We understand that at present a number of companies are facing challenging times and boards are being asked to make difficult decisions and grapple with an uncertain future.
This note provides an overview of the law for boards facing these challenges.
The important point to make at the outset is that the law does not require boards to be perfect or to have access to perfect information. Most companies facing such challenges face uncertainty and have to manage risks and the law acknowledges this. What it does expect is for a board to act reasonably and take reasonable steps before acting.
Below are 5 steps a board can take to put itself in a much better position. The rest of this note expands on this and details some other practical steps:
- Constantly monitor if you are able to conclude that the company has a reasonable prospect of avoiding insolvency
- Take appropriate professional advice and follow it
- Ensure access to reliable financial information and constantly update and monitor that information
- Put the interests of creditors first
- Meet regularly and minute your deliberations.
When a company starts to experience financial difficulties the duties of the board shift over time from prioritising the interests of shareholders to protecting the company’s creditors.
As part of this process the board has to apply the “wrongful trading test”. This requires the board to continually consider whether the company has a reasonable prospect of avoiding an insolvent liquidation.
This does not mean the company has to be balance sheet solvent now. What the board needs to ask is:
- Does the company have a plan which will enable to the company to get to a point where it is balance sheet solvent?
- Is the board able to conclude that there is a reasonable prospect of that plan being implemented?
In considering the viability of the plan the board should identify each of the conditions that have to be met in order for the plan to be implemented, which will include various cash flow considerations, and then assess whether there is a reasonable prospect of each condition being met.
It is important that this test is repeated at regular board meetings and that the considerations and the conclusions are carefully minuted. Ideally the minutes should contain details of the basis for reaching the conclusions, providing contemporaneous evidence of the board’s deliberations. See further below.
Obtain suitable professional advice
In dealing with these matters it is very important the board obtains appropriate professional advice. Boards can face difficult decisions where the outcome is uncertain. The risk for the board if they get this wrong is either personal liability or potential disqualification for being involved with the management of a company for a period of up to 15 years. What the courts have said is that provided the board has taken professional advice and followed it then then this will offer a significant amount of protection for the board members.
Maintain accurate financial information
In order for the board to be able to assess its position it is very important that it has access to accurate financial information that is constantly updated.
The precise details will vary but this is likely to include:
- A detailed business plan
- Cash flow projections, showing any pinch points where exposure is likely to peak.
Put the interests of creditors first
The first duty of a board is to act in the best interests of the company. When a company is in good financial health then the priority is to consider the interests of shareholders. As the financial position weakens that duty shifts towards creditors and may reach a point where the board is acting solely to protect creditors.
In order to understand how this translates in practice it is important to take some practical steps:
- The board has to consider the interests of the creditors of the particular company. How this interacts with a company which is part of a wider group can be complex and is beyond this note but the first stage is to understand the current liabilities of the company in question.
- Are some of the creditors secured or do they have other rights to rank ahead of other creditors?
- As well as protecting the position of existing creditors it is very important to be careful about taking on new credit during this period.
- The board should constantly evaluate in its deliberation and minutes whether the proposed actions are in the interests of creditors and consider the impact of actions on creditors.
- As above, these issues can become complex quite quickly so always take advice.
Meet regularly and record your discussions
Having undertaken the above steps it is very important that the board meets on a regular basis to review the plan it has put in place against the financial information available to it.
As a default position we would suggest these meetings be attended by professional advisers (again this will vary depending on the facts) and this is an opportunity for the board to record that it has at all times sought to act in accordance with advice and in the best interests of creditors.
The purpose of recording this is that the board is seeking to provide a contemporaneous record which you can rely on in the future. This is because if a company does have to enter an insolvency process a director could be faced with questions months or potentially years later asking why the board took a particular step. It is incredibly difficult to answer these questions at a later stage without any notes. By maintaining full minutes this enable the board to record its thought process and also the advice received and can provide an answer to these questions.
This note is just a high-level summary and it is not possible to provide a comprehensive guide. It is though useful to flag a few more points that commonly arise for a board to have in mind:
- Do not transfer out any of the company’s assets other than for full market value
- Avoid preferring one creditor over another – either repaying a particular creditor or granting security
- It will often be appropriate for the board to start to develop a “Plan B”, so that if the company does fail then the board has taken steps in advance to ensure creditors are protected as far as practical.
- You cannot mislead or lie to creditors. Communicating with creditors is a very important aspect and is another point where professional advice is crucial.
If you require further information about anything covered in this briefing, please contact David Fletcher, or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, March 2020