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Are insolvency avoidance schemes too good to be true?
Mike Fortune from Leonard Curtis looks at why SME owners should not be swayed by fancy insolvency avoidance offers – where there is likely to be a catch.
Over the last few months, I have seen various adverts from businesses asking, ‘Are you looking to avoid insolvency?’. These profess to buy a director’s company, take on all liabilities, and deal with all creditors which means no more stress or worry.
Recently, I was speaking to a company director about his business who said that he had been recommended to speak to an insolvency avoidance company. Let’s call the business ‘Too Much Debt Limited’ or ‘TMDL’.
The company was insolvent, and facing a seemingly inevitable liquidation, had little in the way of assets and huge liabilities, some of which were personally guaranteed.
The company was under threat of being wound up by HMRC and there was no realistic prospect of turning things around, yet someone was offering to buy his worthless shares in the company and take away all their troubles.
Let’s call this insolvency avoidance business Too Good To Be True Limited’, or ‘TGTBT’. TGTBT was selflessly willing to buy his shares for £1, have the business owner resign as a director, and appoint a new director to deal with all those annoying liquidation formalities.
What’s not to like?
Well, as it turns out there is quite a lot. The purchaser wanted a fee upfront to buy the shares which in this case was £10,000 or 10% of the liabilities, whichever was greater. So, they were willing to ‘buy’ the shares for £1, but only after being given a minimum of £10,000 first.
The director of TMDL was told that upon selling his shares and resigning as a director he would have no responsibility for his actions, would not need to deal with anything relating to the company’s insolvency, and could disappear into the sunset with nothing to worry about. This could not be further from the truth.
Consequences the same up to three years prior to resignation
Once a company is in liquidation, the appointed liquidator must investigate the conduct of all directors of the liquidated company up to and including the three years prior to insolvency.
A director has responsibilities for their actions up to the date of their resignation so, in reality, the potential consequences for a former director of TMDL would be largely the same as they would have been had he not resigned.
While in most cases directors of insolvent companies have nothing to fear from these investigations, in some cases they do – which can include personal liability for debts of the company, disqualification, or criminal sanction – and that will not change by resigning before the event.
Obligations still in place
The director of TMDL would not be able to avoid any personal obligations that he has to creditors e.g. personal guarantees that he may have given to suppliers or lenders. These guarantees crystalise on the insolvency of the company and certainly do not disappear.
The responsibility for any personal guarantees cannot be assigned to TGTBT or anyone else without the agreement of the lender or supplier, which it is fair to assume would not be acceptable to those parties, or to TGTBT.
So, when you work it through, it is not the simple solution being sold and unlikely to be the outcome that the director was expecting. Fortunately, in this case, the director followed my advice, kept hold of his money and dealt with the liquidation of his company appropriately.
Government advice to directors
The government has responded to calls from the insolvency profession to provide greater guidance to directors on what steps to take if they are concerned their business may be facing insolvency. In March 2022, The Insolvency Service issued a useful guide, entitled Company Health Check: keeping your business on track, to help directors recognise the signs of insolvency and understand their duties as a director.
The guide provides valuable guidance at a time when businesses are struggling with interest rates, inflation, and the cost-of-living crisis. As always, the best course of action is take professional advice early and maximise the options available.
Moral of the story? Too good to be true insolvency avoidance schemes are most likely exactly that.
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