The economy needs more insolvencies
May 2015 | SPOTLIGHT | BANKRUPTCY & RESTRUCTURING
Financier Worldwide Magazine
The difference between what the public think a profession does and what its qualified experts actually do varies from one profession to another. Lawyers, doctors, soldiers, police and their work are the subject of much film and television drama, no doubt romanticised and quite unrepresentative of everyday reality. But the insolvency practitioner is rarely, if ever, accorded such glamorous treatment, and most of the population have little idea what an administrator or liquidator does, unless they unfortunately find themselves involved in an insolvency.
An insolvency is a worrying and stressful experience for anyone, whether as a company director, or an employee, or probably worst of all, as an owner of a small business with personal liability for its debts. On the larger scale, the effects of insolvency can be long-lasting, even permanent, as when the closing down of a major employer due to structural change in an industry means that a community which has grown up in the service of that industry loses the reason for its existence. Short-term financial compensation is provided by the government to the unfortunate employees, but the prospect of devastating long-term unemployment becomes a grim reality for people who have grown up into working lives devoted to that ailing industry. They perhaps more than anyone need strong economic growth to provide them with new opportunities.
Dispelling the myths
A familiar expectation among the employees in an insolvency is that the administrator appointed over their employer will waste no time in closing down operations and making employees redundant. Perhaps more accurately, that is what the employees fear, but generally they have little idea what to expect. The usual situation in a company of any size, with employees distinct from directors and shareholders, is that the employees have heard rumours but know very little about how discussions held behind closed doors will impinge on their jobs, their security and their rights.
However, if you ask any insolvency practitioner whether they enjoy their work and why, you will find their answers to be invariably positive and that their job satisfaction comes from fundamental aspects of the work that are quite beyond the preconceptions of the general public. Saving the underlying business and securing a successful resolution for all parties is paramount.
IPs to the rescue
The terms insolvency practitioners have used to describe what they do have evolved over time: what was once ‘insolvency work’, became ‘business rescue’, became ‘corporate recovery’, became ‘restructuring and insolvency’. Though they are not ‘company doctors’, insolvency practitioners are like doctors in the sense that they do not want companies to fail any more than medical doctors want humans to fall sick. A key concern of the profession is therefore to portray itself as a constructive force in the wider economy, and that reflects a fundamental purpose of insolvency legislation.
A reputable profession
In the UK, the legislative framework in which insolvency practitioners principally operate was put together in the Insolvency Act 1986. This assembled the relevant parts of the Companies Act 1985, the Insolvency Act 1985, and the Bankruptcy Act 1914, and is supplemented by rules and a substantial body of case law. There have been changes in details of the statute book since 1986 but it remains, in broad terms, the law for insolvency practitioners now.
The other act of Parliament that concerns them particularly is the Company Directors Disqualification Act 1986. This is really incidental to the main operations of the insolvency practitioner, but by their position they are well-placed to investigate the conduct of an insolvent company’s directors, and they are required to report any unfit conduct to the UK government’s Insolvency Service.
Supported by the above legal framework, two all-embracing principles of the work of the insolvency practitioner are to maximise the value of asset realisations, and to deal with creditors according to their legal rights so that any security or preferential status they hold is treated correctly, and that creditors of similar rank share in recoveries in proportion to their claims.
A case example
Giving clarity in worrying times. A newly-appointed administrator and their team must engage with the company’s workforce, overcome negative preconceptions, gain their trust and establish with them the understanding that it is in everyone’s interests to preserve as much value as possible in their employer’s business. Employees often welcome the clarity provided about the situation and what is actually required of them.
Keep the company alive. If it is possible to keep the business or part of it trading, then a sale as a going concern will preserve their employment while achieving a substantially better recovery for the company’s creditors than a shutdown and breakup sale of assets. A business sold with its workforce, its stock and its operating assets may be worth significantly more than the individual assets sold separately, and the realisation of the sales ledger will be greatly enhanced if customers are assured of continuing supplies.
Maximising the assets. An essential factor in successful recoveries from assets is that the realisation process be conducted in a controlled and orderly manner. Insolvency practitioners are entrusted with a wide-ranging set of powers over a company and all its concerns. Their position commits them to contentious issues with many areas of legislation – for example, employment law, environmental law, licensing law and in all cases creditor’s rights both contractual and statutory. Their position as it touches on the above legal minefields can engender serious risks for them personally, and a vital aspect of their work is effective risk management. More fundamentally, in order to maximise the realisation of assets, the insolvency practitioner is empowered to prevent a free-for-all recovery chaos in which the self-interested creditor who steals a march on the competition is the one that benefits at the expense of the others, while undermining much potential value in assets.
Promotion of a healthy economy
In the bigger picture, the role of the insolvency practitioner in a healthy economy is not only to preserve and maximise value from assets, but to bring about their effective recycling. Mergers and acquisitions, and purchases and sales of businesses, made possible by investment and lending, supported by banks and experts in corporate finance, are part of that picture, and likewise are parts of a healthy economy. What is not part of a healthy economy is a climate in which underperforming assets stay where they are.
The UK economy has been free from macroeconomic catastrophe for a handful of years, but it is also underperforming. It is characterised by minimal inflation, interest rates at record low levels for an extended period and colossal banks that have to balance commercial operations with external political pressure. The ‘Zombie Company’ (ZCO) is the epitome of what is wrong with the current UK economy. ZCO represents wasted opportunity. Based on legal definitions it is insolvent, i.e., it cannot settle its liabilities as they fall due, or its liabilities exceed its assets. So as a company, ZCO has no value. The problem is that nobody can wind it up.
The proportion of live companies in England and Wales going into insolvent liquidation fell to a record low in the year to September 2014, with official statistics recording a figure of approximately 0.5 percent. The corresponding 12-month statistic in the early 1990s was at times above 2.5 percent; it fell steadily to around 1 percent in 2000, and from then on has continued down to its current level.
Estimates vary as to how many UK companies fall into the ZCO category, some exceeding 300,000, but there is also a question of definition. The superior ZCO has a viable business but is over-geared, carrying the legacy of pre-2009 borrowing. It would benefit from a debt restructuring, so that its business could grow and flourish. The inferior ZCO is inherently uncompetitive, but carries on with a loss-making business in spite of the inevitable failure that eventually awaits it.
What will the future bring?
This economic paralysis is a deep structural malaise for UK PLC. Its cure will be connected with a return to interest rates that make a difference to a company’s financial position, and to the manner in which banks operate. At present, and certainly for some time into the future, the major UK banks are committed to dealing with their own structural problems, political pressure, vigilant regulators, the damage caused by past working practices that attract costly fines and negative publicity, and much of the blame for the 2008 financial crisis.
When these lenders are again able to operate more commercially and to clear out dead wood from their portfolios, this will bring greater opportunity for entrepreneurs, i.e., the risk-takers who create new business and drive economic growth. Then the insolvency practitioner’s constructive recycling of assets will resume, and despite perceived bad news from insolvency statistics, the economy will be on the way to fulfilling its great potential.
Jeremy Fricker is a senior manager and Jeremy Willmont is head of restructuring and insolvency at Moore Stephens LLP. Mr Fricker can be contacted on +44 (0)20 7651 1819 or by email: email@example.com. Mr Willmont can be contacted on +44 (0)20 7651 1526 or by email: firstname.lastname@example.org.
© Financier Worldwide
Jeremy Fricker and Jeremy Willmont
Moore Stephens LLP