Trading in the twilight zone

The latest insolvency statistics confirm that although we are technically out of recession, the effect of the financial crisis is still being felt by businesses. Sacha Pickering looks at the risks associated with continuing to trade without the benefit of professional advice.

With the UK economy now slowly recovering, it is essential that all businesses take account of what effect the economic crisis has had on their financial situation and, if necessary, take action to reconstruct their affairs. This may involve simple changes to the way you do business or could require more drastic action.

The latest insolvency statistics confirm that, although there is light at the end of the tunnel, businesses are not yet out of the danger zone. The number of compulsory liquidations is down by over 17 per cent. However, voluntary liquidations have increased by over 11 per cent and the number of liquidations has risen overall. Whilst these statistics are nowhere near as high as in their peak, they are still well above those seen in the boom years, suggesting a large number of businesses continue to be at risk. 

Michelmores' Restructuring & Insolvency Team has seen an increase this year in businesses requiring restructuring and insolvency advice. Whilst the worst might be over, investment markets have not yet opened up to struggling businesses and in the recovering economy, lack of readily available investment can lead to insolvency situations.

Typically, a lack of cash flow is the issue. Whilst balance sheets may appear relatively healthy, successful liquidity management is now more essential than ever. Prudent financial management at board level is critical and directors must consider the very real risk of directors' personal assets being available to satisfy shortfalls to unsecured creditors.

Early advice key to success

It is not all doom and gloom. For example, GUL International Limited, the south west leisure brand, was recently rescued from an insolvent situation with 10 retail outlets and 80 jobs being saved.

The key to the success of GUL's restructuring was the early advice sought by the Board. Reduced sales and difficult foreign exchange rates had put the surf retailer into difficulty. The business was split into retail and wholesale and each side of the business was sold as a going concern, using the administration process as a vehicle. This process allowed GUL to continue trading and has attracted increased investment. By speaking to restructuring and insolvency professionals early, the Board allowed their advisers to consider the whole range of options available. Had they sought advice any later, the options would have been drastically reduced.

There are two main reasons why it is never too soon to take advice. First, the earlier professional advice is obtained, the greater the range of options available in terms of turnaround and restructuring. The second reason, and often the one that prompts action, is the risk to personal assets.

Judging when to bring in professional support is the single most important consideration for businesses in a difficult financial situation. The ability to turn a business around hinges on the necessary advisers having sufficient time to make the necessary changes. Typically the advisers look at such things as cutting costs, diversifying, downsizing and credit control. If there is no time to consider and implement any required changes, because of creditor pressure for example, the business will face a sliding scale of formal insolvency options, including company voluntary arrangements, administrations and liquidations. If directors seek help too late, liquidation becomes more likely and the company is likely to be well into wrongful trading territory by that stage.

Wrongful trading and putting personal assets at risk

As a director, continuing to trade whilst your company is insolvent, or 'wrongful trading', puts your personal assets in jeopardy. Unless there is a real prospect of the company recovering, the company must cease trading immediately. As soon as the Board suspects a financial issue, early advice can protect the personal positions of the directors. There is no sense in trying to save the company a relatively small amount of money by not seeking professional advice, if decisions made in ignorance of the relevant legislation put a director's personal assets at risk.

Provided advice is obtained early, there are ways a company can continue to trade in order to maximise payments to creditors. One option is a twilight trust, where a bank account is opened and operated to ring fence funds for trading whilst not increasing the deficit to any creditors. The restructuring team at Michelmores LLP is dealing with an increasing number of situations where such a trust may be appropriate. There are many other options which can be explored such as internal restructuring, pre-pack administration, or a trading administration. The main factor that affects the number of available options is the Board's grip on financial management and the speed which relevant advice is obtained.

Ultimately, in relation to whatever decisions are made, Boards must act within the law. Falling foul of, for example, the provisions relating to illegal dividends or trading whilst insolvent simply because early advice was not obtained, is a risk too far.

Taking swift, decisive action to ride the storm

Unfortunately, given the slow recovery of the economy, it is inevitable that many businesses will experience financial difficulties in the coming months. However, provided swift, decisive action is taken by directors as soon as issues arise, there are restructuring and turnaround strategies that can be implemented. Whilst the economy is slowly recovering, we must still manage our own businesses appropriately and, provided any issues are first acknowledged and then dealt with decisively, we should be able to ride the storm into the calmer waters ahead.

Sacha Pickering specialises in insolvency and restructuring at Michelmores. For more information on the issues discussed in this article, or for advice on your business options, please contact Sacha at: sacha.pickering@michelmores.com