The consequences of a third national lockdown

The latest lockdown may bring the reset button into play

Where do we start?  One minute the country is rejoicing at the licensing of various vaccines and anticipating a swift return to some form of normality, the next the latest mutation of the virus sends us spiralling back to the early days of a full lockdown but without the nice weather and long, sunny days.  London and the Home Counties enjoyed being in Tier Three for precisely one day before being relegated to Tier Four.  Christmas was going to see restrictions eased before they were tightened at the last moment.  And then we plunged into another full lockdown, which looks set to last well into February and possibly beyond.

How can businesses plan in the face of such rapid changes in government advice? What do retailers and the like do with all the stock they have purchased in anticipation of being allowed at least limited trading?  We know what they cannot do, which is to pay for it.

Although regional and national lockdowns may be necessary, they undoubtedly increase fear and uncertainty as well as make planning extremely difficult.  Certain sectors have already been devastated – bars, restaurants, hotels, retailers, travel companies, airlines, leisure – and many businesses within those sectors will not be able to recover from the effects of the pandemic.

We believe that 2021 will be the year that many businesses press the reset button.  Let’s look at a typical scenario to underpin our thinking:.

  • Your business has been mothballed or operating at significantly reduced levels for most of the time since March 2020
  • Many of your employees have been furloughed
  • Your rent has continued to accrue
  • Income has been severely reduced
  • You have taken advantage of government backed loans which are not yet due to be repaid
  • You have entered into a Time To Pay agreement with HM Revenue & Customs
  • You now believe that you either do not need such large premises or that the cost of those premises is too high, but you are locked into a lease
  • You have been unable to pay rent since March 2020 and this continues to accrue
  • You also wish to reduce your workforce but have no funds with which to make redundancy payments
  • You do not know how quickly your trade will return

The first thing to determine is whether your business is solvent.  There are two tests:

  1. The balance sheet test – do assets exceed liabilities?
  2. The section 123 Insolvency Act test – can you pay your debts as and when they fall due?  This means all of your debts, not just some or most of them.

If you fail either test, your business is insolvent and you must act solely in the best interests of its creditors.  It is vital that you now document the background to and rationale for all of your decisions – you might get things wrong but if you act responsibly, demonstrably with the best interests of creditors in mind, then at least you will not be required to personally contribute to the businesses liabilities.  Holding regular board meetings is an ideal way to demonstrate that you are aware of the issues facing your business and, through minutes, that you are doing your utmost to maximise the return to your creditors.  At this stage you should be aware of the hierarchy of creditor claims in an insolvency scenario and be sensitive to the priority in which you should pay your creditors.  If in doubt, take advice.

Secondly, is your business viable going forward?  What does your cash flow forecast look like?  How quickly can you return to profitability and start repaying the debts that have accrued during the pandemic?  Forecasts need to be reasonable and their assumptions documented.  You should ask your accountant for assistance if you do not have in-house capability.

It is expected that many businesses will be insolvent and unable to trade out of their financial difficulties as a result of the pandemic.  This is, of course, why the government keeps on extending the furlough scheme.  This scheme just prevents unemployment; it does not pay rent or rates or VAT or other expenses and it is not economic support. Many of these insolvent businesses are likely to be profitable as we eventually come out of lockdown and normal trading conditions start to re-establish themselves. The reality, however, is that they will just not be profitable enough to repay the debts accumulated in almost a year of restricted trading conditions.

It is those businesses who will press “reset” and start again with a clean financial slate.  How do they achieve that?  There are a number of ways, including:

Voluntary Arrangement

This is a contract between a business and its creditors within a statutory framework.  Under the contract, the business agrees to either:

  1. Introduce a lump sum to enable a dividend to be paid to creditors;
  2. Make monthly contributions for a period up to five years which will be paid to creditors; or
  3. A combination of 1 and 2.

The dividend to creditors must be greater than those creditors might expect to receive from any other insolvency process (such as Administration or Liquidation).

There are many benefits to a VA including the removal of liabilities from the balance sheet (making it easier to obtain investment), certainty, as well as the retention of name / trading history / bank account / VAT registration number.

One drawback concerns the recent elevation of many debts owed to HM Revenue & Customs to secondary preferential status.  This means that in the hierarchy of claims, HMRC sits behind employees’ claims for arrears of wages or salary (capped at £800 per employee) and holiday pay (not capped) but ahead of floating charge holders and other unsecured creditors.  In a VA, this means that the higher the amount owed to HMRC, the longer other creditors will need to wait in order to receive a dividend; this length of time may be so long as to be a disincentive for such creditors to vote in favour of the arrangement.

Find out more about CVAs here.

Administration

In simple terms, the business and assets (but not liabilities) are acquired from the Administrator. This is generally by way of a pre-packaged Administration (“pre-pack”) where there is a seamless transition between the insolvent business and the acquiring vehicle.  There are a number of factors to consider here:

  1. The purchaser must pay a demonstrable premium for the business and assets to avoid any accusations that the business has been sold at below the market price;
  2. The Administrator must be able to demonstrate that the business has been properly marketed (given the inevitable time constraints);
  3. If the business is subsequently placed into Liquidation (as is normal to pay a dividend to unsecured creditors) there may be implications regarding the restriction on re-use of company names.

Creditors are not required to approve an Administration although pre-packs tend to attract negative media comment, the implication generally being that the Administrator has failed to maximise the value of assets given the completion of the sale immediately upon appointment.

Find out more about Administrations here.

Liquidation

The business ceases to trade but its business is not acquired from the Liquidator (it can be but it is more usual to do this through an Administrator).  The assets can be purchased by a successor business although, as with pre-pack Administrations, there are sensitivities surrounding “phoenixism” (the purchasing entity rising from the flames of the insolvent business like a phoenix from the ashes…).

There are of course different perspectives to consider and if a business has been affected by the pandemic to the extent that it is unable to trade out of its liabilities, why should the principals behind that business not be entitled to draw a line under it and start again?

Find out more about Liquidations here.

These options have been described in broad terms and each situation is bespoke.  If you would like any further detailed information on any of these processes, free of charge and without any obligation, you can obtain specialist advice by pressing the button below.

Stephen Goderski

Director - London

t: 0207 516 2224

e: stephen.goderski@pkfgm.co.uk 

James Sleight

Director - Leeds

t: 0113 426 7404

e: james.sleight@pkfgm.co.uk

News & Insights

Explore our insights for help with managing financial pressures and building resilience in your business.