Albert McClelland (solicitor, New Zealand Qualified) sat down with Vernon Dennis (Partner and Head of Business Advisory at Howard Kennedy LLP) to get his views on insolvency levels and the issues businesses are currently facing.
Total company insolvencies in England and Wales in the second quarter of 2022 reached their highest level since 2009. There has also been an increase in corporate insolvencies of 21% in November 2022 compared with November 2021 – what do you think are the main contributing factors to this?
To start, it is important to note that the rise in insolvency numbers is mostly attributable to a large increase in compulsory and voluntary liquidations, as opposed to restructuring processes such as CVAs, administrations, schemes of arrangement and restructuring plans.
The reason for the rise in liquidation numbers is that the Covid restrictions on creditor enforcement were removed in 2021, so we have seen an uptick in compulsory liquidation, with HMRC being more inclined to take enforcement action and you are now seeing them pursuing more and more compulsory liquidations.
The increase in voluntary liquidations is even more concerning. In this context, we have businesses that have decided that due to rising costs and falling profit margins they simply have no future and are therefore shutting up shop.
It would be more positive for the UK economy to see companies looking at restructuring options, which see the business being rescued as opposed to being shut down. However, for that there needs to be an appetite for investment – and that is lacking at this particular moment. The reason for this is primarily concern as to future economic conditions, but perhaps even more importantly in terms of investment decision making, is market uncertainty. This feeling of uncertainty was exacerbated in the last quarter by the short period of 'Trussonomics' and resultant market turbulence.
But it wasn’t just the budget that wasn’t, which created such market turbulence and uncertainty. One of the main contributors has been the supply chain issues, caused by Covid and its continuing impact, particularly in China. On top of this has been the war in Ukraine and the energy crisis arising from that. There is also the overhang of Brexit and the lack of replacement trade agreements which has caused particular issues in the UK.
In the past, we have seen inflation caused by overdemand/overstimulation of the economy, however now we are dealing with supply chain problems where supply cannot meet demand, and this type of inflationary pressure is not so easily dealt with by traditional methods such as tax rises and expenditure cuts. This supply side problem is one that will not be easily resolved and thus uncertainty persists which in turn discourages investment and therefore restricts restructuring and business rescue opportunities.
What are your predictions for the next quarter and throughout 2023, and why?
There are some very significant headwinds against economic growth at the moment (without wishing to talk down the economy), such that you could say with a fair degree of certainty that a recession is highly probable.
While we can hope that the rise in inflation will soon start to level out, in its place will be a period of low-growth or negative growth during the course of the next year, and I think that will be caused by continuing supply chain problems but also a fall in demand caused by the restriction on public spending, higher taxation and higher interest rates. I do note that interest rates are still pretty low from an historical viewpoint, but they are of course now much higher than they've been since the Global Financial Crisis of 2007/08, and this will bite at some point. It will bite into regular household borrowers but also the corporate world. Then there is also the energy crisis which is impacting individuals and businesses (particularly in certain sectors) and will continue to cause real problems in 2023.
Do you expect corporate insolvency levels to continue to rise?
I do. The key for me is whether we will see a point where the economy seems to be bottoming out or there is a prospect of recovery. At that stage, investors who are looking towards rationalising businesses and returning them to profit will come into the market. But those opportunities only present themselves when the market is bottoming out and I think we have a way to go before that happens. So, you will see insolvencies of liquidations, personal bankruptcies and individual voluntary arrangements all rising, but potentially restructuring numbers will not significantly rise for some time.
Do you see disputes/litigation arising as a result of increased insolvency levels, and if so, of what nature?
Yes, I do. We will certainly see more creditor pressure as those businesses will need money themselves. It is likely credit terms will be restricted and there will be less latitude given to debtors. This will obviously result in disputes and litigation. However, I do not expect to see the levels of contentious insolvency rising until we see a large number of insolvencies going through the system, and this will typically take 12 to 18 months from the peak of insolvencies. This is because insolvencies obviously require investigation, and it is not until these processes are completed that you will then start to see disputes/litigation arising.
Currently, the Insolvency Service seems very focused on money owed to HMRC/money owed through bounce back loans or business interruption loans – so where businesses are failing, we are seeing proceedings against individual directors for fraudulently taking loans in circumstances where the business didn't have much of a future. I can only see these types of claims continuing.
What do you consider to be the main issues for businesses going forward?
Supply chain pressure and also the continuing and increasing energy costs. In regard to the energy crisis, this will impact certain sectors more than others. Take, for example, the hospitality sector and the hotel industry. To stay open these businesses require a lot of energy, so increased costs will undoubtedly impact these types of businesses if they cannot be passed onto the customers.
As to supply chain issues, we are seeing massive labour shortages in a lot of areas – particularly in construction (which will also be affected by the energy crisis) as well as hospitality. So, even where businesses have a good order book, they may not be able to meet these due to supply chain issues and labour shortages and therefore they may have to forego certain opportunities.
Another area which is going to be very interesting is the Building Safety Act 2022, and in particular, the rectification of cladding problems. These make up a huge amount of the spend by the construction industry and, if developer insolvency arises as a result, the Act potentially ensures that other businesses which form part of a Group's overall structure meet these obligations.
In August 2022, more than 1 in 10 UK businesses reported a moderate-to-severe risk of insolvency – what options are available to distressed businesses to avoid liquidation?
I think seeking proper advice is important – that includes accountancy advice, financial advice and legal advice. It will also be important for businesses to liaise with their key stakeholders, including shareholders, employees, landlords, suppliers and/or lenders, as the case may be. This will allow distressed businesses to align the interests of all stakeholders and hopefully take decisions which are sustainable and in the long-term interests of all.
Businesses often fall into a trap where insolvency (or risk of) arises, where they either hide the risk of insolvency from themselves or other stakeholders. Sometimes sharing the problem being faced is the best thing to do. I believe we saw an element of that in Covid where businesses which were experiencing difficulties were given more time by the Government/HMRC but also by their wider stakeholder community.
Also, it has to be remembered that if a company can't be rescued then the business often can be, and that's what insolvency and restructuring is all about: ensuring that enterprise and economic value is retained, potentially through an insolvency process. Take advice before it is too late!
When do you expect corporate insolvency levels to slow down?
It is very difficult to say. Usually, one would expect an economic cycle of boom, bust and recovery to run for a period of 18 months to 24 months. But there are so many uncertainties; the war in Ukraine, China's continuing response to the Covid crisis, the UK post Brexit trade position and whether interest rate rises will effectively tackle inflationary pressures. While we have such uncertainty the future remains unclear.