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Is this the calm before the storm for business?

Phil Farrelly

Is this the calm before the storm for business?

At the start of the COVID 19 pandemic many were predicting that this could be the busiest time ever for insolvency professionals. Early indications seemed to indicate this with many insolvency practitioners  and lawyers experiencing an initial manic period of providing (often free) telephone advice, but most companies now appear to be hunkered down waiting for the lockdown to finish and surviving by utilising the rescue packages created by the Treasury.

Why are we not seeing an upturn in insolvent businesses?

The usual pressure points which force business owners to take insolvency advice are typically HMRC enforcement, pressure from landlords and bankers and fear of personal responsibility for continued trading.

Many of these pressure points have been alleviated by legislative changes and support of government. Legislative changes include a ban on forfeiture by landlords, their use of statutory demands and their use of winding up petitions where a company cannot pay its bills “due to coronavirus” and  legislation preventing landlords using Commercial Rent Arrears Recovery (CRAR) unless they are owed 90 days of unpaid rent , the ability to furlough staff and the suspension of wrongful trading provisions.

Policy changes include a relaxation of HMRC enforcement, increased sympathy to time to pay proposals , deferral of VAT, exemption from business rates in certain sectors, small firm grants of up to £10k and Coronavirus Business Interruption Loan Scheme (CBILS). Not all of this money will be used as the government intended/be well spent by its recipients but at the moment there appears to be little scrutiny of this.

More generally while lenders may be viewing covenants nervously most are varying or extending terms or simply ignoring breaches in the light of reputational damage which might ensue if they are seen to take a heavy-handed approach. In any case enforcement of security now when there is little market for businesses and assets, may not produce a satisfactory outcome .

What will the post lockdown world look like?

As most of the support is in the form of deferrals or debt then businesses are effectively delaying payments and hoping to be in a position to finance this post lockdown. The furlough scheme which applies to employees is currently due to end in June leaving employers back on the hook for staff salaries.

If demand does not rocket when lockdown ends many companies will have to find cash to pay deferred VAT or repay CBILs loans from significantly reduced turnover. Decisions will have to be made about whether to retain furloughed staff when government support for their continued employment ends.

It is hard to imagine that there won’t be an increase in insolvencies – liquidations of those holed below the waterline or forced into liquidation as embargos on creditor action end and pre-packs or CVAs as otherwise viable businesses seek to shed debt or lenders start to see the possibility of an exit. Investment funds seeking to acquire businesses at cheap valuations might become more relevant over time.

Liquidators and Administrators  may well be called upon to look at recovering funds taken or used improperly by directors.

The wrongful trading provisions have been suspended but from a director’s point of view this is not a panacea to end all ills. There have been  few successful wrongful trading cases reported since the Insolvency Act 1986; the “point of no return” (when the company could not avoid insolvency) needs to be established and the reasonableness of the directors’ actions has to be considered. Given the nature of the investigation required and the subjective criteria involved it has rarely been seen as an attractive proposition for IPs.

Other claims are far more common and the right to pursue these claims has not been suspended. They include:-

  1. Recovery of directors’ loan accounts.
  1. General misfeasance claims against directors for breach of their duties ( for example, duties to act in the company’s best interests, to exercise reasonable skill and care). Where the company is likely to become insolvent, the directors’ duty is to act in the best interests of the company and it is regarded as a duty to act in the interests of its creditors as a whole, and those interests are regarded as having become paramount.
  1. Claims to set aside transactions at undervalue ( for example, gifts or sales of assets at less than market value).
  1. Claims to set aside preferences ( i.e. transactions designed to put certain creditors in a better position than they would have been in a liquidation or administration. For example repayment of sums due to directors, repayment of loans guaranteed by directors).
  1. Claims for repayment of dividends. When declaring a dividend, directors are obliged to consider whether the relevant accounts show sufficient distributable reserves but they are also obliged to safeguard the company’s assets and take reasonable steps to ensure that the company can pay its debts as they fall due. This requires them to take into account events since the accounts and consider the cashflow implications of paying dividends.

So while the insolvency market appears to be relatively calm at the moment exiting the lockdown, especially if the new normal is considerably different to the pre-lockdown normal, probably signifies entering choppy waters for a number of businesses.

For advice on any aspects of insolvency and restructuring contact the team at Insolvency Homepage