Anatomy of an insolvency

SO much time, effort, blood, sweat and tears is invested in starting and running a business failure is simply not an option.

But as any good entrepreneur will tell you it’s a constant possibility and one that has to be fought off effectively. There are numerous tools in the anti-insolvency armoury but even the most experienced corporate gladiator can find themselves staring into the grim face of defeat.

Recent research on insolvency rates show a sharp increase in the number of business failures in the last quarter and the rate of insolvencies is destined to increase. Just how many firms are teetering on the edge of collapse is almost impossible to guess but accounting firms across the region are reporting unprecedented demand for corporate restructuring services.

Unsurprisingly cash flow is the biggest issue and the difficult economic climate means traditional remedies such as business growth, bank lending or personal savings are unlikely to ease any issues.

Knowing that your business is in failure and accepting the reality are two different things. But not taking action quickly could worsen an already difficult situation. Inviting in restructuring advisors when the company still has options is essential if the company is to have a chance of survival but there are no guarantees. Sometimes the inevitable is just that – inevitable.

However, once reality has been accepted there is a significant shift in focus as Dan Butters, a reorganisation services partner in the Leeds office of business advisory firm Deloitte explains.

“Instead of a prime responsibility to your shareholders, you now have an overriding duty to the creditors and protecting their interests as best you can,” he says.

“At this stage it is important for the whole board to take advice from experienced and qualified advisors, involving a combination of legal advice and discussions with a registered insolvency practitioner.

“Throughout this process it is important to ensure that all decisions are clearly documented within the company records. From this advice, it should quickly become apparent whether it is appropriate to carry on business in its current form, albeit with support from lenders and suppliers.

“The position will need to be monitored closely ensuring that the position does not deteriorate further. The company must be able to meet all its debts as and when they fall due.”

Furthermore such action doesn’t necessarily signal an unpleasant demise. Directors can seek insolvency protection through placing the company into administration, with the immediate impact being to provide a moratorium period.
While in administration creditors are unable to take further action to recover the debts and appointed administrators are given the task of trading the business to sell as a going concern. The concept of an administrative receiver is much the same, although the process is becoming less common following regulatory changes in 2003.

“If the business is so distressed that it has no future, the directors will appoint liquidators to take control of it. This will bring an immediate end to all employment contracts and will see an orderly wind down and sale of the assets,” continues Butters.

“In all these situations, the sale proceeds of the business/assets will be used to pay creditors, in the order of priority set out by law and the relevant security granted in favour of lenders. Ordinarily this would not result in a return to the shareholders.”

According to Mark Firmin, restructuring partner at KPMG in Leeds, the administration process is favoured by most banks and key creditors because it promotes company rescue and enables directors to drive a turnaround plan. As a result directors should be reassured that administration is not a censuring process – albeit a stressful one.

He believes that the number of companies choosing this route will increase as nervous banks and consumers lead to an increase in the number of firms experiencing difficulties.

“Earlier in the year, the property and construction sector and the automotive industry were experiencing some stress, as a result of the slowdown in the property market and the rise in the cost of fuel,” adds Firmin.

“Now, falling consumer confidence and the instability in the financial markets are resulting rising numbers of businesses in difficulty in further sectors including financial, retail and consumer products and leisure and hospitality.

“KPMG’s Leeds restructuring practice has managed the administrations of a number of businesses this year that highlight this point, including Consort Homes, Macfarlane Transport, ScS, Dolcis and Rosebys.”

As administration is a legal process, it is the administrators as officers of the court who will make the key decisions for the company not the directors. Management have the assurance of knowing that their business is being run in accordance with their legal obligations. As the administrator is a court officer, the process also includes a duty of fairness to all stakeholders.

The option is not open to everyone. According to Julian Pitts, a partner with business rescue, insolvency and restructuring specialist Begbies Traynor in Leeds, an initial appraisal of the company and its business should indicate whether problems are temporary and the company can potentially survive, given support from creditors.

“In such a situation a company voluntary arrangement (CVA) may be feasible, whereby the company enters into a legally binding arrangement with creditors who agree to their debt being frozen on the basis that they will receive an agreed repayment either in full or in part at some stage in the future,” he says.

“If a rescue is not viable, directors will be faced with an orderly closure of their company through a creditors voluntary liquidation. The liquidator appointed will seek to realise the company assets for the best price, deal with creditor claims and pay such dividend as funds permit. At the end of the process the company will then be struck from the register and cease to exist.”

“If directors fail to take action themselves, creditors may seek the winding up of the company through the court. Such action results in the making of a winding up order and the company being placed into compulsory liquidation with the official receiver initially being appointed as the liquidator.

“However the one procedure that does not apply to a company is bankruptcy – this relates to an individual only.”

On paper, insolvency processes seem almost manageable. But the strain should never be underestimated. Emotionally trying to save or losing a business can be extremely testing.

Indeed, many have described it as equal to bereavement or divorce. Advisory support is undoubtedly important, but support from peer groups is equally  valuable. Keeping all lines of communication open is essential.