Liquidation or Administration : does it matter?

If all attempts to avoid formal insolvency have been exhausted and the company is about to fold, directors might be forgiven for having scant regard to the type of process that might be  suitable for their company.  When a director is faced with the prospect of losing his business, some simply walk away, but others remain interested when they realise that some or all of the trading activities might be saved in a new company under their control.  So, what should a director think about if the company is heading towards collapse ?

In Scotland, the ability to appoint a receiver has been with us since the enactment of the Companies (Floating Charges and Receivers) (Scotland) Act 1972, the terms of which were updated when the Insolvency Act 1986 “the Act” came into force.  The holder of a floating charge, typically a bank, appoints a licensed insolvency practitioner “IP” to act as receiver.  The IP is the bank’s agent and works to return as much money as possible to the bank i.e. a clear focus about realising assets for best value as the bank’s agent.  However, in September 2003 the corporate landscape changed because a bank holding a floating charge dated after 15 September 2003 cannot appoint a receiver. Thus, the use of receivership in the last ten years or so has been minimal.

The holder of a floating charge now tends to appoint an IP to be an administrator.  It is quite normal for the director to appoint an administrator : achieved after a formal written notice has been provided to the holder of a floating charge, giving them 5-business days in order to consider their response.  The concept of administration was introduced by the Act in order to create the opportunity of saving all or part of an existing business, either within the current corporate shell or through a new entity.  The IP has power to trade, buy/sell assets, recruit/dismiss employees and generally do whatever is necessary in order to help preserve a business activity and create maximum value for the general body of creditors.  This creates an opportunity for the board to be involved in the process, because some of the directors of the failed entity may wish to establish a new company in order to acquire certain assets or parts of the business.  Insolvency legislation helps to regulate a pre-pack sale when the business or key assets are sold to a director’s new company, such that full value is paid and creditors’ interests are protected.

A company voluntary arrangement “CVA” is broadly similar to administration.  Creditors are offered the prospect of a dividend if there is a realistic view that the company can trade out of its current difficulties, howsoever incurred. Typically, creditors should receive a better financial return than if liquidation incepts.  The difficulty with a CVA, and hence their relatively infrequent use, is that many creditors find it difficult to accept that the company to whom they have provided services/foods will continue to operate yet only pay a dividend of, say, 30p in the £, whilst they are expected to provide ongoing support.

Liquidation is generally seen by many as the end of the road and tends to be less expensive than administration.  It is unusual for a liquidator to trade, other than for a short period of time e.g. to finish a contract or retain the value of licensed premises pending an early sale.  When liquidation incepts, directors tend to have less interest in the process although the law requires them to cooperate with the IP as appropriate.  Liquidation is normally instigated either by the board or a creditor e.g. HMRC or a trade supplier.

Two types of liquidation are possible, a creditors voluntary liquidation and a court liquidation.  The overall outcome is the same and it should be noted that most insolvency matters these days no longer require a physical meeting of creditors.  Current legislation means that unless 10% in value of creditor claims, 10% in number of the total creditors, or 10 separate creditors ask the IP to convene a meeting, everything is handled online.

Whether liquidation or administration, directors should note that the IP has a legal obligation to submit a report to the Director Disqualification Unit. There is no escape.

Occasionally, a director will seek to close the company using an informal route i.e. selling assets privately and paying creditors from the proceeds, without necessarily adhering to the legislation of determining who is preferential and who is unsecured.  The difficulty with this is that a director has no protection against subsequent challenge to his activities should a creditor elect to liquidate the company. Human nature tends to mean that it is difficult to ignore local creditors/friends when distributing scarce resources (deemed an unfair preference under the Act) and hence, a DIY route is ill advised. Further, without a formal insolvency process, former employees are not able to readily access the Redundancy Payments Office in terms of being paid for unpaid wages, notice pay, holiday pay and redundancy ( the rate is up to £571 per week for each part of the claim ).

Whether to appoint a liquidator or an administrator can be a complex issue and is invariably decided upon the facts of a case.  Directors need to be fully advised of the consequences of whichever formal insolvency route is adopted and be satisfied that they are acting in the best interests of all stakeholder groups, whilst observing their fiduciary duty.  Don’t be scared to ask your local insolvency practitioner for advice.

This article is written by Michael J M Reid, licensed insolvency practitioner and partner of Meston Reid & Co, Aberdeen. The views expressed in this article are his rather than those of the firm.

The many challenges of the overdrawn director’s loan account

As the number of formal insolvencies begins to increase and there are signs that recessionary pressures in 2023 will witness a further wave of company failures, it is often unwelcome news to a company director that as well as losing his company, the liquidator will be pursuing him for monies withdrawn from it i.e. an overdrawn loan account “ODL” has been created .

From the liquidator’s viewpoint, the first place to start when determining if there is an ODL tends to be the most recent set of signed accounts.  On the basis that the director and the external accountant have agreed/discussed the ODL, and the statutory accounts have been signed, a specific balance can be pursued.

However, it is not unusual to find that statutory accounts have not been signed for a number of years which leaves a considerable period of time for transactions to take place, and a differing view to emerge between the director and the liquidator about what represents valid business expenses, rather than a director simply drawing cash from the company bank account.  Thus, arriving at a balance that can be agreed is often fraught with discussion, argument and negotiation.

There have been many reported court cases in the last twelve months or so reflecting the actions of either the liquidator or The Insolvency Service pursuing a director who obtained a bounce-back loan and withdrew the money for personal purposes rather than applying it for business reasons. That position is clearer to pursue.

Ignoring the bounce-back loan position meantime, the liquidator will want to establish if a director has drawn so much from the company that an ODL exists.  For example, the liquidator might look at a company’s bank statements from the date of the last set of signed accounts and allocate withdrawals to the director.  This is often the approach when the liquidator is dealing with a one-man personal services company and there are no obvious reasons for money to be spent on company-related matters.

The task for the director is to try and demonstrate why some (all) of the transactions listed are not personal, or perhaps contend that some of the money should be treated as dividends or salary, and therefore excluded from the calculation.

The difficulty with dividends is that the HMRC rules are fairly clear on what constitutes a dividend. Further, a company that has been in financial difficulty for some time and hence not earning distributable profits is unlikely to be able to declare a dividend.  Indeed, there are cases where a director has sought to suggest that monies withdrawn are dividends, only to find the liquidator pursuing him on the basis of recovering such money because there were insufficient reserves to support the payments.

Another option is for a director to claim that a salary should be applied in reduction of an ODL. Of course, if he has been in the habit of paying himself below the NIC threshold for many years (which can be evidenced by annual accounts, payroll records and personal tax returns) it is hard to persuade a liquidator that, for some strange reason, the recent period permits a substantial salary.  Compounding the director’s misery with this line of defence are the Income Tax Regulations which provide that if a director has taken a salary and wilfully ignored the PAYE/NIC deductions relating thereto, such deductions can become a personal liability.

It is not uncommon for a director to blame the external accountant for the existence of an ODL and claim that he had never been advised of the personal financial liability should liquidation arise.  Enquiry with the external accountant will often produce letters, file notes etc. making it quite clear that the director had been advised of the implications of an ODL but had not taken action to rectify matters. Blaming the external accountant rarely produces a successful outcome for the director and of course, company law makes it clear that it is the director who is responsible for the accounts, accounting records and transactional activity rather than an external party.

Invariably it is possible to reach a negotiated settlement with a director, possibly repaying the balance over a specific period of time but if all reasonable dialogue fails, court action against the director is probable.

In the last few years, a number of litigation funders have emerged who undertake legal action on the liquidator’s behalf and fund the process. Thus, a “clever” director who thinks that by denuding the company of all cash means that he will not be pursued, may well find that his personal assets are under attack by a litigation funder with deep pockets to pay legal expenses.

Experience suggests that where an ODL exists a director should not ignore the position and hope that “everything will sort itself out eventually”. If the company is subject to liquidation and there is an ODL, either evidenced by signed accounts or a calculation drawn from the accounting records, the director is unlikely to be able to walk away financially unscathed.

It is an area that can be cause much frustration, annoyance and financial hardship to a director  : not an issue to be ignored.  It always pays to obtain specialist advice as soon as possible.

This article is written by Michael J M Reid, licensed insolvency practitioner and partner of Meston Reid & Co, Aberdeen. The views expressed in this article are his rather than those of the firm.

Dealing with personal financial challenges in these tricky times

Much is written about the current cost of living crisis i.e. low or non-existent wage increases coupled with  inflationary pressures on everything we buy, and there is no doubt that it has created the most difficult conditions that the North East of Scotland has seen for many years. Unsurprisingly, the Meston Reid & Co insolvency team are finding that more people are seeking personal financial advice.

When one’s level of income  is falling behind rising prices, a strain is imposed upon the  household. Most of us have a relatively set amount of income e.g. a job, pension or State benefits, but what happens when there is simply not enough ?  Whilst the first reaction tends to be one of panic and uncertainty, a clear head is required to look at matters objectively. The key areas of focus when looking at what is affordable is the level of income and essential expenditure.

Clearly, cutting back on any type of expenditure is never an easy task because each person becomes used to a certain standard of living. It is hard to make choices which reduce that standard and everyone has a different view on what is essential. For example, does essential expenditure include an expensive mobile telephone/contract, or TV package ? When difficult choices are being made, an independent second opinion helps to introduce a sense of reality and pragmatism. We all have to eat and keep a roof over our head, but choices may mean a different basket of food at the supermarket, selling the car, reduced entertainment or hobby costs, or downsizing accommodation. If a person is faced with the option of “eating or heating”, or how to feed the children, the room for manoeuvre is restricted, and there is more evidence of family/friends being asked to help, together with food bank visits.

A key step in taking charge of your finances is to prepare a monthly budget that covers a full year. Taking a twelve month view helps to identify those months when expenditure is higher than normal. For example, it may well be acceptable to spend a little more in some months e.g.  at Christmas, if there are other months when you expect to have reduced outgoings, and undertake to stick to the budget.

Once a budget has been prepared, it should be reviewed no less than quarterly because it is human nature to prepare the initial budget in an optimistic light, which means that the reality of the level of bills to be paid and monthly shortfall will require a revision as the months pass. Again, unpopular choices may well have to be made and will help focus upon what is genuinely “essential”. Not a pleasant task, but necessary in the current climate.

There are plenty of sources of a standard income/expenditure analysis e.g. using the Meston Reid & Co website ( www.Scotdebt.net ). Using a bespoke document will provide a memory trigger in order to ensure that all items are included in the assessment.

Even if you have little disposable income after paying essential expenditure i.e. mortgage/rent and utility bills, there remains an opportunity to assess where savings can be made e.g. undertaking a mortgage review or asking for a mortgage deferral for, say, three months. Perhaps switching utility providers will reduce your costs or a frank discussion with your landlord.

There are many sources of information about personal financial management and plenty of ways to access help/advice e.g. online, Bank, citizens advice bureau, money advice centre, and independent financial advisors. Look around and judge what source is best suited to you. All will be confidential.

Your budget will take account of loan repayments and other creditors. Thus, when you have credit card repayments that stretch the family budget, you need to decide how best to tackle them. For example, you might elect to pay the minimum sum for a month or so whilst remaining mindful of adhering to the terms of every credit agreement : falling into arrears can become a serious matter. The general experience at the moment is that creditors, Banks and HMRC all make it clear that they want to help wherever possible. If there are pressing creditors, why not have a chat with them, explain your position and discuss a reduction in monthly payments for a set period such as 6 months.

If it all becomes overwhelming and there is no realistic hope of dealing with the situation, your thoughts might turn to debt relief mechanisms such as a trust deed, bankruptcy or the debt arrangement scheme. Each of these has merits and if one is to be used, individual circumstances must be considered before choosing the appropriate route. Experienced advice is essential rather than what you might hear from family/friends…..or that bloke in the pub .

Whatever happens, don’t feel alone, embarrassed or afraid. Many others are in a very similar situation. Advice is available and you should not feel shy about speaking up and taking action.

This article is written by Michael J M Reid, licensed insolvency practitioner and partner of Meston Reid & Co, Aberdeen. The views expressed in this article are his rather than those of the firm.

One reads plenty media comment about an increase in both corporate and personal financial failure due to various factors and certainly, although there is some Government assistance for energy costs, many of the temporary law changes and financial support structures that we saw in recent years have now been removed.  Government changes/pronouncements, coupled with a rise in both inflation and interest rates seem to have created an increased element of uncertainty. There is no doubt that the Meston Reid & Co insolvency team have fielded far more questions about the impact of insolvency.  A separate article will deal with personal financial issues, but this one will consider whether liquidation may be the answer when corporate financial problems rear their head.

The principal definition of insolvency is being  unable to meet debts as they fall due in the ordinary course of business (section 123 of the Insolvency Act 1986 “ the Act”) and this probably applies to many companies at the moment as they seek to defer settling creditors for as long as possible because they are struggling to collect the book debts and manage the cash flow generally.

It is important to have a financial plan that shows how the company can recover from a temporarily insolvent position. Rather than based upon hope, such plan should be both realistic and achievable because, if not, the level of liabilities may increase further leading to the problem of a director being asked to contribute personally to an insolvent position as a result of the wrongful trading provisions contained in the Act. A key reason why directors operate through a limited liability company is to contain personal financial exposure and clearly, anything that risks that veil of protection needs to be considered very carefully.

When looking at a company’s balance sheet, accounting convention reflects assets at their book value, but most businessmen understand that in the event of a distressed sale, plant and equipment, vehicles, IT equipment etc. tend to realise far less than the carrying value in the accounts.  Accordingly, when looking at the balance sheet, a director may well think that there is a comfortable asset base, but what happens if the older book debts are not collectible or some of the newer/larger ones are not recovered because the customer collapses into insolvency? Further, what is the market value of second-hand desks/chairs and IT equipment? It might be argued that a formal liquidation process merely reduces the value of assets to the disadvantage of creditors, and experience suggests that even when directors think there is plenty cash to go round, the sad truth is that only a small dividend (if any at all) is available once market forces dictate how much assets are really worth. That is not a reason to avoid liquidation and an orderly realisation process, because the position might worsen to the detriment of all concerned : particularly directors if wrongful trading applies.

For many directors, it has been a struggle to keep a company afloat in recent years. There are increasing creditor demands to settle some old liabilities, and being unable to pass price increases to customers erodes the margin that generates cash. Also, higher interest rates simply mean more money paid to the bank on a monthly basis rather than being available as working capital.  Directors are under pressure to start repaying a bounce-back loan and many comment that have tried everything to save the business.  Trying everything might include refinancing vehicles, entering a factoring agreement for book debts, trying to refinance buildings, or seeking additional investment, but there comes a time when all avenues have been explored and there is simply not enough cash flowing through the business, resulting in difficulties in paying creditors and worse, meeting the weekly/monthly payroll burden.

In such cases it is tempting to liquidate the company because, for example, there may be insufficient resources to make longstanding employees redundant because of the cost of paying notice pay and redundancy, meaning that liquidation is the only way of ensuring that employees receive their statutory entitlement using the Government fund.

It is not unreasonable for a director to take the view that “enough is enough” and seek to liquidate the company. It removes the stress that has been causing sleepless nights and does not signify personal failure because there are many perfectly valid reasons why the financial plan makes it clear that corporate survival is simply not possible.

Clearly, it is easier to assess a company’s asset/liability position internally whereas, from a creditor’s perspective e.g. a supplier or HMRC, one cannot gain access to the accounting records and may have to rely upon accounts filed at companies  house which are often out of date.  In such case, a creditor might consider whether liquidating a company will produce a better return than a drip-feed of cash from the company in its current form. One thought might be that supplying a different entity, albeit run by the same people, but which is better funded is a more financially appropriate business opportunity.

Typically, a bank will have clauses in a lending agreement that permits the appointment of an independent person to conduct a financial review and that sometimes provides the catalyst for directors to realise that it is time to stop trading because the insolvent position has no realistic prospect of being reversed.

A landlord is often a creditor and if there is a perceived risk of rent default or inability to pay dilapidations, liquidating a company allows the premises to be vacated and a replacement tenant found.  All of the arrears might be lost but at least there is the prospect of ongoing income at a sensible level, as long as there is the ability to find a suitable tenant.

There are plenty ways in which to view a company’s financial condition and the common ground means applying experience, practical knowledge and realism. Although a difficult decision to take, sometimes ceasing to trade and appointing a liquidator is the only sensible way forward. Of course, if liquidation incepts, certainty descends upon the situation and the Act determines how assets are dealt with and creditors paid.

That said, deciding to liquidate is a serious matter and advice should always be sought but there are many cases where liquidation is the answer.

The views in this article are those of Michael J M Reid, Licensed Insolvency Practitioner and partner of Meston Reid & Co, chartered accountants, Aberdeen.  They do not purport to represent those of the firm in general.

It is often said that challenging economic conditions create financial uncertainty and result in an increase in fraudulent activity by the unscrupulous. For example, the Covid-19 pandemic caused significant financial upheaval for almost everyone and many reports of fraud were publicised.  One might point to the incidence of furlough fraud, which occurred when an employer claimed furlough support from the Government despite the fact that an employee was continuing to work and generate an economic return for such employer.  Various estimates suggested that up to 9.6 million workers benefitted from the furlough scheme. A welcome support mechanism for many, but not the subsequent estimate from HMRC that at least 30,000 companies had made fraudulent claims.  How were these false claim monies utilised/abused ? We may never know.

Further, a Parliamentary report in 2021 suggested that nearly 40% of bounce-back loans totalling £17 billion would never be repaid, with another £5 billion being lost due to fraud and error.  We are beginning to see the results of  reviews by regulatory bodies which reveal that many company directors  inflated annual turnover in order to claim a bounce-back loan to which the company was not entitled, only to  remove the cash from the company for personal purposes as soon as it was provided, sometimes not long before the company collapses into insolvency.

We should remember that it is the taxpayer who is picking up the tab for all of the money provided in these schemes which will never be recovered.

A briefing paper issued by the Association of Business Recovery Professionals “R3” last month reported a 41% increase in fraud since 2019. The report also estimated that 64% of businesses were affected by either fraud or corruption.  Further, there was a 422% increase in fraudulent applications for grants, insurance fraud jumped by 135%, and that an estimated 40% of all crime committed across the UK is linked to fraud.  When you work hard for money, it is always frustrating when some people defraud the system.

In the fight against crime, it is not unreasonable to ask if a liquidator has a role to help recover monies either for the Government or the general body of creditors of a company which has collapsed after the directors have disappeared with all the money?

One of the challenges in detecting fraud is the ability to obtain documents that support an allegation. Of course, if a company is in liquidation, the liquidator has authority to locate, secure and review the company’s accounting records e.g. bank statements, cash book, invoices etc. This provides a quick and effective route to help determine what has happened rather than embark upon a time-consuming court process to try and recover documents for examination.  Further, a liquidator has legal authority to interview directors either informally or before a sheriff and, of course, report the conduct of directors to the Director Disqualification Unit.  It is not uncommon for a large creditor, often HMRC, to help fund a liquidator’s investigations on the basis that recovery of monies ( which will ultimately benefit the taxpayer ) is expedited and directors brought to justice.

As some may recall, the law was changed recently in order to allow a company which has been struck off to be restored to the register of companies and thereby thwart the actions of a rogue director who  defrauds a company and seeks to have it dissolved before anybody notices.

Some of the more robust suggestions from media commentators suggest that directors should be made liable for certain company debts in the event of a company falling into liquidation.  This is perhaps unduly harsh because, for example, a company may fail through no fault of the directors e.g. the largest customer goes bust and cannot pay a large debt, there is a change in legislation, or the company itself is subject to fraudulent activity.

The R3 report introduces the concept of automatic disqualification for any director (whether or not liquidation incepts) if the company fails to file statutory accounts with the registrar of companies on time two years in a row.  Again, this might be unfair depending upon the reasons for late filing of accounts but it certainly points to a general consensus that directors require to act responsibly.  When one thinks that a director of a UK company does not need any prior qualification other than being at least sixteen years of age, it is easy to understand why some unscrupulous individuals can use a corporate entity to defraud others.

The role of a liquidator helps to speed up the process of obtaining documents, liaising with regulatory bodies and instigating legal action which may well result in a better financial return to the general body of creditors.  Using a liquidator and the powers provided under the Insolvency Act 1986 can provide a significant deterrent to fraudsters if they know that a liquidator might be on their tail with the many investigatory powers provided by law.

The views in this article are those of Michael J M Reid, Licensed Insolvency Practitioner and partner of Meston Reid & Co, chartered accountants, Aberdeen.  They do not purport to represent those of the firm in general.

There has been a marked increase over the last few months in those seeking independent and experienced advice about the financial condition of their business because the overt signs are that the business has, or anticipates in the near future, trading difficulties that are likely to create cash flow challenges. Without positive cash flow, a business can grind to a halt very quickly.

Seeking advice is a positive sign of a businessman acting responsibly and in such cases, one of the first questions to him is to provide a set of recent management accounts. It is remarkable how frequently one hears the response that there are no management accounts, or offered a set of annual accounts dating back a year or so that have never been read. Perhaps unsurprisingly, the next question will focus upon how the individual runs the business, to be met with responses such as “I just know”, “I’m there everyday and I see what is happening” or “I keep an eye on the bank balance and if it is OK, everything must be fine”.

You would not expect to drive a car without a windscreen (how would you know where you were going?), a steering wheel (how can you guide the car?), sufficient fuel to run the car  (how do you know you have enough cash to run the business), or an effective instrument panel (how do you know how fast you are going, what might be going wrong and what indicators help to remain in control ? ). Thus, if you wouldn’t dream of travelling in a car without the relevant support mechanisms, why would you do so with your business?

For some, preparing management accounts is seen as an unnecessary and boring chore which wastes valuable time. However, working on the basis that positive cash flow is the lifeblood of a business, particularly when challenging times are being faced, it is fair to say that reliable, relevant and timely financial information is a basic fundamental of understanding any business activity.

It is accepted that a page full of numbers might act as a sleeping pill for many, but it is not a sign of weakness to admit that something provided in a more understandable format would be helpful.  For example, graphs, pictures or a brief narrative might be preferred. Every business will have Key Performance Indicators “KPI” which may well be sufficient to retain overall control over the financial position, with supporting schedules that give more detailed analysis as required.  For example, a firm of lawyers might look at the monthly level of staff utilisation, chargeable time invoiced to clients and cash collected. Broadly speaking,  if these three KPIs are at, or above, a pre-determined level, the financial basics of the business are in place.

Whilst your KPIs will be wholly relevant to your business activity, without looking at trends e.g. what do the figures tell you every month/quarter as the year progresses, it is difficult to form meaningful conclusions.  Preparing management accounts that are both informative and understandable is an easy process to adopt once the basic framework has been agreed. Further, the information is likely to be used rather that left in a drawer to gather dust.

As part of this process, a well run business should have a financial forecast for at least the next twelve months i.e. rather than simply hoping for the best. If you look at the forecast and the results are not as anticipated, it is easier to determine why and take corrective action : sooner rather than later so that bad habits don’t become established.

Returning to the car analogy, if you want to go from A to B but do not have a map, how will you know the route, how you will know when you have deviated from the route, and how will you know when you have arrived? Management accounts will address all of this, and in a format that you find useful.

As one might expect, a financial forecast is likely to concentrate upon sales, costs and cash flow, which evolves neatly into a business plan.  For the avoidance of doubt, a business plan does not have to be a detailed document that costs thousands of pounds and never sees the light of day : it could be one or two pages with relevant KPIs. The inevitable conclusion is that without the basic tools of monitoring and controlling the finances, it is quite easy for a business to run into financial difficulty without realising it, and then left wondering why that was allowed to happen.  Worse, it may be too late to take corrective action with the result that undue harm is caused to the business………………or it fails.

Accountants are helpful and approachable. They have experience of this aspect of a business. Never be afraid to speak to them  as often as you can.

The views in this article are those of Michael J M Reid, Licensed Insolvency Practitioner and partner of Meston Reid & Co, chartered accountants, Aberdeen.  They do not purport to represent those of the firm in general.