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Businesses are in a state of constant flux. They are either moving forward or in decline. When a business is in decline, there are opportunities to turn things around at various stages of the decline curve. Taking action early can be done while funds are still available. Left too late, the turnaround must be done under liquidity and creditor pressure in the “zone of insolvency,” where a liquidity event could trigger the need to file for insolvency protection. In most jurisdictions, this is a statutory obligation, usually defined as the inability to make payments as they fall due in the normal course of business. Although this may be a clear legal definition, in practice there can be some flexibility in this definition, particularly where a viable business exists and processes are in place to stabilise and rectify the adverse cash flow.

A well-managed turnaround is in the best interest of all stakeholders. However, priority must be given to ensuring that creditors are not put in a worse position than they would be in an insolvency. It is therefore imperative that cash collateral is not impaired during the process. To achieve this, a robust and effective cash flow management system is required.

The most effective tool for cash flow management is a 13-week cash flow model with sufficient detail to highlight the important receipts and payments. The model should build in critical payments and significant cash receipts, showing a weekly cash receipts total and a cash payments total, along with a net cash generation or deficit and a closing cash balance compared to funding facilities and a closing headroom. This should be positive across the period if insolvency is to be avoided. The report should be finalised before business closure at the week's end, and variations of actual to forecast challenged, with people held responsible for shortfalls in performance. A revised forecast should be issued with achievable objectives; no moving goalposts! Peaks and troughs should be levelled out by realistic management of creditor expectations. All senior management should be aware of their responsibilities. They should know that they are part of the turnaround process, that they have obligations to a changing level of stakeholders, and that for them, it is not "business as usual."

The most effective tool for cash flow management is a 13-week cash flow model with sufficient detail to highlight the important receipts and payments.

Most turnaround managers would focus early attention by taking management control of the cash forecasting and cash management process. Cash control is the number one priority at the initial stage of an engagement. Only when the cash burn is stopped, cash flow is stabilised, and accurate forecasting is in place, can essential decisions on business viability and operational improvements be made. Controlling payments is an obvious first step, but some payments are critical, such as payroll and essential services like telephone and utilities, which usually cannot be delayed. There will also be pressing creditors for critical goods in the production process that will need careful management. The calming presence or intervention of a turnaround manager will often help achieve an acceptable payment approach to what had probably already become a fractious relationship. These payments must be factored in as priorities in the cash forecasts and adhered to. Failure to honour agreements or other essential payments can precipitate a more critical situation.

While most pressure comes from the creditor side, there can also be a positive cash flow benefit from challenging invoicing and billing processes or resolving other disputes or cash generation activities. On one assignment, a large company's invoice dispatch process was handled remotely from the team responsible for invoice calculation, resulting in a time gap of many days between work completion and invoice dispatch. Accelerating invoice preparation and dispatch generated a significant one-off cash bonus that alleviated creditor pressure. On another assignment, a long-outstanding and significant VAT receivable from an overseas customer had been left unresolved and filed in the "too difficult" folder. Diligent investigation by the turnaround manager resolved the issue positively. In another instance, a company was entitled to a large tax loss refund, but due to delinquent filing of accounts and tax returns, the refund had not been claimed. Addressing this issue helped alleviate creditor pressure. In another case, when a company's payroll was in jeopardy, a solution was found by selling a valuable but no longer business-critical license agreement to an overseas producer. Such situations are not uncommon in poorly managed businesses. By challenging accepted practices and thinking creatively, surprising benefits can be achieved.

From experience, it is often the case that accounts receivable collection has been neglected or handled at too low a level. Aggressive debt collection and payment inducement through fast pay discounts can uncover a treasure trove of low-hanging fruit that can buy time for more permanent solutions to be implemented. In some cases, customers whose suppliers fail may experience production disruptions and may be open to temporary "fast pay" processes while the turnaround is achieved. It is surprising that in such crisis situations, senior management often considers accounts receivable collection to be below their status level when, in fact, the survival of the business depends on it. Other short-term solutions may be available. Disputes and warranty issues can be resolved positively through senior-level involvement. Collections may be delayed due to disputes over only a portion of an invoice, and a small concession in such cases may unlock a larger payment. However, understanding the reason for the dispute can also be enlightening. Warranty claims and service level disputes may reveal underlying business and performance issues that are at the heart of business underperformance and are pointers to where operational changes are needed to restore the business to profitability and positive cash flow.

Cash pressure can have severe consequences in group companies, especially where there is inter-group trading. Local finance managers may become cash hoarders and hold onto cash for their local interests. In groups, cash flow needs to be managed on a consolidated basis, and a senior-level manager should have close control over the process, authorising and approving payments over a certain level. There may be a tendency to understate local cash availability in reports sent to head office, so vigilance should be exercised, and cash flow reports should be checked for accuracy against bank statements. A group approach to critical payments should be adopted to ensure that local subsidiaries are not prioritising non-critical payments ahead of group needs. Good practice is to allow local authorisation for small payments, making up the majority of the number but a small proportion of the value, while focusing control on the larger payments, which make up the majority of the value. Local sales subsidiaries should be aware that they depend on the manufacturing entities that have pressing supplier needs to maintain production. This can be particularly acute in industries that have significant seasonal variations or protracted plant vacation shutdowns.

As the turnaround process unfolds, cash flow management becomes routine, and business disciplines become embedded as better practices. Operational improvements revealed during the cash management process can be implemented. Opportunities for better asset-based funding may arise with improved cash management disciplines. The downward momentum on the decline curve will have been reversed, and the turnaround will be underway. However, continued vigilance on cash management is crucial. It is the foundation upon which the turnaround is built and should never be forgotten.

A major lender to tech firms, the bank faced "inadequate liquidity and insolvency" as it scrambled to raise money to plug a loss from the sale of assets affected by higher interest rates, according to banking regulators in California. Its struggle set off a series of customer withdrawals and sparked fears for the wider banking sector.

The Federal Deposit Insurance Corporation (FDIC) said it had taken charge of the roughly $175 billion in deposits held at the bank, the 16th largest in the US. Many firms with money tied up in the bank have been left in uncertainty regarding their futures.

The bank's UK branch was put into insolvency from the evening of Sunday 12 March but swiftly rescued by HSBC for only £1 in a move praised by Krista Griggs, Head of Financial Services & Insurance at Fujitsu. “The UK technology industry is thriving and it requires a commitment to long-term success if the country is going to achieve its ambition of becoming a scientific and technology superpower," she said in a statement.

“HSBC’s fast response is a welcome move that will ensure continuity for businesses at risk from the collapse of Silicon Valley Bank. It shows commitment to innovation and I expect to see more involvement from traditional banks as they look to provide stability during disruption - as well as further union between them and FinTech companies as this sector continues to rapidly evolve."

The latest figures from the Monthly Insolvency Statistics report registered that company insolvencies in May 2021 was 1,011, which was 7% higher than the number registered in the same month in the previous year (946 in May 2020).

We are seeing the impact of an activist government supporting businesses across two fronts – financial support and temporary suspension of pre-existing corporate insolvency and governance legislation. 

Insolvency protection extended
In a critical move the Corporate Insolvency and Governance Act 2020 (CIGA 2020), which received assent in June 2020, comprised of eight permanent and temporary measures intended to give struggling businesses a pandemic lifeline.

The Corporate Insolvency and Governance Act 2020 (Coronavirus) (Extension of the Relevant Period) Regulations 2021 has extended key measures in different ways:

One key measure is continuing with temporary suspension of wrongful trading, which provided company directors with much-needed breathing space. However, on a more cautionary note, they must keep in mind all sources of risk and liability under the Insolvency Act 1986 are unaffected by the Act. For example, directors are still bound by fiduciary duties and fraudulent trading provisions of Section 213, facing sanctions and penalties if they knowingly attempt to defraud company or creditors.

In addition, directors have duties under the Companies Act 2006 and must continue to act and be mindful of the interests of creditors if the likelihood of insolvency increases.

If directors are worried their business is in or expecting financial difficulty, it is crucial that they continue to consider the needs of all key stakeholders and creditors in any decision and maintain ‘good housekeeping’ in the form of board meetings and keeping records of actions taken with an assessment of the reasons for certain decisions.

What does this extension mean?
Overall, temporary suspension of wrongful trading doesn’t change the attention directors should be giving when evaluating their company’s financial position. Directors’ actions will remain subject to scrutiny, making it critical they consider very cautiously whether to continue trading if there is no realistic chance of avoiding insolvency.

The initial extension provisions in relation to filing deadlines no longer applies. The Act had granted automatic extensions for filing deadlines between 27 June 2020 and 5 April 2021 to relieve burdens on companies during the pandemic, allowing them to focus all efforts on continued trading.

Landlords and commercial tenants

The Government has also published a consultation paper seeking responses and evidence from the property industry generally as to how negotiations between commercial landlords and tenants on rescheduling rent liabilities have been handled during lockdown.

The protective measures the Government introduced back in April 2020 were only ever meant to be temporary. This was a lifeline for many but now there is a significant risk for those who relied on this during the pandemic that once those protections are lifted – scheduled for June 2021 - businesses may fail when rent arrears are pursued.

It is hard to envisage the government allowing a cliff edge to come into view when it has spent so long over the past year seeking to protect embattled businesses.

Post-lockdown outlook 
Although easing of lockdown measures is accelerating and businesses are beginning to open, numerous challenges lay ahead, particularly with expected long-term reduction in consumer demand and confidence. Many company directors will likely face challenging decisions whether to continue trading or instigate insolvency processes soon.

There is also pent-up private equity demand and high levels of debt funding. This desire to deploy capital, combined with what we could term a ‘flight to quality’, mixed the optimism as a result of the vaccine programme, as well as near-record levels of corporate liquidity and a strong market for M&A, we could well see a positive market.

If directors are worried their business is in or expecting financial difficulty, it is crucial that they continue to consider the needs of all key stakeholders and creditors in any decision and maintain ‘good housekeeping’ in the form of board meetings and keeping records of actions taken with an assessment of the reasons for certain decisions. Where possible, they should also seek appropriate professional advice.

In a statement on Monday, Frasers Group – owned by retail tycoon Mike Ashley – confirmed that it is in talks with Debenhams’ administrators regarding a possible rescue bid for its UK operations.

The 242-year-old UK department store chain entered administration in April and has since been exploring avenues for rescue. As recently as the end of November, JD Sports had been closing in on a deal to purchase the struggling retailer. But following the collapse of Philip Green’s Arcadia – Debenhams’ biggest concession operator – JD Sports pulled out of talks at the beginning of December, forcing the company to prepare to wind down its business.

Mike Ashley had already made an offer for Debenhams shortly after it entered administration in April, but his £125 million bid was rejected as too low, and JD Sports was left as the sole bidder.

Frasers Group said in its Monday statement that, while it hopes that a rescue can be pulled off, “time is short and the position is further complicated by the recent administration of the Arcadia Group, Debenhams' biggest concession holder.”

“There is no certainty that any transaction will take place, particularly if discussions cannot be concluded swiftly,” it said.

While Frasers Group did not offer details of its potential offer, the Sunday Times speculated that the bid could value the chain at up to £200 million.

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Debenhams currently operates 444 stores in the UK and 22 overseas and employs around 13,000 people, 9,294 of whom are currently on furlough. These stores are continuing to operate as the company winds down its business, with the aim of closing once stocks are cleared.

Frasers Group shares fell 2% in early Monday trading following its announcement.

Arcadia, the UK-based retail group owned by billionaire Sir Philip Green, is set to enter administration imminently, according to the BBC.

Questions over the future of the retail empire were raised on Friday as it emerged that Arcadia had failed to secure a £30 million loan from potential lenders. A spokesperson said at the time that senior leadership were “working on a number of contingency options to secure the future of the group’s brands”.

Rival retail company Frasers Group, owned by billionaire Mike Ashley, said that it had offered Arcadia a £50 million loan to save it from collapsing and was “awaiting a substantive response”. Sources among Arcadia’s senior staff told the BBC they do not expect a last-minute rescue deal.

Arcadia owns several major high street retailers and brands including Topshop, Miss Selfridge, Dorothy Perkins, Wallis and Evans. It has struggled in recent years with a shift in consumer activity from city-centre businesses to online retail, and has acknowledged that the COVID-19 pandemic in 2020 had “a material impact on trading” across its brands.

The retail group operates over 500 stores across the UK and employs around 14,500 people, whose jobs will be at risk should the company enter administration.

Shares in some of Arcadia’s rivals rose on Monday in response to news of the company’s probable insolvency. Next gained 2.8% on forecasts of weakened competition on the high street, and JD Sports rose 6.5% on predictions that it may choose to drop its proposed purchase of Debenhans.

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Online fashion retailer Boohoo, which may be interested in buying Arcadia-owned brands such as Topshop, gained 5.5%.

Frasers Group on Monday also said it “would be interested in participating in any sale process” of Arcadia’s brands should they be sold off.

Alexander Pelopidas, Partner at Rosling King LLP, analyses the changes to come into effect and the impact they are likely to have on insolvency cases.

In any insolvency, there is a statutory hierarchy that determines how creditors are repaid, including HMRC. Since 2003, HMRC has been an ‘unsecured creditor’ after the 2002 Enterprise Act. This however is about to change with far reaching consequences for businesses. Under the Finance Act 2020, HMRC will become a Secondary Preferential Creditor on insolvency from 1 December 2020.

To properly assess the impact of the new policy, it is important to look at the existing (pre-December) hierarchy of creditors. They are as follows:

  1. Fixed charge creditors. These are creditors whose lending to a company is secured against a definable object. This could, for example, be a mortgage on a building, or a company warehouse.
  2. Costs of the insolvency process. This could include staff wages, or even the rent due during the process. Alternatively, it could be the fees of the administrators/liquidators (as applicable).
  3. Preferential creditors. This currently covers some payments due to employees, and money owned as part of the Financial Services Compensation Scheme.
  4. ‘Floating charge’ creditors. These are creditors whose lending is secured against a class of asset. For instance, this could be the ‘stock’ in a warehouse, but not specific items of stock. Asset-based lending is a common type of floating charge lending.
  5. Unsecured creditors. This refers to all other creditors, including pension schemes, customers and trade creditors. HMRC is currently an unsecured creditor.
  6. Shareholders.

While significant, the shift in policy is in fact, in some ways, a return to the pre-2003 policy, when HMRC was classed as a preferential creditor in corporate insolvencies. The 2002 Enterprise Act which made HMRC an unsecured creditor sought to establish a culture of business rescue within which certain ring-fencing was implemented for UK businesses.

The government’s decision to assign HMRC as a preferential creditor once more has sparked considerable anxiety amongst borrowers, who rely on asset-based lending or invoice discounting.

While significant, the shift in policy is in fact, in some ways, a return to the pre-2003 policy, when HMRC was classed as a preferential creditor in corporate insolvencies.

At the core of the problem is that while HMRC remains one of the largest creditors in many insolvencies, at present it sits behind floating charge holders as an unsecured creditor. This means its claim does not dilute the funds available to pay secured lenders. After 1 December 2020 however, this will change and HMRC’s claims for unpaid employer NIC, PAYE and VAT will rank ahead of floating charge holders and unsecured creditors and consequently reduce the pot of money available for distribution in corporate insolvencies.

The impact of this will be substantial due to HMRC’s claims often being significant. In addition, there will be an increase in the cap on the amount of the Crown preference from £600,000 to £800,000 with effect from 6 April 2021. This will mean less cash for businesses as many lenders will likely increase their calculations of the borrower’s solvency to address the impact on returns.

The largest impact will be on asset-based lending or invoice discounting, a very common form of business finance. Typically, a floating charge is all that is taken by way of security. When the changes come in, lenders will have to assess a borrower’s assets and make adjustments based on potential HMRC VAT and PAYE liabilities. These liabilities are hard to quantify but will be significant enough to prompt a Lender to require more security such as guarantees and fixed charges. All of this impacts liquidity for borrowers, and in the event of insolvency, likely means more liquidations than administrations as administrators cannot deal with fixed charge assets in the same way as they do with floating charges i.e. without lender consent.

Under these types of financing, new borrowers will see themselves submitting to greater costs for monitoring and audits by lenders and existing borrowers will be caught by the changes which do not have any transitioning period. This could result in good borrowers being deemed bad borrowers involuntarily, as the new Crown preference will require the lender to make adjustments.

Company Voluntary Agreements (CVAs) may no longer be a viable option for a company where HMRC has preference, as CVAs cannot be used to compromise a preferential creditor. This is a significant insolvency tool, which is particularly being relied upon at the moment by the retail sector, that will now be hampered. Similarly, there exists the possibility that HMRC will become less prepared to negotiate time to pay deals with companies as it has priority ranking, so why would it compromise its new status in the hierarchy of creditors?

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Overall, there are now very real fears that in the medium term there will be a domino effect for SMEs who are already struggling, and on whom these changes will result in even greater distress. The upcoming change may ultimately force the hand of some companies who may reach the uncomfortable yet unavoidable conclusion; namely, that it would be wiser to enter into administration or liquidation before the new rule takes effect.

In the longer term, the effects could impair the UK’s attractiveness as a place to do business. R3, the insolvency and restructuring trade body, has already warned that the changes have potential to cause long-term damage to the UK economy as well as to the UK’s business rescue culture. Moreover, R3 says that it will end up costing the public purse more in lost income and higher expenses than it will ‘save’ in extra taxes returned following corporate insolvencies. As a consequence, the body thus vows to continue to lobby for the legislation to be reconsidered.

Only time will tell if the Government will eventually listen to the unified concerns of business representatives and insolvency professionals and will repeal the impending changes to the Crown preference. However, for now businesses and lenders should prepare themselves for the challenges that the changes will create.

German payments fintech Wirecard, which collapsed following a fraud scandal earlier this year, will see a significant portion of its remaining assets purchased by Madrid-based Banco Santander.

Wirecard’s insolvency administrator Michael Jaffe said on Monday that Santander “will acquire the technology platform of the payment service provider in Europe as well as all highly specialised technological assets”. The deal marks the conclusion for the dissolution of Wirecard “despite unfavourable conditions”, Jaffe added.

In a separate statement, Santander said that it would acquire technological assets from Wirecard’s merchant payments business as part of plans to accelerate the bank’s growth in Europe. A source familiar with the deal told Germany’s Süddeutsche Zeitung that Santander had agreed to pay around €100 million for these assets.

Around 500 Wirecard employees who manage the technology acquired by Santander will join the bank’s global merchant services team, but remain in their current locations, according to the Santander statement. No Wirecard companies were involved in the acquisition and Santander will not assume any legal liability relating to the company or its past actions.

Wirecard was a rising star in Europe’s fintech scene until June this year, when it emerged that €1.9 billion of customer deposits could not be found in the company’s accounts. The resulting fraud scandal led to the arrest of former Wirecard CEO Markus Braun and a warrant being issued for the arrest of COO Jan Marsalek. The company filed for insolvency in August.

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The scandal was an embarrassment for German financial regulator BaFn, and Jan Marsalek remains at large despite an ongoing Interpol search.

Investor processes are still underway for the sale of Wirecard’s other subsidiaries in Asia, Turkey and South Africa, Jaffe said. The sale of assets from subsidiaries in North America, Brazil and Romania has already been included, with results expected in the coming weeks.

However, directors should be aware of some important changes to the rules and those facing financial difficulties should waste no time in seeking expert support. Simon Underwood, insolvency partner at accountancy firm Menzies LLP, outlines what company heads should know about the Government's support going forwards.

The extension of the temporary insolvency measures put in place to protect businesses during the pandemic reflects the ongoing financial distress that many organisations are facing as the UK enters a second wave of coronavirus. Aligning with a general tightening of government rules, the step provides organisations with “extra time to weather the storm”, in the words of Business Secretary Alok Sharma.

Introduced in March, the original easements sent out a strong message to UK business managers, emphasising that the normal insolvency rules did not apply and that directors should focus simply on keeping their companies from going under. However, the Government’s decision not to extend its relaxation of the wrongful trading provisions indicates a significant change of stance. Directors who should have concluded that there was no reasonable prospect of avoiding insolvent liquidation but continue to trade could be liable for any losses incurred after 1 October, in the event that their business goes into liquidation. Directors in this position who are also applying for government financial support, for example, under the Coronavirus Jobs Retention Scheme, will also be more exposed to the risk of investigations from HMRC.

Businesses facing financial difficulties should also be aware that from December, HMRC will regain its status as a preferential creditor. This is particularly important for directors who have provided personal guarantees to banks or other financial institutions. This may result in the payment of higher sums under personal guarantees in the event of an insolvency, as financial institutions’ ability to recover their debts under floating charges is reduced. The fact that they will be able to recover lower amounts under their security is also likely to make them more risk-adverse when it comes to lending. This could make it more difficult for companies to secure this type of funding and cause banks to increase the cost of borrowing, both of which could have a negative impact on an organisation’s working capital.

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Announced on 16 September, the extension to Government’s commercial eviction ban will also help to provide many businesses with breathing space, protecting those that are struggling to pay their rent as a result of the pandemic from being evicted. However, it’s also vital to bear in mind the challenges this development poses for landlords, especially in the event that tenants have run up significant rental arrears. In the long term, closer collaboration between landlords and tenants and a fresh approach to rental agreements will be required to find solutions to tenants’ financial problems. For example, this could involve the ability for tenants to reduce the amount of space they’re paying for based on their changing commercial needs or switch to a turnover rent model, where rental payments are based on the turnover of individual business outlets.

For those experiencing pandemic-related financial distress, remembering that “cash is king” is key to avoiding insolvency. Three-way forecasting is an essential decision-making tool, enabling directors to calculate their organisation’s likely future financial position and take steps to address any cashflow gaps before it’s too late. This type of modelling involves combining data for the organisation’s profit and loss, cashflow and balance sheets, allowing ‘what if’ planning to be conducted for a number of possible business scenarios. As turnaround measures take time to implement, forecasts should be undertaken for at least the next two to three years. If cash projections indicate the lack of a viable financial future for the organisation, businesses should waste no time in seeking the support of an insolvency specialist, who will be able to suggest the steps needed to transform the company’s financial fortunes and continue trading.

The extension of Government’s temporary insolvency measures will certainly have bought more time for UK business owners and directors feeling the financial effects of the coronavirus pandemic. However, it’s important to note that these measures won’t be around forever and in order to future-proof their organisations, directors must take a proactive approach to strengthening their cash position. By using three-way forecasting effectively and getting expert advice now, businesses can improve their long-term performance and keep insolvency at bay.

The appointment of additional administrators to scrutinise Laura Ashley’s finances and pension scheme in the lead up to its administration is a reminder of the added value that forensic accountants often bring to insolvency processes. While Laura Ashley’s collapse was not specifically linked to coronavirus, a significant increase in the number of retailers and other businesses feeling financial strain, and the growth of COVID-19 related fraud, may well result in a spike in demand for forensic accounting skills in the coming months. Gavin Cunningham, partner and head of forensic services at accountancy firm Menzies LLP, discusses the role of forensic accountants and why they may soon be in demand.

The use of forensic investigation techniques in insolvent situations can unravel transactions that contributed to the downfall of a company and lead to asset recoveries to benefit creditors. Fraud can be a factor and the detection of irregular or inaccurate accounting practices may lead to the discovery of underlying fraud. The ability of forensic accountants to sift significant volumes of data to identify potential causes for a company’s financial difficulties, including in some circumstances the misapplication of funds, can help to secure the best possible outcome for creditors by enabling recovery action against those responsible.

The combination of tough economic conditions and the availability of government-backed wage grants and support packages means that the conditions are right for a rise in opportunistic fraud. At the same time, the lockdown restrictions and the large numbers of businesses claiming under such schemes are making it more difficult for organisations to address any financial shortfalls.

The combination of tough economic conditions and the availability of government-backed wage grants and support packages means that the conditions are right for a rise in opportunistic fraud.

In the business world, the lines separating best practice, acceptable practice and illegal business practice can sometimes become blurred. This means that to the untrained eye, it may be difficult to determine whether a business insolvency is simply the result of ineffective management, or whether other nefarious activity may have occurred. Forensic accountants are experienced in uncovering the truth behind what appear to be suspicious or unusual transactions and assisting the appointed insolvency practitioner in reaching decisions about the recovery strategy.

When instructed to investigate the financial position of a business leading up to the insolvency proceedings, forensic accountants will begin by gathering information related to the company before it fell into financial difficulty. This often involves delving deeper into a particular financial issue. In the case of Laura Ashley, for example, questions have been raised about the activities of the company’s directors before filing for administration. To get to the bottom of what happened, the forensic accountant will gather evidence from a wide range of sources - from complaints made about the business on social media, to direct conversations with individual employees, as well as securing the financial records of a company. Analysis of all the evidence gathered could potentially uncover clues about the behaviour of the directors in the months leading up to the appointment of administrators.

For a forensic accountant there are often ‘red flags’ observed, which could indicate irregular business practices in the past. For example, some obvious signs include a rapid decline in the value of assets which could indicate rapid disposals or overvaluation, high volumes of transactions with associated companies, or changes in balances owed on director loan accounts. Occasionally, the discovery of irregular or inaccurate accounting practices may also be a sign of underlying fraud. When there is evidence of unusual financial behaviours, it is then the job of forensic accounting specialists to investigate whether or not there is a clear explanation for this and it may show people obtaining financial benefit through dishonest or deceptive behaviour. They can then investigate how much has been obtained and follow through the money trail to see if the losses may be recoverable.

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Depending on the circumstances, the review of historical financial performance may lead to restorative action being possible for the Insolvency Practitioner under various recovery provisions of the Insolvency Act 1986. These cover antecedent behaviours and thorough analysis might show that directors could be civilly liable for their past actions, including, in some circumstances, for wrongful trading.

This statutory provision can render directors of a company liable for losses suffered if trading continues past a point at which they should have concluded that there was no reasonable prospect of the company avoiding an insolvent liquidation, or insolvent administration. They then have an overriding duty to take steps to minimise potential losses to the company’s creditors and should they fail to stem losses personal liability can follow. The provision has itself fallen foul of the pandemic such that the Government temporarily suspended it from 1 March 2020 until at least 30 September 2020. As a result, in the aftermath the process of calculating company losses resulting from wrongful trading will become even more complex.

With many businesses likely to be feeling the financial effects of coronavirus-related disruption in the months ahead, a further surge in insolvency cases is likely. Helping to get to the root cause of an organisation’s financial problems, forensic accounting skills can help to restore value for creditors and mitigate the financial crisis resulting from the pandemic.

Steve Swayne, Chair of the Institute for Turnaround (IFT), describes the steps embattled businesses can take to stay afloat.

To state the obvious, while the playbook constructed through the 2008 global financial crisis may provide a guide for responding to the current situation, businesses across the world are facing unprecedented challenges. The combination of health, operational and financial tests will pose challenges for previously stressed sectors, and for successful businesses and talented management teams alike. At the end of 2019, the Institute for Turnaround, the accrediting membership body for turnaround professionals, estimated that some 130,000 businesses were distressed, and mid-pandemic, the challenges are even more acute.

On average some 300 plus companies fail every week in the UK, with multiple effects: employees lose their livelihoods; customers lose access to services; suppliers, creditors and shareholders lose money. Not every company can or should be turned around, but there are many stressed businesses that, with professional time-limited expertise, can reverse their decline and prosper. In 2019 we conservatively estimate that our members saved more than 200,000 jobs and protected £2 billion in enterprise value. In 2020 and for the medium term we are likely to see even highly competent leadership teams, with heretofore successful business offerings stressed and challenged.

What is turnaround?

Corporate challenges that lead to failure come in different forms, whether internal factors such as the wrong governance, the wrong people, the wrong financial structure – or from external factors that are harder to control: asset damage, competitor innovation – or black swan events such as the COVID-19 pandemic.

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Turnaround occurs when a business takes successful actions to correct a period of declining financial performance or shock, which may threaten its solvency. A typical turnaround business:

The first measure in turnaround is crucial: stepping in early enough to address both immediate and underlying issues and rejuvenate the business. The sooner a business engages in a turnaround process when they are on the distress curve, the greater the prospects of success and the better the outcome in terms of jobs secured and value saved. Just as you would call in a lawyer or an IT specialist for expert help when required, so too do businesses call on turnaround experts when the outcome is the difference between a business rescue or collapse.

Over the typical 18-month period of a successful turnaround, there are core phases.

  1. Diagnosis: involving an urgent, high level analysis of the problems the business faces, to determine whether there is a pathway to success.
  2. Build stakeholder confidence and support: getting everyone on board with the plan: shareholders, lenders, investors, suppliers, employees and customers.
  3. Stabilise the finances: get cash flowing into the business, reduce debt, extend credit, reduce inventory, cut costs
  4. Rehabilitate: restructure finances, cost base and cost controls. Refresh leadership skills. Develop strategic vision and turnaround plan.
  5. Articulate a strategy for growth: develop a sustainable business strategy for future growth.
  6. Exit: turnaround should be a situational intervention: once a normalised state of affairs has been achieved it is time to move on.

Turnaround professionals combine specific situational financial and operational restructuring skills with the experience, often having been CEOs of running businesses at the sharp end. They are united by a single motivation: a deep-seated desire to resuscitate viable but stressed businesses.

The IFT is the accrediting membership body for turnaround professionals. Every IFT member has undertaken a rigorous accreditation process and signs up to transparent professional standards. The IFT can recommend turnaround professionals directly to business.

Last week, news broke that EY auditors refused to sign off on Wirecard’s accounts for 2019, citing a missing sum of €1.9 billion that documents purported to be held in two bank accounts in the Philippines. CEO Markus Braun claimed that the company was the victim of “the victim in a substantial case of fraud,” and COO Jan Marsalek was suspended, later to be terminated. Braun then resigned from the company on Friday.

Braun turned himself over to Munich police on Monday evening after a warrant for his arrest was issued. He is suspected of recording false transactions to artificially inflate Wirecard’s sales, increasing its value in the eyes of customers and investors. Philippine authorities are also investigating the whereabouts of Marsalek as part of a broader probe into the company.

On Thursday, the company said in a statement that it would apply to the Munich district court to open insolvency proceedings as a result of its “impending insolvency and over-indebtedness.”

The company’s shares were suspended from the Frankfurt Stock Exchange before the announcement was released.

Wirecard was long regarded as a star in the German fintech scene – a DAX 30 company which was once valued at €24 billion. That value has plummeted through the floor as the week of revelations continued, though it saw a brief 27% uptick on Tuesday following the news of Braun’s arrest.

Trading on Thursday saw Wirecard’s value drop by a further 76% once news of its insolvency broke.

The return of the UK Prime Minister has given us hope for greater focus and direction in dealing with the inevitable economic fall-out of the pandemic. Based not least on personal experience, the PM is understandably cautious about easing lockdown and avoiding a potentially catastrophic second peak.

There is a consensus, however, that we are on the cusp of the biggest wave of cash-flow and trading insolvencies in living memory. We are already seeing a knee-jerk tightening of credit and the re-coronation of cash as king as businesses in every sector transition to “survival mode”, as commentators are putting it.

We have seen proactive steps taken by the UK Government to assist otherwise perfectly viable companies financially in the short term, which other than in their speed and administration have been applauded. However, it is already clear that these measures will not be enough to stop many thousands of businesses entering into some form of insolvency down the line. The big question is whether the existing corporate insolvency regime is in tune with the national policy of saving good businesses. The bad news – for corporates and consumers alike – is that it is not.

At the heart of the problem is the creditor-led nature of the current insolvency regime. It prioritises the rights of creditors to realise what remaining capital there is in the failed business and to deploy that capital elsewhere. If the creditors do not want to let the business continue for months or more, they simply do not have to. Each insolvency is treated in isolation and not as part of a national strategy where the government is taking steps to give businesses breathing space until the crisis is over, whether by paying employees 80% of their salary or delaying payment of VAT.

What is needed in this crisis is a paradigm shift – at least temporarily – away from a creditor-centric process, to a regime which has the short-term survival of business at its core; a form of trading insolvency to enable companies to weather the storm. As Mark Phillips QC, a doyenne of insolvency and the man behind the proposals for a ‘light touch administration procedure’ put it - “if we get this right, it is the difference between a recession and a depression”. The process has been adopted, with a considerable media fanfare, in the recent Debenhams’ administration. At its heart is a new(ish) consensus between officeholders and directors whereby where the administrators delegate responsibility to the directors and take a monitoring role and apply key safeguards where appropriate.

Lessons may be learned from how the Debenhams administration is dealt with by FRP and the extent of the protections built in to protect the officeholders.

One key reason why the process is needed is that there may be insufficient capacity in the insolvency profession to cope with the volume of likely applications for the new procedure. One thing that is becoming clear is that the new light-touch process is not going to be a panacea. It clearly won’t be appropriate for already failing and debt-saddled business. However, otherwise viable COVID-19 hit businesses aren’t the usual culprits in corporate failures and should not be penalised. As Boris Johnson has said, they have “done nothing wrong”.

Pending legislative changes that are likely increasingly to ape US-style “chapter 11” procedures (which are better structured to support trading insolvencies), this initiative will be popular, not least given the recent decision in the Carluccio’s administration confirming the UK Government’s furloughing scheme is available to entities in administration.

Another procedure attracting significant attention in the profession at the moment is the so-called “supply chain CVAs”. Given the symbiosis between entities within the same supply chain and the likelihood of only one (certainly not all) procuring better government support as well as likely having shared creditors, pre-emptive conjoining and/or coordinating between IPs and organisations seems highly sensible.

While in practice it can be common for administrators to involve directors in ongoing trading, there is a risk that in the present lockdown scenario, IPs may end up handing too much power back to directors. The ICAEW has already cautioned its insolvency practitioners against the widespread use of this process. While it is heralded as a saviour at the present time of lockdown, there is a significant potential risk to IPs from giving too much control back to directors. As Alison Broad of the ICAEW put it recently: “The motives of some directors may be well-founded, but it may be difficult for IPs at the present time to be able to make a reasoned judgement about the skills and motives of directors that they are approached by, particularly if the communication has largely been carried out remotely.”

There appears to be a consensus that the profession needs more and better options in its toolbox to deal with the pandemic’s economic fallout, and that a fundamental change in approach will be required to get us through this. As part of that process, IPs are likely to need better protection so that they can engage in the consensus/co-operative approaches with existing management that are being mooted. Lessons may be learned from how the Debenhams administration is dealt with by FRP and the extent of the protections built in to protect the officeholders. Arguably it is helpful that it was widely reported that the incumbent advisers KPMG declined to act on the light touch appointment due to the perceived risks. Potential protection will need to be industry and sector-specific, but some that have been mooted include appropriate financial controls and restrictions, such as barring directors’ access to the administrator’s post-appointment bank account; capping orders; pre-selection of business partners and suppliers; and payroll, expense and debt collection carve-out and independent control.

Either way, it seems inevitable that at some point insolvency practitioners will get caught in the crossfire. Creditors will disagree about the viability of businesses. Some would have failed anyway. Valuations will be called into question. IPs will have to decide whether to take action against debtor companies which, in a domino effect, could trigger knock-on insolvencies. If a new regime is introduced it will (like all legislative interventions) be riddled with uncertainties on which IPs will need expert legal advice.

In most cases, this time it has to be about consensus, not conflict. A creditor led (particularly, institutional led) narrative this time around simply won’t serve the nation’s interests.

The current debate also concerns what other jurisdictions are doing, what we can learn and adapt for UK plc. Spain and Germany have suspended the obligation to file for insolvency until 30 September. Australia has implemented a number of initiatives including a moratorium against personal liability for wrongful trading; an increase in the level of debt required for creditors to issue a statutory demand; and increased time limits to satisfy and respond to statutory demands.

These are all designed to stifle litigation in the short term, but in some respects, it could curtail mechanisms to procure cash and sustain businesses owed money.

In terms of the likely disputes to emerge from the pandemic, we have already seen the first waves of litigation concerning the ‘f words’: force majeure and frustration. We are now seeing policyholder disputes in the context of business interruption insurance, in particular where a number of big insurance players have already stated that COVID-19 is unlikely to comprise an insured event and so will not compensate companies. This has, in turn, led to the recent formations of Hiscox action groups. Given further restrictions on cash flows and liquidity, there will be (certainly in the short term) a depressing of values (based on discounted cash flow valuations). This will impact loan to value covenants and trigger other covenant defaults. This will also bleed into financial and derivative contracts where margin calls are already happening in significant quantities.

Whilst there may a brief lacuna in claims as businesses focus on survival, leading judges and commentators anticipate there is a deluge of litigation coming in the wake of the coronavirus pandemic. It remains to be seen if the current insolvency options fit for purpose and will be able to cope.

About the author

Marc Jones acts for financial institutions, public and private companies, states and state-entities, and high-net-worth individuals in complex commercial and financial disputes. His key practice areas include banking and financial services litigation, securities litigation, company and shareholder disputes, professional negligence, fraud claims and asset tracing.

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