Why do directors fail to take appropriate steps when their company is failing?

A general trend that I and many other Insolvency Practitioners see, is the length of time directors take, firstly to recognize that their company is failing and, secondly to take any concrete steps to remedy the situation.

A lot of small businesses normally do not have an accountant retained to advise them when a business is struggling. This becomes apparent when cash flows are impacted to the extent that only fixed costs are being paid, Inland Revenue returns being lodged but not paid and certain trade creditors only being paid if further supply is required.

Initially, business owners do not want to believe that their business is at risk of failing and believe that they only need to secure that one major deal/contract/investment that will lift the company from present fraught conditions to a situation where the company continues to trade at a profit, and everyone gets paid along the way. This can often lead to the business owner putting more money into the business to keep it afloat by leveraging the equity in their residential property. Often, this is a case of throwing good money after bad.

Clearly, with the benefit of hindsight, almost all business owners realise that they should have taken steps to address the precarious financial position of the business long before its inevitable failure. However, hope, often misplaced, and a stubborn refusal to recognize the inevitable, springs eternal.

Some business owners just don’t care whether continuing to trade creates greater losses for creditors, but I like to think that most business owners do care but feel almost powerless to do anything to arrest the situation. They worry that their staff will be unemployed, that they will lose a source of income, what their spouse and friends might think, etc. Then when they finally awake from this slumber, the damage is too great to be rectified and they must file for the liquidation of the company or be liquidated by a creditor, often Inland Revenue.

Business owners should be aware that as a director of a company, they have certain duties. These include the duty to act in good faith and in the best interests of the company, to avoid trading recklessly, duty to not incur an obligation without a reasonable expectation to perform such obligation, a duty of care and a duty to maintain proper accounting records. The failure to observe these duties can have serious consequences for directors.

Often the first loss incurred by a company is the “best” loss. That is, if a business owner has the gumption to take steps to either restructure, downsize or stop trading when they first realise, they have a problem, that loss is invariably going to be a lot smaller than it otherwise becomes.

When faced with this situation, professional advice should be sought from a competent accountant or similar professional, and that advice should be followed. This will lead to the avoidance of a lot of annoyance/discomfit/financial losses that invariably ensues when liquidation becomes inevitable.

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