Menzies LLP – A leading chartered accountancy firm.
Due to the corona virus pandemic, it has been an extremely challenging time for businesses. The Corporate Insolvency and Governance Act 2020 (“CIGA 2020”) introduced temporary measures to help businesses through the pandemic. Though the former insolvency framework still applies, the addition of CIGA 2020 constituted the biggest COVID-related development in insolvency law. These temporary provisions are expected to expire in March 2021 (expect this to change), so businesses will need their own long term solutions then. A further update includes granting HMRC secondary preferential creditor status (Crown Preference), where certain liabilities are concerned and this comes into force in December 2020.
What are the first signs of insolvency?
“Often the first sign that a business could be heading for insolvency is a reduction in revenues. This could be more obvious for businesses in some sectors than others. For example, for businesses in the retail and hospitality & leisure sectors, reduced footfall during periods of national lockdown and Tier 3 restrictions had an immediate impact on turnover.
“In other sectors, such as manufacturing, businesses have experienced mixed fortunes. Some managed to diversify or refocus their activities, in order to offset a reduction in revenues in other areas. Others that are heavily reliant on large customers or complex, global supply chains, experienced significant disruption during the early stages of the pandemic and even when supply chains opened up again, recovery has been slow and tentative.
“Many businesses are in a situation where the signs of insolvency are not yet obvious due to the tax deferments, support measures and easements that have been put in place. However, if businesses are using this support to prop up their cash position in the short term, a surge in corporate insolvencies seems likely in Q1 2021.”
When should you consider speaking to an insolvency practitioner?
“The earlier a business seeks advice from a professional insolvency practitioner, the more options there are likely to be to avoid a winding up process. Exploring a company administration for example, the appointed insolvency practitioners will assess the financial position of the business, take action to ease pressure on cashflow and realise value where possible. In some cases, it is possible to position the business for sale as a going concern, while also protecting employee and creditors interests.”
In terms of debt relief, company rescue and turnaround, what options are available to ensure the business can continue to operate?
(e.g. company voluntary arrangements, company administration and liquidation)
“Many businesses are unaware of the range of options that exist when seeking advice from an insolvency practitioner. If the problem has been identified at an early stage, it may be possible to initiate a Company Voluntary Arrangement (“CVA”). This is essentially a restructuring process, which involves making a proposal to creditors, setting out when payments will be made. These have been widely used in the retail and hospitality & leisure industries and are often used to put pressure on landlords to reduce rents.”
In legal terms, when must a company start insolvency proceedings and what are the requirements once the process is underway?
“There are two tests of insolvency for a company, the balance sheet test and the cashflow test. If a company fails either of these tests then the directors need to make sure they have a plan to protect the position of creditors ahead of shareholders. Liquidations can start by means of a court order, usually on a creditor’s petition or following a shareholder dispute. This is known as a Compulsory Liquidation.
“However, not all liquidations are compulsory – some are entered into voluntarily by the shareholders and directors – these are known as Creditors’ Voluntary Liquidations. If a company is solvent it goes into a Members’ Voluntary Liquidation and all the creditors are paid.”
Are there any risks a business owner needs to identify, such as unscrupulous operators? How can these be avoided?
“When selecting a professional insolvency practitioner to advise the business, it makes sense to seek references in the usual way and ask them to set out the approach they will take in assisting the business. Those that have a good grasp of the directors’ personal and professional objectives, combined with a strong understanding of the commercial pressures facing the business, are likely to deliver the best outcome. To make sure that you chose someone who is a qualified insolvency practitioner you can cross reference them on the Insolvency Service website or the R3 website.”
With many firms struggling as a result of the coronavirus pandemic, are we likely to see a wave of insolvencies at Christmas/early in 2021?
“A wave, or even tsunami, of insolvencies is inevitable. Corporate insolvency figures, as released by the Insolvency Service, show that the number of insolvencies has been suppressed by the support measures that are currently in place. The reintroduction of ‘Crown preference’ at the start of next year could also have negative effect on lender confidence, forcing some to pull the plug.
“In terms of timing, it is likely that the recent extension of Government support measures will have deferred the start of the expected spike in corporate insolvencies to beyond Q1 2021. You could say that the beach is looking ever larger as time goes by.
“The support measures that have been in place for much of 2020 can’t last forever and at some stage businesses will have to demonstrate their viability and self-sufficiency. Those businesses that have prepared well by reviewing cashflow forecasts, reducing costs and protecting revenue streams, will be best placed to avoid insolvency in the challenging months ahead.”
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Author Of this post: Sam Coombes