In a Trowers & Hamlins survey of more than 200 UK business leaders conducted in the summer of 2020, nearly nine in ten respondents felt that government support was going to be crucial to future business success.
With the Chancellor Rishi Sunak announcing in early November that the package of support measures implemented in the Spring would be extended to cover a second national lockdown until the start of December, attention has turned once again to the extent to which government support will prevent or simply delay a wave of business failures linked to the Covid-19 pandemic.
In June, the government fast-tracked a new raft of insolvency rules into legislation to help rescue companies in financial distress. The Corporate Insolvency and Governance Act 2020 (CIGA) was already being discussed as part of a further move towards a more debtor-friendly regime and as part of a culture aimed at rescuing distressed companies where there is an underlying viable business. The two new procedures introduced, a Moratorium and Restructuring Plan, allow current directors to stay in office, with oversight from an insolvency practitioner, with the intention of facilitating a restructure of the business.
Dan Butler, an Insolvency Partner at Trowers & Hamlins, says: “The new insolvency legislation has introduced new permanent procedures which are really designed to rescue companies where at all possible. There are also temporary measures in place to limit winding up petitions and enforcement action against companies encountering financial difficulty as a direct result of the pandemic. Unfortunately, without the emergency government support measures currently in place, which are going to have to stop at some stage, we anticipate a huge significant rise in the numbers of companies in financial distress. Corporate insolvency numbers are actually down year on year but that must be due to the emergency measures. It is highly likely that levels of distress will rise in January onward as the government cannot continue with the funding of furlough or other necessary relief forever.”
We have already advised an insolvency practitioner on his appointment and role in the new Moratorium procedure, few companies have so far sought to make use of the new procedures, instead relying on the support coming from government to keep going. In certain sectors, including retail, hospitality, construction and aviation, there is increasing evidence of insolvency practitioners gearing up for a wave of formal appointments, but for now the focus is on advisory work and planning restructurings. Those industries are seeking targeted government support in the wake of Lock Down 2.
Virgin Atlantic became the trailblazer for CIGA when it announced plans for a £1.2 billion recapitalisation in July. To secure approval from creditors, its Restructuring Plan will go through a court-sanctioned process as set out by the new rules, allowing the courts to interpret the fledgling legislation for the first time.
Navinder Grover, an Insolvency Partner at Trowers & Hamlins, says: “The new restructuring processes had to be put on the statute books in a hurry and are really going to be interesting. The new procedure is only going to help businesses of a certain scale, because the costs of those processes are very significant. Unless you can throw £500,000 at a court process to set up a restructuring, it is not going to be an option.”
He points out that it is questionable how effective the moratorium provisions, which leave directors in control while they implement a plan to rescue the company as a going concern, will be in the current climate.
“A lot of businesses will use that time to negotiate with creditors, but we would expect those discussions to be taking place anyway. There are always discussions to be had with landlords, customers and banks, and the fact there is now a measure of protection around those discussions is helpful, but it probably won’t significantly change outcomes,” says Grover.
The challenge is that sectors such as retail and food and beverage are lynchpins of local economies, so a wave of failures in those industries will quickly impact landlords, banks, suppliers and more.
Local government is being called upon to step up. When the UK moved into a tiered system of lockdown restrictions in October, the spotlight shifted to local authorities to decide on alert levels and oversee funding. The government provided local authorities with around £1 billion of new financial support; even before that, in the summer, some 80% of our respondents felt support from local government would be crucial to their long-term success.
The question now is what the government will do next. “Everyone is intrigued to see whether the government, which has so far adopted a fairly one-size-fits-all approach, will move towards a more nuanced route for particular sectors,” says Grover. “In areas like retail and food and beverage, we are looking at a tsunami of corporate failures. There are zombie companies out there, already probably beyond the point of rescue, where the support being given by government is the only thing keeping them at least nominally alive.”
Many businesses are looking at crunch points at the end of December when they will no longer be able to pay their quarterly bills, unless something significant happens in terms of more government support or bank forbearance. Some are being creative and making use of adverse conditions to reduce the costs of restructuring now, but others are quickly moving towards throwing themselves at the mercy of banks and landlords.
Butler says: “Ultimately there is going to be a massive crunch coming, whether that be companies in supply chains being unable to discharge debts or tenants not paying rent with the knock on effect of landlords breaching bank covenants.”
Grover points out that landlords, unless they have significant cash reserves, are going to be turning to the banks for support. “Just like in 2008,” he says, “it is the banks that are going to be making the key decisions. The extent to which the government engages with the banks, to push them to either show considerable flexibility on terms or not enforce their rights, will determine how much the floodgates will open, and when.”
We are already seeing the beginnings of a fundamental shift in the landlord-tenant relationship, as businesses reassess their property requirements and demand more flexible lease models. The concept of signing 15 to 20-year fixed term leases looks unlikely to endure, as tenants seek shorter terms with the option to increase or decrease footprint during the life of a lease, and potentially even share space.
But one final challenge looming on the horizon for struggling businesses (forgetting Brexit of course!) is the upcoming change to HMRC’s creditor status. For a long time, the tax authority has ranked alongside unsecured creditors in the order of who gets paid out in the event of insolvency. From the start of December 2020, new rules mean HMRC will revert to preferential status, meaning it will be paid before other creditors, including the company pension scheme, suppliers and customers.
That is an additional headache for directors try to turn around struggling firms, because HMRC can insist on being paid what it is owed immediately, potentially pushing viable companies to closure. The availability of asset based lending may also decline. Butler says: “If the new rescue plans are going to be effective, HMRC is going to have to be supportive and we don’t yet know what will happen at a time when tax debt will have been deferred across the economy and HMRC will ultimately be obliged to commence tax collections.”
Certainly, a supportive government is going to be crucial for the survival of many businesses until the pandemic is behind us.
