As a company director the last thing you want to have to grapple with is a failing business.
But the reality is that financial adversity can strike even the most successful business at any time, and the earlier you address the problem the better your company’s prospects of recovery will be.
Moreover the Companies Act obliges you, on pain of risking personal liability, to take appropriate action.
What should you do? Should you enter into an informal arrangement with creditors or should you seek formal business rescue protection? We discuss the pros and cons of both options…
The business rescue provisions in the Companies Act are regarded as progressive and world class and there is evidence that it has worked well.
Yet a 2016 survey showed that more distressed businesses opted for an informal approach and appear to be more successful than those opting for the remedies of the Companies Act.
What’s the difference?
Business rescue in terms of the Companies Act is a process whereby the company informs stakeholders of its situation and a business rescue practitioner is appointed to try and salvage the company. A moratorium is placed on creditors which gives the practitioner room to find a solution.
With an informal arrangement, the business enters into negotiations with some or all of its creditors.
The two significant differences between the two approaches are that –
- With an informal approach there is no protection from creditors demanding to be paid – this is a substantial risk because if creditors decide they want to be paid, the company could collapse.
- The other big difference is that the informal way offers confidentiality to the business – with business rescue the financial position of the company becomes common knowledge to all stakeholders and the general market place. The company thus suffers reputational damage from which it may never recover even if it reaches a favourable settlement – e.g. consumers of the company’s product may opt to use a rival’s product in case the company does go into bankruptcy.
Directors: Plan ahead to prevent falling foul of business rescue requirements
Once a company becomes aware that it has run into or is going to experience financial difficulties, the directors are required by the Companies Act to perform liquidity and solvency tests and if these show the business cannot meet its obligations for the next six months, then it is required to either declare insolvency or apply for business rescue.
Should the directors decide not to proceed with business rescue or liquidation, they are obliged to provide stakeholders with reasons for their decision in writing – hence the company’s stressed position is revealed to the public.
Therefore if you want to take the informal route you need to do this before the business becomes financially stressed as above.
You will also need to present creditors with a credible plan when you embark on this option. Clearly, monitoring of the cash position and planning a comprehensive strategy are critical to the success of the informal turnaround process.
Your personal liability risk
Directors are personally liable for any losses as a result of their actions or inactions if it can be shown that they acted recklessly or negligently.
So plan accordingly and carefully.
Remember also that staff and stakeholders could be financially ruined if the business fails.