Insolvency: what are the options for troubled businesses?

“On 28 March the UK government announced proposals to amend aspects of insolvency law, to allow businesses adversely affected by the coronavirus to continue trading while they explore options to restructure,” explains Katharine Lawrenson, Partner, Head of Creditor Services, at DWF Law LLP.

“A key element of the changes is to wrongful trading provisions for company directors. Under the terms of this legislation, if an insolvency process is inevitable, and a director is aware of this but fails to take all reasonable steps to minimise the losses to creditors, for example, by continuing to trade, they could be deemed personally liable for company losses and forced to contribute to the assets of the company. It is that personal liability that directors are so fearful of.

“Under the draft Corporate Insolvency and Governance Bill 2019-21 there is no change to liability only quantum. The court can still hold that a director has traded while insolvent for this period, but must assume he is not responsible for the worsening of the company’s position. 

“This will take effect retrospectively from 1 March 2020, to 30 September 2020 (extendable in six month increments) and is aimed at supporting directors as they navigate this period of great uncertainty. In some ways it could be deemed unnecessary as wrongful trading cases are so rare. It also creates other potential problems. 

“The courts have a wide discretion, and a personal liability to contribute to company assets for creditor compensation may not automatically be applied. Currently, directors are in an impossible situation and facing huge uncertainty about the future of their businesses, and the courts may give them the benefit of the doubt.

“It could also give directors a false sense of security. Wrongful trading may be a rare claim, but others, such as breach-of-duty claims, which can include increasing losses to creditors by continuing to trade, are still there, and could incur personal liability.

“There are repercussions for creditors as well. If directors continue to trade when they shouldn’t, it could plunge companies into further debt and deepen creditor losses. 

“The changes to wrongful trading could also potentially be used by unscrupulous directors to defend legitimate claims, which is a worry for the insolvency profession. My advice to my business director clients is to carry on as usual, do the right thing, which they should anyway, and protect themselves against all types of claims.

“Other changes to insolvency laws include three measures that actually formed part of a 2016 draft paper consulted on by government in 2018. They include a moratorium, up to 20 business days with an option to extend for a further 20 business days, designed to give viable businesses, especially those facing liquidity issues, some time to seek a rescue or to restructure; a new restructuring tool; and a requirement for certain categories of suppliers to continue supplying to companies in financial distress as they navigate their way through the short-term difficulties.

“Often legislation done in haste is not the best legislation, but it will be interesting to see if the changes reflect the needs of businesses during this period of disruption and uncertainty.”

“As history has demonstrated many times, more businesses go bust coming out of a crisis than heading into one,” says Tyrone Courtman, Partner, RSM Restructuring Advisory LLP.

“In some sectors it will take considerable time to recover to pre-crisis levels, if ever. For most, the reality will be that the economy, and their business, will be smaller.

“Those struggling before the crisis had clearly been getting things wrong for some time. Once those business owners start totting up their losses from the pandemic and realising the adverse impact on cash flow they will face some difficult decisions.

“Another concern is the withdrawal of the government’s pandemic response. Businesses will be striving to pursue every profit opportunity to combat their losses, and will run a significant risk of overtrading.

“Forecasts are critical to them having a detailed understanding of the implications of their actions on the business, and these should be revisited regularly, potentially daily, for the next six months, to reflect the rapidly changing environment.

“Look at where the business is going. I suspect forecasts incorporating revenues at 75% of pre-crisis levels will not be misplaced for many, and for a few, revenues down as much as 50% are not inconceivable. The challenge will be to establish whether the business’s costs can be reduced accordingly and afforded, without resulting in the failure of the business. Forewarned is forearmed.”

“Insolvency is devastating,” says Greg Palfrey, Partner and National Head of Restructuring & Recovery Services, Smith & Williamson. “It’s difficult enough for someone when their business goes bust because they made mistakes. In the current crisis, however, no business owner could have foreseen what was coming. I suspect that the biggest human impact of this crisis will be on the mental health of people who stand to lose everything.

“A lot of businesses are finding ways to adapt their model. Some have managed to get their trade back to near pre-crisis levels. This could be self-sustaining and lead to long-term increases to their markets. Others are doing everything they can to save their business. 

“The government’s financial support will help, but a lot of people won’t be able to cope when they have to repay that finance. As IPs, a big part of our role is to be a sounding board, or a shoulder to lean on, for those who come to us early enough to ask for that help.

“Another concern is the potential impact of Brexit on the UK’s insolvency profession. Currently, if you have an insolvency in the UK with subsidiaries in other parts of Europe, or vice versa, thanks to the United Nations Commission on International Trade Law model, our systems are recognised, making it easy to carry through the insolvency procedure. However, there is currently no agreement that this will continue or even be recognised by the EU.”

“There will be more insolvencies, but a slow increase rather than a spike, because I don’t think government can afford to let it get out of control,” explains Chris Laughton, Partner, Mercer & Hole. “They will have to relax business support slowly, and a percentage of companies will find that without it they can’t carry on.

“The key for a business lies in planning the lockdown exit, replanning it as things change, and creating a roadmap of what could happen and the consequences. The more visibility you have of the future the better placed you will be to take advantage of the opportunities and avoid the pitfalls. There are many solutions that IPs have access to that can help struggling businesses survive.

“It is inevitable that some businesses will find that things have caught up with them, which we’ve already seen with some of the high-profile failures in industries such as retail and leisure. Debenhams has gone into administration again, which is not so surprising as its financial position hasn’t been good for some time.

“The insolvency profession is keen to remind the world that administration is a restructuring tool, based on the concept of a light-touch administration, where the company directors remain in place. Debenhams is one example of this. 

“Administrators have particular knowledge of the legal structure around companies that can’t pay their debts. While we manage that financial and legal side of the company’s relationship with the outside world, its operations need to be handled by people who know and understand businesses operating in that sector.

“People tend to think that because a business has gone into administration it is worthless, but it can be a very effective rescue mechanism that saves businesses and jobs.

“Chartered accountants have a huge role to play in helping businesses in the current crisis avoid some of the pitfalls that lie ahead, advising on planning and cash-flow forecasts, but they must look beyond that to the viability of the business in the current circumstances. 

“Once the business starts to become distressed, and has stepped away from its normal routine of generating cash, that’s when you need to think about talking to an IP. It doesn’t automatically mean that the business is going to go bust. The largest part of my practice work is about advising business owners how to avoid insolvency.

“We are situational specialists, with access to mechanisms for overcoming these situations and challenges, but generally not ones that the average business owner or chartered accountant is terribly familiar with. When you need a specialist, call one in.”