This blog gives you the latest topical news plus some informal comments on them from ShareSoc’s directors and other contributors. These are the personal comments of the authors and not necessarily the considered views of ShareSoc. The writers may hold shares in the companies mentioned. You can add your own comments on the blog posts, but note that ShareSoc reserves the right to remove or edit comments where they are inappropriate or defamatory.

Insolvency changes announced by Alok Sharma

The UK government has announced new insolvency measures to prevent businesses unable to meet debts due to the impact of coronavirus from being forced to file for bankruptcy. Alok Sharma, the UK business secretary, said the wrongful trading law would be suspended to protect directors during the pandemic.

As the definition of insolvency is not being able to meet debts as they become due, and nobody knows what might happen in the next few weeks, this is not unreasonable. But it would be good to have a more wholesale reform of insolvency law.

The way the current law (pre Sharma announcement) works and is interpreted is:

Directors have responsibility under S172. Primacy is to shareholders.

When a company is in danger of trading insolvently, the directors are obliged to seek advice on what they should do. They are allowed to continue trading if they think there is a reasonable chance that insolvency will be avoided.

If they think the company is insolvent they then have to consider the interests of creditors. They (the directors) may decide it is in the best interests of creditors to continue trading whilst they look for a sale or to renegotiate terms with creditors (e.g. write off part of loans, reduced or deferred payments to suppliers, etc).

If you are in these circumstances it is important to make good file notes, to make sure as a director you have not done anything wrong. Companies sin such circumstances will seek legal advice and or advice from insolvency experts.

Directors can put a company into administration. Or a creditor can make a petition to the Court to put a company into administration.

How does this apply to the current circumstances?

If you (i.e. a company) have no or little income, then you have a problem. (Some) Directors may take the view that they may get some bailout from government and so the best approach is to continue to trade, to conserve cash as much as possible and wait and see what happens.

The FT.com has a good article about this and the comments under it are even more useful. Many commentators think that the announcement makes little or no difference. It will of course depend on the small print. See https://www.ft.com/content/ad5d47d3-1572-4d67-b0b6-e64c5858c848 

In our submission to the BEIS review in 2018, we suggested the Government consider a US style Chapter 11 arrangement, this seems to work well in some cases and companies continue to trade and emerge after a period back into normal operations. I have talked to BEIS about this (I think this was months ago when they were reviewing the submissions) and think this could be what one of the things have in mind.

For the moment we will have to wait until the draft legislation is published.

Readers may also be interested to (re-)read the joint the UK Shareholders Association-ShareSoc response to the BEIS consultation on insolvency, that we made in June 2018. https://www.sharesoc.org/sharesoc-news/beis-consultation-on-insolvency-and-corporate-governance/ where we said, inter alia,

Directors are usually much less well informed than the insolvency practitioners, who negotiate terms and conditions that guarantee them large fees, often open ended. Such behaviour is not in the best interests of creditors, employees or other stakeholders. Insolvency practitioners also try to insist on and frequently obtain guarantees and indemnities. They seem to be very unwilling to put their own capital at risk, which we would view as an appropriate quid pro quo for the high fees they are charging. It is wrong to charge very high fees and not put your capital at risk.

Insolvency practitioners too often seem to operating for their own benefit. From an investor point of view, there are not many stories of good insolvency practitioners and perhaps this is evidence of them not operating in the best interests of their clients.

In the US, Chapter 11 seems to work well in some cases and companies continue to trade and emerge after a period back into normal operations. The UK environment seems to favour either a pre-pack, a quick trade sale or an insolvency. All of the UK options are very painful to one or more groups, with the exception of the Insolvency Practitioners.

And in a comment on  accounts:

The reform would involve developing a more scientific and quantitative approach to the risk of capital being exhausted. This is already well developed in the risk management profession, but the accounting profession has lagged somewhat behind since the professions diverged in the 1950s. A practical approach would be to add a risk management module to the IFRS accounting standards, which currently have little or no engagement with the issue. This would encourage investment by allowing a company to articulate a clear risk appetite to its prospective shareholders. A market- based and principles based reform would be the most practical solution. Using publicly available accounting standards (e.g. IFRS) would be preferable to excessive and complex (and ‘gameable’) regulation.

We are in uncharted waters. We will continue to update members on issues that are critical to investment decisions.

This issue will, I think, be of interest to all investors, particularly if you hold shares in pubs, restaurants, hotels, airlines, airports, travel companies, retailers and banks.

Cliff Weight, Director, ShareSoc.

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