Farmers - beware the risks of insolvency

Tuesday, 6th December 2016

It is an unfortunate reality that many farming businesses are operating at their limits and are struggling financially. There are several aspects of the insolvency law that should be borne in mind should you run your farm through a limited company that begins to face financial difficulty.

Directors' Duties

Directors' duties under the Companies Act:

  • s.171   Duty to act within powers
  • s.172   Duty to promote the success of the company
  • s. 173  Duty to exercise independent judgement
  • s.174   Duty to exercise reasonable care, skill and diligence
  • s. 175  Duty to avoid conflict of interest
  • s. 176  Duty not to accept benefits from third parties
  • s.177   Duty to declare interest in proposed transaction

These duties are cumulative.

As well as the duties under the Companies Act as given above, directors owe a further duty to act in the best interests of creditors when insolvency becomes an issue.

"Where a company is insolvent or on the verge of insolvency, the directors owe a duty to the company to act in the best interests of the creditors of the company" West Mercia Safetyware Ltd v Dodd [1988] BCLC 250

Tests For Insolvency

There are two tests for insolvency; the cash flow test and the balance sheet test.

The cash flow test is set out in section 123(1)(e) of the Insolvency Act 1986 that "the company is unable to pay its debts as they fall due".

The balance sheet test is set out in section 123(2) of the Act that a company will be "deemed unable to pay its debts if the value of the company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities".

A company need only be insolvent on one of these two base

Trading in the twilight periods

There is no statutory definition of trading in the twilight period; however it is often said to be the period between the company becoming insolvent but before going into a formal insolvency process. By trading during this period there is a risk of wrongful trading and of a director becoming personally liable to pay compensation where the company goes into Administration or Liquidation and the directors "knew or ought to have concluded" at some earlier date that the company had no reasonable prospect of avoiding it. From that point, the directors are under a duty to take all steps to minimise the loss to creditors.

Whilst not always desirable, trading whilst insolvent is not necessarily unlawful, and in certain circumstances it may be appropriate to do so. This was confirmed in Secretary of State for Trade and Industry v Gash [1997] 1 BCLC 341:

"The companies' legislation does not impose on directors a statutory duty to ensure that their company does not trade while insolvent. Nor does that legislation impose an obligation to ensure that the company does not trade at a loss. Those propositions need only to be stated to be recognised as self-evident. Directors may properly take the view that it is in the interests of the company and of its creditors that, although insolvent, the company should continue to trade out of its difficulties. They may properly take the view that it is in the interests of the company and its creditors that some loss making trade should be accepted in anticipation of further profitability. They are not to be criticised if they give effect to such view".

Misfeasance

Misfeasance is a claim that can be brought by an Administrator or Liquidator against a former director or officer of the company for breaching their directors' duties and is set out in s212 of the Act.

In "the course of the winding up of a company a person who:

  1. is or has been an officer of the Company; or
  2. is or has taken part in the promotion, formation or management of the company has misapplied or retained, or become accountable for, any money or other property of the company, or been guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company."

Directors will avoid liability if they can satisfy the court that they have done everything possible to minimise the loss to creditors. If a court finds a director guilty of misfeasance they can compel him to repay, restore or account for the money or property misappropriated, or to pay any sum that the court thinks just.

Whilst this article is focused on farmers trading through a limited company, there is of course also a risk to sole traders and partnerships. Sole traders could face bankruptcy, and partnerships could be faced with a Partnership Winding Up Petition and the bankruptcy of the individual partners. In a partnership, the partners will be personally liable for the debts of the business, whereas in a Limited Liability Partnership the partners' liability is more limited, as in a limited company.

Insolvency can be a very expensive process, especially in a sector where businesses are often asset rich but cash poor. Trading when a company is insolvent is a risk often taken and taking sound professional advice at the earliest possible stage is vital. As soon as you become aware of any potential insolvency risk, seek legal advice from a member of our Insolvency Team, or contact a specialist insolvency practitioner.

This article was written by Olivia Bridger and David Pomeroy.

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