Weighing up the cost

Lance Feaver, Partner, Lawrence Graham LLP, shares his views on some of the issues that may arise in the current market

Finding ways to reduce costs is, for many, easier than finding new business in the current climate and this has given rise to more clients thinking about ways to achieve a reduced cost base. Increasingly, more innovative practices are being adopted by businesses, such as the avoidance of redundancy programmes by
offering employee sabbaticals, unpaid leave or shorter working weeks. In addition, companies are looking at ways of generating cash and maintaining cash flows to keep the business alive. In this issue we explore a couple of key issues that may well be relevant to a business in financial difficulties:

1. What happens if a struggling company decides to sell assets cheaply to bring in cash?

If a company has assets and they are in financial difficulty it might be tempting to sell them off at significantly less than their real value (whatever that may mean in today’s market!). If they do and at the time the company is insolvent (or becomes insolvent as a result), the transaction may be set aside by a liquidator or administrator. So be careful, as this can catch transactions that take place in the two years before the onset of insolvency.

2. What happens if a struggling company prefers one creditor over another?

Generally speaking, paying off one creditor ahead of others in an effort to keep the business going, rather than because of a desire to prefer the creditor, should not constitute a preference. But if you put a creditor in a better position than it would have been in should an insolvent liquidation occur, perhaps by granting security over assets to that creditor but not to others, again the deal may be set aside.

3. What is wrongful trading and how might it concern me as a director?

Directors of companies facing financial difficulty should be aware of their legal responsibilities and duties and in particular the risk of wrongful trading, which carries the risk of both personal liability and possible disqualification from being able to act as a director in the future.

If a company’s financial situation deteriorates then a wrongful trading action may be brought against company directors and, in the event that the business becomes insolvent, the directors may be asked to contribute personally to the company assets, if at some time before the winding up the director knew or ought reasonably to have known there was no reasonable prospect of avoiding insolvency and failed to take every step to minimise loss to the company’s creditors.

The important point is for directors to show that they did take such steps, and to make sure that these (and the reasons behind them) are recorded in the board minutes. In looking at their roles in any wrongful trading, directors will be judged on both their actual general knowledge and their specific function, so a finance director would be judged by a different standard to a sales director, because of their understanding and experience of financial matters.

You can’t escape this liability by resigning – it’s not that simple, former directors can also get caught!

Like all of these things, taking advice is the oftensaid, but never underestimated, rule of thumb. When companies are in financial difficulty, taking advice early can help to ensure you are protected.