What if the CEO asks me about… the options available for a company facing financial difficulties?

The latest government insolvency statistics highlight that the downturn in the UK economy is still taking a significant toll and the number of UK corporate insolvencies in February 2024 remains high (and 17% higher compared to February 2023).

Latest insolvency statistics

February 2024 saw 2,102 company insolvencies, the highest February figures for at least four years.  

And the corporate outlook remains uncertain.  It is anticipated that ongoing economic pressures may lead to an increase in the number of larger UK companies, including those in the retail sector, coming under financial strain and entering into a formal insolvency process, such as administration.

But financial distress does not necessarily mean insolvency and, in certain circumstances, it may offer opportunities for growth, through acquisitions. 

Key considerations for directors

Even if a company is facing financial distress, it does not automatically mean that it must cease trading. Often the situation can be managed by proactive cashflow management.

If cashflow management is unable to alleviate financial pressure, the key consideration for directors is that, once a company is facing likely insolvency, the focus of their duties must shift. When the company is financially stable, the directors owe their duties to the company and its shareholders.

However, once a company enters the "zone of insolvency", the interests of the company's creditors also have to be considered.

When determining whether a company is insolvent, there are two tests:

• the “cash flow test”:  is the company unable to pay its debts as they fall due?
• the “balance sheet test”:  is the value of the company's assets less than its liabilities?

Although failure of either of these tests determines insolvency, unlike in some other jurisdictions, there is no requirement under English law for a company to immediately commence insolvency proceedings upon triggering either test.  Therefore directors should be aware that failing an insolvency test does not necessarily mean the end of the company. Instead, one of the key determinants that  directors should consider is whether there is any reasonable prospect of the company avoiding an insolvent liquidation or administration. This flexibility provides distressed companies with breathing space to consider options and potentially restructure outside of an insolvency process and thereby preserve value.

Time should therefore be taken to consider options and to take appropriate legal and financial advice as early as possible as there may be restructuring solutions available.  

Consider the options available to the business

There are several options which may enable a business to be saved as a going concern.  They can include:

• coming to a consensual arrangement with the company's key creditors (such as lenders, HMRC and key suppliers) in respect of outstanding debts – this might include, for example, agreeing a standstill on those creditors taking enforcement action against the company for a period of time and/or agreeing upon a restructuring or rescheduling of those debts; or
• the company seeking to restructure and/or compromise some or all of its debts through a formal process, such as a company voluntary arrangement, scheme of arrangement or Part 26A restructuring plan.

In recent times there has been the emergence of the restructuring plan. It is a "debtor-in-possession" procedure similar to, and closely modelled on, the well-established scheme of arrangement process, under which a company may make a compromise or arrangement with its creditors or members (or any class of them). 

Unlike a scheme, the restructuring plan can, provided certain conditions are met, potentially 'cram down' dissenting classes of creditors. This clearly has its benefits as it can enable a company to proceed with a restructuring, even where there are categories of 'hold-out' creditors.

2023 also saw a number of plans being proposed by smaller-to medium sized companies. The terms of any plan must always be carefully considered, particularly if it seeks to compromise any tax debts owed to HMRC.

Are there any opportunities?

Whilst the current economic uncertainty may initially seem concerning for those operating within the retail market, it may also present unique opportunities.

With more companies facing financial distress, suppliers and landlords may be more open to negotiating better terms, whether it is lower rental rates, extended payment terms or more favourable supply contracts.

The rising number of insolvencies may also lead to weaker competitors being forced to exit the market and/or their businesses or assets being sold.  This can present opportunities for others in the market or companies looking to expand into new sectors.

Any such sales are often made by way of a "prepack".  A prepack is a pre-arranged sale of the business and/or assets of an insolvent company that completes immediately or very shortly after the company has been placed into administration.

Although prepacks have, at times, been criticised, particularly by unsecured creditors left with unpaid liabilities, there are important potential benefits to a prepack too. Most fundamentally, a prepack can enable a viable business or enterprise to continue trading without interruption through a sale, and thereby preserve jobs, supplier relationships and provide continuation of services to customers.

2024 appears that it may be another challenging year for many participants in the retail market.  However, by approaching the situation strategically and taking proactive steps early, it can be possible in many cases for those challenges to be overcome and, where opportunities for expansion arise, for businesses to emerge larger and stronger. 

Whether you are a director of a company in financial distress, foresee financial difficulties on the horizon, or are looking for opportunities in the current market, we would always recommend that you take expert legal and financial advice about your position as soon as possible in order to maximise your available options.

Disclaimer: The information in this publication is for guidance purposes only and does not constitute legal advice. We attempt to ensure that the content is current as at the date of publication, but we do not guarantee that it remains up to date. You should seek legal or other professional advice before acting or relying on any of the content.