In a recent case, Cheyne Finance, the court decided that debts that become due in the future can sometimes be taken into account when deciding whether a company is insolvent under S123(1) Insolvency Act 1986. This, the cash based insolvency test under s123, is an important test that directors and their advisers have to be aware of because once at or beyond the ‘point of insolvency’ directors’ actions come under far greater scrutiny, the effects of which could include causing them to become personally liable for new debts incurred under the wrongful trading provisions of the Act.
The judge pointed out that each case rests on its own merits – sometimes future debts should be taken into account, sometimes not. As the question of whether a company was insolvent at a given point in time is often only considered by the courts once the company has gone into, say, liquidation – that is the final chapter of the book has been read and the outcome known – the importance of cash flows covering the period and taking (and following) appropriate advice at all the right times cannot be over emphasised, if the directors are to protect themselves from personal attack.
Take for example the situation where the directors of a company know that a Corporation Tax or VAT liability of a known, and considerable, size has to be paid a few months down the line, and only if certain (good) things happen in the business between now and then will the company have the cash to pay it. The company may have no immediate cash problems. Are the directors allowing the company to trade wrongfully now when there is some uncertainty over whether the company will be able to pay the debt in the future, and if not insolvent now, when will the point of insolvency be reached?
It is essential that the directors take on board the likely date that a court could say that the point of insolvency has been reached, so that they understand when and to what extent they are personally exposed, and take the right actions at the right time to reduce, if not eliminate, the risk they are facing. This is exactly what happened in a fairly substantial case that I got heavily involved in a few years back – I advised the directors that I could get the company to a particular point some four months down the line, but once a particularly large debt became due, if alternative funding sources could not be secured in the meantime (which seemed unlikely), then formal insolvency was inevitable – it was this knowledge that dictated how the business was managed in the meantime, how we liased with the major creditors and the Stock Exchange, what insolvency routes we pursued and when (an Administration leading to a possible CVA was agreed in principle with the major creditors). Although the Administration/CVA route fell apart sometime down the line (for reasons completely out of the directors’ and my control), my close working together with the directors and the pursuit of appropriate strategies prevented the directors from being attacked by the IP who was appointed sometime down the line – the directors houses/personal assets were safe. In that case the directors, with whom I am now good friends, saw their working with me as an IP as a form of insurance, protecting all they had worked so hard for and avoiding the DTI taking disqualification proceedings.
The lack of cases that have passed through the courts on this issue is not helpful – I suspect that we will see more going through in coming years as major creditors, including the banks, asset based financiers, major trade creditors and the government departments, consider their options for ‘stripping the veil of incorporation’ and attacking the directors’ personal assets. In the meantime, the importance of taking advice from an insolvency specialist and at the earliest possible opportunity cannot be over-emphasised.