INSOLVENCY - That sinking feeling

Spin doctors acting for insolvency lawyers and accountants are movingorris. so fast that the concept of insolvency is going out of fashion and is being replaced by the idea of turnaround. It has even been suggested that the Society of Practitioners of Insolvency (SPI) should change its name to drop any reference to the dreaded ‘I’ word.

Does this represent a fundamental change in the way troubled companies will be dealt with? Or is it just cosmetic, a dutiful nod towards the concept of the rescue culture? Tempting though it is to be sceptical, there has been an important change in attitude among banks and professional advisers.

Lending banks increasingly see receivership as an unattractive option of last resort. The new statement of principles issued by the British Bankers Association, Banks and Businesses: Working Together, came into force on 1 July. All the main banks lending to small and medium-sized companies have agreed to be bound by it. Two of the principles encompass all aspects of the relationship of a bank with its business customers:

– ‘We (the banks) will add our support to a rescue proposition which we believe will succeed.’

– ‘If you (the borrower company) act in good faith; keep us informed about developments; keep to your agreements with us; heed what your own and any independent advisers say; and are prepared to make the changes needed early enough to preserve the underlying business, we will not normally seek the immediate appointment of a receiver or start other recovery proceedings.’

There is now a community of top executives who, as creditors or directors of troubled companies, have experienced the distress of insolvency. Together with a likely legal shift to favour rescue mechanisms, this means the next wave of corporate insolvencies will be tackled very differently to the unfortunates of the last recession.

So what has changed? Business will say the banks are still looking out for themselves. But banks don’t like receivership either. It gives them a bad press, can be expensive and puts off business customers.

The London Approach is a template to follow when a company starts to fail. Approved by the Bank of England, it is cumbersome and does not avoid bickering among the banks. Because of the expense, it is only practical for the biggest failing companies with substantial exposure to a group of banks. A lot of large companies now avoid bank-borrowing by going direct to the capital markets so the number of cases in which the London Approach helps in the rescue may fall anyway.

Administration is the UK version of the US Chapter 11. But, with few exceptions, most recently the rescue by Buchler Phillips of Millwall Football Club, it has been unsuccessful in saving companies as opposed to their businesses.

Fully-secured banks block orders to avoid having the enforcement of their security frozen. Administration is expensive, especially for a failing company. And it puts an insolvency practitioner (IP) in charge, unlike Chapter 11 where management, broadly speaking, retains control.

The voluntary arrangement lets a company reach a deal which can be imposed on a minority of opposing, although not secured or preferential, creditors.

But it takes time and can’t work without an administrator stopping creditors liquidating the business.

At some stage, the DTI is to press ahead with reform which will provide small companies with a quick-fix voluntary arrangement procedure protected by a quasi-administration order. Secured creditors will not be able to appoint administrative receivers during a 28-day moratorium.

In Darwinian terms, a failure allows the more efficient to flourish. And saving fundamentally flawed businesses is wrong. But receivership can be unnecessarily destructive of jobs and shareholders’ investment. It becomes inevitable because the cost, particularly for small or medium-sized businesses, makes devising a rescue strategy difficult.

A recent independent survey of intensive care for SPI showed the considerable but necessarily unsung success IPs have had in corporate rescue outside formal insolvency procedures. What’s more, against the grain of public opinion, banks are supportive of work-outs.

It is in this fertile soil of disillusion with receivership, and with the shortcomings of administration and the voluntary arrangement, that the seeds of the turnaround idea have taken root. The best known of several ventures is the Postern Group which concentrates on providing turnaround expertise.

Members of the team take directorships of an ailing enterprise, despite the risk of personal liability for wrongful trading. In general, fear of liability has not, as was intended, prompted directors to take radical action while there’s still a chance of survival. But it has stopped banks and creditors getting involved in sorting out company problems.

Part-fuelled by conservative lawyers, this has proved to be overblown.

A turnaround team would never take on a job unless there was a reasonable prospect of avoiding insolvent liquidation. Directors run little risk of liability as long as they act reasonably. But it is wrong to be too sanguine. An aggressive liquidator coming along after a turnaround has failed may well want to target the team.

What makes turnaround so attractive to creditors, encouraging them to delay taking hostile action, is the team’s ability to provide finance.

Nothing is more telling in business generally, and particularly in the context of a company in trouble, than the willingness of a new and dispassionate player, with a reservoir of skills and experience, to make a financial commitment.

Postern has an equity investment fund to back its projects: to stabilise a company’s position and provide capital to pursue the turnaround plan.

The object is not to tackle businesses that have never succeeded but rather to apply the skills supported by a financial commitment to restore value to the shareholders.

It is high risk. So the team and its investment fund are entitled to look to the upside to make a significant return – not necessarily in the short-term but geared to the practical prospects of the turnaround. IPs similarly are developing ways of preventing their fees from obstructing a rescue – Millwall’s administrators took part of their fees in shares.

Postern is not alone in moving into this area. Leading IPs have a huge amount of institutional knowledge and skill in managing non-performing companies. Price Waterhouse has also set up its own turnaround practice. Like the other big firms and specialist insolvency practices, it has dealt with some of the most difficult insolvencies over the years and steered many to survival.

If creditors, managements and shareholders are prepared to invest faith in the idea, turnaround could be the catalyst for a whole range of imaginative and creative restructuring tools for reviving value and saving jobs.

Howard Morris is a partner in the banking and financial markets group at law firm Denton Hall.