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Risk is inevitable but don’t gamble on your business

Posted on: 31 Oct, 18

When your business faces financial difficulty you need to know: Are you insolvent? What are your options? What is the risk to the business and the directors?

I had this pretty surreal dream last night, Oury. I was in a casino that was full of CEOs, crowded around roulette tables and betting on their businesses.

Clark says...
Oury says...

Have you been up late watching gangster movies and eating cheese again, Clark? We’ve talked about this.

No…but I think this constant talk about the Death of the High Street might have crept up on me. What with Jamie’s, House of Fraser and Debenhams all hitting trouble it’s a bit disturbing.

Clark says...
Oury says...

Well it’s not easy running a business and there are times when you do have to roll the dice.

So, if you take a gamble that doesn’t pay off is that game-over or are there steps a business can take when it is insolvent?

A company is deemed to be insolvent when either:

  • Its liabilities exceed its assets; or
  • It is unable to pay its debts as they fall due
Clark says...
Oury says...

There are insolvency procedures that a company can adopt in an attempt to alleviate these financial pressures. The most common are liquidation, administration and something known as a company voluntary arrangement, a CVA.

So you’re not necessarily bust if you adopt insolvency procedures?

Clark says...
Oury says...

No, not at all. In fact, administration and CVAs are concerned with enabling the business to continue trading. However, the reality is that once people realise you are in trouble it can have such a devastating impact on your customers and employees that sadly it is rare to come out of administration with the same owners. Liquidation, on the other hand, involves the closing of the business and the sale of assets in order to meet debts owed, whether in full or in part. Technical rules apply to each and…

Oury! Is this going to involve lots of technical details and just reading out legislation? I overheard enough of that when you dragged me to your speed-dating event last week.

Clark says...
Oury says...

First, I saw how much you enjoyed that speed dating, and second, you are absolutely right… let’s not get lost in jargon. There are technical details and most of these are set out in the Insolvency Act but it’s possible to explain them relatively simply.

Phew! And by the way, I was only smiling at the speed dating because you seemed to be having so much fun…

Clark says...
Oury says...

That’s because I was pretending to be a lion tamer, you should try telling people you’re an accountant, it’s a disaster. Anyway, administration is commonly used when a company cannot continue trading because its debts are so significant but there remains a viable underlying business which can be sold as a going concern.

A going concern means that the business retains the assets and resources - such as commercial premises, stock and staff - to continue operating but its debt needs to be restructured.

So would a customer even know when a company enters administration or does it all happen behind closed doors?

Clark says...
Oury says...

The reality is that customers will know and staff will know. I mean let’s face it, the boss leaving is generally a pretty major event!

The boss leaves?! That could be fun. Like when they leave early on a Friday.

Clark says...
Oury says...

Not really because an Insolvency Practitioner is then appointed to take over the day-to-day running of the company. In this period creditors are prohibited from taking steps to recover assets or taking certain legal actions against the company and so the Insolvency Practitioner will usually attempt a swift sale of the business.

Hmm…not such fun then.

Clark says...
Oury says...

No and as you can imagine an Insolvency Practitioner rarely has sector knowledge and is not there to drive the business forward to success. They are there to protect the creditors and will generally adopt a method of minimising damage to recover income by putting in systems of cash flow and accounting to carefully document where the business is financially.

That’s what happened with House of Fraser, wasn’t it? The business was sold to Sports Direct on the same day that it went into administration. By making an offer for House of Fraser after it went into administration, Sports Direct acquired the business free from its debts.

Clark says...
Oury says...

Exactly and that’s a huge plus for a potential acquirer but not so good for the poor creditors. Sadly that’s the way it is: some people keep their jobs, others lose theirs and the company carries on. The big losers are the creditors but hopefully they can individually stomach the loss.

I’ve seen a few of these big high street brands and restaurants entering into CVAs. How are they different to administration?

Clark says...
Oury says...

CVAs basically involve a company making a deal with its creditors that they will accept a pro rata reduction in the debts owed to them.

Can any creditor agree to the pro rata reduction in debt, or do all have to agree?

Clark says...
Oury says...

No, it requires the support of creditors who own 75% of the total debt of the company to vote in favour of the proposal. A number of household retailers have been seeking terms in the CVAs that reduce liabilities, particularly rent reductions on leasehold premises. This has been met by strong opposition from landlords who believe that they are being unfairly treated.

Well I guess their concern is justified when they receive lower rents and retail is the only viable use for the properties they hold. But I guess something is better than nothing isn’t it?

Clark says...
Oury says...

Yes, particularly as there may be even less money available to creditors when administration or a CVA fail to rescue the company and it goes into liquidation.

Liquidation is the end of the road for a company. Its assets are sold, the profits are distributed to creditors and the company is struck off the register or dissolved.

Thinking about it, my big concern is for the directors of these companies that are in difficulty. Often the first concern of any director is the potential personal liability. There’s a real risk for any person holding the position of director if the company becomes insolvent isn’t there, not only officially appointed directors but also de facto or shadow directors?

De facto directors: are individuals who perform the acts and duties of directors but are not officially appointed.

Shadow directors: are where appointed directors take instructions from a non-appointed individual concerning the corporate affairs of the company and act on these as instructed then that individual could be deemed to be a shadow director.

Clark says...
Oury says...

Exactly. There are two principal claims that can be brought against directors of a company that goes into liquidation: fraudulent trading and wrongful trading.

Fraudulent trading is the most serious and means that offences such as fraud or theft have been committed but it is really quite rare, whereas instances of wrongful trading are far more common but remain actually incredibly hard to prove. That’s right isn’t it, Oury?

Clark says...
Oury says...

Exactly. Wrongful trading occurs where the decision taken by directors to continue trading causes avoidable loss to creditors. This often means that liabilities and debt are incurred or increased and credit is taken on in the full knowledge that there is no reasonable prospect of the company being able to meet these obligations and so going into insolvent liquidation. Any director found to have committed wrongful trading may be personally liable to contribute to the company’s assets to help meet the demands of creditors and they would risk being disqualified from being a director of a UK company in the future too!

Yikes! But surely there are times that when you look at the big picture and know that it is possible to trade your way out of financial difficulty?

Clark says...
Oury says...

Of course. Where directors act reasonably, sensibly and within the law then they can navigate periods of financial difficulty whilst avoiding wrongful trading. With the risks to the company and directors being so great the key is to hold your hand up when you are worried. Go see your accountant, get your management accounts up to date, do a cashflow, speak and meet with the other directors. Ask: can we continue, what are the real opportunities, what can we do? There will likely be a series of these meetings and it so important that you involve the decision makers and document the discussions had and decisions made. It is a vital part of any defence to show you were considering the problem properly.

So what you’re really saying is don’t bury your head in the sand, take advice, talk to your other directors. Don’t keep gambling and hoping on a big win to save the business.

Clark says...
Oury says...

Yes. In business there is rarely a silver bullet, a huge deal that changes everything, mostly things are grey. If the company is struggling you have to look at everything: all costs, all income and be realistic. It is not a case of looking at accounts from yesterday and saying, “Oh it might be alright tomorrow”… is it alright today? What can we do, what is the tangible reality, what do the numbers look like today? What does your accountant think? What do your sales team actually know they are going to bring in? Most entrepreneurs live on a permanent knife-edge whilst they build the business. The law isn’t there to undermine them and stop them taking these risks but there comes a time when you switch from tough, to impossible and you need to recognise it. Not just for the risk but for yourself, your employees and your investors.

Too right. There’s a big difference between taking a calculated risk and taking a gamble.

Clark says...

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We are but two fictitious characters throwing out ideas and comment to stimulate debate and collect information. As professional service firms, we are open minded people and think independent thought and debate is essential to help understand, as well as navigate, complex problems. By joves – doing business across Europe (and the world) is set to become a whole lot more complex in light of recent seismic political events. As businesses - we provide information and hopefully some wisdom - and we see this blog and its caricatures merely as a much more fun, perhaps slightly controversial way, of stimulating debate and collecting ideas. We’re searching for some true pearls of wisdom, and as we find them, we’ll share them with you.

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