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4-12-2013

Restructuring and Insolvency analysis: Amid warnings that a rise in interest rates could lead to the collapse of 'zombie firms', debt-laden companies only surviving due to rates remaining low, Frances Coulson, former president of R3, the insolvency trade body, and a partner and head of insolvency and business recovery at Moon Beever, offers advice on how struggling firms can be prepare effectively.

Original news: 
Bank of England warns high inflation and low productivity is the reality of the UK's economic future, LNB News 14/11/2012 49
The Bank of England is warning that rapid inflation and weak economic recovery is likely to shape the future of the UK.

What effect will the rise in interest rates have on 'zombie firms' 
In many cases, businesses have been servicing interest on debt (and this is true also of roughly a third of individual debtors) and paying little or nothing from capital borrowing. There has been little point in banks tipping them over whilst they can keep them on the right side of the balance sheet. If rates rise so that interest cannot be maintained, debts may escalate, causing a decision crunch for banks and other lenders.
The difficulty in servicing such borrowing may also have a knock-on effect on businesses' ability to service other debt to HMRC or suppliers and so may also precipitate action. Depending on the rate rise, given rates are so low at the moment I would speculate that this may take six to 12 months to materialise.

What should zombie firms do now to be prepared when interest fees rise? 
To best prepare for the rise in interest fees, Zombie firms should:

  1. consult their accountant or an insolvency practitioner to look at contingency plans, possible savings/restructure, and what may need to be done if the lender pulls the plug
  2. if possible, secure an overdraft on term lending so it cannot just be pulled, as that is something the directors won't be able to control, no matter how good they think their relationship with their bank has been thus far
  3. maintain tax and VAT payments. If HMRC's time-to-pay policies tighten they are the biggest petitioner in the country and most likely to action liquidation
  4. think about other forms of procedure with the insolvency practitioner. You do not have to be presently insolvent to think ahead and take advice, and the earlier advice is taken, the better protection for the directors. Take regular advice and record it

What should in-house lawyers and those advising zombie firms keep in mind? 
The most important thing is cash. Lack of it is what most tips businesses over, however good they look on paper. Look at your own credit terms. Do they need tightening? Review your debt recovery procedures: can you improve your debtor days? Do you need to get tougher? You should look at your retention of title clauses--ensure contractual procedures are tight so you win in a battle of terms.
These are all things businesses should do but don't and are heightened in importance when times are tough. Also logically (if logic works in these times) a bank is more likely to back a business which is well-managed in this way when it comes to choosing who to pull and who to continue with.
Many businesses concentrate on sales at all costs, particularly in difficult trading times. Sales come with costs and if the buyer doesn't pay, they are a negative, not a positive. Think about credit and payment as much as sales. Look around--are there merger possibilities or are you of interest as a takeover target for a competitor? That may be another option best managed outside a forced situation.

With only 10% of struggling companies estimated to survive, what can the remaining 90% do to make their possible demise as smooth as possible for all parties involved? 
I reiterate, take advice. Ensure your creditor levels do not rise and try to realise assets for maximum value in a non-fire sale sort of way if that is possible. Can you do that and wind down trading gradually? If you cannot tail off and reduce liabilities, or they are likely to increase, see an insolvency practitioner now about the best procedure for the business and its creditors. It may well be liquidation. Not all businesses are viable for rescue. Many are simply to fund the director's remuneration in a new company, but if that is going to be at the expense of creditors, and the business will not be viable going forward, the director may just be putting off the day when he is held to account and his own liabilities may have increased.
Of course, directors will probably have personal guarantees to the bank. Take separate advice on your own position as a director, you may need to think about an Individual voluntary agreement (IVA). If the position of a company is precarious, any small rate rise could precipitate the start of the demise of the company and so trigger the potential personal liability for the directors for matters such as wrongful trading or their duties to creditors, which makes it doubly important to receive early advice about the company position.

Should viable firms now get into starting position to expand? 
I agree that the level of zombie businesses drags down viable businesses which would be capable of expansion. This is because of:

  1. the additional competition--the zombie isn't producing a positive return to the economy in terms of investment but is still competing for business against better companies
  2. reduced funding availability: whilst credit is still out there to zombies, it is not available for lending to decent business
  3. reduced confidence in the market, meaning good businesses are retaining cash reserves rather than investing it for growth and infrastructure. The overall feeling within the economy is still one of malaise. This cannot go on indefinitely and once the economy has the clear-out it is overdue the good businesses should ensure they are in a position to capitalise on it and move forward

Interviewed by Duncan Wood
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor

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