Benjamin Wiles: Laying the groundwork for Bounce Back Britain
Benjamin Wiles, managing director, restructuring advisory at Kroll, examines the state of the economy with respect to insolvency and the M&A market as the UK emerges from lockdown.
The scale of the shock to the UK economy as a result of Covid is now clear following the Chancellor’s Budget. It is now estimated to have reduced gross domestic product (GDP) by as much as 10% in calendar year 2020.
The Office of Budget Responsibility (OBR) is taking an upbeat view predicting an increase in UK GDP of 4% in 2021, followed by around 7% in 2022. On their assumptions GDP could well be back to its pre-Covid level by mid-2022, which is six months sooner than the OBR forecast last November.
While this all sounds like good news, it is still worth recording that GDP under this modelling is still forecast to be 3% lower by 2026 than it would have been if Covid had not happened.
And yet despite the doom and gloom associated with the fall in GDP, corporate insolvencies appear to be telling us a different story. The latest figures from the Insolvency Service report that corporate insolvencies fell by 9% to 686 in February 2021 compared to January’s figure of 754 and were 49% lower than February 2020’s figure of 1,348.
Looking at this at a granular level, in February 2021, when compared with the number of company insolvencies registered in February 2020, compulsory liquidations were 86% lower, Creditor Voluntary Liquidations (CVLs) 38% lower, Company Voluntary Arrangements (CVAs) 68% lower and administrations 62% lower.
It sounds counter intuitive to the broader narrative on the impact the pandemic. But we are seeing the impact of an activist government supporting businesses across two fronts – financial support and the temporary suspension of pre-existing corporate insolvency and governance legislation.
For businesses still struggling with lockdown and dramatically reduced trading levels, there was some hope as the Chancellor unveiled a number of support initiatives in the March 2021 Budget.
At the heart of the new support package lies the Recovery Loan Scheme, designed to ensure businesses of any size can continue to access finance up to £10 million per business once the existing Covid loan schemes close.
The bounce back loan scheme (BBLS), coronavirus business interruption loan scheme (CBILS) and coronavirus large business interruption loan scheme (CLBILS) applications all came to an end on 31 March 2021. The new scheme came in on 6 April 2021 and a number of lenders have already signed up.
Support to date
The figures in terms of support already given to UK plc are startling. As of February, £45.6bn had been deployed to more than 1.5mn SMEs through BBLS, over £22bn loaned to just under 100,000 businesses via CBILS and over 700 loans worth a further £5.3bn were granted under CLBILS.
Added to that is a further £1.1bn spent on convertible loans for 1,140 companies as part of the future fund scheme.
There is no doubt that the economic impact of the pandemic and the disruption to businesses cash flows has lasted longer than anyone expected. There is little certainty on when businesses can return to pre-pandemic operating levels. As a result, the UK government needed to provide as much support as possible to ensure businesses stay afloat. Given the scale of government-backed loans now sitting on balance sheets, short term cashflow concerns may have dissipated for many but the hangover will now begin to be felt over the next six months. VAT deferments now need repaying, loans need servicing, staff need to be bought back off furlough, and rent arrears need settling. Corporate Britain has been piling up the debt and while that may have seen many through the pandemic, payback time is starting.
Insolvency protection extended
In a critical move the Corporate Insolvency and Governance Act 2020 (CIGA 2020), which received Royal Assent on 25 June 2020, has seen the temporary measures it introduced extended enabling the Government to use the measures only until in some cases the end of June or September for others.
The Act is comprised of eight measures which fell into two types: permanent measures to update the UK insolvency regime, and temporary measures to insolvency law and corporate governance, intended to give struggling businesses a lifeline during the pandemic.
The Corporate Insolvency and Governance Act 2020 (Coronavirus) (Extension of the Relevant Period) Regulations 2021 has extended the key measures in different ways.
These can be summed up as follows:
- The suspension of liability for wrongful trading has been extended until 30 June 2021 for directors who continue to trade a company through the pandemic with uncertainty as to whether their company may be able to avoid insolvency in the future.
- The prohibition on termination clauses is also extended until 30 June 2021, although small suppliers will remain exempted from the obligation to supply.
- The relaxation of entry requirements into the new moratorium procedure will also be extended, in this instance until 30 September 2021.
- The continuation of restrictions on statutory demands and winding-up petitions until 30 June 2021.
One of the key measures is the continuation of the temporary suspension of wrongful trading, which provided company directors with some much-needed breathing space. It does not completely relieve them of all their duties, however.
The Act stipulates that when considering the input that a director must make towards a company’s debts, the court must now act as though they are not responsible for any worsening of the financial position of the business or its creditors.
For directors who may have previously hurried to start insolvency proceedings and avoid the possibility of any personal liability, the temporary suspension will help postpone many from triggering that process and assist them to emerge intact on the other side of the pandemic.
However, on a more cautionary note, company directors must keep in mind that all other sources of risk and liability under the Insolvency Act 1986 are unaffected by the Act. For example, directors are still bound by their fiduciary duties and the fraudulent trading provisions of section 213, which means that they will still face sanctions and penalties if they knowingly attempted to defraud the company or creditors.
In addition, directors will still have duties under the Companies Act 2006 and must continue to act and be mindful of the interests of creditors if the likelihood of insolvency increases.
Overall, this means that the temporary suspension of wrongful trading doesn’t change the attention that directors should be giving when evaluating the financial position of their company. Directors’ actions will remain subject to scrutiny, making it critical that they consider very cautiously whether to continue trading if there is not a realistic chance of their company avoiding insolvency.
The provisions of the initial extension in relation to filing deadlines no longer applies. The Act had granted automatic extensions for filing deadlines between 27 June 2020 and 5 April 2021 to relieve the burden on companies during the coronavirus pandemic and allow them to focus all their efforts on continuing to operate.
It remains to be seen whether there will be a further extension of these provisions. Much is likely to depend upon the success of the vaccination programme, and the opening up of the economy and the ultimate recovery.
Landlords and commercial tenants
The Government has also published a consultation paper seeking responses and evidence from the property industry generally as to how negotiations between commercial landlords and tenants on rescheduling rent liabilities have been handled during lockdown.
The protective measures the Government introduced back in April 2020 were only ever meant to be temporary. This was a lifeline for many but now there is a significant risk for those who relied on this during the pandemic that once those protections are lifted – scheduled for June 2021 - businesses may fail when rent arrears are pursued.
That said it is hard to envisage the government allowing a cliff edge to come into view when it has spent so long over the past year seeking to protect embattled businesses.
There is no doubt that the speed of the Government’s response to the crisis – from the loan schemes through to the efficiency of the furlough scheme – has been impressive. However, for businesses large and small the challenge now is how to come out of this crisis without a dramatic hit to revenue, cashflow or balance sheet.
Although the easing of lockdown measures is picking up pace and businesses are beginning to open their doors, numerous challenges lay ahead, particularly with the expected long-term reduction in consumer demand and confidence. Many company directors will likely face challenging decisions over whether to continue trading or instigate an insolvency process in the coming months.
There is also pent-up private equity demand and high levels of debt funding. This desire to deploy capital, combined with what we could term a ‘flight to quality’, mixed the optimism as a result of the vaccine programme, as well as near record levels of corporate liquidity and a strong market for M&A, we could well see a positive market.
If directors are worried that their business is in or expecting financial difficulty, it is crucial that they continue to consider the needs of all key stakeholders and creditors in any decision and maintain ‘good housekeeping’ in the form of board meetings and keeping records of actions taken with an assessment of the reasons for certain decisions. Where possible, they should also seek appropriate professional advice.