A potential tsunami of business failures, liquidation and insolvency
A dramatic decline in profits caused by the lockdowns has reduced equity buffers and left many UK companies highly indebted, whilst they simultaneously experience a reduction in their capacity to service debt.
The unprecedented and decisive response of the UK Government helped UK businesses to overcome the short-term liquidity problems that arose without warning, as a result of the economic shock of the COVID-19 outbreak. Now that the economy is attempting to recover, that shock is likely to feed into a wave of corporate insolvencies, liquidations and administrations.
This has led many to question whether the insolvency sector and the supporting bureaucracy, including lawyers, accountants, HMRC and the courts will have the capacity to deal with the potential tsunami of business failures.The economic recovery from the pandemic will be held back
The economic recovery from the pandemic will be held back if significant numbers of companies are stuck in a financial purgatory awaiting the outcome of insolvency, liquidation, debt recovery or administration proceedings instigated as result of defaulting on government backed loans.
This scenario will result in delays in redundancy payments to employees and uncertainty for creditors. It is therefore easy to imagine the knock-on effect on vulnerable companies whose future viability depends on recovering something from the insolvency of a customer.The time needed to manage an insolvency will be much longer post-covid
It is clear that many sectors, including the service sector, manufacturing and construction are struggling to deliver pre-covid levels of service. Because the insolvency processes require input and approval from multiple bodies it is obvious that the time needed to manage an insolvency will also be much longer, post-covid, than it was 18 months ago.
There is well researched evidence, not least from the OECD, which supports the grim prediction of a sustained period in which the numbers of business failures leading to insolvency and liquidations will challenge the resources of IP practitioners and the entire sector.
The OECD has identified two key types of risks in the medium and long-term. They say,“The number of firms that are anticipated to have a negative book value of equity and therefore a high risk of insolvency, is expected to increase worldwide. At least two channels could be at work. First, the economic shock following the COVID-19 crisis diminished actual and expected sales and profits, thereby potentially putting downward pressure on the value of firms’ assets. Second, the injection of liquidity provided in the form of loan guarantees and new lines of credit increased firms’ leverage ratios and hence their default risk”.The impact of debt overhang
Increased corporate debt requires businesses to reduce investment, limiting the pace of any recovery. So called “zombie firms”, a term coined after the crash of 2008, further undermine the strength of the recovery by locking-in resources in less productive firms.
Support for non-viable companies has to be balanced against the consequence of viable businesses moving into premature liquidation, insolvency or protracted administration.
According to the OECD, “Insolvency frameworks tend to become less efficient in a time of crisis, especially when courts are congested, potentially leading to liquidation of a higher number of viable firms than desirable, with adverse effects on growth”
.Flattening the curve of insolvencies
For the UK Government, their key concern should be to reap the maximum return on the support provided to business during the pandemic, by ensuring the fastest and most sustainable bounce back and recovery.
This will not be achieved if the required shakedown of non-viable companies does not take place, and the recovery is held back by bottlenecks in the insolvency process.
The insolvency process, enshrined in law and expedited by licensed and regulated insolvency practitioners, supported by lawyers, and requiring input from multiple organisations including HMRC
, accountants and redundancy services, not to mention the company directors themselves, is the complete opposite of an agile operation.
It is highly unlikely that the current regulations, processes and its practitioners have the leeway and flexibility to deal quickly with the unprecedented and urgent need to free up the resources trapped in businesses which could be capable of contributing to the recovery.
The Government are strangely silent on this subject. However, it is unlikely that the insolvency process will prove fit for purpose if the predicted wave of business failures arrives. The normal measures of viability have been skewed by factors totally beyond the control of business operators, and the reality is that “the new normal” is significantly different to the old one. UK companies are emerging into a landscape characterised by higher debt, supply chain disruption, inflation, raw material shortages and changed customer behaviours.Business recovery – the alternatives to liquidation, insolvency and administration
Whether the post-pandemic business environment becomes be a catalyst for a major overhaul of the insolvency process remains to be seen. One option is that there is an outcry and backlash when the abuse of the government-backed support for business is revealed and the existing regulations are vigorously applied.
The statistics around this subject make very uncomfortable reading.
According to www.parliament.uk
, UK taxpayers face covering billions of pounds in the Bounce Back Loan Scheme with potential losses estimated in the region of £15 billion to £26 billion. The Government estimates the majority of this will be credit losses, where the borrower wants to repay the loan but cannot - but it lacks the data to assess the levels of fraud within the Scheme, or its actual economic benefits.
In a report earlier this year, the Public Accounts Committee criticised the Government’s “astonishing” lack of economic planning and preparation for a pandemic, despite it being one of the top risks identified in the National Risk Register. The Government was “taken by surprise” that small businesses would require tailored support in and after the lockdown and moved quickly to create the Bounce Back Loans Scheme, which guaranteed loans, enabling business to borrow money in as little as 24 hours.
Through this process, HM Treasury, the Department for Business and the British Business Bank prioritised delivery speed over all other aspects of value for money, and they have not been able to offer clear objectives or measures of the Scheme’s success.
This focus on speed means businesses self-certify their application documents and lenders are not required to perform any credit or affordability checks. The lack of checks creates risk for lenders which meant the Government had to agree to guarantee the loans 100% - so that if the borrower doesn’t repay the loans, the taxpayer will.
Crucially, HM Treasury is yet to agree the process and protocols that lenders are expected to follow in recovering overdue loans. The Committee says Government’s plans for managing these risks to the taxpayer - from either fraudulently obtained loans or genuine borrowers who are unable to repay - are “woefully under-developed”.
Meg Hillier MP, Chair of the Public Accounts Committee, said:“We all hope the Bounce Back Loan Scheme saves a significant number of Britain’s small businesses, who will play a key part in the economic recovery from this pandemic.
But despite knowing that it was a case of ‘when’ rather than ‘if’ a serious pandemic hit the country, Government didn’t develop plans for how to support the economy. Rushing to get money out of the door after the fact didn’t allow for analysis of how many businesses needed this help, could benefit from it, or could repay it.
Dropping the most basic checks was a huge issue that puts the taxpayer at risk to the tune of billions.”Providing new options and an alternative to traditional insolvency or liquidation
, our prediction is that some form of “soft- touch” liquidation and a new framework for assessing viability will have to be created. As so much of the new debt has been guaranteed by the Government, it will require legislation to update the process. This will only happen if the Government is persuaded of the net positive value of allowing a light touch shake down of companies and a rapid reset – liberating talent, resources and entrepreneurialism to drive the economy forward by flattening the curve of insolvencies.
Until these changes are forthcoming, companies like Corelco are able to offer a highly personalised service
to businesses – providing new options and an alternative
to traditional insolvency or liquidation.Call Corelco today on 0203 773 1417.