Burying the (Corporate) Dead

Insolvencies have been at unprecedented levels over the past few years and although numbers are reducing, the statistics are expected to remain high over the next couple of years.  This article, will deal with the ways companies can be “put to bed” when they become insolvent or there is simply no further use for them.  I will also discuss what insolvency is and what directors need to do to protect themselves from the consequences of their company becoming insolvent.

A limited company is a “living” entity in a strictly legal sense: it can trade, own property, incur credit, enter into contracts, employ people, sue and be sued.  It is “born” by being incorporated via Companies House; and it dies by being dissolved.  Sometimes dissolution is initiated by Companies House because the company has failed to file returns and accounts, indicating (on the face of it at least) that it is no longer trading.  For smaller companies that have ceased trading and have few or no debts or assets, voluntary striking off may be appropriate: this is done by the directors filing a form at Companies House.  If a company goes into liquidation, it will be dissolved after the liquidator has completed the liquidation.

A company may come to the end of its useful life for a number of reasons, such as retirement of the owner-directors; completion of the purpose for which it was formed; as part of a tax reconstruction; loss of viability caused by a shrinking marketplace; or most frequently, insolvency.  Other than in very small cases when a company becomes insolvent and there is no hope of a rescue or turnaround it will go into liquidation.  This can be initiated by the directors, who instruct an insolvency practitioner to act on their behalf (creditors’ voluntary liquidation); or by an application to court, called a winding-up petition, which is usually presented by a creditor.  This is called a compulsory liquidation.

A solvent company can be liquidated voluntarily as a tax-efficient way of returning funds to its shareholders or simply laying it to rest.  All the debts are settled and the balance of funds paid to the shareholders.

An insolvent liquidation, by definition, is one where not all the creditors will be paid in full.  There is a statutory pecking-order whereby the costs are paid first, followed by secured and preferential creditors, then the ordinary creditors, such as suppliers.  HM Revenue and Customs no longer enjoy any priority of payment.  Very often the company’s bank will hold a security called a debenture, which gives it priority status over unsecured creditors although the liquidator must usually set aside a legally “prescribed part” to allow for a token payment to the unsecureds.

The liquidator is an official appointed to administer the liquidation.  His role is to turn the assets into money and pay the creditors what he can.  He also has to do a certain amount of investigation to see if the directors have hidden any money away or been guilty of misconduct.  He will usually be an insolvency practitioner – a licensed specialist – although in a compulsory liquidation it could be the official receiver, who is a government official. 

Administrators are usually appointed where there is a chance the business can be turned round or traded on and sold as a going concern.  The appointment of a receiver is now very rare.  In a company voluntary arrangement, its affairs are monitored by a supervisor, whose job is to collect the funds being made available for creditors and pay them out accordingly.

Directors need to be very wary when their companies get into trouble: they can for example, end up becoming personally liable for the debts if they allow the position to worsen by trading on without regard for the consequences.  In my second part I will explain the definition of insolvency and outline some practical examples of how to deal with insolvent situations.

Companies get into difficulties for many reasons – lack of permanent or working capital, poor managerial control, declining markets or bad debts suffered when their own customers become insolvent.  The first sign is that cash flow comes under pressure – the bank might start bouncing cheques or ask the directors for personal security.  It might actually start reducing the company’s overdraft facility.  Payments to creditors become overdue and they start to threaten legal action.

There are two definitions of insolvency: that the company cannot pay its debts as and when they fall due (the cash-flow test); or that its liabilities exceed its assets (the balance sheet test).  There is no such thing as “technical insolvency” or being “technically insolvent” – the company is either insolvent or it isn’t; and only one of the definitions has to be satisfied.. 

When a company experiences cash flow problems, it is very tempting for its directors to stop paying VAT and PAYE deductions over to HMRC.  After all, what value does the company receive in return?  It’s not as though the government is supplying anything, is it?  It’s not like failing to pay a supplier, who will put the company’s account on stop if its invoices are not paid.  Actually it can have serious consequences: running up large Crown debts is one of the main grounds for director disqualification and it can also lead to claims against them by liquidators.

So, what should a director do if his company starts to come under serious financial pressure? 

• The first thing is to get on top of the figures and have a plan: all well-run businesses use forecasts to measure how they are doing.  It helps them control their spending and anticipate and prepare for any problems. 
• Review all expenditure and make cuts where possible.  Shop around for cheaper materials and utilities.  Consider redundancies and reducing his own remuneration even if only temporarily.
• Review the company’s marketing and understand where leads come from, how much they cost to generate and the conversion rate.
• Look at service/product costing and margins.
• Ask HMRC for a time-to-pay agreement if there is a danger of VAT, PAYE or corporation tax arrears building up.
• Talk to the bank and suppliers and keep them informed of any rescue plans – their support will be vital.
• Tighten up on credit control and follow up rigorously on all overdue customer invoices.
• Look at investing further money in the business or the possibility of outside investment; consider alternative sources of finance such as factoring, which is very flexible and not nearly as costly as many people think.
• Check the position weekly or even daily and monitor the bank account closely.
• If things seem to be getting out of control, seek professional advice from the company’s accountant or an insolvency practitioner without delay.

Attitudes to companies in difficulties have changed significantly over the past 10-15 years and most creditors are now happy to consider supporting a company through a rescue rather than steaming in with judgments, bailiffs, winding up petitions, etc.  The important thing is to keep key creditors informed and involved to gain their confidence so they help, rather than hinder the process.  Of course, not all businesses can be saved; but where a company is offering a good and popular product or service; and its directors are prepared to review and if necessary change the way they operate, there is usually a fighting chance.

© Alan R Price, 2011

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