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Business recovery: Formal insolvency – is there hope on the horizon?

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If a company’s financial position reaches a point where it is unable to pay its debts as they fall due, then a formal insolvency process may be needed. In the third and final installment of this series in association with Sage, Carol Baker looks at the formal insolvency options available and asks if they hold hope that any part of the business can be saved.

20th Sep 2021
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In our previous article Business recovery - turnaround options we looked at how restructuring under the expert eye of a turnaround specialist could be an alternative. But if this option is not possible, or if it has been tried and hasn’t had the cooperation and support of all parties involved to rescue and grow the business, then insolvency is the next step.

Insolvency Act procedures can be used not only for shutting down a business, but also for attempting to rescue the business by way of turnaround or a sale. 

“We are now in the era of rescue rather than closure,” said Julie Palmer, regional managing partner at Begbies Traynor.  

“Since the financial crisis when one bank came perilously close to going into some form of insolvency themselves – which could have led to a run on the other banks and possibly a collapse of the banking system as we know it – banks have had to change how they handle vulnerable corporate clients and adapt their own business models accordingly.”

Administrations

The modern “administrations” process that superseded the administrative receivership model, where the receiver works solely in the interests of the secured credits, is more in line with the emerging business rescue culture. 

In an administration, the filing of a “Notice of intention to appoint an administrator” or the appointment of an insolvency practitioner (IP) as an administrator creates an automatic moratorium and prevents a fixed or floating charge holder from appointing an administrative receiver.

The administrator must inform all known creditors of their appointment within 14 days and has up to 10 weeks to develop a proposal for consideration by all creditors. The timescale for achieving an administration under the Insolvency Act is very tight and should be completed within 12 months, although the court can extend this.

The main purpose of an administration is to:

  1. Rescue the company as a going concern, either by restructuring the company or via its sale.
  2. Achieve a better result for the company’s creditors as a whole.
  3. Realise property in order to make a distribution to one or more secured or preferential creditors.

During the administration, the administrator will pursue money owed to the insolvent company and try to repay debts owed to secured creditors. As well as being able to receive a dividend, unsecured creditors are protected by the “Prescribed Part” as laid out under section 176A of the Insolvency Act 1986, and the Insolvency Act 1986 (Prescribed Part) Order 2003. 

The Prescribed Part is calculated as a percentage of the value of the company's property which is subject to a floating charge (namely, 50% of the first £10,000 of net floating charge realisations plus 20% of anything thereafter), and this must be set aside and made available to satisfy unsecured debts.

Also, during the administration, the administrator will investigate whether any fraud has taken place within the company that has led to the company’s unstable position. When it comes to trying to find a buyer for the company it needs to be done as quickly as possible before any goodwill of the business has a chance to erode.

Often the existing directors or management team are interested in buying the business, and this is known as a “connected party sale” (or a “pre-pack” if agreed before the company enters administration). In a connected party sale, the IP must test the market so that they can satisfy their duty to creditors that there isn't somebody out there who is willing to pay much more for that business.

“We walk a difficult tightrope during the pre-administration period. On the one hand, we know if we openly advertise the business for sale, that knowledge will cause the value to plummet further. On the other hand, we need to show creditors that we have got the best possible value for the business,” said Palmer.

“In order to do this, we often run an accelerated marketing process whereby on a no-name basis we will send around a teaser document to an interested party database and test the response before going into a secret data room to disclosure arrangements.”

Connected sales and the pre-pack pool

To increase transparency of the pre-pack process and to provide assurance for creditors, under the Administration (Restrictions on Disposal etc. to Connected Persons Regulations 2021), any sale to a connected party should be referred to the pre-pack pool for evaluation as recommend by the Graham report, although this recommendation remains voluntary.

Due to the critical timelines involved in preserving businesses and jobs, a pre-pack pool evaluator will assess the case within 48 hours – and many cases are reviewed within 24 hours. Evaluation typically costs £1,500 + VAT.

Company voluntary arrangements

A flexible formal insolvency option is a company voluntary arrangement (CVA). In a CVA payment of debt can be delayed or reduced over a set period of time and can allow for capital restructuring with a view to rescuing the business. In addition, it allows for the orderly disposal of assets. The CVA process must be overseen by an IP, but unlike other insolvency procedures, in a CVA, the IP does not replace the directors of a company. Instead, the IP acts as a ‘nominee’ (prior to the CVA’s approval) and ‘supervisor’ (after the CVA’s approval).

Formal liquidations

When there is no prospect of rescuing the company, a formal liquidation process must take place:

  1. Members’ voluntary liquidation is initiated by the directors of a solvent company and is used when the creditors can be paid in full.
  2. Creditor’s voluntary liquidation is used when the company is unable to meet its debts in full and must be overseen by either a licensed IP (acting as a liquidator) or by the Official Receiver.
  3. Following a petition for winding-up, a compulsory liquidation can take place. Handled by the Official Receiver in the first instance, creditors can request that an IP takes the appointment to maximise asset realisations.

Accountants and insolvency advice

“There are many changes happening in the insolvency world which will have a direct impact on how accountants’ advise their clients,” said David Kerr, insolvency practitioner and member of the technical committee of the Chartered Institute of Credit Management (CICM).

“Aside from all the temporary Covid measures currently making their way through Parliament is the Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Bill,” continued Kerr. “This will give the Insolvency Service retrospective powers to investigate and disqualify directors of dissolved companies which previously fraudulently claimed Bounce Back Loans.

“And access to funding might become more difficult. In December, we saw HMRC reinstated as a preferential creditor in all insolvency processes ranking them above floating charge holders and unsecured creditors. During the pandemic, many winding-up petitions were put on the back burner, but as government support eases, HMRC can recommence its winding-up activities (subject to the very latest temporary measures increasing the limit for petitioners),” continued Kerr.

“Not only could this hamper the rescue culture, but the change in HMRC status could adversely impact on lending in the market, as lenders who rely on floating charge security factor in the risk of HMRC priority.”

Conclusion

All businesses will have their ups and downs, and there is no shame in a business getting into difficulty. The earlier you can spot the warning signs that a business may be struggling the earlier you can seek advice to see whether the business can be restructured and turned around.

For accountants in business and those in practice, being able to advise directors on insolvency issues and seeking the right advice at the right time will go a long way to create resilient businesses capable of thriving in the uncertain post-pandemic world.

This article was brought to you in association with Sage. Sage Accounting is perfect for accountants and bookkeepers small business clients. Speak to Sage experts for a demonstration to find out how Sage can help your practice. Get in touch with Sage.

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By AndrewV12
23rd Sep 2021 10:50

extract above
“We are now in the era of rescue rather than closure,” said Julie Palmer, regional managing partner at Begbies Traynor.

Or is it seen as a radical way of tidying up the balance sheet and walking away from some nasty creditors.

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