The construction sector has been particularly vulnerable to cashflow and solvency problems during the pandemic. Government restrictions delayed projects, whilst supply chain issues choked material supplies which, when combine with labour/skill shortages, sent costs skywards.
Many CFOs will have spent months dealing with the inevitable uncertainties created by those issues and some will have had to grapple with the challenge of potential insolvency. Difficult decisions will have been taken and the circumstances in which they were taken, highlight the need for complete, and accurate, financial information.
The experience NMCN is likely to have been no different and the ongoing investigations into why the specialist engineering and construction company failed demonstrate the importance of proper, complete and timely reporting as well as appropriate professional advice on the additional duties and responsibilities directors have to juggle when solvency problems arise.
NMCN was the largest listed company to go under since Carillion’s collapse in 2018. It went into administration in October 2021 after it failed to secure re-financing after months of delays in publishing its 2020 results.
Grant Thornton, the appointed administrator, said in its initial review that the company owed its creditors £60.5m. Further investigations and their full review concluded that the true figure is almost double that amount at £115.3m.
BDO, which audited the company’s 2019 financial statements, is now being investigated by the Financial Reporting Council (FRC).
The most profitable elements of NMCN’s business were sold off in pre-pack deals, with 1,642 employees keeping their jobs. However, 80 redundancies still had to be made from the company’s building section and shareholders were left with nothing.
Twenty-six former employees have also lodged an employment tribunal claim which alleges that NMCN failed to follow a collective consultation process before making them redundant.
Grant Thornton has also instructed lawyers to look into why NMCN became insolvent and what claims may lie against its directors.
Scope and scale of investigations
The FRC investigation is likely to consider whether BDO performed its role properly with a focus on the preparation of NMCN’s financial statements and final set of pre-administration accounts. The audit watchdog will likely also look into why the previous auditor didn’t identify the deep losses that led to the company’s demise.
As with any insolvency, the lawyers will consider whether dividends were properly declared, whether there were any uncommercial loans taken out, or any borrowing by directors. They will also look at whether any creditors were treated more favourably than they should have been (for example being paid ahead of others before the company went into administration).
In addition, lawyers will examine any decision the directors took to continue to trade when they should have decided otherwise and tried to minimise creditors’ losses. Depending on the findings, the administrators (or subsequent liquidators) may consider claims against the directors for breach of duty. The majority of litigation in this area arises from situations where directors knew, or should have known, that the company was in a potentially insolvent position but either carried on trading or did not act in the company, or its creditors’, best interests from that point onwards. Directors can be ordered to contribute to a company’s assets to increase the amount available to its creditors if they are found to have breached their duties.
Other creditors, such as the former employees, claim that NMCN failed to follow the rules around the redundancy process. The rule requires employers to run a collective consultation process for at least 30 days before it decides to make an employee redundant. This rule applies whenever there is a risk of 20 or more employees being made redundant in a 90-day period.
The employees argue that there was no meaningful dialogue over how their redundancies could have been avoided, and NMCN should therefore face liability over its failure to consult, as a result. They allege that the company knew (or should have known) about its potential insolvency and therefore, should have put them on notice sooner. Had the proper process been followed, the employees say they may not have had to face sudden dismissal and the prospect of losing the wages that they were owed. Their claim seeks compensation for the loss of wages through a Protective Award which the Insolvency Service will have to pay if the claim is successful as NMCN is unable to. Each employee can receive an award of up to eight weeks’ pay rather than the actual sums they lost, which may exceed that amount.
The only defence to this sort of claim is if the directors can prove that they relied on professional advice from auditors or others, to conclude that the business was not at risk of insolvency. Even this, may only amount to a partial defence, if the Employment Tribunal find that the CFO or other directors had the appropriate professional qualifications and knowledge required to analyse and question the advice given by the professional. The employer would need to show, for example, that the business was performing well financially and had no solvency issues.
Learnings for CFOs
As a potential recession looms, CFOs (and all directors) must run tight ships.
If a poor financial situation is clear, CFOs should recommend to directors that action is taken immediately to protect employees and other creditors.
If the security of jobs cannot be guaranteed, employees at risk must be notified and consulted. When claims are brought by employees, Employment Tribunals will be particularly keen to see if the insolvency was truly unexpected. So, if there is a clear risk of insolvency, then the advice should be to inform and consult your employees by following the correct procedures. Failure to do this could mean additional liability for up to 90 days’ full pay for each affected employee.
Similarly, early, and well documented, advice on solvency concerns will be an important line of defence in breach of duty claims against directors. Most litigation arises when they fail to act on financial information, or take it as read.
Directors naturally expect audit and other reporting advice to be reliable, so we wait to see what the FRC says about BDO, but there is no substitute for taking care and to scrutinising any audit reports and other advice to check for discrepancies.
Recessions throw up many problems. Those affected invariably look for someone to blame, and you don’t want to be in the firing line.
The authors of this article are Helen Young, associate, commercial litigation & dispute resolution team at SA Law and Nishma Chudasama, solicitor, employment team at SA Law