- What is insolvency?
- When to appoint a licensed insolvency practitioner?
- What does an insolvency practitioner do?
- UK legal reform in response to the coronavirus pandemic
Businesses have attracted a great deal of support from the Government in response to the coronavirus (COVID-19) crisis. However, even the Chancellor has admitted that not every business will survive these difficult times. Many businesses are facing a real risk of insolvency, and they either need to adapt quickly to survive or face the real prospect of closure.
What is insolvency?
Where a company cannot pay what is owes, or when the value of its assets is less than its liabilities (ie when it has a negative balance sheet), then it is technically insolvent.
The economic impact of the coronavirus crisis means that the value of real assets has been significantly impacted. At the same time, many businesses are facing cash flow problems that mean that they cannot pay their creditors, and some are even forced to enter into more debt by applying for loans. A drop in asset value compounded with an increase in liabilities means that otherwise healthy businesses are suddenly plunged into a technically insolvent position.
Having a negative balance sheet does not automatically mean that formal insolvency proceedings must begin, but facing up to the problem sooner rather later can help avoid a worse position than if nothing is done.
When to appoint a licensed insolvency practitioner?
There can be a natural reluctance in appointing a licensed insolvency practitioner (IP) and the stigma of failure can be attached when addressing the subject. It is also a point at which the accountant may feel that now is the time to hand over their client to a licensed IP. Whilst this is true to some extent, it does not mean that the accountant no longer has a role to play with their client. IP’s will work closely with their referring accountants when delivering their services.
It is also important to remember that a licensed IP will first seek to examine the business in order to seek opportunities to save it. Restructuring and insolvency go hand in hand, and the appointment of a licensed IP does not necessarily spell the end of a business. The ICAEW has shared an interesting business recovery success story from a director of a business who appointed an IP early, with a successful outcome.
Almost all businesses are suffering from cash flow problems during the lockdown, but this also means that suppliers and customers are offering more understanding, and longer terms can be easier to negotiate. So a short-term shortfall in cash may not be an immediate cause for concern if normal working capital practices can help ease pressure. However, a constant and sustained lack of cash leading to an actual or potential default on bills is a sign of something being wrong. Defaulting on HMRC is a particularly significant indicator of distress.
A high cost of capital and large interest burden is another significant indicator of fundamental distress. Lenders will match interest rates to a measure of risk and so a high cost of capital can indicate that there is doubt over financial viability. Recent headlines talk about small businesses being denied CBILS. If a bank is unwilling to lend even with 80% security being offered by the Government, then fundamental questions over the long-term viability of the business must be asked.
As a general rule of thumb, if a business foresees running out of cash within a three-month period, a licensed IP should be consulted. Any action taken today will generally take two to three months to work through, and so early consultation is vital. A directory of licensed IP’s can be found on the GOV.UK website.
What does an insolvency practitioner do?
The IP will first seek to save the business by familiarising themselves with it and seeking ways to maximise cash flow. A detailed cash flow forecast will be drawn up and revisited, typically on a weekly basis, to monitor and critique viability.
However, if restructuring is not possible, then there are certain insolvency measures that can be taken:
Company Voluntary Agreement (CVA)
A CVA is a negotiated agreement to repay some or all of the company’s debt. The IP will negotiate and oversee the process.
This is a formal procedure to try to restructure and sell the company and / or sell the assets of the company. The IP will oversee this process.
This is where the IP appoints a receiver to recover money lent to the business for a secured creditor. It is the corporate equivalent of appointing bailiffs.
A court ordered liquidation is a winding up, but liquidation can also be entered voluntarily. The process involves the sale of all assets to repay creditors. The IP will oversee the process in a voluntary liquidation. If the winding up is court ordered then an official receiver will be appointed by the court.
UK legal reform in response to the coronavirus pandemic
The Corporate Insolvency and Governance Act 2020 (CIGA 2020) received Royal Assent on 25 June 2020. It gives companies breathing space to help them keep trading while they explore options for rescue.
The key changes brought about by the Act include:
A moratorium for companies
Distressed companies are able to take advantage of a new insolvency process whereby directors of insolvent companies, or companies that are likely to become insolvent, can obtain a 20 business day moratorium period. This is designed to allow viable businesses time to restructure or seek new investment free from creditor action (Insolvency Act 1986, Part A1 as inserted by CIGA 2020, s 1).
Protection of a business’ supplies during the moratorium
Suppliers of goods or services are unable to rely on contractual clauses to enforce termination clauses in contracts. There are conditions applied to this, but the aim is primarily to protect companies that are subject to the new restructuring plan or moratorium, although other companies may also be able to benefit (Insolvency Act 1986, s 233B as inserted by CIGA 2020, s 14).
Temporary restrictions on winding up petitions
Winding up petitions by creditors must additionally include a demonstration that the creditor has reasonable grounds for believing that coronavirus has not had a financial effect on the debtor company (CIGA 2020, Schs 10, 11).
New ‘restructuring plan’
This is a new formal process to enable companies to cram down dissenting creditors. It includes the ability to bind dissenting classes of creditors who vote against a restructuring plan. Note that the moratorium and the restructuring plan are distinct and do not have to be used together (CA 2006, Part 26A as inserted by CIGA 2020, Sch 9).
Suspension of wrongful trading
CIGA 2020, s 14 introduces a temporary suspension of the wrongful trading provisions under IA 1986, s 214 and s 246ZB. The suspension applies retrospectively from 1 March 2020 until 30 September 2020 (although this may be extended). It aims to give company directors greater confidence to continue to trade during the pandemic, without the threat of personal liability should the company ultimately fall into insolvency.
Existing laws for fraudulent trading and the threat of director disqualification continue to act as a deterrent against director misconduct.