Guide

Coronavirus: insolvency considerations

Gateley Legal

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Unfortunately, one of the inevitable consequences of COVID-19 will be an increase in business insolvencies.  

The government has unveiled a package of financial measures to shore up the economy against the COVID-19 impact. The loans, grants, payment holidays and other financial measures are to be welcomed. However, for some businesses the COVID-19 outbreak will have arrived at a time when the businesses are already under significant financial pressure and the new financial measures may not be enough. Other businesses will have difficulty in accessing the new financial measures in time. Lenders will have their own operational issues to deal with and are likely to become overloaded with work, and so they will need to prioritise. 

Some businesses will be protected against the disruption that COVID-19 will cause. We can all think of examples of businesses whose goods or services are currently in high demand. Also, some businesses will have insurance and other businesses are resilient to disruption, because they have tried and tested contingency plans in place or because they have built up significant cash reserves. 

There are other businesses that will have no protection against the disruption, other than the ability to access the new financial measures and lender forbearance. Directors will need to consider if this is enough and there is a distinction to be drawn between a business whose sales are delayed by the disruption and a business which permanently loses sales. Reliable cash flow forecasts will be crucial.

We await further information about the new financial measures, but businesses will be aware that loans need to be repaid and some directors will be concerned about increasing a business’ liabilities in these uncertain times. Directors will need to consider all relevant options, which for some businesses will include insolvency options.

This guide provides a brief overview of two of the insolvency procedures available to companies and how business owners could use these procedures to help save their businesses.

Administration:

An administration is an insolvency process which is intended to achieve either the rescue of a company as a going concern, a better result for the company’s creditors than would be likely if the company was wound up or the realisation of property so that a distribution can be made to secured or preferential creditors.

After an administrator is appointed the administrator will usually attempt to sell the company’s business and assets. The sale may have been pre-planned and may be completed immediately following the administrator’s appointment, or it may be completed after a period of trading while the business is under the administrator’s control.

An administrator will often conclude that a sale of the company’s business and assets to the company’s existing owners will produce the best result for the company’s creditors. 

When the business is sold, the buyer will only acquire those assets that the buyer chooses to acquire and will only become responsible for those liabilities that the buyer chooses to accept (in addition to those liabilities that transfer to the buyer under legislation, such as certain liabilities to employees). Because of this a sale of the business to its existing owners can be controversial, but administrators are highly regulated and other measures exist to prevent abuse. 

In normal circumstances, the buyer will not need to make any payments to the company’s creditors.  The creditors submit their claims to the administrator and may receive dividends from the administrator, if realisations allow.

Some of the key considerations for businesses considering administration and for business owners considering acquiring a company’s business and assets from an administrator are likely to be:

  1. Is the company insolvent (in that its liabilities exceed its assets or in that it is or will become unable to pay its debts as they fall due)?
  2. What effect would an administration have on key contracts and relationships?
  3. Would the company’s business be viable if the company did not have its current liabilities?
  4. Bearing in mind that the administrator should attempt to achieve the best result for the company’s creditors, will the current owners be able to demonstrate that their offer for the company’s business and assets is better than any other offer?
  5. Do the owners have the support of key employees, suppliers and landlords?
  6. Have the owners addressed the causes of the company’s insolvency and can any changes be made to reduce the risk of a future insolvency?
  7. Is there funding available for the business, bearing in mind that many suppliers may change their credit terms?
  8. If the company enters into administration and the owners acquire the business, will they have access to the new financial measures and will these be sufficient?

Company Voluntary Arrangement:

A company voluntary arrangement is a composition in satisfaction of a company’s debts or a scheme of arrangement of a company’s affairs.

The main differences between a voluntary arrangement and an administration are that:

  • a majority in excess of 75% in value of the company’s creditors present at a creditors’ meeting, either in person or by proxy, must vote in favour of the proposal;
  • the company’s business and assets continue to be owned by the company and the company continues to be owned by its existing shareholders;
  • the company’s business continues to be managed by its directors under the supervision of an insolvency practitioner and subject to the terms of the voluntary arrangement;
  • instead of receiving a dividend after assets are sold, the creditors typically receive a dividend from the company’s future profits; and
  • when the company has complied with the terms of the voluntary arrangement, the voluntary arrangement ends.

The terms of the voluntary arrangement are flexible and can be written to meet the needs of a business and the requirements of its creditors. For example, the main terms of a voluntary arrangement may be that:

  • the voluntary arrangement will last for up to 5 years;
  • the company will pay 50% of its net profit to creditors each year, until its creditors receive 50% of what they are owed;
  •  the voluntary arrangement will end after 5 years or, if earlier, when the company’s creditors receive 50% of what they are owed;  each of the creditors will be paid a minimum percentage (specified in the terms of the voluntary arrangement) of what they are owed; and
  •  provided that the terms of the voluntary arrangement are met, the company’s creditors will accept the payments they receive in full and final satisfaction of the company’s liabilities.

There are some restrictions on the terms that can be included in a voluntary arrangement, such as terms which affect the rights of secured creditors or the status of preferential creditors, but generally a voluntary arrangement is a very flexible tool.

Some of the key considerations for owners considering a voluntary arrangement are likely to be the same as the key considerations for owners considering administration. In addition, they will need to consider whether a majority in excess of 75% in value of the company’s creditors will vote in favour of the proposal. This barrier to entry sometimes gives the company’s creditors powers that they do not have in an administration and can often lead to negotiations between the company and its creditors, resulting in modifications to the proposal. However, the owners would have to agree to any modifications and typically when a voluntary arrangement is proposed, the company will demonstrate how the voluntary arrangement will deliver a better result than an administration or if the company is wound up. Therefore, a creditor or a group of creditors holding 25% of the vote will always have to consider if its proposed modifications could result in the company withdrawing the proposed voluntary arrangement and a worse outcome for the creditors.

How can we help?

Whilst the prospect of having to follow a formal insolvency process is always daunting, they provide effective solutions for cleanly resolving otherwise impossible situations.  If you are affected by any of the issues covered in this article and would like to explore how these solutions could assist you, please do get in touch with our experts listed below.

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