This is the final in a four-part series prepared by Restructuring and Insolvency Specialists Association of Bermuda [RISA Bermuda], on insights to help small- to mid-size organizations manage financial, operational, and staffing considerations, as well as directors’ duties and responsibilities, in view of the current COVID-19 crisis.
The first three articles dealt with issues to be considered when adjusting your organization to operating during the COVID-19 crisis are liquidity and cash management, employee considerations, and operational flexibility.
In this article we consider some key “to dos” and “not to dos” if, after analyzing the impact of the COVID-19 crisis on your organization, you determine that the organization is insolvent. The steps recommended in the first three articles in this series will assist in that analysis. Some of the points raised in this article relate specifically to the duties of directors of a company, but they are also relevant considerations for the owners of unincorporated businesses – sole traders and partners, whom we will refer to as proprietors.
What is insolvency?
Your organization will be insolvent if it is suffering a cash flow shortfall and is unable to pay its debts as they fall due; or if the liabilities of the organization exceed the value of its assets.
Directors’ duties
Directors have a duty [under the Companies Act 1981] to act in the best interests of the company. When the company is insolvent or likely to become insolvent, they have to take into account the interests of the creditors of the company in priority to interests of the shareholders, when fulfilling that duty.
“To dos” if your organization is insolvent
Assess The Financial Position
There is no prohibition on an organization continuing to trade while insolvent in Bermuda’s legislation.
- Directors may still be acting in accordance with their duties if they allow the company to continue to trade, provided that there is a reasonable prospect of the company returning to solvency. Therefore, you should assess the financial position of the company to determine whether its inability to pay its debts is a short-term or long-term issue. Does the company have a reasonable prospect of surviving this crisis?:
- If the company was in good financial shape before the crisis began and it is reasonable for the directors to consider that it will be able to recover as soon as the country is open for business again, the directors are likely to be acting in accordance with their duties by keeping the company in operation.
- However, if the company was already experiencing financial difficulties before the pandemic and/or the crisis has put the company beyond the prospect of recovery, the directors will need to consider whether it is in the best interests of the company to cease operating and go it into liquidation.
- Proprietors should make a similar assessment of their organizations, bearing in mind that are personally liable for the debts of their organization, which if unpaid could result in their bankruptcy.
Consult restructuring & insolvency specialist for advice
It may be prudent to seek advice from a restructuring and insolvency specialist who can assist in determining what course of action your organization should take in order to protect the interests of all stakeholders.
- If riding out the crisis and continuing in business is likely to provide the best prospect of your creditors being paid, a specialist can advise on what steps the organization can take to enable you to do so without falling into any of the pitfalls outlined in the “not to dos” below.
- If continuing in business is not feasible or is unlikely to result in a better prospect of creditors being paid, a specialist can advise on options for closing down the organization.
- For a company this would include:
- a creditor’s voluntary winding-up, an out of court process which is commenced by the shareholders, with the liquidator [who takes control of the company and manages the winding-up of its affairs] appointed by the creditors;
- a winding-up by the court – in which the liquidator is appointed by, and the process is subject to the control of, the court.
- For an unincorporated business this will include advice on:
- the orderly wind down of the organization,
- dissolution of the partnership.
“Not to dos”
Don’t engage in fraudulent trading
While it is possible for a company to continue in business, even when insolvent, it must not engage in fraudulent trading.
- Under the Companies Act 1981, fraudulent trading occurs when any business of a company has been carried on with intent to defraud creditors of the company or for any fraudulent purpose. If the company continues to incur credit even though the directors [or other persons controlling the company] know the company is insolvent, and they deceive the creditor into extending credit to the company by concealing the true financial position of the company, that will be fraudulent trading.
- If a company goes into liquidation and it is found that it engaged in fraudulent trading, any persons who are found to have knowingly been parties to the carrying on of the business in this manner can be held personally liable for the debts of the company.
- Therefore, to avoid any allegation of fraudulent trading, if your company is insolvent or in danger of becoming so, you should ensure that you do not cause the company to incur more debt, whether by way of loans, or by accepting delivery of supplies which the company cannot immediately pay for, without letting the lender or supplier know what the financial position of the company is and that there is a possibility the company may not be able to pay the debt.
The final point should equally be taken into account by proprietors, who risk liability for fraud if they engage in trading in a manner which would amount to fraudulent trading if done by a company.
Don’t enter into preferences
If your organization is continuing in business, at a time when you are unable to pay your debts as they fall due, you need to carefully review any proposed transactions with creditors, to avoid any risk that a transaction will be set aside as a preference.
- A transaction with a creditor entered into by an organization when it is insolvent, may be challenged as a fraudulent preference:
- if the company goes into liquidation, or the proprietor goes into bankruptcy, within six months of the transaction; and
- it appears that the organization intended to prefer the creditor in question at the expense of the other creditors.
- A transaction which is found to be a preference may be set aside by the court in the liquidation or bankruptcy of the company or proprietor.
- A preference does not have to involve a payment to a creditor. For example, if you give a creditor additional security for an existing debt without receiving anything further in return, that may be considered a preference.
- A payment to a creditor made in the ordinary course of business, or in response to legitimate commercial pressure to pay, is unlikely to be considered a preference.
Don’t fail to pay employee deductions and taxes
If you are continuing to employ staff, you should not cease to pay employee deductions and taxes. Directors or proprietors may be held personally liable for unpaid pension contributions, social insurance, medical insurance and payroll tax and may also be subject to criminal penalties.
The assessment of your organization’s solvency position should be an ongoing process throughout the COVID-19 crisis and beyond, into the recovery period. This will help to enable you to take critical action as necessary either to preserve the organization’s business, or to wind it down in an orderly manner to minimize the adverse impact on all its stakeholders of its insolvency; and to ensure that, in the case of companies, directors are fulfilling their duties.
*RISA Bermuda consists of accountants, lawyers, and other individuals who are directly or indirectly engaged in the business of insolvency and restructuring in Bermuda. Refer to www.risa.bm for further information. No insights from this article constitute legal, financial, commercial or other professional advice.
