Warning signs for Company Directors

Posted by Katie James on
It is important for company directors to understand why they need to care about the signs of financial distress.  When a business is healthy, busy and profitable it is very easy to keep carrying on being healthy, busy and profitable.  Hopefully this presentation will show that it is at this time that it is best to take a breather and review what is going on both in the business itself and in its market, including the company's competitors, suppliers, and customers.

Directors should care about spotting signs of financial distress in their own company because if a company goes into liquidation or administration, they will be a target.  Liquidators and administrators have to file reports with the Insolvency Service as to the reasons for the company's failure – these reports are the basis for any decision to bring disqualification proceedings against a director.

There are various reasons why a disqualification order or undertaking might be sought by the Insolvency Service;-

  • Conviction of an indictable offence;
  • Persistent breaches of companies legislation;
  • Fraud;
  • Summary conviction;
  • Unfit conduct of an insolvent company;
  • Expedient in the public interest;
  • Breach of competition law; and
  • Participation in wrongful or fraudulent trading.

Such orders can be made for periods of anything from 2 years to 15 years, depending on the circumstances and this will have a significant impact on a director's ability to earn a living.

 If a director's conduct has helped the company's downfall, a liquidator may bring a claim against that director to contribute to the company's assets; this could be for wrongful trading, fraudulent trading, misfeasance, breaches of the Companies Act 2006 or even deceit.  I mention deceit because in the case of Contex Drouzhax Limited –v- Wiseman & Another [2007] EWCA CIV 1201, a company director was found liable to a creditor in deceit for signing a contract on behalf of a company when he knew that company could not afford to fulfil that contract.

Looking outwards, the insolvency of suppliers can have a catastrophic effect on a company's ability to serve its own clients and to trade, whilst the insolvency of a customer, could simply kill cash flow debt.  An example of this was the MG Rover insolvency back in April 2005 which sparked a number of further insolvencies of companies that relied solely on its trade. By the time it failed, it owed creditors nearly £1.3billion. All four directors gave disqualification undertakings for 6, 5 and 3 years respectively.

The first question for company directors is "what is insolvency?"  There are two ways of looking at this:  firstly the technical legal definition and then the practical reality.

Turning to the legal definition, there are two tests under the Insolvency Act 1986:

  • Cash flow; and
  • Balance sheet

Cash flow insolvency is where it is proved to the satisfaction of the Court that the company is unable to pay its debts as and when they fall due.  The case of BNY Corporate Trustee Services Limited –v- Eurosail-UK 2007-3BL PLC and others [2011] EWCA CIV 227  restricted this definition so that only those debts falling in the reasonably near future are to be taken into account.  The Court took the view that the further ahead the liability, the more speculative the exercise is and you therefore move to a test of present assets against present and future liabilities (discounted for contingencies and deferment) which is essentially the balance sheet test.

The balance sheet test is where it is proved to the satisfaction of the Court that the value of the company's assets is less than the amount of its liabilities, taking into account contingent and prospective liabilities.

In a practical sense, insolvency practitioners and accountants look at what is called the decline curve.  The idea is that you spot the signs as high up in the curve as possible so that more can be done to save the business, or to save jobs, or to prevent an increase in any loss to creditors.  The first part of the curve is called "under performance" and that is where a company suffers a loss of profitability.

The second part of the curve is "distress" which is where a company cannot fund any activity outside of its immediate operation.

The third part of the curve is where the company suffers a critical shortage of cash, ("crisis") and the end of the curve is failure, whether by liquidation or administration, or some other terminal process.

As you can imagine the curve starts off relatively benign but as you move through distress to crisis and then failure, the curve becomes much more acute until effectively it becomes a drop off the cliff.

So what are the signs? 

In short, anything unusual or out of the ordinary during the course of the business.  It is crucial that directors know their key contacts and relationships very well so that they can identify what is normal and what is not.

Set out below is a list of behaviours; each of which will suggest the point in the decline curve at which a company is at any given time.  A reoccurring theme of this presentation is that it is important the directors pick up any problems as high at the decline curve as possible which will give them more options.



Point in the decline curve

Profit warning

The company likely to make less profit than it predicted


High staff turnover

Poor terms and conditions or poor working environment


Change in market condition

More competitors, change in the law, lack of demand


Decline in profit

This is likely to be a loss of sales together with increased costs


Increase in liabilities long-term

This may be an indication that the company is trying to fund expansion or other contingencies


Decline in turnover

Company is losing sales


Low staff morale

Lack of productivity, lack of motivation, perhaps the staff are being paid late or not at all


Parent company support

Whilst this is a common phenomenon, each company is a separate entity and its insolvency must be considered separately; it is quite frequently a reason for accounts being prepared and filed at Companies House on a going concern basis. The question is how long can the company survive without that parent company support? What is that support for? Is it for day-to-day funding or is it for extra-ordinary activities



The company is trying to cut costs or restructure its business


Nobody seems to have enough time



Slide in reputation

A reduction in quality of goods or services, cutting costs


Increase in debt



Increase in debtor days

The company does not have an effective credit control policy and its cash flow is therefore being impacted


Increase in liabilities short-term

The company has immediate cash flow difficulties



The company may be trying to cover up its previous financial difficulties or simply attract new business


Request for part payment or instalment plan

The company is trying to improve cash flow


Slow delivery

The company is waiting for money in in order to pay the supplier to complete the order


Slow payment

The company is waiting for payment from its own customer before paying the supplier


Lack of communication

The company and its staff are avoiding answering difficult questions


Clear hostility between directors and shareholders



Spurious claims to reduce a price

The company is trying to cut costs


The site is not clean and tidy

The company may be failing to pay its cleaners etc or it may have significant other priorities that do not afford it the time to consider the state of its site


Time-to-pay arrangement in place with HMRC

Effectively the company is using HMRC as a bank


Management seem to be fire fighting



Lack of credit insurance available for a particular customer

The insurers consider there is a real risk that this customer will not pay, this can have significant impact  i.e Woolworths

Crisis/ Failure

Changes in the board of directors

Directors trying to avoid liability i.e. wrongful trading


Plant/equipment/materials disappearing

This may be down to ROT claims, employees helping themselves, other liens, or the landlord levying CRAR


Late filing of accounts

The company is trying to avoid publicity and announcing to the world at large their financial difficulties


Cheques having been returned unpaid

There is effectively not enough cash in the bank account to pay these cheques


Change of company number

The business and assets move to a new entity


Much of the information above will may not be immediately obvious or apparent.  Some of the publicly available information goes out of date quite quickly i.e. filed accounts at Companies House.  There will be much reading between the lines in these situations.  Don't underestimate the personal relationships; gossip can be right.  Directors should encourage their employees, particularly those in credit control or sales teams, to speak to their contacts at customers or suppliers on a regular basis.  They may be able to pick up on other signs such as someone being absent frequently or not sounding very happy.  In particular, some of the more junior members of the accounts team may speak more freely.

The local press is usually a good source of information and may give you a clue.

Directors should consider signing up to a service like Experian so that they can do frequent checks on their customers and suppliers.  Again, directors should use Companies House to look at filed accounts, changes in directors, annual returns and whether or not the company has granted any fresh security.  If the company is granted one charge, it is relatively common, however if there are three or four and in particular to lenders that the director does not recognise, that may be another warning sign.

Depending on the relationship, directors may be able to request copies of monthly management accounts for their customers and/or suppliers.  Such an obligation could be included in the contract or service agreement, which would generally give the directors a bit more foresight as to how the customer or supplier is performing.

The London Gazette is useful as it contains advertisements of all winding up petitions and some other legal processes.

If there is any doubt as to whether or not a winding up petition or document related to an administration has been filed against a customer or supplier, the director should phone Central Index on 0906 754 0043. Alternatively, the director can email Central Index to request this information at RCJCompanies.Orders@hmcts.gsi.gov.uk. This is a list of all winding up petitions and administrations which can be searched by company name.  It also includes a Notice of Intention to Appoint Administrators as well so that may give you a little bit of time.

One of the most important things however is for the company to keep good records for the directors to review those records regularly and spot any changes in patterns.  This is likely to be the earliest indication of any trouble.

Having spotted a problem, what then is to be done? 

This will very much depend on how bad the situation is, what the relationship is between the company and its customer/supplier, and what it is that the director of the company wants to achieve.  Often it is simply a case of cutting the company's losses as soon as possible but at the other end of the scale, depending on the relationship, it might be worth considering buying the business assets of the supplier so that the supply service is bought in-house.

It is very important to identify a clear strategy when a company's customer or supplier is in financial difficulty i.e. what do you want to happen and what is the best way to make that happen?  At this point good legal and accountancy advice is essential. Such a strategy may need to be reviewed on a regular basis as circumstances change.

One issue will be to avoid making the situation worse by provoking other creditors; this may mean control is taken away from the company, customer or supplier which might prevent the successful rescue of the business.  So directors should be cautious about what is said.  However, it will be crucial that all key relationships are on board for a successful rescue but it is an extremely fine balance.

Directors should also understand the impact that the insolvency of a supplier or customer will have on their own business.  Will it be catastrophic and what alternatives are there?  It might be worth incorporating this into any disaster management plan.

Possible options are to renegotiate trading terms to include payment on delivery.  It is also useful to review trading terms on a regular basis to ensure that any retention of title clauses are as effective as possible.  Again, depending on the nature of the relationship site visits can be conducted, reviews of management accounts undertaken and regular feedback meetings held.

Ultimately however it may come down to terminating the contract and finding another supplier or customer and presenting a Winding Up Petition for the sum owed.

An effective credit policy is key and will often identify issues at an early stage.  I have seen systems go through the following process:

  1. Invoice being sent;
  2. Statement being sent 14 days later;
  3. Chaser letter being sent 14 days after that; and
  4. A telephone call 7 days after that.

Usually the telephone call uncovers what is going on or results in payment.

The upshot of all of this is that good advice is also key in terms of legal accountancy and tax, and being able to have open conversations with your customers and suppliers.

About the Author

Katie is an experienced insolvency Lawyer, aiming to maximise recoveries for her clients, whether through sales of assets or by way of litigation.

Katie James
Email Katie
0118 955 3048

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