Concerned about a company’s solvency? What are your options?
Solvency is a key consideration for many directors in the current environment. If you have concerns as to the solvency of a company where you are a director, it is important to address them early and consider whether continuing to trade is in the best interests of the company and its creditors. Taking prompt action will mean you can consider and assess a range of options. We set out below various avenues that may be available to you if you consider the company may be (or may become) insolvent. This includes current director safe harbours, debt hibernation, voluntary administration, creditor compromises, receivership and liquidation.
If you would like to discuss your concerns or your next steps, then please get in touch.
Director Safe Harbours
On 3 April 2020, the Government announced a safe harbour regime for directors in regard to certain director duties under the Companies Act, including reckless trading. The purpose of the regime is to give companies that are impacted by COVID-19, the confidence to continue to trade in situations where directors may be nervous about solvency and potential personal liability. In order to fall within the safe harbours, the directors need to certify that the company was able to pay its debts when due on 31 December 2019 and that in good faith the directors consider that the company has or will likely face liquidity issues in the next six months due to COVID-19 and it is more likely than not that the company will be able to pay its due debts from 30 September 2021. For more detail refer here.
This is not a solution for a company that has no real prospect of recovery. Rather it is a way to give directors confidence to continue to trade, where without this safe harbour, they may be quicker to consider resignation or to liquidate an otherwise viable company. Note that these safe harbours are only available until 30 September 2020, unless the time period is extended.
Business Debt Hibernation
This regime was also introduced as part of the COVID-19 response. It is intended to give a company breathing room to engage with its creditors and to seek to agree to defer some debts to allow it time to work through its recovery. A company can enter debt hibernation if 80% of the directors agree and the company was able to pay its debts as at 31 December 2019. Similar to the safe harbours, directors will also need to certify that the liquidity issues are a result of COVID-19 and it is more likely than not the company will be able to pay its due debts from 30 September 2021. Following notifications to the Companies Office and creditors, the company will be allowed an initial one month moratorium on debt enforcement (excluding holders of general security interests), during which the company will put a hibernation proposal to creditors. If the proposal is approved (by 50% of creditors by number and value), the company will have a further six month hibernation period.
This regime is directed towards viable companies that need time to get back on their feet following the pandemic. It cannot be used to reduce the amount of debt owing – only reduce the amount payable during the hibernation period. It is not a solution for a company with no real prospect of recovery or of ever being able to meet its existing and future debts. More detail can also be found here.
Often companies in distress will negotiate a compromise with their creditors. This may involve reducing the amount owing or altering the timing or other terms of payment and may be formal or informal.
An informal creditor compromise can be undertaken at any time as a commercial negotiation, and does not require a specified process. An informal arrangement can be non-public, but will only bind those creditors directly party to it.
A formal creditor compromise is carried out under the Companies Act and if creditors vote in favour by the requisite majorities, will bind all creditors. The directors can propose a compromise if the company is insolvent or believe it will be insolvent. A compromise can also be proposed by a receiver, liquidator or by a creditor or shareholder with leave of the court. The compromise will be adopted if approved by creditors (by 50% in number and 75% in value), however dissenting creditors can apply for relief. Broader schemes of arrangements can also be approved through a separate court process.
These procedures are useful where the company is insolvent but could recover by restructuring the terms of its existing debts. Note that there is no moratorium on debt enforcement or protection for directors for insolvent trading while working through this process, so directors need to remain mindful of their duties during this time.
Voluntary administration is a process for insolvent or near insolvent companies and is designed to resolve the company’s future direction quickly. One of the main purposes of voluntary administration is to provide breathing space free from creditor enforcement steps, during which an independent and suitably qualified person (the voluntary administrator) takes full control of the company and can assess the company’s situation, continue to run the business if appropriate, and seek to put together a proposal for the company’s future. It also allows directors to protect them selves from personal liability during this time if they are concerned about insolvent trading.
Directors can resolve for the company to enter into voluntary administration if they consider that the company is or may become insolvent. An administrator can also be appointed by a liquidator, fully secured creditor or by the court.
The administrator is there to form an opinion as to whether it would be in the interests of creditors for the company to enter into a deed of company arrangement (which may include a process to realise assets over time and specify how creditors will be repaid), be returned to its directors or be placed in liquidation. The creditors vote to approve whether the recommended path is to be followed.
Receivership is a process whereby a secured creditor enforces its security to recover a debt due. The relevant security document will enable the secured creditor to appoint a receiver, who will take over the management of the secured assets, generally for the purpose of selling the assets to repay the debt. It is not uncommon for the board to invite the appointment of a receiver if it is in financial difficulty and is seeking a resolution through an insolvency process.
The receivership applies to the secured assets only and the receiver’s rights will be set out in the applicable security document and at law. The receiver’s primary duty is to act in the best interests of its appointing secured creditor, and in good faith and for a proper purpose. Often following a receivership there will be little value left in the company and it often leads to liquidation.
The shareholders of a company can resolve by special resolution to appoint a liquidator. A liquidator can also be appointed by the board if the constitution allows, or by the court. As above, liquidation can also follow voluntary administration or receivership.
Liquidation is for companies with no prospect of recovery. A liquidator will seek to realise the assets of the company, return funds to creditors in order of priority and ultimately the company will be de-registered.
It can be a difficult and uncertain time if you are a director of a company that is facing financial distress. We suggest you seek out professional advice and consider your options from an early stage. As outlined above, there are a range of tools available to the company and what is right for your company will depend on its current circumstances and future prospects.
If you would like assistance to work through this process, then please get in touch with the Lane Neave Business Law team.