Coronavirus disruption - insolvency options for SMEs - FAQs
There remains no visibility on the duration and extent of the disruption caused by Coronavirus (COVID-19) and the Government's lockdown response. Many SMEs are seeking cash under the government assistance programme, including the Coronavirus Job Retention Scheme (CJRS) and the Coronavirus Business Interruption Loan Scheme (CBILS), although there are increasing reports that access to the CBILS is proving difficult in certain cases.
On 3 April the Government announced that lenders cannot first recommend non-CBILS loans to applicant companies, nor demand security or personal guarantees for CBILS loans of under £250,000, which might improve access (other Coronavirus Government-backed loan schemes are available, but are directed at larger companies, so are not discussed further in this article).
With reduced or no income, directors of SMEs may need to consider what options are available should they conclude that the business cannot be saved in its current format.
Should an eligible business always take out a CBILS loan?
A feature of participating banks' decision-making in issuing CBILS loans has been whether the applicant SME was viable before the Coronavirus disruption began. Even if the bank gives approval to a loan, perhaps encouraged by the Government's 2 April clarifications, directors should carry out their own, similar assessment.
If a loan would have been difficult to repay before the shutdown, it will inevitably be so thereafter, and the additional drain on profits (even with the 12-month interest holiday) may render the SME unviable. It should be remembered that the CBILS is rescue finance rather than a grant, so some companies may not benefit from it in the long run.
The FAQs below briefly address the key considerations for SME directors where a company is insolvent or at risk of becoming so, or where winding up represents the best commercial option:
The flow chart at the foot of article sets out, at a glance, potential options for solvent and insolvent companies.
The test for insolvency is nuanced and fact-dependent but, in brief, asks whether a company: (i) is unable to pays its debts as they fall due; and (ii) has a balance sheet showing liabilities which outweigh assets. The 'balance sheet' element of the test includes contingent and future liabilities, potentially complicating the outcome. For example: a company may be paying all invoices on time but have significant future liabilities that render it balance sheet insolvent. Directors should, through regular cashflow forecasting and careful monitoring of accounts, be alert to signs that the company is in danger of breaching either or both of these criteria.
Members' voluntary liquidation (MVL)
Where a company is solvent but its directors consider that winding the business up is the most appropriate course, the company's shareholders may pass a special resolution resolving to place it into MVL. A liquidator will be appointed over the company, settle its debts in full and distribute any surplus to its shareholders, before dissolving the company. Professional and administrative costs, which are modest where the company's assets are uncomplicated, will be payable.
An MVL may be appropriate where a solvent company's medium to long-term trading outlook appears unsustainable, or where its directors wish to mothball the business and reanimate it in future.
Scheme of arrangement
A scheme of arrangement is a statutory, court-administered process under which a company reaches a binding compromise agreement with its members and/or creditors, or any class of them (including secured creditors). Given the expense and time involved in a scheme, it will generally be inappropriate for SMEs, but may be considered where a company with substantial cash reserves is seeking to implement a restructuring. The process may be used whether or not a company is solvent.
Company voluntary arrangement (CVA)
A CVA is a compromise agreement between a company and its unsecured creditors only, in which unsecured creditors (or certain classes of them) are asked to agree to a reduction in the debts owed to them. Recent use of CVAs to limit claims by landlords in the retail sector has been much publicised, and increasing creditor opposition to the process, as well as a high failure rate, has seen their popularity diminish. A CVA is, however, a relatively inexpensive process that can, creditors willing, buy time for a struggling company to attempt a turnaround.
Either the directors of the company or an administrator may propose a CVA which, if agreed by sufficient creditors by value and number, will be supervised by an insolvency practitioner. A CVA may be implemented in parallel with administration, to gain the benefit of the moratorium on legal claims against the company that is an automatic feature of the latter. Failed CVAs generally lead straight into administration or liquidation of the company.
The directors or shareholders of an insolvent company may place it into administration by filing certain notices at court. Lenders with qualifying floating charge security over the company's assets may also initiate the process. An administrator appointed over the company will seek to rescue or sell the business as a going concern or, if that is not possible, realise its assets to pay creditors, invariably culminating in the company being wound up. Once all assets have been realised, whether through an intact sale or piecemeal, unsecured creditors with unpaid debts have no further recourse to the company, its members or any buyers of its assets. The administrator's duty is to the company's creditors, who will be entitled to payment from assets in a strict statutory order; broadly, secured creditors are paid first and unsecured creditors last, with any surplus distributed to shareholders.
From the commencement of the process, a company in administration will have the benefit of a moratorium on any legal claims against it, allowing breathing space for an administrator to carry out his or her functions. Making an administration filing can, therefore, be a crucial step where creditors are threatening enforcement action. Costs of the process will be payable from the assets of the company in the first instance.
Unlike administration, liquidation is intended solely to repay creditors from company assets, with no obligation to seek to preserve the business as a going concern if possible. The members of the company may pass a special resolution to wind the company up (a creditors' voluntary liquidation, or CVL); alternatively, a creditor (or certain other parties) may issue a winding up petition against it in the court (compulsory liquidation).
A liquidator, selected by creditors, will be appointed; like an administrator, the liquidator will manage and realise the company's assets to pay creditors in the statutory order. There is no automatic moratorium on legal claims in a CVL, but the liquidator may apply to the court to stay any claims. The company will be dissolved following the conclusion of the process, and costs are payable from company assets in the first instance.
Scheme of arrangement
Discussed above, and available to both solvent and insolvent companies.
Summary of options
This flow chart summarises, at glance, the options available depending on a company's circumstances. However, which process may be the most appropriate option will be a nuanced question, and directors should seek specialist advice to assist with their decision-making.
Legal support for distressed businesses
These FAQs summarise, in very broad detail, certain procedural options for distressed companies affected by the continuing Coronavirus disruption.
If you would like to discuss any of the issues raised in this article, or have other concerns about the impact of Coronavirus, please contact Sacha Pickering or Karen Williams in Michelmores' Restructuring & Insolvency team.
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This article is for information purposes only and is not a substitute for legal advice and should not be relied upon as such. Please contact our specialist lawyers to discuss any issues you are facing.