Protect your business..and yourself

The Autumn Statement didn’t do anything to alleviate our feeling of doom and gloom and post-Brexit and Trump vote uncertainty.

The SME sector, and the Owner Managed Businesses that make up the bulk of the UK economy face increasing challenges over the next few years. Auto enrolment and changes to taxation all add up to increased administrative and cashflow demands as the Treasury try and maximise tax receipts as early as possible.

This means that Owner Managed Businesses need to be on top of their finances. We have in the past provided comment and articles on the importance of successful planning, budgeting and business review. Now would be a good time to carry out a review and keep the position of your business under constant scrutiny so that preventative or correctional actions can be taken at an early stage.

Best practice remains best practice. As always the strong and well-run business will survive troubled times whereas the poorly managed and run business will not. I fear that over the next few years the number of failing businesses will increase dramatically.

We have certainly been dealing with increasing numbers of insolvency cases involving Director misconduct; particularly where Directors have drawn too much money from the business resulting in outstanding overdrawn Directors Loan Accounts at the point of insolvency.

Case 1

My first example involves a business that had not kept adequate financial records. Despite having a board of 4 Directors the business was very much run and controlled by one individual. The proper checks and balances that would normally be in place with a 4-man board simply were not there. The controlling Director managed to treat the company’s funds as his own personal bank account, withdrawing in excess of £300,000 over a relatively short period.

The company became insolvent and once a detailed review and reconstruction of their financial records had been completed, the Director had to repay the withdrawn funds and make a substantial contribution to the costs involved.

Case 2

In another recent case I was appointed as liquidator over a company that had operated a care home. On the face of it the reasons for failure, being the squeeze on the welfare costs of looking after its residents, coupled with increasing operational and staff costs seemed very plausible. However, on closer inspection of the financial records it soon became clear that the real reason for the demise of the business was once again the Director/Owner drawing on the company’s account when the profits were not there to support his spending. This case is ongoing and it is likely that proceedings will be issued against the Director/Owner to recover the funds so that the creditors can get some return.

Case 3

While the previous two cases probably represent the extreme worse case scenarios, I am also liquidator of a contracting business which had previously been run very successfully and as a consequence the Directors/shareholders had been used to receiving drawings from the business partly as salary and partly as payments on account of dividends. These on account dividends were posted through a Directors Loan Account which was then “cleared down” at the end of the financial year by voting dividends from the profits achieved.

This is of course a very efficient way for Directors/Owners to pay themselves when a business is operating successfully. The problem comes when there is a downturn in the company’s fortunes, as was the case here.

Despite insufficient profits, the Directors continued to draw funds from the business. When they realised that the company was facing insolvency they managed compound the problem in a number of ways:

  • They increased their salaries to take account of the enhanced drawings and cover the retrospective “dividends”. They did this knowingly to avoid having to repay funds that had been drawn from the business.
  • They made sure that a number of key suppliers were repaid as they wanted to continue a business relationship in their “new company”. Payments were made literally days before they instructed an Insolvency Practitioner (not me) and certainly after they received advice that the company was insolvent. These payments amounted to £85,000.
  • Closer inspection of the records also identified certain purchases that were clearly for personal use; I have never seen a site office with a £1500 state-of-the-art fridge!

The Directors concerned are now facing recovery action.

Best Practise

As a Director you have an obligation to act in the interests and promotion of the company.

When a company is insolvent that obligation extends to act in the interests of the creditors. In these circumstances it is important to recognise your responsibilities and do everything that is necessary to protect and maximise the return for creditors. This includes repayment of overdrawn Directors Loan Accounts. This results in creditors getting a much better return as we are able to deal with matters in a much more cost-effective way and avoid the substantial investigatory and legal costs of pursuing recovery.

If your actions make the position for creditors worse or indeed you do something to “prefer” one set of creditors against another (the wronged party is often HMRC) then you have breached your duties as a Director and could be made to make a contribution to the company to rectify that misfeasance.

Take professional advice at an early stage if your company is struggling so that you minimise the risks of being liable for a contribution to its failure. Dealing with matters this way avoids substantial costs, gives certainty and ownership of a solution and very much results in creditors getting a better and quicker return.