Challenging Times Ahead for Directors in the Hospitality Sector
03 June 2020
Notwithstanding the phased return to some level of normality, some businesses will continue to be significantly affected, particularly those in the hospitality sector where longer term challenges may be encountered due to social distancing requirements, consumer unease and the likely absence of international travel for many months, or perhaps even longer.
However, there are a lot of options open to otherwise good businesses facing cash-flow and other financial issues as a result of COVID-19, even businesses that may have no alternative but to alter their business model and/or operate at reduced capacity for some time.
As we begin to have a clearer picture of when the most severe elements of lockdown might end, it is important to consider how a business has been affected and how long those effects will last. Businesses that simply cannot return to normal may determine that the business is no longer viable but in many instances it may be feasible to look at some form of restructure, formal or informal. Balanced against that is the challenge for directors who may be concerned at making decisions which ultimately transpire to be incorrect.
Safeguarding against personal liability
It is important to be aware of the fact that, if a business is verging on insolvency, the directors must be careful that the position of the creditors of the business, as a body, is not materially worsened. This period is sometimes referred to as ‘the twilight zone’ and can be a challenging time for directors as they must balance their duty to creditors with the objective of solving the company’s financial difficulties. Difficult decisions will arise where projections are more uncertain than ever and the risk of insolvency is greater.
However, the courts have held that it is not in the interests of the community that a company ceases trading whenever it appears there is a significant risk that it will become unable to pay its debts. To make a finding of reckless trading against a director, the court must determine that he/she knew or ought to have known that their actions or those of the company would cause loss to creditors.
In this context the courts have taken the view that “loss” does not include a minimal loss or a minimal percentage increase in an inevitable loss. Therefore, even where a company is insolvent it may continue to trade, with limited risk to the directors, provided the directors cause no or minimal further loss to the creditors and they reasonably believe that the company can recover financially.
Courts also accept that business decisions are made at a point in time and such decisions are usually not assessed by a court with the benefit of hindsight, once they are made in an informed and prudent way.
Accordingly, to properly carry out their duties in these circumstances, directors of a company verging on insolvency should insist on:
- Delivery of frequent management accounts to enable the directors to form a view
- Sensible controls on costs, pricing and staffing levels to maintain cash flow
- Frequent board meetings with careful minutes of all decisions taken
- Proper distribution of responsibility, especially proper delegation of the duty to keep books of account to a competent person
- Appropriate outside professional advice, and
- Appropriate communication to creditors with a very careful assessment of any payments that are made to creditors
If there is a divergence of opinion amongst the directors regarding the steps being taken or, more significantly, the prospect of the company’s financial position improving, then it may be advisable for individual directors to take separate advice to protect their own position.
Is restructuring an option?
As the crisis unfolds, a business, or a portion of it, may find itself in a position where it is unable to trade profitably but could be returned to viability if, for instance, it:
- Renegotiated or avoided the obligation to pay its debts in full
- Closed a portion of the business, either temporarily or permanently
- Reduced its product line
- Renegotiated leases priced above the current market rate
- Renegotiated the terms of its bank loans, or
- Made a number of staff redundant
Irish restructuring law and especially examinership can, in appropriate circumstances, facilitate a business in taking any or all of the above steps, if they result in the survival of the company and all, or part of, its undertaking as a going concern.
If examinership is suitable, it can result in the company exiting from the process in just over three months with no legacy debt and a viable future business.
Equally, as examinership enables some or all of the foregoing steps to be taken, it is sometimes possible to negotiate a favourable outcome with creditors and other third parties against the backdrop of what could be achieved in examinership.
Examinership is not the only option and all forms of restructuring should be considered, especially where a business may have a small number of significant creditors that may be capable of being addressed in another way, outside of a court process.
However, if the current and on-going situation has an immediate effect on the business and its cash flow, then the immunity from creditor action that is offered by examinership may be attractive.
One key point to keep in mind from the start is that a business needs to avoid running out of cash before completing any necessary restructuring.
Where feasible, a current cash positive position should not be eroded by simply supporting on-going losses. Equally, new funds should not be injected to support such losses before careful consideration is given to using that cash to complete any necessary restructuring.
When the business is no longer viable
Regrettably, there probably will be some casualties in many sectors, with predictions suggesting that the hospitality sector may be particularly affected.
Therefore, if there is no reasonable prospect of survival, it is incumbent on the directors to ensure that the business ceases trading, that no further debt is incurred and steps are taken to wind up the business as soon as this becomes clear.
The option of a fresh start
However, even in the bleakest case where insolvent liquidation of the company is inevitable, there may still be options for the future.
For example, although there are certain restrictions, there is usually nothing to prohibit the directors of a company acquiring some or all of the assets of the company from the liquidator. This may be something to consider if there is a viable underlying business that could benefit from a fresh start.
But, in order to preserve this as an option it is imperative that directors act in the best interests of the company and/or the creditors in the period prior to liquidation as any attempt to derive personal gain to the detriment of the company or creditors may expose an individual director to personal liability.
As with any plan, on-going consideration of the possible impact is key to the solutions.
However, although we are now several months into the crisis, the situation remains uncertain. Any business that believes its viability will be impacted should consider the range of tools under Irish law. To the extent possible, the business should retain the flexibility to react quickly and implement the most appropriate plan for the situation as it unfolds to ensure the interests of all stakeholders, including the directors, are adequately protected.
The content of this article is provided for information purposes only and does not constitute legal or other advice.