Extraordinary measures for extraordinary events
Wednesday, September 23, 2020
Coronavirus is an extraordinary event. While some sectors have done well in the downturn – video conferencing, online retail and groceries to name but a few – print, in some sectors at least, has had its share of problems but is coping.
Dominion Print set up a masks wing of its business, De La Rue may see its authentication technology used to certify individuals with Covid-19 immunity, and JICMail has seen a double-digit increase in the effectiveness of direct mail and door drops.
But for other industries – in particular those that require large gatherings of people – have had to start the process of making job cuts. For them, there’s a real need to find urgent solutions to two knotty problems: survival and cashflow.
When firms are in dire straits fingers tend to be pointed at the management. Peter Windatt, a director at insolvency practitioner BRI, says all too often he sees little in the way of proactive steps being taken by directors of firms in trouble. “Most,” he says, “are reactive.” He’s of the view that when business sours “you sort the men from the boys”.
A different perspective is offered by Gawain Moore, a partner in the Banking, Restructuring & Insolvency Team at Walker Morris LLP. He sees relatively sophisticated directors “who are proactive in seeking advice when they become aware that their business may be facing financial challenges”. He wonders, though, if this because they have been through an insolvency before.
Likewise, for Paul Taylor, partner in the Corporate Department of Fox Williams. He has advised a range of struggling companies over the years and for him, “those that have seen better outcome are those whose directors have taken early advice and are aware of their responsibilities and duties and also of the risks of personal liability if they have engaged in ‘wrongful trading’”.
Nevertheless, Moore thinks that early engagement isn’t always sufficient to save every company, “particularly where there has been a structural change in the company’s market and there isn’t sufficient time or funding to implement a restructuring other than through an insolvency mechanism”.
So, understandably, when serious trouble arises, Moore’s first recommendation is to seek advice because “company directors have a wide range of responsibilities under statute, regulation and the common law, and they should ensure that they are aware of and understand them”. Second, he advises not panicking for, as he says, “provided directors take reasonable and sensible decisions and follow professional advice, it is very unlikely they will face personal liability”.
And Taylor agrees. But worryingly, he says that directors of failing firms “often are not aware they should have been attempting to look after the interests of the creditors as a whole.” He also thinks that the “procedural steps are often just as important as the ultimate decisions made”.
In fact, Taylor often has to tell clients to prepare accurate and current management accounts, prepare cashflow statements that reconcile to the balance sheet and profit/loss account, keep board minutes that detail decisions made, obtain asset valuations, review retained profit before dividends are paid out, review all trading information, ensure each director has a defined area of responsibility and critically, review the position of all creditors.
Turning a business around isn’t easy but formally acknowledging the problem and collating data is central to completing the task. As Moore says, directors with good information “can take informed decisions on what is the best course of action for the company and its stakeholders.”
Directors should also consider the cause of the troubles. Is it structural or something that results from the way that business is done, or is it supervening such as that imposed by government (to deal with coronavirus, for example)? Whatever the cause, regular meetings to discuss the financial and trading position, particular creditor pressures, and threat of insolvency proceedings are essential says Moore.
But once the true position is understood, Windatt reckons that it’s then possible to plan a road to recovery. And this, he says, is the decisive part of any recovery – firms should not be in a position where they have to keep going back to creditors. As he explains: “If you have to make cuts, do them once and deep, rather than death by a thousand cuts for those who are still working for you will be left wondering if they’re next for the chop.”
Cash is king, there’s no getting away from it. This is why Moore says to focus on it: “Even the best turnaround plan will fail if the business does not have sufficient liquidity to see it through.”
While Windatt echoes Moore’s points, he advises also talking to creditors to let them know what is happening so that non-payment isn’t the first sign of trouble. “People,” he says, “want to have their expectations managed. They too have plans and budgets and you’re about to put a spanner in their works.”
Moore takes the point further in relation to the company’s secured lenders, “as they will control the assets”. Generally, he says that there is likely to be a greater prospect of the lenders buying into the recovery plan if the company is open and engages with them at an early stage, rather than being presenting them with a turnaround plan they have not had a chance to contribute to and which may have come as a surprise.
Beyond lenders, Moore says landlords need to be onside where commercial premises are rented and a CVA is mooted. Then there’s the Pensions Regulator, PPF and trustees if pensions are at risk. And key suppliers should be considered for their cooperation is essential.
As for creditors, Taylor takes a moment to remind directors that “the duty to promote the success of the company for the benefit of its shareholders will be modified by an obligation to have regard to the interests of creditors as a whole as a company nears insolvency”. He cites a 2016 case – BAT Industries PLC v Sequana SA – which found that as a firm’s position worsens so the position of the creditors rises in importance.
There is one crumb of comfort though, says Taylor – that the wrongful trading provisions of insolvency law were suspended from 1 March to 30 September. Even so, he still advises acting in the best interests of creditors.
Potential solutions to raise funds
An option open to businesses with assets that have a realisable value is to consider a ‘sale and leaseback’ arrangement where the asset is sold and leased back for the long term; the business continues to be able to use the asset but no longer owns it.
Sale and leaseback has a number of advantages – the conversion of assets into capital without the need of the occupier to lose control; lower costs usually associated with conventional debt; rental payments that are tax-deductible; and any borrowing on the asset will be removed from the balance sheet.
But there are disadvantages to note too: any future appreciation in the value of the asset is no longer available to the seller; the company can no longer enjoy the value of the asset as part of any sale of the business; and there is scope for detrimental tax implications.
On top of this, Moore warns “that companies with significant borrowings should be aware that any transaction of this nature is likely to require lender consent, even where the lender does not have security over the asset involved”.
For some sale and leaseback is just a sticking plaster instead of a long-term cure. As Windatt highlights: “It can be fantastic in the right circumstances, but it can just kick the can down the road in many others.” He says that it can work for those that truly know where they are when following this course of action. Those that don’t lose cash and the benefit of their golden asset.
And Moore agrees. He says: “Sale and leaseback is not a generally recognised restructuring mechanism to deal with a company facing financial difficulties. It may, however, form part of a wider future strategy for a company and as part of that, where it wishes its capital to be deployed.” He too thinks that it is unlikely to deal with underlying issues in the business itself.
Apart from traditional sources of finance, there is the potential of funding from the peer to peer (P2P) sector. But Moore emphasises the need to be “very wary when dealing with P2P lending, in particular, as a means of raising debt to meet anything but a very short-term issue.”
He’s also aware of structural liquidity issues within a number of P2P platforms that are leading investors to quit the platform with no option but to require repayment of the debts funded by those investors.
Also, any firm borrowing more should be cautious, reckons Taylor because of the wrongful trading risk: “The board should be mindful of taking on new debt if it is not comfortable it can repay it.”
There are also various government coronavirus-related lending schemes which are helpful but not so simple for firms to access. The Bounce Back Loans for SMEs are taking their time to filter down (see p24). And then there are government’s corporate lending schemes such as CBILS.
Feedback from Taylor’s clients suggest that CBILS “is working well, and the banks have listened and are generally not asking for personal guarantees”. But he says that to gain funding the business must have been affected by the pandemic and be commercially viable were it not for the pandemic. This last qualifier makes CBILS more restrictive to firms in need of funding.
Seeking fresh equity
Another option is to seek fresh equity from existing or new investors. As to how effective this is, it will depend on the nature of the company and its capital structure, but Moore suggests that “for an SME with a single or limited number of investors, fresh equity is a relatively cheap and straightforward process. For a listed PLC, with complicated investment structures, share warrants and other instruments in place, the process could care very significant costs, risk and the requirements of the Listing Rules to navigate and satisfy”.
If equity is the preferred route, Taylor is of the view that the “directors will need to think long and hard as to how monies are introduced into the business. If they can find an equity investor, they will obviously need to decide what price the shares are issued at and what the dilutive effect is on the other shareholders.” But he does point out one advantage of equity as opposed to debt, that it reduces the risk of wrongful trading allegations against the directors.
It’s interesting to Moore that “since the 2008 financial crisis, distressed private equity has become an increasingly popular investment strategy, with institutional investors looking to gain exposure to companies in financial distress as a result of the difficult economic climate”.
But from an insolvency practitioner’s point of view, Windatt explains that “most ‘white knights’ are clever, shrewd, businesspeople. They will keep the company talking and most likely buy it much cheaper once it has fallen off its perch”.
Who to pay first
Firms in a spot of bother will be fending off calls for payment. A natural question to ask is who should be paid first?
As a starting point, Taylor makes it clear that there is a statutory order for the repayment of debts on insolvency which, in basic terms, means that secured creditors are paid first, preferred creditors next, and the remaining percentage of the balance goes to ordinary creditors and shareholders. “Directors,” he says, “should be careful of paying debts out of order on the run-up to insolvency as payments could be set aside if considered a ‘preference’.”
And Windatt takes a similar line noting that the ideal is to treat them all the same: “No creditor wants to discover that you have done a deal at 40p in the pound for them when others have got 50p. You may decide to pay trivial creditors and try to negotiate with the bigger ones – there are no hard and fast rules.” However, he adds that firms should recognise those creditors whose future support and assistance will be needed; it’s key, in his view, to not over-promise only to under-deliver if later there’s a prospect of needing to look at a Company Voluntary Arrangement (CVA).
A CVA, for the record, is a restructuring mechanism under the Insolvency Act which allows a company to enter into a legally binding procedure to permit payment of its unsecured debts. The benefit to firms, as Moore highlights, is that CVAs generally “allow the existing equity structure to remain in place without the company having to enter administration – and management remain in control.”
However, it should be remembered that CVAs have no effect on secured debt without the consent of the secured creditor and for smaller companies it can be a complicated and expensive procedure. This is one of the reasons why Taylor tells clients to put together all of the information outlined earlier as a CVA “is supervised by a nominee, who, if not a liquidator or an administrator, must submit a report to the court stating whether a meeting of the company and of its creditors should be summoned to consider the proposal”. The nominee will require details of the business’ affairs to complete the report. Upfront information speeds the process.
Sight shouldn’t be lost of the fact that a CVA is just another promise says Windatt: “Significant creditors can be outvoted and CVAs are very hard to secure when there is a history of broken promises.” To cite a positive example, book printer Charlesworth Press secured the support of Close Brothers Asset Finance for its CVA because, despite the debt, the underlying business was strong, according to managing director Mark Gray.
Moore counsels that if the business model isn’t working it will be difficult to see how a CVA and other changes will save it in the long term. On the other hand, Moore reckons that where an otherwise profitable business has been affected by one specific challenge, not of its own making, which has left it temporarily unable to pay its creditors – a global pandemic for example – that “it may be exactly the mechanism that is required to save it and ‘share the pain’ in a fair way among creditors, with a return to them that would be greater than if the company had ceased trading.”
But time is of the essence. Moore knows from bitter experience that “if the first advice the client takes is a week before the company runs out of cash, there is little time to consider and implement a solvent restructuring, unless the company has liquid and supportive shareholders and/or lenders.” A CVA for example, typically takes three to four months to consider, draft, consult on and implement.
There is one more thing for directors to consider says Taylor: “Unlike administration, a CVA doesn’t automatically result in a statutory moratorium protecting the company from creditors taking action to recover their debts.” Even then, a CVA must be approved by a simple majority in value of the members and 75% in value of the company’s creditors present and voting.
Throw in the towel?
There will come a point when directors of a troubled business will have had enough. Should they throw in the towel and wind up the business? Maybe, says Windatt, but he tells directors not to take any precipitate action because that could make the problem worse.
His advice, when things start going wrong is to “remember the duty to avoid wrongful trading and take every step possible to minimise losses to creditors”. If it really is the end of the road, he suggests that an orderly wind-down is likely to be the least harmful: “The golden rule of holes remains though: when you are in one, stop digging.”
And as Taylor warns, resigning as a director won’t necessarily save an individual from personal liability: “A liquidator will not look kindly on a director who resigns when the ship is deemed to be sinking.”
Pre-pack sales of failed firms are common, but Moore explains that this tends to happen if “the directors are comfortable that the transaction will complete, and it will provide a better outcome for the company’s creditors than would otherwise be the case”. In this situation, they may want to continue trading for a limited period pending completion of the sale.
But at the other end of the spectrum, is the business that cannot be saved without damaging the interests of creditors. “Between the two,” says Moore, “is the position where a rescue of the business may be a possibility, but it is difficult to keep trading with the creditor pressure and requirement to keep funding the business.” This presents directors with a real dilemma: trading in the hope of a better outcome or appointing an administrator or liquidator which invariably means the end of the company.
Ending the life of a business, even in an orderly fashion, isn’t always a no-cost option. As an insolvency practitioner, Windatt outlines that everything turns on the facts. He says that costs can vary from nothing where the business is left to the creditors, £10 to pay for the cost of strike-off at Companies House, to £2,000 or more for a Creditors Voluntary Liquidation (which needs a minimum £6,000 of free assets to deal with both the pre and post liquidation costs), to £4,000 for a solicitor to put the company into Compulsory Liquidation.
At the end of the day, no matter how unpalatable the thought or intractable the problem, directors must take action and responsibility. If they stick their head in the sand, they risk others driving the process and with their agenda determining the direction of travel. On top of this comes personal risk.
EXPERT OPINION: The impact of Covid
Roger Aust managing director of Close Brothers Asset Finance’s print division, outlines how the pandemic has affected the industry and some of the options for recovery.
The most obvious and immediate impact was the drying up of orders for many printers as customers paused or cancelled activity.
From a printing perspective, there has been a decline in in-office printing with the rise of working-from-home schemes. This is also true for offline media where many are of the view that traditional print marketing material, while still relevant, will be optimised and used on a case-by-case basis with marketing budgets moving toward online and more focus placed on short-run on-demand printing.
The packaging and label sectors witnessed a surge in demand due to the rise of e-commerce activity. On the other hand, wide format graphics, commercial printing as well as sheet-fed digital printing were areas heavily affected by Covid-19, but which we expect to bounce back quickly after the pandemic passes.
On a more positive note, we’ve witnessed a number of our customers diversifying their offering. In one case a customer successfully changed its focus from sustainable packaging manufacturing to mass production of face shields for the NHS. Market sector is key. Entertainment, leisure travel, have all be affected badly, but any businesses associated with pharmaceutical or online shopping have boomed. Printers that offer their services direct to the public online, either via gifts, cards or publishing have fared much better.
The vulnerabilities for print businesses
Print by its nature requires people in factories running machinery; home working is not an option. Printing machinery is expensive and the fixed costs associated do not disappear; just because the factory is closed does not mean cash is not required. The recent periods of total lockdown have caused major funding shortfalls in all businesses no matter how big.
In the medium to long term printers will have to assess the markets they are in and in many cases will have to diversify and will have to address customers’ requirements for a total online experience. Printing and allied trades must take seriously the current political imperative that is strongly in favour of all industries offering a greener approach. With environmental regulations being adopted globally, and the pandemic increasing the pressure on governments and businesses to follow sustainable business practices, print service providers will eventually need to invest in sustainable technology if they are to remain competitive.
We’ve seen that those who have been slow to transform their objectives and operational model, and to look toward new avenues to diversify their offerings, are the ones being left behind by their competitors.
It’s difficult to say when a product is – or isn’t – appropriate because we typically use a blend of solutions to suit a customer’s individual needs.
Common examples of asset finance products
● Hire Purchase (HP) Allows the customer to buy the equipment on credit. The finance company purchases the asset on behalf of the customer and owns the asset until the final instalment is paid, at which point the customer is given the option to buy it
● Refinancing (Capital Release) The finance company purchases the asset and finances it back to you. Repayments are calculated in line with the income stream that will be generated by the asset; at the end of the refinance term, you own the asset
● Finance Lease The full value of the equipment is repaid to the finance company, plus interest, over the lease period. At the end of the term, the company can choose to: ● continue to use the asset by entering a secondary rental period ● sell the asset and keep a portion of the income from the sale ● return it
● Operating Lease Similar to a Finance Lease, an Operating Lease allows you to rent the asset while you need it. The key difference between the two is that an Operating Lease is only for part of the asset’s useful life. This means you pay a reduced rental because the cost is based on the difference between the asset’s original purchase price and its residual value at the end of the agreement.
Strategies for recovery
Close Brothers has many recent example of how an understanding of assets, and a willingness to not just see the current situation, but also take note of businesses future plans and aspirations has enabled companies to see a brighter and sustainable future. For example the restructuring of a press using the Coronavirus Business Interruption Loan Scheme (CBILS) and raising an additional £250,000 of working capital in the process. The restructure led to the customer consolidating its existing debt and freeing up the working capital necessary to help the firm trade through the current pandemic. By restructuring long-term debt and raising working capital with CBILS assistance, it meant the business could manage overheads for the foreseeable future and have a strong strategy moving forward.
A second example allowed our customer to gain the time and cash headroom required as their focus changed to the production of PPE and associated products.
Close Brothers Asset Finance
At Close Brothers Asset Finance we are proud of our heritage and our long-term support of our industry. We understand the assets, and we know their value; this enables us to structure safe and affordable propositions, even in dire times. This can be releasing cash or restructuring finance to fit more comfortably with a company’s future plans, or funding new assets as businesses adapt and diversify.