Market report (2/2)

IN 2008, my articles explored the impact of fast changing market conditions on the broader economy and business in general. There is universal agreement that the corporate market is going to be significantly different to previous years. Accordingly, over the coming months, our focus converges on your business with a series of articles designed to provide you with information that will assist your decision making, whether you’re a shareholder, director, owner, CFO, CEO or corporate stakeholder. The coming articles will cover topics such as understanding your duties when it comes to preventing insolvency, understanding your business (in terms of financials, value and from the perspective of your stakeholders), protecting your business (from defensive and communication strategies to corporate transactions) and succession planning.

As we move into one of the toughest economic climates in decades, it’s important for everyone to adjust their thinking and strategy. For many, ‘insolvency’ is a dirty word. Your shareholders, creditors and bankers don’t want to hear it. But you don’t have to be insolvent to talk about insolvency and the big tip here is to ensure that this word is not ‘taboo’ at your board meetings. In fact, talking about it ahead of time is likely to be one of your most important defences.

Tip 1: Recognise the indicators or causes of insolvency. These are numerous, and many are obvious (such as high cash burn rate, decreasing cash flow, difficulty in raising funds, through debt or equity). Make a regular assessment to gauge how close you are to the line and when to take action. Some indicators require more analysis or are more subjective. Here’s some examples: You ’re sticking to the budget (which worked 12 months ago). There’s plenty of current assets on the balance sheet (but are they really liquid?). You’re optimistic that the next big project, sale or contract will ‘save’ the business (no need for a plan B). The last quarterly reports looked okay (I’ll assess again in three months). The point is old habits probably won’t suffice for 2009, so take the test now, review and forecast at least monthly.

Tip 2: Understand directors’ duties. As well as the main duties, there is also a duty to prevent insolvent trading. Understanding your company’s financial position when signing off yearly accounts is not enough. If you have trouble understanding the accounts, have some sessions with your accountant. Scale up the quality and regularity of your internal management reports. Civil penalties, compensation proceedings or criminal charges may otherwise await. And if you’re thinking of relying on the business judgment rule, think again – it doesn’t apply to insolvency proceedings. There are four statutory defences, each with very specific criteria and are notoriously difficult to rely on. If you’re not proactive – they will be of little help.  

• ROB Hutson is a partner of KordaMentha with a focus on servicing the firms banking and financial services clients.

• He has more than 18 years experience in corporate recovery and insolvency, with recent assignments including MFS Limited, Storm Financial Limited and advising a number of banks regarding their exposure to Raptis Group Limited.

• Hutson says the biggest challenge facing directors in the current market as managing cash flow in an environment where asset values are either declining or cannot be realised given lack of liquidity. 

THE directors of Project Management Co (PMC) knew that things weren’t going so well. After granting extended credit terms to some large developers (including R Co) there was a hole in the short term cash flow forecasts. They sought short term financing from their banker (who was usually accommodating) and while waiting for a response, conducted business as usual. Unaware of the potential cash shortage, PMC’s project managers continued to place forward orders for large amounts of building materials.

The bank manager (mindful of the difficult economic climate and the already overdrawn working capital facility), sought evidence that PMC could pay the debt if they failed to secure payment from a number of their key clients. Unable to provide it, the loan was refused. 

A week later, R Co collapsed leaving PMC with no cash to pay for the orders placed by its project managers. The creditors threatened to put PMC into liquidation.

Did you know?

Appointing a voluntary administrator (VA) may give you some breathing space and provide an opportunity to keep the creditors at bay. During administration, claims by creditors or lessors cannot be pursued, charges and personal guarantees cannot be enforced and court applications to appoint a liquidator cannot be commenced.

A VA’s role is also slightly different to a liquidator. Wherever possible, a VA will try to save the company and its business, so if appointed early enough it may not mean an end to your business. 

Additionally, while a VA must still report potential offences, they do not have a positive obligation to investigate the company and its directors for possible insolvency proceedings. Noting that directors involved in two or more liquidations may face disqualification, a VA will generally be the more preferable option. The court will also consider whether a VA was appointed, when and the results, in considering defences to insolvency proceedings.   

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