Business recovery: search and rescue

Does the rise in administration figures mean insolvency laws need rescue and repair

A dramatic rise in administration figures – up by 26% in 2006 compared with 2005 – seems to be at odds with the widely held view that we are enjoying benign times in the economy.

In the past year, recruitment and business support services saw a 90% rise in administration figures, while hospitality and leisure saw an increase of 50%, as did financial services businesses. Is the increase a sign of economic cracks or even a fundamental weakness in insolvency law?

It is true that certain industry sectors have had specific issues to deal with, such as the costs associated with meeting new regulation standards and operating with a high fixed cost business model exposed to small changes in economic conditions.

But the overarching factor behind such a marked increase is the change in insolvency culture, brought about by the Enterprise Act 2002, which effectively abolished administrative receiverships (with certain exceptions) and made the administration process quicker and less costly.

Overall, the introduction of the Act has succeeded in promoting a more collective approach to business rescue. The removal of preferential creditor status of certain government claims and the effective abolition of administrative receivership in favour of a new style administration (a court appointment where the appointee must act in the best interests of all creditors) means unsecured creditors now have more of an interest in insolvent businesses.

It is this enhanced interest which brings with it a desire to support rescue packages out of administration, providing a better return than liquidation. In many cases, companies in administration continue to trade under the control of the administrators and a sale of the business as a going concern is achieved. Such going concern sales can prevent operational closures, minimise staff redundancies and improve the overall return to the creditors. These changes have led to a decline in administrative receiverships but also liquidations.

The rise in overall corporate insolvency has been driven by smaller businesses. Larger companies often have more possibilities to restructure both financially and operationally to avoid insolvency. Financial restructuring can include re-financing, debt for equity swaps, distressed share/business sales and selling debt at a discount.

Even though there are more opportunities to avoid insolvency, some failures are inevitable. And the main causes of business failure remain the same – lack of leadership, poor management, poor financial information and control, inappropriate finance structures, loss of competitive advantage, failed acquisitions or projects, deterioration in market and better competitors.

All of these problems are within the control of senior management if they act in a timely manner, but all too often, advice is sought too late. Turnaround situations require strong leadership: someone who can simultaneously take control of the situation, enter into a productive dialogue with key stakeholders (banks, pension trustees and credit insurers) and be clear on strategy – both operational and organisational – to fix the business and resolve any funding issues.

At the same time, there is more liquidity available to the restructuring market, things like asset-based finance and hedge funds. Often a company will be able to increase gearing to buy more time to restructure, but this will not guarantee that it will succeed in turning the business around in time.

Many financial stakeholders have their own dedicated high risk/business support units, which are tasked with managing their high risk clients back to good book. These teams are becoming ever more sophisticated in identifying high risk clients earlier and in working with accountants to devise restructuring solutions that benefit both company and financier.

Business advisers, meanwhile, are starting to work with underperforming and financially distressed businesses and their stakeholders at ever earlier stages in the distress curve. And the advice they now offer – from turnaround planning, cash and working capital management, and debt advisory through to performance improvement to recommend and implement profit enhancing strategies and even placing chief restructuring officers in businesses to devise and implement turnaround/restructuring plans – has never been more comprehensive.

We don’t believe that the current insolvency legislation is inadequate. Indeed, the changes made with the introduction of the Enterprise Act 2002 have promoted the rescue culture and the UK’s insolvency legislation is seen by other European countries as more creditor friendly and a less expensive process.

Much of the work that is now being undertaken by turnaround professionals now focuses on situational expertise to improve business success rates. Failure is part and parcel of risk and the entrepreneurial culture. Make failure impossible, and we stifle creativity. Make it too easy and you may encourage irresponsibility.

Problem solving

Insolvencies reached 107,288 in 2006, up almost 60% from the previous year’s total of 67,584, according to figures issued by the Insolvency Service, with personal insolvencies touching the 30,000 mark for the final quarter of the year.

With Britain’s debt crisis spiralling out of control, key industry figures have expressed their views on irresponsible borrowing and who is to blame for the UK’s credit card culture.

Mark Hoban, shadow financial secretary to the Treasury, says: ‘Part of the problem is that there are eight organisations that regulate insolvency practitioners so it’s actually very difficult at the moment to regulate that sector because of the fragmentation of the bodies. That’s something that I think those organisations need to take some responsibility for to get the regulation right.’

Dr Vincent Cable, MP for Twickenham, and Lib Dem shadow chancellor, says: ‘The level of financial education at the moment is abysmally poor and very patchy. […] It’s not getting through to large numbers of people at the moment. The government’s idea is that you should include financial education in the maths syllabus in order that people learn about compound interest and so on, which is fine, but incredibly limited and doesn’t grasp the magnitude of the problem.’

Melanie Giles, an insolvency practitioner with 20 years’ experience, says: ‘While we have a banking system that is very prepared to lend, and we have a consumer system which is very prepared to borrow, this is going to continue. I find with the majority of clients I see a complete lack of financial awareness of what debt is and what money is, and I think we’re losing the value of what money and what owing a debt actually is.’

These comments were made at The Great Debt Debate, an event held during Debt Awareness Week in February organised by IVA.co.uk.

See www.debtweek.iva.co.uk

Nick Dargan is head of insolvency at Deloitte