Bruce Jones, corporate partner at Bircham Dyson Bell, considers some of the risks for directors of distressed companies that are surviving against the odds. 

Bruce Jones, corporate partner at Bircham Dyson Bell, considers some of the risks for directors of distressed companies that are surviving against the odds.

On 26 January 2010, the Bank of England governor, Mervyn King, was reported as saying that the UK economy had shrunk by five per cent in 2009 –the largest fall in output since 1931.

Fast-forward to the present day and things scarcely seem any better. According to a report in The Guardian on 20 June 2011, household finances in Britain are deteriorating at their fastest rate since the depths of the recession in 2009. Yet according to recent statistics produced by the Insolvency Service, the liquidation rate among UK companies remains low, compared with both the peak in 1993 and the average over the past 25 years.

The figures would seem to be borne out by experience: on the high street, for instance, there has been a handful of high- profile casualties – most recently Habitat announced the closure of all UK stores except those in London –but large-scale failures of smaller businesses have not occurred in the way that one might have expected in such a difficult trading environment.

Small businesses in particular will not be slow to tell you about the difficulties they have in raising bank finance at the moment. However, for struggling businesses with loan facilities already in place, anecdotally, the banks appear more reluctant than historically to force businesses into administration or liquidation.

For lawyers and other professionals this means that the restructuring work that normally comes to the fore in a recession is rather different this time round.

There is still work to be done regarding administration, and pre-packs in particular remain popular, but it now seems to be much more about advising directors of companies being fed an unexpected lifeline by bank creditors about the nature and scope of their duties.

WRONGFUL TRADING

The difficulty for directors of companies teetering on the brink is the ever-present risk of wrongful trading allegations. This practice, under section 214 of the Insolvency Act 1986, occurs where a company has gone into insolvent liquidation and, at some point before the commencement of the winding up, a director of the company ‘knew or ought to have concluded’ that there was no reasonable prospect that the company would avoid going into insolvent liquidation.

The fact that a bank is continuing to offer support to a failing company is not sufficient for the directors to conclude without more information that the company will necessarily be able to trade its way out of difficulty. The best you can say is that the court would not make an order for wrongful trading against a director of a company that ended up in liquidation if the director, knowing that there was no way of avoiding liquidation, still took every available step that he ought to have taken to minimise the potential loss to the company’s creditors (Section 214 (3) of the Insolvency Act 1986).

This is to be assessed by the standards of a reasonably diligent person having both the general knowledge, skill and experience that it is reasonable to expect of someone carrying out the functions carried out by the director in question, and the general knowledge, skill and experience which that director actually has. In other words, it is both a subjective and an objective test.

The upshot is that directors need to tread a fine line if they wish to continue to trade in circumstances where the outlook for the company would otherwise seem bleak, notwithstanding the apparent support of its bank. Regular (often daily) board meetings and careful and thoughtful minuting of decisions made are essential.  

Trading in such circumstances is a challenge, but distressed businesses seem to be surviving, for the time being at least.

Don’t say it too loudly, but perhaps a social conscience is resting somewhere in the banking system after all.

Bruce Jones, Partner
Bircham Dyson Bell
Tel: 020 7783 3525
Email: brucejones@bdb-law.co.uk
Web: www.bdb-law.co.uk