Directors should recognise danger signs

THE benefit of hindsight, commonly observe that company failure may have been avoided or its repercussions minimised if only directors had acted earlier and more purposefully. To protect themselves from personal liability company directors need to ensure that they take steps to recognise and respond to danger signs.

. Failure to keep proper books and records can of itself give rise to personal liability and for good reason. Without an effective system of budgeting and monthly management accounts, directors cannot properly monitor finances and performance on an ongoing basis.

There is a temptation to focus only on "real business" meeting orders, providing the service, dealing with customers. But without the discipline of regular financial analysis and planning, all that effort may be fruitless. The annual audited accounts, following many months after the financial year end, only provide historical information.

So often, creditors attend meetings convened at the start of liquidation, armed with a copy of the most recent audited accounts filed with the Companies Registration Office. They then find themselves presented with a more up to date statement of affairs showing rapid deterioration of the company's finances. Although the discrepancy is to some extent attributable to the difference in going concern and liquidation values, this is rarely the full story.

Far too often, professional advice - legal, accounting or banking - is not sought until the directors have already fried unsuccessfully to trade out of their difficulties or an unmanageable number of creditors are clamouring for payment. It often surprises directors to learn that their company is insolvent on a cash flow test (i.e. inability to pay debts as they fall due) when the balance sheet shows a surplus.

All an adviser can do is tell the directors to convene a shareholders' meeting to recommend that the company be would up and to face the music at an acrimonious creditors' meeting.

Until the winding up is formally commenced, the directors will be advised to refrain from paying (or "preferring") any one creditor over others, not to lodge any monies to an overdrawn bank account, not to incur any further credit and generally to act only in the best interests of the creditors even where that conflicts with their personal interests.

Contrast the possibilities if the directors had sought advice earlier.

. First, one could a brief but meaningful assessment problems. Is it a short term crisis there a more fundamental problem with the product, service or market?

. One can search for a "quick fix" to arrest the slide to liquidation. This provides breathing space to piece together the longer term solution. If there is a reasonable prospect of implementing that solution, continued trading may be justified without exposure to personal liability for reckless trading although this requires constant review.

. Maintaining customer confidence is vital so the first step is to approach key creditors in confidence. Outline the problem and put their dilemma into perspective by two statements of affairs: what creditors recover on a winding up and the other showing how, on a going concern basis, they would fare better.

. Offer some realistic proposal for solving the crisis or commit to acting decisively within a relatively short time scale, so that creditors' positions are not worsened. Although the initial reaction may be hostile, directors may be surprised to find that their creditors will appreciate being consulted fully and frankly at an early state. Furthermore, if they feel they can rely on the figures being shown to them, they are more likely to co operate, however reluctantly.

One recurring reason for bitterness and recrimination in insolvency is the extent to which creditors feel they have been misled.

This informal approach may achieve a moratorium during which creditors will take no action or the interest clock may be stopped or scarce cash resources may be applied by making interim pro rate payments to the general body of creditors. This may tide the company over a short term crisis or may buy valuable time, without risk to the directors' personal position, while continuing the search for refinancing.

But the risk with this informal approach is the company's dependence upon Securing and retaining creditors' goodwill. Some creditors may be unsympathetic or have similar difficulties. If one breaks ranks, months of painstaking work may be ruined.

. The alternative is to avail of the examinership procedure which secures court protection from hostile creditors. As only a four month period is allowed for formulating a solution, the more preplanning that can be done the better. Thus, even if a negotiated work out does not succeed, it can still provide an examiner with a good starting point.

While the procedure is expensive and fraught with uncertainty, it is a powerful remedy. In negotiating an informal work out, the implicit threat of examinership can, of itself, be very effective. If a consensus does not emerge, creditors risk having an even less palatable proposal being formulated by an examiner and approved by the court despite their objections.