Solvency considerations for purposeful businesses

A coronavirus guide.

If you’re a social enterprise, a B Corporation (B Corp) or another profit-with-purpose business and you have concerns about the solvency of your business through the Coronavirus crisis, we’ve prepared this guide. Lenders to such businesses may also find it useful.

If you are a charity, please read our guide on Charity Insolvency and Rescue Mechanisms.

Due to the impact of the coronavirus, many businesses will be facing cashflow and resourcing difficulties, which could have an impact on their ability to meet obligations to their lenders. This could include, for instance: delays in the ability to produce financial statements and annual reports (which could lead to breaches of information undertakings under a loan); an inability to pay interest or other payments (payment defaults); breaches of financial covenants (for example requiring certain financial ratios to be maintained); or a default under one loan triggering defaults under other loans (cross-defaults). You can read more in our guide on Coronavirus and contractual obligations.  

Lenders are encouraged to consider the impact of COVID-19 on businesses

The Financial Conduct Authority (FCA), Financial Reporting Council (FRC) and Prudential Regulation Authority (PRA) have issued a joint statement to help companies preparing financial statements, while also ensuring that information continues to flow to lenders and investors in the current uncertain climate. In summary, the regulatory authorities have strongly encouraged investors and lenders to take into account the unique set of circumstances arising from COVID-19 which might result in uncertainty in companies’ financial positions, and potential delays in the provision of financial information. They have strongly encouraged lenders and other parties to take into account these circumstances in responding to potential breaches of covenants arising directly from the COVID-19 pandemic and its consequences, given the common goal that the financial system should be a source of strength for the real economy during this challenging period.

Lenders that specifically lend to profit-with-purpose or social businesses may be more willing to take a collaborative and creative approach to borrowers’ financial difficulties during this period. In relation to social enterprises in particular, a significant number of social investors have indicated that they are looking to work with borrowers to provide flexibility during this period, and to work with government to identify further support options.  

Given that B Corps and other profit-with-purpose businesses seek to positively impact multiple stakeholders, lenders may find that their approach to financial difficulty emphasises sustainable, long-term functionality of the business rather than solely focusing on financial metrics affected by the pandemic. This stakeholder approach is likely to influence to how these businesses approach their relationships with their staff members and the communities they serve, as well as their creditors, during the crisis.

New government proposals to protect companies

The government is planning emergency legislation to enable companies undergoing a rescue or restructure process to continue trading, giving them breathing space that could help them avoid insolvent liquidation, and to temporarily suspend wrongful trading provisions  for a period of three months. This suspension will apply retrospectively from 1st March 2020, but we do not know when these new provisions will be introduced.

Currently, there is a form of de-facto moratorium for winding up petitions as the High Court has given a blanket adjournment to any creditor winding up petitions to June 2020 at the earliest.

This suspension will temporarily suspend the threat of personal liability for directors of a company if it eventually falls into insolvency. The aim is to encourage companies to continue trading and keep people employed during this time.

The government has also suggested that they will fast track proposed legislation to allow a moratorium on the ability of creditors to force companies to wind up their operations and the protection of essential supplies during this moratorium period.

The government has not yet announced any Covid-19 specific amendments to the directors’ duty regime in the UK and it is expected that the existing laws on fraudulent trading and director disqualification will continue.

Rescue mechanisms

There are various rescue mechanisms available to companies facing financial difficulties.  If you have reached this point, you will need to appoint an insolvency practitioner and should take legal advice. These mechanisms can be expensive and, depending on your individual circumstances, you may choose to engage in an informal rescue procedure with creditors. These rescue mechanisms are relevant to all forms of limited company, including companies limited by shares, companies limited by guarantee and community interest companies.

Company administration

In an administration, an insolvency practitioner is appointed as an administrator for a company in financial difficulties. The administrator must try to achieve one or more of the three following objectives:  to rescue the company as a going concern (i.e. as a solvent company); or(if the first objective is not possible), to achieve a better result for the company’s creditors than would be likely if the company were wound up (without first being in administration); or(if the second objective is not possible), to realise the property of the company in order to make a distribution to creditors.

There are three routes into administration: (i) by court order; (ii) by a notice filed at court by the holder of certain types of security (known as a ‘qualifying floating charge holder’); or (iii) by notice filed at court by the company or its directors.

A key feature of the administration process is that it includes a statutory moratorium, which is essentially a period during which creditors cannot take certain enforcement actions against the company except with the consent of the administrator or the court.

This means that: the company may be able to continue operating through the administration; jobs can sometimes be saved; the statutory moratorium stops any legal action being taken against the company by its creditors, which prevents the financial position of the company becoming worse; and this in turn reduces the risk to directors of wrongful trading claims.

Company Voluntary Arrangements (CVAs)

A CVA can be used by an insolvent company to pay its creditors over a fixed period and/or to accept a reduction in their debt. In certain circumstances, if the creditors agree, the company can continue to deliver its services and operate through a CVA. 

A CVA is implemented through a CVA agreement, which binds all unsecured creditors (including known and unknown creditors), but only binds secured creditors or certain ‘preferential creditors’ (e.g. certain employee claims and contributions to pension schemes) if they agree to the proposals. A secured creditor is one that has a charge over the company’s assets.

Unlike an administration, a CVA does not automatically result in a statutory moratorium to protect the company from creditors taking action to recover their debts. However, certain companies can currently opt to take the benefit of a 28 day moratorium (by application to the court for a CVA moratorium).

A CVA can allow the company to continue operating with its directors retaining control. It allows for creditor pressure to be taken off the company and enables it to write off or reschedule repayment of unaffordable debts.

Pre-pack sales

A ‘pre-pack’ is not a special type of insolvency procedure; it is simply a term used to describe a sale of the business or assets of an insolvent company by an insolvency officeholder (typically an administrator), where the preparatory work (identifying the purchaser and negotiating the terms of the sale) has taken place before the appointment of the insolvency officeholder. The sale is then concluded almost immediately after the appointment of the insolvency officeholder. A pre-pack does not require the sanction of either the court or creditors and may be used in circumstances where it may not be an option for an administrator to continue operations.

A pre-pack sale generally limits the value-destructive effect of an insolvency filing and can often save more jobs than an administration.

Other options

The government has announced various forms of support for businesses, including through the Coronavirus Business Interruption Loan Scheme. Businesses should check that they are making use of all appropriate business support schemes available through this particularly difficult period, and should remain in close contact with lenders to discuss all options to ensure business continuity at this time.

For further information please contact your usual Bates Wells advisor or Luke Fletcher ([email protected]), Sung-Hyui Park ([email protected]) or Keya Advani ([email protected])