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Understand insolvency – and keep your business safe

11 June 2010

As hospitality insolvencies continue to soar, Robert Burns looks at how to stay out of trouble and keep the cash flowing.
It is more than a year since Gordon Ramsay breached the terms of a £10.5m loan and was advised by his bank to place his company into administration. While Ramsay was able to raise the finance he needed to avoid insolvency, many less well known businesses have not been as fortunate.

Officially, the UK is now technically out of recession, but the fragile economy and, more precisely, the health of all our small and medium-sized enterprises remains a hot and often controversial topic, not just for the new Government, but in the minds of the general public.

Nowhere has this been more evident than within the hospitality industry. In 2009 more than 2,000 businesses failed in this sector alone, 60% of which were hotels or restaurants. This marked an increase of 5% over 2008. A further 340 tried to save their businesses through procedures that included receiverships, administrations, and company voluntary arrangements.


How it works

With so many businesses leaving the industry because of financial failure it is more important than ever that everyone from company director to employee understands how the insolvency regime works.

Insolvency Service chief executive Stephen Speed says the service aims "to create a fair and straightforward environment for businesses struggling with debt, whilst working to secure the best results for creditors".

This is carried out through a statutory framework - mainly using the Insolvency Acts 1986 and 2000, the Company Directors Disqualifications Act 1986 and the Employment Rights Act 1996.

The Insolvency Service's staff are responsible for administering and investigating the affairs of all bankrupts, companies and partnerships wound up by the court and establishing in the process why they became insolvent.

At the service we are responsible for regulating the insolvency profession, advising the Government on insolvency law, and taking action against wrongdoing or abuse through the investigation and enforcement team - something which is critical to maintain business confidence.

We take effective action when misconduct is discovered and ensure that dishonest, negligent and incompetent people are excluded from the business world. This includes investigating companies which may still be trading, using powers under the Companies Act.

This was the case with one Surrey-based wine investment company which, following an investigation by our company investigations unit, was found to offer potential investors wine at prices that were up to 90% higher than those offered by other sellers. People who purchased the wine were, therefore, likely to have suffered loss or, at the very least, not achieved the return on their investment that the company's literature had promised.


Investigation

The business refused to co-operate with our investigation, and it was unclear whether any wine had ever even been received by their customers. Following a hearing at the High Court, the company was wound up in the public interest. This case represents a classic "too good to be true" opportunity, with investors seeing no return on their capital. That's why we urge all reputable businesses, as well as the public, to be vigilant in checking all the facts before making an investment and, where necessary, getting professional advice.

At the Insolvency Service we are committed to protecting good businesses and the public from unscrupulous companies. But it is not just businesses that can be stopped from trading. We will also, when necessary, use our powers to disqualify individual company directors.

Each month more than 100 company directors are disqualified for wrongdoing, fraud or other misconduct. Once disqualified they cannot take part in the formation or management of any company for as long as 15 years - as the company director of a restaurant and catering business in Blackpool found out.

The director failed to obtain any employee liability insurance despite being legally required to. When two of his employees were seriously injured working in the restaurant they were unable to make claims for compensation worth an estimated £11,000. He also failed to pay VAT or make national insurance contributions worth £64,394.

The business failed and was placed in voluntary liquidation. As the result of an investigation by our company investigations unit he was also disqualified from acting as a director for six years.

In the current economic climate it is more important than ever that good businesses have the help they need to remain solvent. However, if a business does get into difficulty, it is critical that its principals understand the insolvency regime and are familiar with their statutory responsibilities and the measures they can take to protect their company.


10 practical tips for avoiding corporate insolvenc

Impose strict credit-control and debt-collection procedures of your own. Guard against the "domino effect". Deal only with customers who will pay their debts. Insolvency practitioners estimate that 27% of corporate insolvencies are triggered by another company's insolvency.

Make sure that you have a broad customer and supplier base, as relying on a few customers can be crippling if they default on payments or fail. If your debtors are not paying on time, chase them up. By allowing them to owe you money you are financing their business.

Stay up-to-date with all Crown payments. If you have cash-flow problems, ask for a "time to pay" arrangement from HM Revenue & Customs. So far it has been sensitive to the needs of business in this recession. However, this must be viewed as only a short-term fix. Money deducted from salaries and VAT does not belong to the business.

Don't "max out" the business overdraft each month. Coming out of the recession, make sure you have sufficient capital reserves to take advantage of opportunities. Have either cash reserves or access to borrowings through your bankers.

Produce a business plan, with forecasts. A business plan gives strategic focus to the business. Ensure that actual performance is monitored against forecast.

Pay accounts on time, not on receipt of writ, and benefit from discounts.
Late payment of bills sends out a clear sign to suppliers, who will eventually grow weary of your ways and may refuse to supply. Pay on time to take advantage of early-payment discounts and create goodwill with your supplier. You may still need to call the favour in. If you are not able to pay, seek an extension from your supplier.

Don't hold a large amount of stock in relation to turnover/profit. In the upturn the challenge is to have the stock to supply the needs of your customers promptly - this is when you will need to carry some stock. But see if you can arrange "just in time" supplies with your key suppliers, as it will minimise stock carrying costs.

Is your accounting system fit for purpose? Have a system that produces the information you want on a timely basis. Also, be on good terms with your bank manager, keep them informed of developments, whether good or bad, and provide management figures regularly.

Don't put off seeking professional help. The sooner a business in difficulty seeks professional advice the greater its long-term chances of survival. Seek professional advice from a regulated professional or reputable trade organisation as soon as possible. Seeing an insolvency practitioner can give you the best chance of turning your business around and avoiding insolvency - they usually offer their first hour of advice free.

Don't put personal assets at risk. Avoid committing personal assets to the business without taking independent advice first.

Review for underutilised assets and unnecessary costs. Assets should be made to "sweat" and work for the business. Surplus assets should be sold to generate cash. Cost savings will also enhance cash-flow.

Source: R3, the insolvency trade body

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