A Bridge Over Troubled Waters (toll free) - some insolvency perspectives

Directors need to be aware of potential personal liability. The prospect of future claims against directors arising from urgent decisions now made in the expectation of keeping their business afloat looks like the Coronavirus infection J curve.

The Government’s announcement of a six months suspension of insolvent trading liability of directors for debts incurred in the “ordinary course of business” assists. To rely on the exemption directors will need to establish that incurring the debt was in the ordinary course and was necessary to facilitate the continuation of the business. This could include, for example, a director taking out a loan to move some business operations online. It could also include debts incurred to continue to pay employees. Directors will need to prepare a plan at the time of incurring the further debt setting out what result they reasonably expect for the business. Perhaps a better way to put it is to ask whether incurring the debt is “in the ordinary course of business in extraordinary times”.

The increase of the minimum amount for a statutory demand (the usual step taken by a creditor to prove insolvency and thereafter commence liquidation proceedings) to $20,000 also assists to some extent. However, no relief has to date been suggested for directors who have provided personal guarantees of a business liability. If a business is to survive the present downturn, its directors need to focus on steps to save it rather than having to deal with personal claims. Arguably, directors should be relieved from claims for a liability to a supplier or a property owner previously paid by the business in accordance with agreed terms, but now cannot be paid solely due to the sudden drop in cash flow.

Perhaps the most important issue to ensure that businesses can “cross the bridge” is to ensure that they can remain in occupation of their leased premises (especially if they are in the hospitality industry shut down by government directive). Tenants have, or will have, little capacity to meet rental liabilities that were previously serviceable from cash flow. Many property owners will have no alternative other than to reach a resolution with their tenants for the interim period. There is unlikely to be a “wait list” of alternate tenants willing to take over premises. Additionally, most property owners will do the right thing by their tenants and the economy generally.

There is however, a possibility that a property owner may wish to use the current circumstances to its own benefit. The leased premises may be a more attractive proposition with vacant possession. The property owner may wish to terminate a long lease to expedite development opportunities for the leased property or consider taking over premises for its own use. The tenant’s goodwill (and in some instances valuable leasehold interests) can be dissipated because it is unable to pay rent because of little or no business.

A possible reform is to restrict property owners from taking possession of premises if there was no default by a tenant prior to the current circumstances (for example prior to 1 February 2020). Additionally, property owners could be required to provide a rent abatement especially if the business has been shut down by a Government directive. There is no benefit to a business if, despite retaining possession, rent that the business will never be able to pay in the future continues to accrue.

All decisions currently made to alleviate the pressures on business will have an adverse flow on effect on other stakeholders. Lenders to property owners will need to consider the position of their borrowers whose rental income has, or will be, severely affected in the current climate.

We are all making decisions as we go. Every day seems to bring a new challenge arising from circumstances that were never in any ones contemplation. Business needs to cross the bridge over troubled waters, toll free. That means without adverse consequences to directors and business in the future. Without urgent reforms, business will not be “Crossing the Bridge”; rather it will be “On the Road to Nowhere”