Corporate recovery

Some practical precautions

The current economic climate would indicate that business insolvencies will increase this year. But what practical precautions can be taken to minimize the risk of becoming insolvent in the first place?

Many businesses fail because of cash flow problems. The two major issues with cash flow are late payment, and bad debts. Legislation introduced in recent years to enable SMEs to claim interest from late payers has proved of limited use, because businesses fear upsetting their customers by insisting on the payment of interest.

Bad debts are a different matter. Simple credit checks are easy to do – though not foolproof – but above all ask yourself whether you believe the customer is able to pay. Importantly, identify your customer. It is surprising how often creditors are not sure of the identity of the legal entity that owes them money. Is it an individual, or the individual's (insolvent) limited company? If you are dealing with a limited company, its headed paper should make that clear and give a company number.

If your customer goes into formal insolvency, it is worth spending a moment deciding whether there is anything further you can do. Professional firms value their relationships with their business clients: get to know an insolvency professional so that if you need to, you can call him on the telephone for a few minutes of specialist advice.

Directors of limited companies are not usually liable for their company's debts, but if they were at fault in allowing it to become insolvent they may nonetheless find themselves personally liable to compensate the company, via its liquidator, under a number of provisions in the Insolvency Act which enable the liquidator to make a claim against the directors.

Similarly, since 2004 individuals who are found to have be at fault in becoming bankrupt risk a Bankruptcy Restriction Order.

If it is your business in trouble, probably the single most important precaution that can be taken against these sanctions is to be able to demonstrate that any decision, even if it failed, was not rash or foolish. Any business should ensure it has a regular flow of up to date management information, and its absence will indicate poor management. Taking, and following, professional advice, is also a practical answer to potential criticism.

If your business does get into financial difficulties, what should you do? First and foremost, treat your creditors as your number one priority. That is your legal duty, and it is also sound business sense. Many businesses fail to spot the early signs of the threat of insolvency proceedings against them, particularly from HM Revenue & Customs (HMRC). Even if the debts cannot be paid in full, in many of these cases HMRC has acted because either no arrangements for payment were made or they were not adhered to.

If insolvency proceedings are started against you, act immediately. You have only a very short time in which to do so, and such proceedings will move remorselessly towards formal insolvency unless firm, prompt, and effective action is taken.

As soon as a bank gets wind of a winding up petition against its customer it will freeze its account. Winding up petitions are advertised not less than seven "business days" before the hearing of the petition (that is for practical purposes about two weeks beforehand, or even earlier) and as soon as the advertisement is published, the bank is likely to spot it. Leaving a response to the last minute is therefore likely to prove fatal.

If you have not taken advice from an insolvency professional before, do so immediately. It is much easier, and cheaper, to avoid formal insolvency than to get out of it once you have been made bankrupt or your company wound up. A rescue procedure such as a voluntary arrangement or administration may well represent a much better alternative and offer a way forward for the business and those involved in it.