What are the options for a business in distress?

This article first appeared in Accountancy Daily on 20 January 2023.

With supply chain problems, war in Europe and other issues leading to higher inflation and an increasingly uncertain economic outlook, this article explores the options available to companies experiencing financial distress. 

As the global macroeconomic picture becomes increasingly delicate, it is anticipated that many businesses will look to restructure their financial position and potentially make use of formal insolvency tools. Indeed, whilst insolvency appointments for 2021 and 2022  have been below long-term averages, appointments in 2023 are widely expected to surpass this. 

Against that backdrop it is all the more critical for all businesses closely to monitor their financial health in order to minimise costs and increase their resilience. In particular, businesses might want to consider:

• producing and reviewing regular forecasts (where feasible, many advisor’s recommend the use of 13-week cashflow forecasts, updated monthly);
• whether the information the business produces provides the level of detail required in order to fully assess the business’s financial position (and if not, what further information is required and how that might be produced); and
• holding regular board meetings to consider financial metrics, operational performance and other factors that may impact the business (such as supply chain risks), and using such meetings as an opportunity to “stress test” performance taking into consideration recent economic data, forecasts and identified risks.

To the extent forecasts suggest the business may struggle to satisfy upcoming liabilities when they fall due, businesses would be well advised to respond by engaging financial (and if necessary, legal) advisers in order to explore the consensual and other options available to turn the business around.

In particular, it may be possible to identify specific liabilities that are weighing on the business’s finances (such as large bank loans reaching maturity, or cashflow issues in paying suppliers). Where that is the case, more often than not the most efficient path for the business is to discuss these issues with the relevant counterparty with a view to reaching a mutually agreeable resolution (for example, rescheduling upcoming loan payments).

Not only does early action provide the business with the best chance of making a full recovery in a cost-effective manner but, from a legal perspective, directors should take comfort from the fact that English law supports directors in taking such action, and makes it much easier for them to demonstrate that they have complied with their fiduciary duty to promote the success of the company under section 172 Companies Act 2006.

Where despite best efforts a consensual resolution is simply not achievable, directors should give consideration to using one (or more) of the formal restructuring tools available that allow the business to continue trading, looking at different options in parallel and always keeping all feasible options “on the table”.

Indeed, there is a global trend towards reforming insolvency laws to promote turnaround, rather than simply providing a regime for managed failure. Recent additions to the UK’s suite of tools (introduced by the Corporate Insolvency and Governance Act 2020) include:

• Part A1 Moratorium: a short-term moratorium initially lasting 20 business days (which is extendable) that aims to provide businesses with the “breathing space” required to determine its next steps, by preventing creditors from taking adverse action against the business. It may prove useful when looking to achieve a consensual resolution or preparing to utilise other early rescue tools.
• Restructuring Plan: a potent alternative to a scheme of arrangement (see below), it is the first UK tool to allow a compromise or arrangement with creditors and/or shareholders to be sanctioned by a court even where one or more classes of creditors/shareholders have objected to the plan (commonly known as a “cross-class cram-down”).

These complement the UK’s more established rescue tools, which include:

• Company Voluntary Arrangement: an arrangement agreed between a company and its creditors, supervised by an insolvency practitioner, which is capable of binding all unsecured creditors. The arrangement can be agreed entirely without court involvement.
• Scheme of Arrangement: a compromise or arrangement agreed between a business and its creditors and/or shareholders but which is capable of binding all creditors/shareholders. The proposed arrangement must be sanctioned by the court.
• Administration: a procedure that imposes an automatic moratorium to allow a business (under the control of an “administrator”) to restructure. Although a rescue procedure, entities in administration are often highly distressed and profitable parts of the business are usually sold off (sometimes to a pre-identified buyer, known as a “pre-pack”).

Across Europe, EU Directive 2019/1023 on preventative restructuring frameworks has prompted significant changes to regimes in, among other places, the Netherlands, France and Germany, all of which have introduced procedures targeted at rescue rather than wind-down by including features such as debtor-in-possession financing, moratoria and/or cram-down. Similar reforms have been seen elsewhere in recent years, including jurisdictions such as the United Arab Emirates and the Kingdom of Saudi Arabia.

Conclusion

In the UK (and elsewhere) there is a strong desire to create a culture of rescue, with a raft of tools available for the entire cycle of distress, from “breathing space” in the form of moratoria through to imposing a compromise on creditors through a plan or scheme. Businesses should seek to act on the early signs of distress and, where necessary, make use of one or more of the available tools, always bearing in mind that with the use of these tools, together with the expertise available in the UK’s mature turnaround market, distress need not be terminal.