UK: Restructuring & Recovery Quarterly Bulletin: Back On Track? - Summer 2012


By Anthony Spicer

Welcome to the summer 2012 edition of the Restructuring & recovery bulletin.

Paul Wood from our Bristol office explains the rise of 'zombie' companies and their continued impact on UK businesses.

Recent research suggests that, despite a summer blessed with the Queen's jubilee celebrations, the Olympics and the European football championships, the licensed trade is still a fragile market to operate in. Colin Hardman explains the issues and how operators and their lenders can better foresee and deal with problems.

Also in this edition, Michael Quach and David Blenkarn provide a round-up of recent UK market trends and the outlook for our industries.

Finbarr O'Connell and Liam Clarke provide an explanation on how Smith & Williamson's broad experience in the agricultural sector reaped significant rewards in a recent trading administration at a fruit growing business.

Finally, I am delighted to introduce Paul McConnell who recently joined us as a partner in our Worcester office and who provides some examples of his vast experience.

As always if there are any subjects that you would like to include in future bulletins please let us know. In the meantime, enjoy the rest of the summer.


By Paul Wood

Zombies – they may remind you of the slow walking mindless undead of many a horror film but the term is increasingly cropping up in relation to thousands of companies. Paul Wood discusses why this is.

The zombie walk

The origins of the credit crunch are well documented. In the subsequent recession, as well as struggling with difficult market conditions, businesses in the UK find it difficult to obtain credit from traditional lending sources and many have therefore looked to survive by other means. This often involves taking extended credit from suppliers, entering into time-to-pay agreements with HMRC and/or freezing or reducing payments of capital to banks and other lenders.

Some businesses have accrued so much debt that they have little prospect of ever being able to repay it. The directors of these businesses continue working each day with no end to the misery in sight as the recession continues to bite and the infection continues to spread. It is not difficult to see how the zombie term came about.

Spreading the zombie infection

Suppliers, reluctant to lose what may be a key customer, succumb to the will of zombie companies and become increasingly exposed to them so that eventually they cannot afford for their zombie clients to fail. This cascades down the supplier chain, with each debtor in turn deferring payments and causing many more companies to become infected with the burden of the original zombie company's debt.

Secured lenders have also been supporting these zombie companies, so that they often cannot afford to enforce their security when the zombie company is unable to pay. As the value of the assets of these companies withers away and decomposes, secured creditors are realising that the zombie companies have little or no inherent value and that there is significant risk of default and loss. While we expect that lenders have appropriately impaired these loans in their own accounts, achieving an acceptable exit is often far from easy.

Zombie death

Recent research by R3 suggests that this infection has spread to around 146,000 companies and that 8% of businesses admit to only being able to service the interest (not the principal) on their debts. Given their debts, the loss of a significant customer, the failure of a key supplier or even a modest increase in interest rates would tip many of these businesses over the edge.

The whole UK economy now risks many years of depression as these businesses continue to infect corporates and financial institutions in the UK and abroad.

The only option left for many of these creditor companies is to cut off the life blood of these zombie companies – namely the extended credit. As in all previous recessions, a proportion of these businesses need to fail to allow healthy businesses the space to grow and pull the economy out of the doldrums. This recession is no different. These zombie companies are tying up capital and resource that could be put to better use elsewhere in the economy. The fact that the infection has spread so virulently will make any correction drastic in its effect; many businesses will go insolvent with the loss of thousands of jobs.

However, strong healthy businesses will be left, with directors that have taken appropriate steps to secure the long-term viability of their companies. This is an extreme measure, which may be a politically and socially difficult pill to swallow, but it is the only way the UK economy can return to strong, sustained growth.

The big question is what will be the catalyst for this to start?


By Colin Hardman

While the pub sector is showing signs of stabilisation after a number of difficult years of trading, there is still cause for concern for operators. Those who cannot react quickly to change should be particularly wary.

In recent years the licensed trade industry has suffered from the triple whammy of changes in government legislation (e.g. the smoking ban), falling consumer confidence and the recession. Price competition, driven in particular by oversupply and supermarket discounting as well as increasing costs (e.g. beer duty, business rates, wages and utilities) has had a sobering effect on gross margins.

Stable but fragile

2012 has seen some stabilisation in the industry, at least partly due to the exodus of competition from the market in recent years. Christie & Co has recently predicted that a further 2,500 pubs need to close before the sector can be competitive again. Household budgetary constraints will continue to have a negative impact on the sector, as it will for the leisure industry as a whole.

According to a recent survey by the Association of Licensed Multiple Retailers, costs finally appear to be stabilising this year, although gross margins were still down by 6% against last year. If there are any further cost pressures (for example if the proposed plans for 'tax stamps' on all British bottled and canned beers is introduced) then the fallout from the sector could be significant.

Debt burden still high

Many operators will also be suffering from the cost of servicing debt taken on in the pre-2008 halcyon days of the industry. Lenders have of course been increasingly concerned by the falling loan-to-value ratios on those customers' borrowing against their real estate assets. However, over more recent years, lenders appear to have gained sufficient clarity regarding their exposure to actively manage their portfolio of distressed customers.

There is certainly evidence of this at both ends of the transactional market, with an increase in deal activity levels (albeit with a heavy persuasion toward cash buyers) and also in formal insolvencies (a number of which we have acted on). Furthermore, there is little evidence of significant lending being made available to small and medium-sized operators.

Smith & Williamson has recently been involved with a number of administrations and Law of Property Act receiverships of licensed premises (including nightclubs, restaurant and hotels). In most of these cases the businesses were trading for a period and sold as going concerns.

Sector trends

Looking within the sector, there are variations in market performance. Geographically, London and the Home Counties are performing better, benefiting in recent months by the weather wash-out, the Queen's diamond jubilee celebrations and Euro 2012. It will be interesting to see where the level of demand will settle after the world has gone home after the London Olympics. A more frequent and careful review of performance against budget by operators and their traders is advisable.

The types of operators who are stealing a march on the competition are those in the value pub market (but only those who have strong controls over their cost base) and the niche, food-led operators (at the expense of the casual dining restaurants). It is becoming increasingly more important for local management to differentiate their businesses from the competition. They need to be able to anticipate their customers' requirements, price their products appropriately and buy in the necessary resources (in particular food, drink and staff) in the appropriate quantities to be competitive. Those who can predict these and adjust quickly to changes in the market will be the survivors and indeed the winners.

Proactivity is crucial

Faced with this challenging environment, it is our experience that many operators have ignored the warning signs of falling trade and diminishing profitability, disregarded mounting creditors and not kept lenders informed of potential cash crises. In short, under-performance can often be down to weak management, e.g. poor marketing, lack of controls and a failure to assess and react to changes in the market quickly.

Too many proprietors do not produce timely monthly profit and loss accounts. Starved of management information and, consequently, with no way of obtaining and reacting to key performance indicators, businesses predictably start to slide. In turn, when a client defaults on a loan or its lender has problems obtaining the information it needs to help it assess the extent of the client's problems, a loss of confidence can ensue.

Lack of management/trading information can be a significant barrier to a sale of a business in the sector, regardless of whether that sale is by management or through an insolvency process. In our experience, value will not hold up unless proper trading information can be provided to prospective purchasers. Lenders should ensure that all of their customers are producing relevant and reliable management information, especially where an exit strategy is likely in the short or medium term.

Independent business reviews (IBRs) provide an opportunity to assist operators improve their business, set it on a firmer footing and rebuild its relationship with its lender. Where it is concluded that management does not have the capability and/or the confidence of its lender, then assistance can be provided by Smith & Williamson, often alongside specialist interim pub operator companies, to improve performance as part of a turnaround/exit strategy.

With strong management manning the (beer) pumps, looking at the fundamentals of the business, producing meaningful accounts that can be used to monitor key performance indicators, implementing financial controls, focusing marketing efforts and embracing the process and the recommendations of an IBR, it is often possible for operators to work their way out of trouble.


By Michael Quach and David Blenkarn

The UK economy slipped back into a technical recession in the latter part of 2011. Real gross domestic product contracted by a further 0.3% in the first quarter of this year following a 0.3% decline in the fourth quarter of 2011. This left the level of output some 4% below its prior 2008 recession peak. The recent downgrading by the International Monetary Fund of the UK's growth forecasts (down from 0.8% to 0.2% this year and 2.0% to 1.4% next year) is a further warning sign that economic recovery will not be swift.

The main drags on the domestic economy continue to be the ongoing severe squeeze on real household incomes (which in turn adversely impacts on consumer spending), deleveraging in the private sector (with households and non-financial corporations having started to reduce their debts) and exposures to the European economic and financial crisis. The impact on the UK of problems in the eurozone are from reduced trade, increased bank funding costs as the crisis has intensified and a fall in private sector confidence. It will take time for the financial sector and credit conditions to normalise.

Support for the economy comes from the ultra-loose monetary policy employed by the central bank and a large depreciation of sterling in recent years. The prospect of a further period of soft economic activities points to a growing need for additional policy measures by the authorities.

Lending to private non-financial companies continues to be sluggish, while borrowing rates on mortgages and loans have risen. The Monetary Policy Committee's preferred measure of M4 money supply has continued to decline and is significantly below its peak in 2009. The other important effect of the current uncertain climate has been to dampen confidence among businesses and households.

Despite the depth of the recession over the last four years, the number of corporate failures through liquidations and administrations has fallen rapidly from the initial peaks of 2008/09. The levels of failures are now on a par with the comparative economic boom times of the early 2000s.

The reasons for the rapid reduction in failures are numerous: low interest rates, high levels of support from banks to struggling businesses, the time-to-pay scheme operated by HMRC and businesses generally adjusting to a new, lower, level of economic activity.

Despite government cutbacks, our national debt is continuing to rise unabated and by 2015/16 will have risen by 59% over the level in 2010/11 to £1.4 trillion. With the UK dependant on its international credit rating to suppress the interest rates charged on our national borrowings, there are difficult economic questions over whether to reduce the cuts in government expenditure or not.

With a backdrop of slowing global growth, further questions are likely to be asked over the Chancellor's austerity drive if the public sector net borrowing position deteriorates further and, moreover, growth continues to flat-line. We still believe that more creative growth policies from the Coalition Government might be needed if the economy is to gain greater traction in its recovery from the financial crisis.


By Liam Clarke and Finbarr O'Connell

Liam Clarke and Finbarr O'Connell explain how tax consequences need to be managed and cultivated in the right way.

In a recent agricultural administration appointment taken on by our London restructuring team, the need was highlighted for purchasers of businesses, and indeed insolvency practitioners selling those businesses, to consider all assets of a company, including the company's tax losses.

Sector overview

The agricultural sector, like many sectors of the UK economy, is struggling with the fact that the current economic forecasts are as bleak as this year's British summer weather forecasts. The recent media and political discussions relating to dairy farm production, and specifically milk prices, highlights the extreme pressures farmers and food processors are currently facing.

Despite the desire of the average UK consumer to support UK growers and producers, the marriage between the UK farmer and the national supermarket chains is a difficult one. The supermarkets' ability to control their own margins and supply chains does not fit well with the average farmer's increasing costs. Yes, the supermarket chains have recently increased farmers' dairy income, but some cynical observers have commented that this has more to do with ensuring the supermarkets' supply of milk by preventing the suppliers going out of business.

Sector expertise

Smith & Williamson's restructuring and recovery team has considerable experience of farming assignments. We have strong connections with farmer-controlled businesses (FCBs), landed estates and farmers, and have worked closely with food companies, including processors, manufacturers and retailers. These involvements have included giving strategic advice and assistance with regard to the acquisition and sale of agri-businesses. Our restructuring practitioners have undertaken a number of agri-business administrations and are familiar with the market-specific issues that an insolvency practitioner will often encounter in these types of assignments, in particular:

  • supermarket relationships
  • farm business tenancies (FBTs) and how these might affect the holders of legal charges
  • weather damage and insurance for it
  • labour management, including migrant staffing issues.

Within the Smith & Williamson group we also have individuals who are heavily involved in the agricultural sector. Steve Ellwood, head of our food and agriculture group, was formerly head of agriculture at HSBC Bank plc. Steve, who serves on the board of a number of food companies, has influential connections with the Food and Farming Foundation (FFF) of which Smith & Williamson is a main sponsor.

Philip Moody, head of corporate finance at Smith & Williamson, is also actively engaged in the agricultural sector. He is a director of FFF and is currently on the board of Openfield Group Limited, a leading grain marketing FCB that works with 7,000 arable farmers across the UK.

Our support of FFF and European Food and Farming Partnerships (EFFP) helps EFFP to develop its role as a specialist agri-food business consultancy. EFFP is aimed at facilitating greater co-operation between food companies and farmers, and also securing a profitable and sustainable future across the food supply chain. Its activities have also been backed by farming and food businesses as well as by governments.

Retention of tax losses

A recent approach to Smith & Williamson for a formal appointment over an agricultural business resulted in the administration of a multi-site trading business with operations throughout the UK. The trading locations and nature of the business allowed our London team to draw on our other offices based throughout the UK to assist in the day-to-day management of operations, as well as bringing in Smith & Williamson's specialist forensic department to assist with investigations into the company's pre-administration affairs.

After a period of post-administration trading and extensive marketing of the business, the company's most significant creditor made the best offer for the business. The creditor in question had been a joint venture stakeholder in the company's business operations prior to administration.

The existing commercial arrangements and offer made by the creditor enabled a combined approach between the purchaser's tax agents and the Smith & Williamson corporate tax team, headed up by Mark Webb. Working together the team recognised that the situation allowed for a sales process that could retain tax losses, despite the background of a formal insolvency process, together with other advantages for the purchaser.

Yielding a better return for creditors

In short, from a position where frequently there would be no tax losses accruing to the purchaser of the business, significant tax losses were preserved and additional benefits were identified.

The sale structure as a whole resulted in tax losses being maintained which helped to maximise the return to creditors by enhancing the going concern value of the company's business. The case highlights that in appropriate circumstances, i.e. where the commercial deal allows, tax planning can help to yield a better return to creditors.


An introduction to Paul McConnell, our new restructuring and recovery services partner.

The late Lord Mishcon said in Parliament when the Cork Report was debated in the 1980s, as a prelude to the introduction of the major reforms of the Insolvency Act 1986, that: "Insolvency is neither an interesting nor amusing subject."

I have to say, with respect to the late Lord of course, that I tend to disagree; I have seen some very funny things over the years and met some extremely interesting people. My insolvency career has been in three parts: I started with The Official Receiver investigating 'long firm' and other frauds; I then joined a 'big six' firm and spent 17 years dealing mainly with personal insolvency and tracking down 'disappeared' assets around Europe. I dealt with many high profile individuals in that period – soap stars, rock legends, sports stars – and had several first division (as was) footballers on my books at one stage.

During these years, I saw and helped unravel scams of every sort, including those involved with wine, coins, whiskey, diamonds, gold bars and Ponzi schemes. We even had a part to play in the 'ostrich scam' and one of the managers in the office was very shocked because he had seen their promotional video before it imploded and had thought that it was a very good idea.

I've spent the last 12 years dealing with smaller owner-managed businesses, companies, sole traders and partnerships. It is very satisfying to be able to see the stress drain from the faces of those business owners when they get good advice that they can rely on and they realise that while the situation is often bad, it can be managed. In an idle moment I worked out that I really have dealt with every type of business from A to Z (although I did have to shoehorn 'radiographer' into the 'X' category).

A story is a great way to show-case what we do and I have had several 'learning experiences' over the years.

  • In a case of extreme irony, the perpetrator of a particularly nasty Ponzi scheme aimed at pensioners, was himself scammed by a French national, accelerating the demise of his own business. We then had to try and recover investments in a chateau restaurant and properties on a south of France naturist beach (there must be a joke there about asset stripping, but it is sadly just out of reach).

    I learned from this case never to let a fraudster know your travel arrangements. Both myself and the lawyer accompanying me were removed from a packed plane by security at Charles De Gaulle airport as someone had phoned the airline to say that we looked suspicious and should be double checked. The fraudster subsequently went to prison for four years.
  • While running an exotic bird garden during a going concern sale, I noticed that an interested party seemed more concerned as to the poses struck by the larger birds than the last accounts; he turned out to be a taxidermist. We didn't sell him anything!

    I also made the mistake of showing my very straitlaced in-laws round at closing time, forgetting that one particular hyacinth blue macaw would roost at the exit gates and encourage visitors in fairly blue language to leave the premises quickly. They say he started to develop a Belfast accent, but that is pure conjecture...

    The bird garden survives still and some of 'our' penguins appeared in one of the Batman movies.
  • It has also helped me over the years to have what my wife calls 'the luck of the Irish' on my side. We took possession of a rented property to find that the tenant had left behind a collection of dangerous snakes, a cobra and a boa constrictor among them. Just by chance our agent had a licence to handle snakes and was able to deal with the situation – what were the odds!

I hope that this next phase of my career with Smith & Williamson will allow me to continue to treat those in genuine trouble with compassion and to bring all my experience to bear on those (thankfully few) who abuse a privileged position.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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