Difficult decisions ahead: Rising Insolvency and the 'Creditor Duty'

Only those with their heads stuck firmly in the sand would fail to know that households and businesses across the globe have been subject to growing pressure over the last three years.

Even before Russia's invasion of Ukraine in late February began to impact fuel prices, businesses were beginning to come to terms with a post-pandemic world which was radically different than before Brexit and the spread of Covid-19.

Such a shift can be seen from the latest insolvency figures published by the Office for National Statistics (ONS).

They revealed that the total number of company insolvencies in England and Wales during the second quarter of this year were at their highest level than at any point since 2009, when the world was grappling with a full-blown recession (https://www.ons.gov.uk/businessindustryandtrade/changestobusiness/bankruptcyinsolvency/articles/risingbusinessinsolvenciesandhighenergyprices/2022-10-07).

For those of us practitioners advising companies dealing with the harsh realities of insolvency on a daily basis and trying to understand the forces currently at play, the ONS provided some possible explanations as to what is going on.

It explained that more than half of all insolvencies in England and Wales during the first half of 2022 occurred among businesses involved in construction, manufacturing, accommodation, hospitality, wholesale and retail.

That is particularly interesting because they are the same sectors most exposed by the global shutdown in 2020 in an effort to limit the coronavirus contagion.

Of course, the UK Government - like many of its international counterparts - introduced a raft of initiatives to shield commerce from the worst effects of seeing trade suddenly grind to a halt.

They included a number of loan guarantee schemes under which companies could apply to the British Business Bank for financial support from a panel of accredited lenders.

Data released a month ago showed that a total of £77.1 billion had been made available as part of the Bounce Back Loan Scheme (BBLS), Coronavirus Business Interruption Loan Scheme (CBILS) and Coronavirus Large Business Interruption Loan Scheme (CLBILS) (https://www.gov.uk/government/publications/covid-19-loan-guarantee-schemes-repayment-data/covid-19-loan-guarantee-schemes-repayment-data-as-at-31-march-2022).

Some of the firms benefitting had been trading steadily before the problems created by Covid.

For others, however, the Government measures only amounted to life support, effectively - and temporarily - staving off their somewhat inevitable collapse.

In addition, some of those who had been successful before the pandemic, emerged from lockdown to a different commercial landscape and saw their prospects limited as a result.

That much can perhaps be seen from the fact that just over 15 per cent of the sums drawn £46.6 billion in Bounce Back loans up to the end of July this year were either in arrears or had defaulted completely (https://www.gov.uk/government/publications/covid-19-loan-guarantee-schemes-repayment-data/bounce-back-loan-scheme-performance-data-as-at-31-july-2022) - £7.2 billion in total.

Having survived the pandemic, there is a natural desire for company directors - even those still struggling to clear Covid-era debts - to want to look to the future.

For many, that future, however, may be anything but rosy.

Furthermore, the role of and responsibilities of directors whose companies are confronted with acute economic challenges have been brought into sharp focus by a Supreme Court ruling within the last week.

At its heart were the duties of directors whose businesses are experiencing difficulties (https://www.supremecourt.uk/cases/docs/uksc-2019-0046-judgment.pdf).

The case involved a debt collector or "assignee", BTI, which had sought to recover a £118 million dividend paid out in May 2009 by a Scottish paper manufacturer, AWA, to its French parent company, Sequana.

As the Court heard, at the time that the dividend was made, AWA was still solvent but had "long-term pollution-related" liabilities, which meant that there was "a real risk, although not a probability" that AWA might become insolvent "at an uncertain but not imminent date in the future".

After AWA went into administration in October 2018, BTI argued that the dividend was a breach of its creditor duty, due to the risk of insolvency.

The judgment of the Supreme Court has confirmed the existence of a common law duty to creditors and reinforced how company directors should begin prioritising creditors if it is "probable" that their businesses will become insolvent.

Given the pressing issues which large numbers of companies are now dealing with, these are considerations which many directors are likely to have to confront in the coming months.

For evidence of that, we only have to glance once again at the latest ONS insolvency figures, one particular feature of which is the increasingly high number of Creditors' Voluntary Liquidations (CVLs).

That confirms that directors are being forced to make the difficult decision to put their companies into liquidation having concluded that they have become irretrievably insolvent.

The ONS' data underlines the impact which rising energy prices are having on many businesses, especially those employing fewer than 50 staff.

Despite Government efforts to insulate businesses from the negative impact of larger energy bills (https://www.gov.uk/government/news/government-outlines-plans-to-help-cut-energy-bills-for-businesses), it is likely that some businesses will be unable to continue.

The Covid-era relief measures have, of course, not been available for some time - a fact compounded by the end of the moratorium on some enforcement methods which kept companies from going under during lockdown.

No-one at the start of 2020 could have predicted the economic toll inflicted by the pandemic but the likelihood of difficulties in the months ahead is arguably easier to forecast.

It's equally clear that the actions of directors now which affect cashflow could well be called into question in the courts in the years to come by creditors.

Whilst that might seem merely a potential occupational hazard for the time being, it is - as with every other aspect of business - best to be prepared.

Taking informed guidance in good time can save personal and commercial distress of a corporate collapse becoming a legal headache thereafter.