Troubled firms advised to take early action as government support ends

Corporate insolvencies in Scotland rose by 29.4 per cent to 211 in period between July and September this year, compared with 163 between April and June.

But even a lower than expected rate of insolvencies does not give the true picture of an economy under pressure.

John Clarke, partner and insolvency expert at Wright, Johnston & Mackenzie, says: “The gut reaction to all of the chaos was that there was going to be lots [of insolvencies] but the number of formal insolvencies remain pretty low.” But he adds: “The number of insolvencies is not the same as the number of businesses in difficulty, and there are lots of businesses in difficulty for a whole variety of reasons, many limping along just now. Whether they will eventually survive is a different matter.”

He says businesses which have taken loans may “just be delaying a problem”, and other problems being encountered now society has re-opened include staff shortages and rising costs.

“Wherever you go there seems to be people shortages these days. If you take the hospitality sector, over the last 18-plus months you have been closed down for an extended period and then when you have a re-opened a chunk of your staff who are probably on furlough have either dropped out of the labour market or got jobs elsewhere.”

Lucy McCann, restructuring and insolvency partner at law firm Brodies, agrees that while some sectors have managed to cope extremely well, it has been really tough for others.

She says: “The raft of protections brought in by the UK Government via the Corporate Insolvency and Governance Act 2020 and by the Scottish Government via the Coronavirus (Scotland) Acts over the past 12 to 18 months have played a significant role in cushioning the impact of Covid-19 on both businesses and individuals.

“For individuals, we have seen protections in the form of increased limits for sequestration [currently £10,000], as well as the extension of personal moratoriums from six weeks to six months.”

But McCann has been impressed with the way corporate Scotland has managed the pressures, saying: “The pandemic has seen major innovation in terms of corporate restructuring, with the introduction of restructuring plans and the corporate moratorium. In addition, we have seen tactical deployment of measures such as the prohibition on winding-up orders, which has provided some businesses with a vital shield from their creditors.”

For those struggling firms, Company Voluntary Arrangements (CVAs) have been particularly popular over the past 12-18 months, especially in the retail and the casual-dining sector, says McCann.

“The response to use of CVAs has been mixed. On the one hand are those who believe their increased use is indicative of a resilient business community that wants to ensure survival, and on the other, are those who believe their popularity is indicative of opportunism among tenants, who use them to re-write existing tenancy agreements to their advantage. It is undeniable that the increased use of CVAs has given rise to high levels of disputes – creditors have raised numerous challenges on the grounds of unfair prejudice and/or material irregularity.”

Clarke, meanwhile, says bigger companies such as major high street retailers which have run into difficulties have had one advantage of being able to use their “muscle” to “stand up to landlords” when in a voluntary arrangement.

So far, he says, not many SMEs have fallen into insolvency. However, he says the risks are there, not least from rising energy costs, and the financial situation of those you do business with. “If you have a business that is particularly exposed to a small number of large customers who themselves have potential risk, then you are in a risky situation. If you are dependent on something like energy, where you cannot control the price, then you are at risk.”

At the small end, he says, micro businesses are “owner-managed and the people are effectively working to live … they have invested in their own company to provide them a wage or salary”. “The risk there is they have declining profitability, they maybe lose a person or two and work harder and harder for the same or less return.”

Clarke urges struggling businesses not to be scared of taking advice or help, rather than letting problems slip further, which can damage personal health as well as making the financial situation worse.

“People are reluctant and embarrassed to throw in the towel in these circumstances. They see it as a mark of failure and quite often they will continue to work way beyond when it is commercially sensible for them to do that. That is particularly the case if they have a personally guaranteed bank debt or something like that.

“It is almost a relief for them sometimes when they do see an insolvency practitioner who says to them, ‘It is OK to give up, we no longer put debtors in prison’.”

He adds: “You have to acknowledge that a lot of people have personal emotion and pride tied up in their businesses, particularly if it is a second or third generation business. But that is where speaking to somebody independent can help; when it is put to them that it is alright to stop and you are not doing anything illegal and then chat through the consequences if you don’t stop.”

Those consequences could be “driving themselves into an early grave for a business which, looked at objectively, is not surviving and cannot pay its way”, says Clarke. Some put savings into a business when it is struggling, but he adds: “While that might seem like the right thing to do, in practice you are depleting your own nest egg to support a business that might be holed below the water line”.

An objective review can look at steps which can be taken to survive, which can include finding investors or even selling the businesses. “It is useful to talk, and the advantage any insolvency practitioner should bring is to say to somebody they have seen it before. Insolvency experience has taught me that the earlier that people have a discussion about things, the better. If you wait until the business is really sinking, you probably have no option but to close.”

Clarke expects more insolvencies in the coming months but cautions that the figures do not tell the whole story. “I can see more businesses ceasing to trade but the smaller ones will probably not go into formal insolvency. Nonetheless, if the doors are closed, people are not employed – the insolvency tidies things up but it is the closing of the doors which causes the personal problems for the people involved and for the suppliers to that business, and so on.”

McCann also anticipates tricky times ahead: “While the temporary measures brought in by the government have been a lifeline for many businesses, providing that all-important ‘breathing space’ until normal operations could resume, there are others who now face a challenging period ahead.

“On 30 September, the temporary suspensions on winding-up orders was lifted, although certain conditions remain and must be satisfied before petitions can be lodged to wind up a business. We have already seen an increase in creditor-led insolvencies.

“On 31 March 2022, the last of the temporary measures that prevent landlords from winding up a business for arrears will be lifted. It will be interesting to see the impact of this on tenants in the commercial property market. We also expect to see an increase in creditor-led insolvencies when the petitioning debt level of £10,000 is removed.

“During the pandemic many businesses have built up large amounts of debt. As government reliefs are lifted or tapered, the ability to trade is really tested and the fault lines can show. For example, the lifting of furlough adds to the amount to be paid in wages which, for a long time, have been subsidised. Bounceback loans will need to be repaid.

“While the temporary measures are in place, businesses have breathing space to try to find ways to repay their debts, for example through new sources of financing, or by agreeing extended repayment terms with creditors.”

McCann agrees with Clarke that acting quickly is the key to survival. She says: “There may still be options available even if matters are quite advanced, so don’t assume all is lost.”

She also has a warning for directors to be aware they have a legal responsibility to behave in accordance with their directors’ duties at all times. She says: “This is most acute if their company is facing insolvency. Penalties for those who are found in breach of those duties are severe, and can result in director disqualification and directors being held personally liable for company debts. Where instances of trading while insolvent, breach of duty or indeed fraud are discovered, we expect those to be investigated and pursued in the coming months.”

This article first appeared in The Scotman’s Legal Review 2021