Business pressures can arise across sectors regardless of wider economic conditions. When financial strain appears -whether actual or anticipated – directors are required to design and implement strategies that protect the company and support its long-term survival. Decisions taken at such times may engage duties owed to the company and, as insolvency risk increases, to its creditors, and can expose directors to personal liability and, in some cases, criminal sanctions.

As a director, you should keep your statutory duties under active review and examine all aspects of the business that are, or may become, affected by financial pressure.

Directors’ Statutory Duties

Under UK insolvency law, directors may be held personally liable for the company’s debts and, in the worst cases, prosecuted for fraudulent or wrongful trading if they continue to trade a company that is insolvent.

Solvency can be tested on either a cash flow basis (the company‘s ability to pay creditors in cash within terms) or a balance sheet basis (assets versus liabilities). A solvent company is able to meet its long-term debt obligations whereas an insolvent company is unable to pay its debts even if it has liquidated all of its assets.

Your general duty as a director is to promote the success of the company for the benefit of its shareholders as a whole. However, if you are no longer confident that the company will remain solvent, your legal duty shifts from acting in the interest of the shareholders to safeguarding creditors. Although the interests of the shareholders remain relevant during any period in which the company is, or may be, insolvent, the interest of the creditors comes first. You must also ensure that your personal interests are separated from the company’s interest, particularly if you are a shareholder as well as a director.

If you have doubts about the solvency status of the company, you can minimise your personal liability risks by:

1. documenting every action that is taken in the interest of the company and its creditors;
2. recording the grounds for your decisions together with any professional advice received;
3. maintaining comprehensive board minutes, dealing with any conflicts of interest or concerns;
4. reviewing the company’s financial position regularly to assess its solvency status;
5. seeking professional advice;
6. conducting regular board meetings and involve all directors in the decision-making process, especially the finance director; and
7. maintaining an open and transparent relationship with the creditors and preferably communicate necessary information to major creditors through the company’s advisors.

The above list is not exhaustive and legal advice should be sought in all circumstances.

Any action or omission to act which does not reduce the losses to creditors or increases the company’s liabilities, can lead to a director being personally held liable for wrongful trading. This means if you continue trading a company where you knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation, then you may have to contribute towards the company’s debts or liabilities out of your own pocket. In order to defend such claims, you will need to show that you took every step possible which a reasonably diligent person would take to minimise potential loss to the company’s creditors.

Factors such as the size of the business and your function would be considered. For example, a financial director would be expected to have a higher degree of competency over account matters. Liquidators usually seek an overwhelming amount of evidence, making it prudent to ensure that your financial documents are all in order and up to date.

An alternative for claiming compensation and damages against a delinquent director is a misfeasance action which means directors can be held personally liable for misapplication or retention of the company’s assets or for breaching their fiduciary or other duty. Unlike a claim for wrongful trading, a misfeasance action is brought in the name of the company, therefore it is quicker and simpler to pursue. These are only two examples of the type of claims that can be brought against a director. If you are in doubt, seek legal or financial advice to minimise the risks of potential claims against you.

Managing business debts

As well as taking steps to protect yourself personally, you should formulate a viable strategy for the company to avoid formal insolvency proceedings. In particular, you should review the company’s funding arrangements and if necessary, consider debt restructuring options. For example, you may want to convert debt to equity or convert short-term debt to long-term debt.

The most common method of debt restructuring is refinancing, which means obtaining a new loan to repay existing loans or overdrafts. If the existing lender is unwilling to refinance, you may arrange alternative sources of funding from other financiers. Refinancing is often used by businesses to either: (a) change to fixed rate products, such as a fixed rate loan, which can provide better cashflow predictability; or (b) negotiate more manageable payment schedules with the existing/new lender.

The finance documents involved in these types of transactions usually include a new loan facility agreement and/or new security or guarantee. You can modify existing agreements or transfer them to a new lender to save time and costs of drafting and negotiating new terms. However, it may be more commercially advantageous to record your arrangements on new terms, particularly where a new lender is involved.

You should keep in mind that a company need not be in financial difficulty to begin considering refinancing. As mentioned below, you should review the company’s financial position regularly and explore viable options.

Employment considerations

You should also consider how an economic downturn may affect your employees and any future recruiting strategies you may have planned. As a first step, you should open an honest dialogue with your employees and support your staff during uncertain times. This helps to preserve a trusted relationship within the team, reduces stress and panic among the staff and minimises personnel shortages created by a large number of employees simultaneously looking for more secure employment.

In addition, you should generally be wary of hiring new employees during the times of financial uncertainty and instead consider whether retraining and upskilling existing staff may address the grounds for hiring new candidates. There may also be circumstances where redundancies are unavoidable. If that is the case, you should take legal advice to ensure that you do not incur costs which could be avoided. For example, for defending employment tribunal claims arising from improperly handled redundancies. The following considerations will need to be taken into account:

As a positive reinforcement, you may want to adopt one of the tax-advantaged employee share option schemes. This allows you to maintain your cashflow while motivating employees to stay with the company. The most common employee share option schemes in the UK are EMI and CSOP, which provide the employers and the employees with certain tax advantages. You can find out more information about EMI option scheme here.

Final thoughts

At Maybrook, we believe that it is better to act than to react to a situation as actions are often based on evaluating and analysing the issues objectively and making calculated decisions. Rather than reacting to an economic downturn, it is more prudent to plan for and implement strategic initiatives that will secure the longevity of your company. We frequently advise and assist businesses, lenders, and investors with debt financing transactions. We strive to find alternative solutions to meet our clients’ needs. If you want to discuss your case, please get in touch with a member of our corporate or commercial team.

Our insights, articles and guides do not, and are not intended to, constitute legal advice or be an exhaustive review of all legal developments. Although every effort is made to ensure that the information provided in this article is accurate as of the publication date, please be aware that this area of law may be subject to change. Please seek legal advice before applying the information provided to any specific circumstances, transactions or legal issues.