In the current climate, many small firms will be struggling to pay their debts on time. Buoyed by new legislation, insolvency may present some options to enable them to keep going. Rob Gray outlines how it works.
Covid-19 has taken a terrible toll in terms of lives lost and damage inflicted on businesses. Lockdowns and recession have hampered companies’ ability to trade and destroyed revenue streams. Many small firms will be unable to survive in their current form.
If your business is in bad shape, what should you do? It’s important to understand what insolvency is and what the first signs are. “Insolvency is defined as not having the money to pay debts when they fall due,” says Kevin Hellard, president of the Insolvency Practitioners Association (IPA). “It can also be defined as total liabilities outstripping total assets on the company’s balance sheet. If the company finds itself in such a situation, or it is foreseen, the company is likely to be insolvent.”
It’s important to know if your business is insolvent, as there are risks involved in continuing to trade. “If it can be proved that a director knew or ought to have known that the company was insolvent and couldn’t avoid a liquidation, they could be liable for any losses accrued in this period of trading,” says Gavin Bates, owner of Smart Business Recovery and a licensed insolvency practitioner (IP). “However, there are other more common issues: if the director is used to paying themselves via dividend, it is likely these are no longer valid and should stop.”
Sources of help
FSB’s legal advice line is a valuable information resource for business owners facing these issues – but the most important step is to speak to an IP. Generally, IPs give initial advice for free, and it may be the case that this will enable you to rectify your issue.
All UK IPs are licensed and regulated by reputable licensing bodies including the IPA and the Institute of Chartered Accountants in England and Wales. Both organisations have searchable directories of members on their websites.
You may encounter offers of help if your business is struggling. Unless this person is a licensed IP, they may be acting unscrupulously – they could be loan sharks, or ‘insolvency advisors’ who are only web-based and offer poor and possibly illegal advice.
The earlier an IP is contacted, the more options there are – including potentially the option to avoid a formal insolvency procedure. Similarly, the sooner an IP is contacted, the lower costs are likely to be.
Various options are available that let a struggling business continue operating. If there is going to be an unavoidable delay in payments, businesses can employ the help of an IP in negotiating with creditors on timelines. In the case of HMRC liabilities, they may be able to agree extra time to pay what is due – HMRC’s ‘time to pay’ arrangement.
If the company needs more time to be rescued, there are different forms of insolvency process it can enter. Smaller businesses would traditionally enter one of two procedures: liquidation or a company voluntary arrangement (CVA), which is a plan for the repayment of all or part of the company’s debts, brokered by an IP with the involvement of all affected parties.
“The new Corporate Insolvency and Governance Act, which came into force in late June in response to the coronavirus pandemic, has introduced
a new moratorium process,” explains Mr Hellard. “This prevents legal action from being taken against the company while a rescue plan is sought.”
This ‘debtor in possession’ moratorium procedure – as opposed to ‘creditor in possession’ – gives 20 business days’ protection from certain creditor action, with a monitor overseeing the moratorium but leaving existing management to run day-to-day business.
“However, between its introduction in June 2020 and 31 December 2020, only four moratoria were obtained, and they are more suitable for large companies,” explains Andrew McTear, a licensed IP at McTear Williams & Wood, which works mainly with smaller businesses. “The new procedure can only be used if a company is insolvent, has sufficient cashflow to pay all its bills during the moratorium and can be rescued as a going concern. For smaller businesses we think those circumstances will be few and far between, and most likely only in conjunction with a CVA or to buy time to refinance.”
End of the line
If the company cannot be rescued and must be closed, a liquidation procedure can be entered – also known as winding-up. This involves either a compulsory liquidation or a creditors’ voluntary liquidation (CVL). The former involves applying to court to liquidate the company; the latter involves creditors. If the company can pay its debts but you want to close it, you can enter a members’ voluntary liquidation.
If your company needs to be liquidated without a long delay, it is better to liquidate voluntarily via a CVL. “Often, company directors will be able to secure finance to start a new company, learning from their experiences,” says John Bell, licensed IP and founder of Clarke Bell. “Many great entrepreneurs have experienced corporate failure before going on to create a highly successful business, so liquidation doesn’t mean the end of the road.”
One controversial insolvency process known as a pre-pack administration can also be effective in preserving a business that is fundamentally sound but has hit misfortune – usually an unforeseen bad debt that has ruined cashflow.
Typical situations for using this option are: the company has cashflow problems and can’t pay its creditors; there is a potential buyer for the business, which could be directors or employees of the company or a third party; there is a realistic likelihood that the buyer will make a success of the business; the value of the business would be eroded if it was first placed into insolvency and then marketed for sale; or liquidation is not an option.
In a pre-pack administration situation, a marketing campaign must be undertaken to ensure that the best possible price for the company is achieved and that, where there is a sale to a third party, there is no conflict. Where no third-party buyer is found
or the existing owners make the best offer, the IP will often sell to existing directors or shareholders.
“This is where the controversy lies,” says Mr Bell. “Many creditors see this
as a cosy stitch-up between directors and a ‘friendly’ IP. Insolvency legislation, supported by best practice guidance, is designed to prevent this and will result in unscrupulous IPs being struck off.
“There is a recommendation that such pre-pack administrations ought to be subject to the independent scrutiny of a panel of industry experts,” he adds. “Some feel the old system, where a court order from the High Court was obtained, might alleviate these concerns in the eyes of the public.”
Given the ravages of 2020, many businesses are living on borrowed time. “A wave of insolvencies is inevitable,” says Simon Underwood, business recovery partner at accountancy firm Menzies LLP. “Corporate insolvency figures, as released by the Insolvency Service, show that the number of insolvencies has been suppressed by current support measures. These can’t last for ever, and at some stage businesses will
have to show viability and self-sufficiency. Businesses that have prepared well by reviewing cashflow forecasts, reducing costs and protecting revenue streams will be best placed to avoid insolvency.”