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At Michelmores we understand that many factors can impact the financial health of a company and have experience supporting clients throughout the full business lifecycle. There will be times of growth and times of greater stress. Find out more about how we can assist throughout here.
What should I do if my company cannot pay its creditors?
As cash becomes tight and financial pressure mounts, directors can be put to the test, with clear thinking and decisive action often vital. How you respond in these crucial early stages can make all the difference, both for the company’s survival, and for safeguarding your own position and reputation.
This article covers some of the key considerations for directors in stressed or distressed business including the personal risks to be aware of, and the practical steps that help protect both the business and the board.
Shifting priorities in times of stress
In normal circumstances, directors are required to act in the best interests of the company and its shareholders. As a company becomes increasingly distressed and moves towards insolvency, those duties shift towards the interests of the company’s creditors. This shift takes place before the company enters a formal insolvency process, so directors must be alive to the position of creditors as the company moves down the decline curve.
There are two tests for solvency.
- The cash flow test. Can the company pay its debts as they fall due, now and in the reasonably foreseeable future? Missed payments, reliance on extended credit terms, or mounting arrears may indicate cash‑flow insolvency.
- The balance sheet test. Do the company’s liabilities exceed its assets? If so, the company may be balance‑sheet insolvent, even if it is still meeting day‑to‑day payments.
As a company’s financial position deteriorates its directors should consider these tests regularly and stay alive to any worsening financial trends that may increase the risk of insolvency. As these risks become more pronounced, directors must ensure that their decision-making processes increasingly prioritises the interests of creditors as a whole, rather than those of shareholders.
By acting early and decisively, directors can help steer the company through turbulent times whilst fulfilling their legal duties and safeguarding their own reputations.
Why does it matter?
If a company enters a formal insolvency process (e.g. administration or liquidation), the conduct of the directors in the period leading up to insolvency will be closely examined and there are various circumstances in which the directors might face personal liability as a result of their actions or inactions.
Directors should also be mindful of any personal guarantees they have given to support the company.
Protective habits for directors
- Keep a close eye on the numbers. Maintain up-to-date financial records, including profit and loss, balance sheets, and cash flow forecasts. Test assumptions rigorously and flag variances early, while monitoring short-term milestones.
- Increase board engagement. Hold regular, focused meetings addressing the company’s cash position and risk. Document all options considered, advice received, reasons for decisions, and how creditors’ interests were weighed. Ensure any dissent is noted professionally and minutes are circulated promptly.
- Seek advice early. Obtain specialist advice at an early stage and act in accordance with that advice.
- Consider the impact of each action on creditors as a whole. Carefully consider the impact of any decisions on the company’s creditors. In particular, care should be taken when incurring additional liabilities and settling existing debts. It may be necessary to prioritise payment of creditors whose support is critical to the continuation of the business.
- Double check your insurance. It is important for directors to ensure that their directors’ and officers’ (D&O) insurance policy remains active, that they are fully aware of any exclusions, and that they meet all notification requirements.
How we can help
We regularly advise directors and boards facing financial pressure, from early warning stages through to formal insolvency processes.
If you would like to sense‑check your position, understand your personal exposure, or discuss restructuring or other options, please contact Sacha Pickering or a member of the Restructuring & Insolvency team.