Customer deposit ringfence could hit company cashflows

by Rachael Singh

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19 May 2011

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ICAS IS CALLING on the government to ringfence customers' deposits, safeguarding their funds in the event of a company collapse.

A good idea in theory, yet this gesture could prove to be a huge burden on businesses that are already struggling in this turbulent economy.

The Scottish Institute wants retailers to hold customer deposits in a separate account, supplying greater protection to them in an administration.

Because businesses would be unable to access deposits currently needed to help run their companies, they could be forced to borrow more from lenders to pay suppliers and keep ticking over.

Experts are also concerned that this would effectively give customers super-creditor status. Payment ahead of secured creditors such as lenders is not something banks will be falling over themselves to endorse.

For customers that lost out in major retail insolvencies, such as Zavvi or Land of Leather, this request is music to their ears. Anyone who bought vouchers or paid a deposit when these companies collapsed became an unsecured creditor – last in the pecking order of payment.

ICAS' insolvency committee chairman David Hall appreciates that the need for extra credit could be a stumbling block, though he argues banks will lend more in future because of government-set targets.

What annoys people the most when a company enters insolvency proceedings is that their deposits is not the business'.

However, neither is credit from lenders.

"Most businesses cease trading because of poor cash flow, not because of a lack of profits. This idea will just compound that," said Richard Pepler, CEO of lending business Ultimate Finance.

This could end up having a "horrendous" effect on the business community, which will have to borrow to keep up payments to suppliers.

As a lender, Pepler said he would not favour such a move as it negates the point of a deposit to ensure the supplier makes and delivers a product. The move also raises questions about whether the banks should lend if there is a possibility they stand to lose funds ringfenced for customers.

Currently, if a business collapses then lenders are paid first as secured creditors; if that privilege is taken away then it is unlikely they'll be quick to offer credit facilities to retailers.

Insolvency trade body R3 president Frances Coulson said customers agree that it is a good idea. However, customers are already protected if they pay using a credit card; under current legislation, any purchase on a credit card of more than £100 is refunded if a business enters administration.

Customers, though, are not in the habit of making all their purchases on credit cards. When Christmas savings club Farepak collapsed, most deposits were made through bank transfers and debit cards; owing more than £40m to creditors, the firm folded in 2006. Unsecured creditors such as the taxman and customers received just 15p for every pound owed: a customer who saved £500 stood to regain just £75.

That model was unsustainable and should not have operated unless it was able to ringfence the funds in some way, argued David Hall.

Another problem for retailers trying to separate funds is that vouchers can last up to two years, warns Coulson. It would be incredibly difficult for a business to keep track of money related to a voucher so that the fund can be released in the event of insolvency.

Voucher purchases also go through peaks and troughs throughout the year, so businesses need access to the funds to keep supplier payments stable throughout the year. Not having access could mean that supplier payments lag at different points in the year.

"There have to be clearly defined thresholds," said Ann Condick, director of insolvency at ICAS. "The government should be looking to open up the discussion."

Although many believe the idea is a step in the right direction, giving super-creditor status and extra accounting work to businesses in these tough economic times might be neither the best nor the only solution.

Coulson believes that the broader macro-economic effect have to be weighed up because you don't want companies to "suffer the law of unintended consequences". The called for ring-fence could hit cashflow so hard as to ironically force firms out of business anyway.

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