Administration – the pros and cons

My role as an insolvency practitioner entails me working with directors to identify and then implement the least worst option for their insolvent company.  I say ‘least worst’ because we do not live in a perfect world, no insolvency process ticks all the boxes, there is always a ‘hangover’.  And all processes have a hangover for any buyer of the business. 

Administration is a common ‘solution’ for large retail insolvencies.  The House of Fraser administration has given us the opportunity to remind ourselves of what’s good and what’s bad about administration generally, and I shall also draw out some of the difficulties House of Fraser’s new owners could be having going forward as a result of the process that’s been followed.  Here are the main Pros and Cons: 

Pros

  • Administration is a good way of writing off creditor debts that a company cannot ever hope to repay.  Creditors are held back, their actions stayed, then later on their debts are written off.  The appointment of the administrator can buy time to formulate a plan for reconstructing the business and/or freeing it of its debt burden.  Typically this is achieved by the administrator selling on the business and assets, debt free, sometimes after some ‘pruning’ of costs / employee numbers.  The additional debts created by such cost cutting by the administrator is written off as an additional unsecured debt, along with the other unsecured debts, rather than having to be met out of the company’s limited cash.
  • The administrator has immense powers, he can do virtually what he wants with the company’s assets, including those owned by third parties, for example assets subject to hp, lease and reservation of title.  I’ve already mentioned the potential sale of the business and assets as an option.  This can be conducted after a period of trading (generally unlikely, this is discussed below) or as in House of Fraser’s case, through a pre-pack – a sale conducted immediately following the administrators’ appointment- done to enable the assets to be sold quickly and without the unsecured debt burden.
  • Although the buyer of the insolvent company’s business takes on employee contacts ‘as is’ under TUPER, it does not assume responsibility for the company’s pension scheme deficit.  In the House of Fraser’s case, right now the deficit is estimated at £170m, two times what Ashley paid for the business and assets.
  • The combination of several of the above pros means that some jobs can often be saved.

Cons

  • Without a period under the management of the administrator, often the problems that led to the company’s failure are not resolved, they remain.  Any buyer of the business and assets still has a good amount of work to do to turn the business around.
  • Landlords cannot, unless the buyer’s covenant is good, be forced to take an assignment of the insolvent company’s leases over to the buyer.  Often – particularly in the case of retail insolvencies – the buyer would like to renegotiate completely new terms.  The problem is he does not have the best negotiating position – it’s just a case of ‘mutually assured destruction’ should negotiations fail.  That’s to say mere administration – if not conducted after a CVA – does not solve the problems caused by a company suffering from excessive property costs.  In the House of Fraser’s case, the new owner will have to conduct a good many tough negotiations with landlords as they try to agree cheaper property costs.  If those negotiations prove to be unsuccessful – there might be no business worth saving.
  • As employees are typically transferred under TUPER, the buyer has to take on many of their existing terms.  In those cases where the failed company has been overly generous, the buyer either has to renegotiate or terminate – whatever he chooses to do, it will be costly for him.
  • The buyer of the business cannot force people to deal with them.  Suppliers are hurting, they have lost money, they want payment for stocks the business is holding.  They might want to charge the buyer more for supplies going forward, or refuse to offer payment terms.  The buyer will have to carry out lengthy negotiations with key suppliers.  The viability of the business in its new form might be in question unless those negotiations prove to be successful.
  • As administration is a complex procedure, it is always a costly process.  Always upwards of £20,000 for even the smallest business, administration is not an appropriate solution for small insolvencies for costs reasons, even if there are commercial reasons making it so.
  • Like all insolvency processes, some business value is lost.  In the House of Fraser’s case, the banks and bondholders (who hold security) are going to lose three quarters of their money, and unsecured trade creditors and landlords will get virtually nothing back.  It can take a buyer years to rebuild that value, the company’s reputation.
  • It can be difficult, if not impossible, for an administrator to trade the company on under his control.  Suppliers and bankers cannot be forced to extend more credit, administrators won’t give any guarantees to lenders, customers can be difficult.  If it’s not possible to trade on and administration is still the most appropriate option, the only option may be a prepack.

The thing that you need to go away is administration deals only with some of the problems of a business, it does not deal with them all, any buyer has a good many of things it has to get right for the ‘new business’ to succeed.

Beware the precise wording of insolvency practitioners’ letters of engagement!

Beware the precise wording of insolvency practitioners’ letters of engagement!

When you as a director approach an insolvency practitioner for advice and support in connection with your insolvent company, the IP has to provide you with a letter of engagement.  The purpose of that letter is to set out:

  • Your legal responsibilities as a director
  • The legal processes that need to be followed to put your company in to CVL / Creditors Voluntary Liquidation (or similar), and in the period immediately after then (including the creditor decision procedure)
  • What the IP’s duties are and what you will do to help them fulfil those duties
  • How the IP gets paid
  • A good number of other things the IP must point out either because his governing body or law require him to do so.

The prime purpose of such letters is to ensure you and the IP both know exactly where each stand.

But do you really know where you stand?

I’ve been approached several times recently by directors looking for a second opinion, a different set of eyes, after they’ve taken advice from bigger firms of IPs.

And they brought with them the IPs’ letter of engagement… which in my view was impossible for the directors to fully understand because the letters were incredibly long, detailed and complicated.  But it goes further than that… a few words amongst the ten pages – which were explained erroneously by the work getter in the IPs’ firm – would have had a major impact on the directors.

Let’s explore this…

The basis of the IPs’ fees were explained in the letter – they would be paid an agreed sum for the work they did up to the date the creditors decide whether or not to allow them to carry out the liquidation, and then once their appointment was confirmed their fees would be agreed by the creditors, or in another way which the directors / shareholders had no input into.  Quoting one such case, £5k plus VAT, ie £6k up to the creditor decision date, but no figure estimated for their post decision fees.

The letter in that case said that ‘in the event that the assets of the company are insufficient to discharge our fees, any shortfall will be paid by the directors of the company personally.  The signature of the enclosed copy of the letter of engagement letter by the directors shall be evidence and confirmation of your joint and several guarantee of all monies owed to us’.

Tell me… how much have you guaranteed?

Nothing, because you hope the IP realises at least £6k.  £5k, the figure before vat (can the IP claim back the vat?)? £6k?  £10k?  £20k? More?

The point is you don’t know, you have no idea?  Did you notice the word ‘all’ in the last few words of the quotation?

Because of this you are guaranteeing the IPs’ entire fees, including that post the creditors’ position.

And you have no control over the his fees or the extent of his work post creditor decision – here his fees will probably be calculated as follows:

    1.  At his rate per hour per staff grade – you have no control over
      -what grade of staff they get to do what;
      – whether he asks the creditors to enhance his rates (he can do so under Insolvency Law if he thinks his work or the circumstances of the case make it appropriate he’s paid more) – and it’s the creditors who get to decide, not you; or
      – by how much he increases his charge out rates each year – you only know his current charge out rates – and as you will see, they are hefty)multiplied by
    2. The number of hours spent – post creditor decision, you have no control over:
      – what work they choose to do;
      – What complexities are caused by others, such as creditors, employees, HMRC etc
      – how many hours they spend;
      – how long the liquidation takes (the longer it takes generally the more time is spent).

All you know is it’s a minimum of £6k plus the reasonable fees of the IP post creditor decision date – work on at least double the £6k figure as a bare minimum.  In reality by signing the letter of engagement you’re signing a blank cheque in favour of the IP.

So was that explained to you?

No it never is – it’s always explained that you’re guaranteeing the IPs’ fees only up to the decision date, his costs after that are conveniently ignored, never raised with you.

And that is why it’s often a good idea to get a second opinion, even if you’ve been introduced to the IP by someone you trust such as our accountant – because the person who introduced you will simply not know about these issues, you’re putting blind trust in your adviser’s recommendation, blind trust that could cost you dearly.

If you would like to arrange a meeting for a second opinion, call me on 01902 672323.

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Been asked to personally pay the costs of liquidating your company?

A day doesn’t go by without me seeing at least one instance of a director being asked by an insolvency practitioner to personally pay the costs of putting their company into creditors’ voluntary, ie insolvent, liquidation.

If this is you, here’s a few questions for you…

What’s the insolvency practitioner said about your responsibility for paying those costs?

Were all of your options explained to you?

The answer to these questions is typically ‘not a lot’ and ‘I don’t know’, all that was said is ‘a CVL is quicker and more convenient way for you to close down the company’.

It might be, it might not be, but let me ask you another question, and this is the knub…

Can you do something better with your money – typically £2,500, £3,000 or £5,000 – like finance your new business, pay down personal debt, or even take a well earned break – than pay an insolvency practitioner’s fees?

Of course you can, because whatever way you look at it, spending your hard earned money – and I’m even seeing directors who go into personal debt on credit card to pay such fees, even after losing their sole source of income – on dealing with a historic issue isn’t great value for money.  Yes, there are low cost alternatives to a formal insolvency process.

So why is this happening?  Why am I being told that CVL is the best option?

Well, there are 2 reasons.

Firstly, insolvency is a incredibly complicated and grey legal area, it’s ever so easy for an insolvency practitioner to say ‘a CVL is the right route for you’ without that statement really being put to the test.

Secondly, many insolvency firms depend on selling directors what I would argue are bad solutions to survive themselves – unless they pile small CVLs high and sell them cheap, the insolvency firm would itself be bust!

It is time for some uncomfortable truth...

There is nothing in the law that says any director has to use his/her own money to personally pay for the liquidation of their company.

Let’s repeat that so it hits home…

There is nothing in the law that says any director has to use his/her own money to personally pay for the liquidation of their company.

You see the law only says you have to stop making the creditors’ position any worse.  Sometimes you can do that by simply ceasing to trade.

But there’s a problem…

You still you need closure.  You need to close down the business and the company.

The secret that many IPs would like to keep from you is that can be achieved without you throwing your own money down the drain.  Ask us how you can do that.