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Lexis+ AI
Stephen Wade

Partner, Bishop & Sewell

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The government faces an awkward position in that it will want banks to recover as much of that debt as possible, but banks will not want to be seen forcing businesses into insolvency proceedings

Insolvencies on the rise and the responsibilities of directors

Insolvencies on the rise and the responsibilities of directors


Stephen Wade discusses some of the drivers of insolvencies and reminds directors of their responsibilities

The first major business causality of the new year is the once-loved ethical beauty brand and high street stalwart The Body Shop, and with insolvencies once more on the rise other businesses will follow. The Insolvency Service confirmed that in 2023, 25,158 companies collapsed into insolvency, the highest number of business failures since 1993. These figures paint a bleak picture and one that unfortunately looks to continue and build throughout 2024. The Centre for Economics and Business Research (CEBR) suggests that some 33,000 businesses are at risk of collapse in 2024.

The economic landscape in 2023 continued to be challenging for many businesses with the cost-of-living crisis, soaring inflation, high interest rates and increasing costs hitting retail, hospitality and construction particularly hard. That uncertainty has continued into the first three months of 2024 with the country slipping into recession, albeit a technical and short-lived one. The chancellor’s Spring Budget on 6 March will have done little to lift the financial spirits of businesses and consumers.

It is often said that many of the businesses that have or will collapse are ‘zombie companies’, companies that earn just enough to operate and service debt, but are unable to clear down that debt. But, according to the CEBR, that is no longer true. Businesses that were once profitable have fallen into financial difficulty largely because of the covid-19 pandemic. The sting in the tail being that many businesses are carrying high levels of debt having been involved in government-backed covid-19 borrowing.

Businesses borrowed a staggering £77bn through the Bounce Back Loans Scheme (BBLS), Coronavirus Business Interruption Loan Scheme (CBILS) and Coronavirus Large Business Interruption Loan Scheme (CLBILS). Banks are expected to recover that money, with the government underwriting 80 per cent of the debt that cannot be repaid. As of November 2023, £30.93bn remains outstanding and HMRC estimates the level fraud at between £3.3bn and £7.3bn. The government faces an awkward position in that it will want banks to recover as much of that debt as possible, but banks will not want to be seen forcing businesses into insolvency proceedings. And with 80 per cent of loans backed by the government, there is little incentive for them to do so.

The question of who will blink first has yet to be resolved, but either way businesses that struggle to repay that debt are likely to be forced into insolvency proceedings.

Tough action on fraud

The Insolvency Service is, however, taking tough action on directors where fraud is obvious, as two recent cases illustrate.

A director of a construction and security business in Chingford, Essex, BI&F Ltd, applied and received a £50,000 Bounce Back Loan. Within two weeks of the receipt of the money, he applied to dissolve the company without informing the bank. Failure to notify creditors of plans to strike off a company is a criminal office. He was caught through powers granted to the Insolvency Service in December 2021, allowing it to investigate directors of dissolved companies it suspects of closing a business to avoid repaying covid-19 support loans. The director has been banned from running a company for 26 years and received a two-year suspended sentence and a four-month electronically tagged curfew.

In a separate case, a director of a Croydon-based company was ordered to repay £50,000 to the public purse after taking a Bounce Back Loan having overstated the turnover of his business. Having received the loan, he transferred over £40,000 to himself and took the rest out of the business as cash withdrawals. A year later he put the company into liquidation, triggering an investigation.

The message is clear – where fraud is evident, the Insolvency Service will act.

Director’s responsibilities

All too often we see directors of companies facing insolvency fall foul of the law, and when they do, they can find themselves personally liable for the debts of the company. They need to be aware of the common mistakes that many directors make that could lead to their actions being challenged by a subsequently appointed liquidator.

Generally, the directors of a solvent company owe their main duties to the company and to the shareholders of that company. The seven general duties of a director are set out in the Companies Act 1986 and include the duty to promote the success of the company for the benefit of its members and to exercise reasonable care, skill and diligence.

When a company is or may be about to become insolvent, their duties change significantly. Now the director’s duty is to protect the interest of the company’s creditors - this duty to creditors overrides all other duties. It is not always obvious to directors that a company is insolvent and recent case law suggests that directors should follow the general rule of thumb that the greater the risk of insolvency, the more weight should be given to the interests of creditors.

If directors act in any way that contravenes their duties, then a liquidator has certain powers to pursue them. These principles are set out in the Insolvency Act 1986 (IA86). Insolvency practitioners are obliged to investigate the conduct of an insolvent company’s directors to ensure that they have not breached their fiduciary duty.

Actions that a director may be liable for include:

  • Misfeasance. Leaving directors liable to compensate a company for losses caused as a result of breaches of their duties. A breach might occur if a director fails to exercise reasonable care, skill or diligence.
  • Wrongful trading. Leaving directors liable if they continue to trade knowing that the company cannot escape insolvency. If directors can show that they took every possible step to minimise further loss to creditors they may have a defence.
  • Transactions at an undervalue. Where assets are sold or gifted to a third person for less than market value. Directors need to remember that their actions over a two-year period will be examined.
  • Preference payments. Where directors choose to settle one debt over an another can leave directors liable for losses to other creditors. Insolvency practitioners can take into account transactions in a six-month window.
  • Personal guarantees. Directors will be liable for any personal guarantees, but if they choose to repay that creditor over others, they may find themselves falling foul of the preference payment rules.
  • National Insurance payments will need to be correctly paid. If not, HMRC has the ability to recover the national insurance contribution (NIC) plus interest and penalties directly from directors.

Protecting directors

So, what should directors do to protect their position if they believe their company is struggling?

  • Hold frequent board meetings. With continued economic uncertainty directors should be proactive and meeting regularly to consider the opportunities and threats that exist.
  • Keep board minutes that explain why decisions are made. In times of financial distress directors are often engaged in multiple discussions with different stakeholders, including creditors exerting pressure. Where insolvency is likely, a company should treat all creditors equally. If one creditor’s interests are prioritised over another, directors could be personally liable for the payments made to the preferred creditor. If payment to a creditor is made, directors should keep a record of why it was deemed appropriate to make that payment. Typically the rationale would be that making the payment preserves the value of the business and is therefore beneficial to all creditors.
  • Regular, in-depth forecasting. Detailed forecasting helps inform decision-making and your position will be much stronger if you regularly update your forecasting to show the knock-on effect of any financial decisions made.
  • Avoid making risky decisions. Directors can be tempted to ‘roll the dice’ in times of financial distress, with the hope of recouping losses. This is a breach of directors’ duties and could result in their conduct being challenged.
  • Keep your stakeholders updated. Keeping your creditors in the dark in the hope of a financial turnaround is never a good idea. It is much better to have an open and honest line of communication with all stakeholders, even if the news isn’t good. It will openly demonstrate that you are working towards their best interests and will restore faith.
  • Take advice. Talk to your lawyer and accountant as early as possible as there are steps that can be taken to potentially rescue the business or wind up the business in an efficient way.

Stephen Wade is a partner at Bishop & Sewell

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