Considering solvency issues in light of the Coronavirus

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Both the supply and demand side of the economy are likely to undergo significant pressures as a result of the Coronavirus outbreak. Certain industry sectors are already being significantly disrupted, including aviation, shipping, tourism, retail and manufacturing; however, this list is likely to expand if the Coronavirus outbreak continues to worsen around the world. It will be important that businesses plan for this period of uncertainty and take the necessary steps to minimise the potential impact of a difficult trading environment.


How important is it for distressed companies to engage with their stakeholders?

A company has a wide range of stakeholders ranging from its suppliers, customers, and lenders, to its employees, directors and owners. Each stakeholder will face its own challenges as a result of a company’s distress and it is important to understand their different perspectives. Early pro-active engagement with stakeholders provides the opportunity for the company to consider the full range of its options to restructure its financial and/or trading arrangements.

It is crucial for companies facing financial distress to have a full and accurate picture of their financial and trading arrangements. Distressed companies will need to identify their key stakeholders under these arrangements and consider negotiating the necessary temporary support to continue to trade. The type of support will depend on the stakeholder; terms of supply and trade credit may need to be varied under trading arrangements, or waivers and forbearances may be required under financing arrangements. 

Where key stakeholders are facing their own financial distress, it will also be necessary to consider whether any steps need to be taken to protect the company against the adverse impact of their potential insolvency in circumstances where the company has provided credit or it is overly reliant on the stakeholder from an operational or trading perspective. 

What duties do the directors of a distressed company have?

Directors need to ensure that they understand the scope of their fiduciary and statutory duties when trading in the zone of insolvency, that is when a company is insolvent or on the verge of insolvency. These duties vary from jurisdiction to jurisdiction. 

In the UK, directors have duties to exercise reasonable care, skill and diligence, and to act in a way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders as a whole. However, when a company is trading in the zone of insolvency the duty to consider shareholder interests shifts to prioritise the interests of creditors. This means that directors of distressed companies may need to consider pursuing more conservative strategies which focus on minimising losses to creditors.

Civil code jurisdictions frequently have a strict statutory requirement for directors to file their company into an insolvency process within a specified timeframe of the company becoming cash flow insolvent and no longer being able to meet its debts as they fall due. This timeframe can be as short as 21 days. In most common law jurisdictions, including the UK, there is no strict statutory filing requirement. Rather, directors have potential liabilities for any losses that creditors incur as a result of the company continuing to trade beyond the point there was no reasonable prospect of avoiding insolvent liquidation. 

What steps should directors of distressed companies take?

Directors need to ensure that they are fully informed of the company’s latest financial, trading and operational position, and have access to appropriate legal and financial advice to support them in their decision making. Regular board meetings should be held and the commercial decisions of the board reported in detail in the company's minutes.

Please contact Alex Rogan (Partner) and Julie Killip (Partner) should you wish to obtain further advice on any of the issues identified above.

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