UK: Insolvency - Recession and Recovery
1992 and All That

A decade ago the UK economy was in crisis. The hangover from the high spending and rampant inflation of the late 80's had kicked in and the Government was forced to execute an embarrassing withdrawal from the ERM. In 1992 there were a record 24,425 insolvent liquidations.

If this was a low point, it did at least mark the beginning of a period of sustained economic growth. Indeed, by 1997 the incidence of insolvent liquidations had almost halved to 12,610 companies.

In the last 18 months this economic upturn has wilted. At the beginning of October Experian announced figures showing a jump in business failures. In the first 9 months of 2002 business failures in the West Midlands rose by a startling 21.7% on the same period last year, with another significant rise of 11.9% in the East Midlands. The fear is that history is repeating itself.

Yet there are differences between the position 10 years ago and the current situation. Despite problem sectors, the UK economy as a whole is benefiting from stable currency and interest rates and has been out-performing the USA, Japan and most of Europe.

Meanwhile, the type of companies facing financial difficulties has changed. In the early 1990s the manufacturing and construction industries showed the highest levels of insolvency. UK manufacturing may have slipped into recession in 2001, but companies in the service industry are now feeling the pinch. This is a reflection of the UK's development of a service-based economy.

As service companies with no "real" tangible assets are now failing, so asset recovery levels have dropped. Statistics produced by R3 (the Association of Business Recovery Professionals) show asset recovery dropping from 23 pence in the pound in 1996 to 15 pence in the pound in 1999, despite an increased use of recovery procedures.

In the early 1990's banks were accused of appointing receivers too quickly, realising assets for themselves at the expense of businesses and jobs. The DTI and the Treasury believe that this caused many companies to fail unnecessarily.

Now banks are showing greater willingness to work in partnership with companies and their advisers by using "rehabilitative" measures. The benefits are only available if a company's management adequately monitors performance and is prepared to consult professional advisers at the first sign of difficulties. Business recovery specialists would like management to see them as business advisers who can effect "turnarounds" given the opportunity. Indeed, a formal insolvency procedure would be a result of a failed turnaround.

Formal rescue procedures include Administrations and Company Voluntary Arrangements. These provide a company with protection from or the co-operation of its creditors respectively, allowing it to re-structure its finances so that:

• Jobs are saved;
• Equity investments in a company are preserved; and
• Levels of asset recovery for the company's creditors are increased.

Observers predict weaker economic growth in the UK over the next year, and businesses are likely to continue to fail at an increasing rate. Whilst the property boom is easing slightly, there is still a danger that demand fuelled by consumer credit will slow and drag the UK economy into trouble. Meanwhile the world's stock markets continue to be bearish and there is the looming threat of war in Iraq.

All these factors give rise to the possibility of various "sector-based" downturns. For example:

• Energy The price of electricity on the wholesale market has dropped 40% in the past four years, forcing the Government to bail out British Energy to the tune of £650m.
• Retail companies are vulnerable to a drop in consumer confidence. Retail prices are actually dropping, and only sales are propping up the sector. War, rising interest rates, collapsing property prices or unemployment fears could all knock this prop from under retailers.
• Manufacturing is facing hard times, with the strong pound making exports expensive and multinationals publicly discussing closing down UK factories unless the UK quickly adopts the Euro.
• Transport and Distribution Recent failures include TSL and John Cox Transport of Staffordshire.

In March 2003 the Government hopes to bring the Enterprise Bill into force, significantly reforming insolvency procedures. The Bill attempts to shift power from the banks to management by ending the banks' right to appoint receivers. The Government hopes to promote the use of rehabilitative measures, and in particular a reformed administration procedure entered into without a court order. Australia has recently introduced a similar system known as voluntary administration. This has proved popular amongst Australian banks despite the continuing existence of receivership.

The Australian experience has been a success for the various stakeholders:

• Management supports the process as it often remains in office under the supervision of the administrator.
• Secured creditors such as banks are not bound by any resulting company arrangement unless they consent, so they often provide funding and rarely attempt to frustrate the administration's objectives.
• Unsecured creditors benefit from higher asset recovery levels.

Post-Enterprise Act administrations will be quickly and easily commenced by stakeholders and will feature defined time limits. If the Australian experience is a good indicator, these factors should further encourage banks to participate in the recovery culture. Management can capitalise upon this trend by calling in business recovery professionals at an earlier stage, giving them the time required to effect turnarounds.