Until now, the general approach has been that a company cannot claim privilege against its own...
Notwithstanding any easing of the current lockdown over the coming weeks, social distancing measures are likely to be in force for many months, resulting in a radically different economic environment to which businesses will be required to adapt. Most obviously, following expiry of the Coronavirus Job Retention Scheme, employers will have to make difficult decisions regarding the structure of their workforce. Many entrepreneurs in badly affected sectors such as retail and hospitality may decide that their business is no longer viable; others will have to evolve in order to survive.
While rent and mortgage holidays, and a furloughed workforce, have allowed a breathing space, it would be sensible to use that time in considering a range of practical steps which might strengthen the resilience of businesses.
Partnership and shareholder agreements
Businesses with multiple stakeholders will undoubtedly encounter challenges as differences of opinion emerge between the respective parties regarding future strategy. Shareholder and partnership agreements which are tailored to the requirements of the business will become increasingly important for a number of reasons.
As the economic outlook remains uncertain, businesses may need to react swiftly to changing circumstances, taking appropriate measures to shore up finances or taking advantage of commercial opportunities which arise as competitors fail. It would be prudent to consider whether the current decision-making structure is still suitable in a post-Coronavirus environment, and whether managers have sufficient delegated authority; any breach by a director of restrictions in a company’s constitution will render him potentially liable to shareholder claims.
An investor may be required to inject further capital in order to ensure the survival of a business. As a condition of doing so, they would be advised to consider bolstering the formal protections conferred on them by the investment agreement, for example enhancing voting rights and requesting an ability to assume control of decision-making if the financial circumstances deteriorate further. Whilst any such provisions will be a matter for commercial negotiation, other shareholders may have little alternative but to accept the terms on offer.
A sale of a struggling business may be the only way of realising value for its owners. Controlling shareholders should check whether their company’s constitution contains so-called drag-along rights which facilitate a sale by requiring minority shareholders to sell to an arm’s length third party on the same terms as have been agreed by the majority.
In a previous blog, we have considered share schemes as a valuable tool for incentivising a workforce where cash flow constraints preclude large bonuses or salary increases. If equity is to be made available other than as part of an “exit only” option scheme (where shares are not issued until immediately prior to a sale) it is essential to ensure that a company’s constitution incorporates standard protections such as:-
- the aforementioned drag along mechanism;
- compulsory transfer provisions which require employee shares to be offered for sale on termination of employment; and
- a good/ bad leaver mechanism in which the price offered for an exiting employee’s shares differs depending on the circumstances of departure.
Corporate reorganisation
Guaranteeing the survival of a business may require more than a few amendments to shareholder documentation. For example, friction between shareholder managers of different divisions is likely to be exacerbated in the current climate, and so-called “deadlock” resolution provisions in a shareholders agreement which seek to resolve fundamental differences by providing a mechanism for one party to buy out the other are unlikely to be triggered where neither party can arrange the funding for a purchase.
A number of more fundamental restructuring measures can be implemented with a view to ensuring that a business is better placed to cope with the challenges ahead.
Business owners might, for example, consider reorganising the structure of a corporate group in order to separate any investment assets such as premises from the trading business, thereby potentially ring-fencing them from creditors. It is possible to do so without incurring tax liabilities provided proper legal and tax advice is sought. Directors must be alert to possible claims from creditors (and, indeed, personal liability) if the business is already in financial difficulties; in such cases, we would always advise directors to consult an insolvency practitioner. If the business is, however, still solvent and there is a realistic prospect that it will trade through the crisis, it would be wise to consider measures to protect valuable assets in case circumstances change.
Shareholders may wish to consider demerging different business units, for a number of reasons. A division which is struggling in light of the pandemic may be dragging down a more successful area of the business. Different shareholders may wish to develop particular business streams under their sole ownership where respective strategies will diverge significantly in a radically changed economy.
Such restructuring can be achieved in a tax-efficient manner provided appropriate advice is sought. A number of options are available, with different degrees of complexity, from a simple dividend in specie to a so-called “three-cornered reduction of capital demerger” whereby a parent company reduces its capital and transfers the assets to be demerged to a newly incorporated company which issues consideration shares to the shareholders of the parent. The process to be adopted will depend on a number of different factors, such as the sufficiency of distributable reserves in the parent.
Those businesses most likely to survive in the year ahead will be those who take a hard look at the strengths and weaknesses of their current business model and corporate structure, and take sensible steps to adapt to changing demands. Professional advice should be sought on the legal ramifications of any such measures.
If you or your business require information regarding any of the issues raised in this blog, or any other corporate matters, please call Philip Round, one of our Corporate partners, on 07826 906849 or e-mail him at pround@georgegreen.co.uk for advice and assistance.