A director's role in managing financial and operational stress

Out-Law Analysis | 22 Jul 2020 | 10:02 am | 3 min. read

A director's duty to promote the success of the business for the benefit of their shareholders must give way to their duty to act in the best interests of creditors where their company experiences financial difficulty

The recently enacted Corporate Governance and Insolvency Act 2020 in the UK temporarily suspends certain of the wrongful trading provisions of insolvency law until 30 September 2020. However, directors' duties to creditors during this period continue and the relaxation is far from absolute in what it covers. With continued good governance in mind, directors would therefore be well-advised to continue to act proactively, with due care and diligence and seek to preserve value for stakeholders.

The new Act provides mechanisms that directors of distressed companies can invoke to explore a potential route for their company out of financial difficulty and avoid insolvency.

 

Actions for directors

In cases where their business is distressed, directors will want to ensure they have regular, minuted board meetings, analyse up-to-date financial information and forecasts, monitor compliance with financial covenants and rigorously consider the use and availability of existing credit facilities.

Where appropriate, directors should consider both increasing or seeking alternative funding support from lenders, investors and other stakeholders such as customers and their own supply chain. Opportunities for assistance from government funding schemes should also be explored - a number of schemes have been outlined by the government to support businesses through the coronavirus crisis. Directors might also want to consider how they might reduce the outflow of cash by consensual arrangements with creditors and HMRC.

Early intervention is important. Directors should seek professional advice – both legal and financial – to allow the business the greatest prospect of trading through operational or financial stress. The short term wrongful trading provisions are not enough to protect directors who ignore advice.

 

The Corporate Governance and Insolvency Act 2020

The Corporate Governance and Insolvency Act includes three provisions which will be of significant interest to directors of distressed business: a new company moratorium, a new restructuring plan and a prohibition on supplier insolvency termination clauses.

 

Moratorium

Under the new company moratorium, insolvent companies or companies that are likely to become insolvent can obtain a 20 business day moratorium period which will allow viable businesses time to restructure or seek new investment free from creditor action.

To obtain the benefit of the moratorium, the directors will need to make a statement that the company is, or is likely to become, unable to pay its debts as they fall due and the 'monitor' must make a statement that it is likely that a moratorium for the company would result in the rescue of the company as a going concern. The monitor’s role will be limited to ensuring that the company complies with the requirements of the moratorium and approving sales of assets outside the normal course of business, as well as approving any grant of new security over the company’s assets. The directors will remain in charge of running the business on a day-to-day basis.

 

Restructuring plan

The new restructuring plan has been modelled on the existing scheme of arrangement procedure but with the addition of the ability to cram down across classes of creditors, binding both secured and unsecured creditors. No financial entry conditions apply which mean that both solvent and insolvent companies can propose the plan. Creditors vote on the plan in separate classes, however, it will be for the court to grant final approval to the plan if it feels the plan is just and equitable.

In both the moratorium and restructuring plan, secured creditors are bound into the arrangements that reduce their traditional influence over the strategy of a business in a time of stress.

 

Termination

UK insolvency law already includes measures to prevent certain core suppliers, such as utility suppliers, from stopping supply, or threatening to stop supply, only by reason of the company's insolvency. The new law extends this prohibition to all suppliers, with limited exceptions, if the supplies continue to be paid for, and also prevents suppliers from amending contract terms to force increased payments. Suppliers can, however, be relieved of the obligation to continue supplying if it causes hardship to their own business.

This requirement to continue supplies will present a valuable tool to those up the supply chain to engender rescue and continuity without falling foul of traditional "ransom" payments as a condition of continued supply.