Directors Should Know Their Liabilities when Sacrificing Salaries to Help an Insolvent Company

Copyright (c) 2010 Alison Withers

Company directors are cutting their drawings and foregoing their pay in order to save their companies in the current economic crisis.

Many of them are still hoping that the market will recover and as a result are retaining costs that their companies cannot afford by sacrificing their personal drawings on the company today.

But for how long can, or should, directors sacrifice their income and dividends in order to retain the company's capacity for growth in the hope the order book fills up?

The example of a construction company that had declined from a turnover of £5 million down to £2 million, with overheads that required a turnover of at least £3.5 million illustrates the questions that need to be asked.

This particular company called in a rescue adviser when it the was losing something in the order of £60,000 a month. The dilemma its directors had was how long they could go on losing that kind of money.

It may have been sensible for them to hold on and forego drawings and salary while they hoped that sales would increase, however it soon became apparent that orders would remain low for some time. In addition despite sacrificing their salary, the losses ate into the balance sheet and within six months the company was insolvent with negative equity and late payments. With the company in negative equity its losses were then being borne by creditors rather than the shareholders.

From the moment that a company's creditors are affected by a worsening balance sheet the directors risk being held personally liable for the mounting debt if they do not take decisive action to get the situation under control, for example by seeking help from a business turnaround adviser.

In any event no company can continue in a situation of insolvency for long in the hope of an upturn in the market without taking some measures to try to move it back to profitability.

At the time of writing (November 2010) it is estimated that there are more than 370,000 Time to Pay arrangements between businesses and HM Revenue and Customs (HMRC). Such a huge number suggests that a lot of directors have sacrificed their drawings in order to prop up their company to keep it going in the short-term by deferring payments rather than restructuring the business for long term survival. This highlights the need for a lot of companies to change their business model and significantly cut their costs.

Doing so would benefit a company's directors, who could then start to pay themselves once the company resumed profitability.

It may be easy in such circumstances to cut your drawings, pension contributions or health insurance but this can only ever be a short term measure. As directors begin to discover that the short term measures are becoming longer term this will have an impact on their personal lives. Indeed as market conditions remain difficult some some directors are already having to put some of their own money into companies, either by remortgaging their homes or taking money out of their pensions to prop them up. Frequently this is another short-term measure that does not restructure the business to reduce or remove costs.

Without a proper review of the company or the ability to make profits they may be prejudicing their personal futures.

This is all indicative of a failure to bite the bullet and restructure in the hope that the market will pick up. But it is also a failure to take advantage of an opportunity. It is a very rare company that does not need to review its business model from time to time, and it may also be that there is a viable core business buried under the current problems that an objective but supportive turnaround adviser may be able to identify and help the directors to nurture.

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