What to do about Toxic Business Debt
More than half of small businesses in the UK are loaded with debt that they may struggle to repay over the next 12 months – commonly referred to as toxic debt. This presents a major risk of insolvency for those businesses, with serious potential consequences for their owners, employees and creditors.
Certain sectors are particularly hard hit by this issue, with hospitality and property businesses making up the largest percentage, according to a recent report. This is probably connected to those businesses hardest hit by the pandemic, with a Bank of England analysis suggesting accommodation, food, arts and recreation, and construction businesses were most affected by reduced cashflows since March 2020.
The rate of company insolvencies also appears to be growing, with an 11% increase in 2021 compared to 2020, according to the Insolvency Service. This was in large part driven by the highest number of Creditors’ Voluntary Liquidations since 2009, although other types of insolvencies remain below pre-pandemic levels, most likely due to restrictions on winding-up proceedings and assistance from various government support schemes.
The Bank of England has warned that it expects a rise in insolvencies in 2022, with all winding-up restrictions ending on 31 March 2022, following a phase out that started on 1 October 2021.
The Bank of England also highlighted that many of the small businesses now carrying significant debt had likely never borrowed before the pandemic and would have been unlikely to have met standard lending criteria. This reinforces the message that this debt is expected to be unsustainable for many of those businesses.
All of this suggests that 2022 will be a very turbulent year for businesses and creditors, with insolvency unavoidable for many. It is, therefore, especially important for both businesses and creditors to understand their options for dealing with toxic business debt.
Insolvency options for businesses with unserviceable debts
For a company with debts it is struggling to repay, there are five main options to consider. Which option is best will entirely depend on the circumstances, so it is important to get specialist insolvency advice as soon as possible. The five options are:
Ad Hoc Agreements
In some cases, particularly if there are only a few creditors, informal agreements can be enough to stave off insolvency. However, there are two problems with this approach.
First, it can be difficult to explain an arrangement of this sort to creditors without them ‘rushing to the exit’ and taking aggressive action. Second, there is no way to force creditors to agree. If some do and some don’t, it may not be enough to save your business.
For a company that cannot repay its debts, administration offers a way to hit pause and look for ways to save the business. The business will not need to pay its existing debts during the administration and any legal action taken against the business by its creditors will be paused.
A company can place itself into administration or a creditor such as a bank can do so. The company will be placed into the hands of a Licensed Insolvency Practitioner who will look for ways to reorganise or restructure the business so it can continue to operate.
Pre-pack administrations are a special type of administration where there is an agreement in place to sell the company’s assets before the administration takes effect. Administrators will be appointed to handle the sale.
A pre-pack administration can involve selling the business to a new owner, or the business can potentially be sold to the directors of the existing company, who will need to form a new company to buy the assets of the old one.
Pre-pack administration can be the best option for the owners of a business but is subject to special safeguards to protect creditors.
Company Voluntary Arrangement (CVA)
Company Voluntary Arrangements are used where a company wishes to renegotiate its debts with unsecured creditors. The idea is to agree on new repayment terms, usually with debts being written down and/or the business being given longer to repay. Controversially, they can be used to reduce liabilities to some creditors (such as landlords) while paying other creditors in full.
A CVA will usually be proposed by the business with its creditors needing to vote on whether to accept the terms of the CVA at a creditors’ meeting. Agreement will be needed from creditors holding at least 75% of the business’s debts.
Creditors’ Voluntary Liquidation (CVL)
If there is no realistic chance of saving the business, then a Creditors’ Voluntary Liquidation may be the best option. A CVL means that the owners of the business are taking the decision themselves to enter liquidation and close the business down.
In a CVL, a liquidator will be appointed to sell off the business’s assets and use any funds from this to pay off as much of the business’s debts as possible.
What creditors need to consider when dealing with toxic business debt
For a creditor of a business, the ideal scenario is obviously to get the full amount owed paid as quickly as possible. However, if a business is struggling to repay its debts, it may not be realistic to achieve this.
In some situations, a debtor will be proactive in taking one of the options set out above. In that case, you will need to consider the proposals carefully. Creditors will often have a say in the arrangements, whether by voting on a CVA or proposing a liquidator. Even if you are unlikely to be paid in full, you could improve your recovery by taking the right steps.
In other situations, debtors bury their heads in the sand. In that case, it may be necessary to consider getting a court judgment and enforcing it against their assets before other creditors get in first. Alternatively, you may need to consider starting insolvency proceedings yourself.
If you are a creditor of a business that is unable to pay its debts, you should therefore seek expert advice before taking action to ensure anything steps you take are in your best interests.
Get expert advice on dealing with toxic business debt
Dealing with toxic debt is a serious challenge, both for a business and its creditors. It is essential to seek expert advice at an early stage so you can make the best decisions from both a commercial and legal point of view.
Longmores has an established reputation for offering intelligent advice for a wide range of insolvency situations to businesses and creditors. We can help you to achieve the best possible outcome under even the most challenging circumstances. We also offer a fixed fee debt recovery scheme, including fixed fees for bringing insolvency proceedings against corporate and individual debtors.
To discuss how we can help with a toxic business debt scenario, please contact Longmores’ Partner Nat Young who will be happy to advise.