicitors, offers some advice

The Problem

In the current economic climate, restaurant and hotel businesses are facing tough times.

The previous readily available options of increasing overdraft facilities or refinancing to inject capital into the business may simply be unavailable. Despite any current financial difficulties, the management might feel that the business is fundamentally sound, that better times will return and that it is appropriate to trade through difficulties but what if they are proved wrong?

The Law

Where a company has gone into insolvent liquidation, a director may be held personally liable and ordered to contribute to the company's assets where some time before commencement of winding up the director knew, or ought to have concluded, that there was no reasonable prospect that the company could avoid insolvent liquidation. This is called wrongful trading.

Expert Advice

Successful entrepreneurial activity requires risk taking. But in deciding to continue to trade the management should keep in mind that, in the event of business failure, their decision-making will be scrutinised.

Management who have sought to introduce reasonable measures to turn around the fortunes of the business and in light of these measures take a carefully considered decision to continue to trade, even if proved wrong, will not be criticised.

Doing nothing, waiting for better market conditions and/or taking imprudent risks is bound to cause problems.

Where a company is insolvent on either a cash-flow or balance sheet basis, the director's overriding duty to promote the success of the company - and thus to act in the best interests of its equity stakeholders - shifts to an obligation to act in the best interests of its creditors.

To immediately cease trading on becoming insolvent may be far from in the best interests of creditors. Indeed, employee and supplier liabilities might be greatly increased. Continuing to trade can be entirely justifiable if it can be shown that it was intended to minimise potential loss to the company's creditors.

To give themselves a defence against an allegation of wrongful trading, there is great onus on the board to show that they took reasonable steps, such as: identifying problems early obtaining the best possible financial information preparing a coherent plan for business reconstruction and obtaining and following advice from appropriate professionals.

Check List

• Obtain accurate, up-to-date financial information.
• If possible, identify the causes of financial difficulty.
• Assess, as a board, the steps that could be taken to resolve the financial difficulty.
• Draw up a plan of action, but remain flexible.
• Meet regularly to discuss the changing situation.
• Carefully minute decisions taken.
• Obtain professional accounting and legal advice.
• Consider discussing the situation with key creditors. If possible, obtain support.
• Review longer-term contracts and orders.
• Review cost base generally.
• Consider alternative options, such as immediate cessation of business, versus restructuring.

Beware!

A director might be ordered to compensate the company for the additional losses caused by trading past a point where a reasonable director would have concluded that insolvent liquidation was inevitable.

Directors' disqualification proceedings may also follow, as well as a raft of other civil and even criminal proceedings. It is important to act quickly and decisively, and to document that, after a full evaluation process, a decision to continue to trade in an attempt to turn around the business is justifiable.

Contact

Vernon Dennis, Howard Kennedy Solicitorsv.dennis@howardkennedy.com