When it comes to insolvency red flags, a company’s accounts and management information should be the first port of call for company directors as an indication of how the business is performing.

There are many signs that a business may be in distress, but the importance of the financials cannot be understated in the current economic environment, and accountants are well placed to advise businesses on their viability, says Caroline Sumner, CEO of R3.

“A typical sign of financial distress is where a company is lengthening its creditor days, as this is often a sign of cash flow issues and may indicate that the company will become increasingly less able to pay its debts,” Sumner says. Other early warning signs include tax debts, pensions deductions, lack of investment and an increase in stock levels, she adds.

Accountants are vital for avoiding insolvency

Accountants are in a unique position to help clients navigate business distress and business recovery as they can identify the signs that a company is heading towards financial difficulty – issues like problems with cash flow, falling turnover and rising debt. “This means they can play a key role in helping their clients engage early with the insolvency profession to address and resolve their financial issues,” Sumner says.

Encouraging clients to engage with the insolvency profession as soon as the business shows signs of financial distress, means clients will likely have more options to take remedial action to resolve problems, have more time to take a decision about how they move forward, and potentially see a better outcome than if clients wait until the problem grows.

“Accountants also have a key role to play in assuring their clients that not every visit to an insolvency practitioner results in a formal insolvency appointment – insolvency practitioners will always seek to support the rescue of a business if they can,” adds Sumner.

ICAEW guides and insolvency law changes

ICAEW’s guide to directors’ duties and responsibilities covers responsibilities in relation to insolvent or financially challenged companies. ICAEW’s Head of Business Law, Charles Worth, says directors of businesses in financial distress would do well to familiarise themselves with their responsibilities, not least how directors’ duties change if a company becomes insolvent and the personal risks to directors of trading while insolvent.

“I think that all directors need to be aware of the gist of this and take away the message that they should seek advice early if they think they might be in financial difficulty,” Worth advises.

Worth also highlights three permanent insolvency measures introduced during the pandemic under the Corporate Insolvency and Governance Act 2020 (CIGA) and still in force today that can be used by company directors to keep their company alive.

1) Restructuring procedure

The first is the introduction of a restructuring procedure (RP), which may be proposed by a company in financial difficulties. It has similarities with the existing procedure of Schemes of Arrangement, but the ability to cram down referred to below is a significant difference that can prevent creditors from blocking proposals in relevant circumstances.

Creditors can be divided into separate classes, by similarity of rights and interests, by the company. After creditors have been divided into classes, and this is approved by the court, the respective classes of creditors (and shareholders, if relevant) vote on the proposed RP.

The RP will bind all classes of creditors (and shareholders) if more than 75% of creditors, by total value, in each class vote in favour. The court may still approve the RP even if one or more classes have voted against the RP by exercising its power to cram down the dissenting class(es).

“This makes it easier to carry out restructurings in relevant circumstances when a business is in financial difficulty,” Worth adds. “It appears that the restructuring plan reforms have already proved useful for larger/SME restructurings. There is perhaps potential for this to develop in a way that might be helpful for smaller (but, given the likely costs, probably not very small) companies in future.”

2) The standalone moratorium

The second is the moratorium that provides struggling companies a short period of protection, initially 20 business days, from creditor enforcement action. This is so the company’s directors are given time to seek advice and seek to agree plans for their rescue as a going concern. This protected period is designed to give companies a better chance of survival.

“It’s a potentially useful tool but seems not to have been widely used so far,” says Worth. “This may simply be because it is new and potential users are cautious, but may be because the circumstances in which is it likely to be appropriate are somewhat limited – the law may need to be tweaked if it is to be more widely used, for example, to extend the range of debts covered (something that might not be welcomed by relevant creditors).”

3) The suspension of ipso facto (termination) clauses

The third is a provision in the Insolvency Act 1986. This generally prohibits the enforcement of ‘termination clauses’ in contracts for the supply of goods and services that engage upon an insolvency event. This means suppliers must continue to fulfil their commitments under contract with the debtor company in the event of it entering a formal insolvency. It is more extensive than the existing provisions in terms of the types of contracts affected.

This will prevent companies in insolvency procedures (which include the new RP) from being ‘held hostage’ by suppliers that either withdraw supply completely or that ask for additional ‘ransom’ payments. The supplier may terminate the contract, through company or relevant officer-holder consent or through permission from the court, if the continuation of supply would cause ‘hardship’ on the supplier.

Worth notes that this is evidence of the government's move towards a more pro-debtor regime in the UK, but it is too early to say how great an impact the reforms have had in practice.

Next steps insolvency tools

While Sumner praises the government for introducing these new business rescue tools under CIGA, she says the take-up of these tools has been relatively low to date. “We hope that they could play a really important role in mitigating corporate financial distress in the months ahead. It will take some time for insolvency practitioners and accountants to become more familiar with these tools, and for directors to be made aware that these options exist,” she concludes.

The government says that each of the CIGA measures is seen to be assisting the rescue of companies as going concerns. This in turn is seen as contributing to job retention in those companies. The government also made a commitment to review the three permanent measures no later than three years after they came into force (on 26 June 2020).This review stated that overall, the CIGA measures have been broadly welcomed by stakeholders and are seen as strengthening the insolvency and restructuring regime enabling more companies to be rescued without first being required to enter insolvency proceedings.