The recent news on the BBC about the rise in insolvencies makes for tough reading. But those who are in business already know how difficult it is out there as they try to weather the trading conditions. Inflationary pressures are increasing the costs of providing goods and services to customers, eroding profitability. Reliefs such as bounce back loans, Coronavirus Business Interruption Loans and postponed HMRC debts – all given at a time when it was expected that life would "go back to normal" immediately after COVID - all now need to be repaid. With interest rates rising, the cost of borrowing has increased, which makes accessing cash more difficult. It is no wonder that insolvencies are on the rise.
Irrespective of what sector you operate in, if you are a director of company, or indeed a member of an LLP, then you do need to be mindful that the decisions you make during tough times are capable of being reviewed in the event of insolvency. The Insolvency Service (IS) has recently produced new guidance to directors entitled Director duties upon insolvency.
An important distinction to make between the UK Government statistics reported by the BBC and the Insolvency Service's guidance is that "insolvency" isn't a term of art. It simply means an inability to pay debts. The Government's report discusses formal insolvencies i.e., when a company enters into an insolvency process and an insolvency practitioner is appointed; whereas the "insolvency" discussed in the IS guidance may actually happen before a formal insolvency process commences. Namely, the period in which a company is, or may be unable to, pay its debts or is balance sheet insolvent - sometimes referred to as the "zone of insolvency".
For directors, this is the danger zone. Ordinarily, directors are not personally liable for a company's debts, but - and crucially - they can be if they allow the company to trade while insolvent, either wrongfully or fraudulently. Directors can also become responsible for a company's debts if they are malfeasant in office. This is what the IS guidance seeks to highlight.
No director thinks their conduct will be challenged – most are trying to do their best in a difficult situation. However, what I know from years of experience in supporting companies, directors and business stakeholders through the challenges of financial distress is that insolvency can be incredibly stressful and challenging. Directors should be very careful to avoid making poor decisions, which could have long term repercussions for them personally as well as professionally.
My number one piece of advice for anyone facing financial distress is to take advice as early as possible. This is the best way to ensure that you mitigate the risk of longer term repercussions.