Is your contractor limited company one of the Bank of England’s all-but predicted failures?

A spike in insolvencies following the lifting of certain Covid-related caps on creditor enforcement is now no longer just anticipated by business rescue experts like me; it’s now actually all but predicted by the end of the year, and inevitably, unfortunately, contractor companies will be among the collapses, writes Gareth Wilcox, partner at Opus Restructuring & Insolvency

In fact, the Bank of England (BoE) has advised that a third of UK small businesses are ‘highly indebted’ (greater than 10x cash) causing financial pressure in many sectors, and storing up “likely” insolvencies as repayments fall due.

What were the covid caps on creditor enforcement?

Following the onset of the pandemic, the government implemented the Corporate Insolvency and Governance Act 2020 (CIGA). This provided a raft of protections for companies including forbearance with statutory filing requirements, a suspension on wrongful trading and a prohibition on creditors presenting winding-up petitions except in very limited circumstances (where it could be proven that the debt did not relate to covid).

The majority of the restrictions, such as the filing forbearance and wrongful trading provisions have gradually been wound-down, as lockdown restrictions have been lifted by the government. The final restrictions which are in place (at the time of writing) are that:

1. Landlords are precluded from presenting petitions based on outstanding commercial rent;
2. The debt threshold required for a petition to be presented has increased to £10,000;
3. Creditors are required to seek repayment proposals and give 21 days for a response before they can proceed with a petition.

These measures will remain in place until at least March 31st 2022.

Why is a spike in insolvencies foreseen?

Even the most casual observer will appreciate that covid has had an enormous impact on businesses, with successive lockdowns reducing turnover in many sectors and forcing workforces to remain at home. 

While insolvency figures were substantially reduced in 2020, this was largely attributed to the support measures in place for business, including those mentioned above, the ‘furlough’ scheme, and the availability of government-backed loans to support cashflow. Indeed, the BoE says (on page 19 of its report) that the UK has seen at least 6,000 fewer insolvencies since the start of the coronavirus (than might have been expected given the average level of insolvencies in the years leading up to the pandemic).

But as these measures are withdrawn, the BoE understandably worries about an upturn in insolvencies due to businesses struggling to repay liabilities incurred during the pandemic. Notably HMRC, for example, has said that it expects to resume recovery processes and those businesses which took Bounce Back Loans, or similar, are now being approached for repayment by their lenders. And while the government provided a guarantee for such loans, it is down to the lending-bank to seek recovery from the borrowing company in the first instance, which is currently a significant cause of financial distress for many companies.

As to contractors, there are broadly speaking three insolvency scenarios which can arise from the strain businesses have so far been able to mitigate:

1. A contractor’s engager enters into an insolvency process;
2. A contractor is required to place their limited company/PSC into an insolvency process;
3. A contractor (perhaps as a result of one or both of the above) has to consider a personal insolvency process.

What if my engager enters an insolvency process?

In the current environment, it is entirely possible that a number of businesses which employ contractors will face insolvency proceedings. 

Unfortunately for contractors, the straightforward answer is that the debt owing to them ranks alongside all other ordinary unsecured creditors, and they will only be entitled to a ‘pari-passu’ (i.e. x.x pence for every pound owed) dividend among creditors, and only once the costs of the insolvency process, and any secured and/or preferential claims, have been paid.

This is in enviable contrast to the claims of employees, whose claims for wages and holiday pay (subject to certain limits) not only hold preferential status, but will also be accepted (along with claims for notice and redundancy pay) for payment from the National Insurance fund by the Redundancy Payments Office (a government body), which then stands in the employees’ shoes in the insolvency process.

HMRC’s new status ought to be factored in

Worse still for workers, in December 2020, secondary preferential status was introduced for HMRC claims for VAT and employee National Insurance deductions, so that such claims rank below employees’ preferential claims -- yet crucially, in preference to unsecured creditors and even the holders of floating charges. While this now-in force upgrading for HMRC will clearly improve the position of the exchequer, in many scenarios, it will significantly reduce the return to unsecured creditors, where such claims would previously have been entitled to an equal percentage share of any unsecured claims.

This has also significantly reduced the values capable of being returned to secured creditors (usually banks) who hold floating charges, which rank behind preferential creditors but ahead of unsecured ones in the order of priority.

Practical tips for contractors whose engagers go to the wall

The upshot? If a contractor’s engager enters an insolvency process, the likelihood is that they will suffer a significant (if not full) shortfall in the amount owing to them. This notwithstanding, it is important for any affected contractors to ensure that their claims are recorded in any insolvency process, and that they review the reports issued during the process so that they can be notified of any dividends being paid. 

It is ordinarily not of any benefit to continue any legal recovery proceedings. However, if contractors have concerns regarding the conduct of directors of an insolvent company, they should advise the relevant insolvency practitioner who is overseeing the process, and provide any documentary evidence. This may enhance the return to creditors if the information provided gives rise to a recovery action.

Keep in mind -- the actual outcome of any insolvency process will depend on the financial position of the company entering into it, and there are certain circumstances where the involvement of a contractor may be required by an appointed insolvency practitioner as part of the process (similar to if an employee’s cooperation is required). If this is the case, the contractor should seek confirmation that charges from the date of insolvency onwards will be paid as an expense of the relevant process, and in priority to fees of the insolvency practitioner(s).

Although this situation is not uncommon, it is ordinarily not possible for accrued arrears up to the date of insolvency to be paid, and so it is worth contractor bearing in mind that an appointed insolvency practitioner has wide-ranging powers to require the cooperation (by way of a court order is required) of any individual, and delivery-up of any records that an individual holds, which are considered pertinent to the company they are appointed over. Be aware, there can be serious civil and criminal consequences for an individual who refuses to comply with an order of the court in this regard.

What if I must consider placing my PSC into an insolvency process?

Inevitably, there are going to be a number of contractors who struggle to secure work sufficient to pay the liabilities which may have been accrued during a period of downtime caused by the pandemic.

The good news for those PSC contractors is that, broadly speaking, they should be protected by limited liability and be able to carry on with their lives even if they are required to liquidate or dissolve their limited company. There is no preclusion on a director of one company setting up another (subject to a restriction that they no longer re-use a similar name to one of a company which has gone into liquidation). In my experience, the majority of contractor companies who have taken covid support will have obtained BBLs, under which they were not required to provide a personal guarantee or any other security.

As with so many situations, however, the above is not the entire picture and contractors should take advice before concluding the appropriate method for closing the limited company.  In previous articles for ContractorUK, I have covered:

1. The possibility for an appointed liquidator to challenge certain transactions carried out by the company in preparation for liquidation;
2. The possibility for certain shareholder drawings to be recovered by a liquidator in the event that they are found to have exceeded distributable profits;
3. The ability for the Insolvency Service to scrutinise the conduct of directors and seek disqualification proceedings (whether a liquidator is appointed or not) where appropriate.

The decision to close a limited company, and indeed the appropriate process for closure, is one which can only be dealt with on a case-by-case basis, since each scenario will turn on its individual facts.  Prior to taking any action, contractors should consult their accountant and/or an insolvency practitioner for advice, most of whom will be willing to offer an initial consultation free of charge.

What if I am considering personal insolvency?

Unfortunately, but inevitably, we are frequently called upon to provide advice on an individual director’s position as well as their limited company. 

This can happen either as a result of personal guarantees being provided by directors to cover company lending, or as a result of claims arising against them (whether for monies due to the company in relation to director’s loans, or recoverable transactions having occurred).

Broadly speaking, there are three insolvency options for individuals in the UK who are unable to repay or otherwise settle their debts:

1. They apply for a Debt Relief Order (DRO);
2. They are made Bankrupt;
3. They agree an Individual Voluntary Arrangement (IVA) with their creditors.

The bad news for contractors is that if they are declared bankrupt, they are subject to the bankruptcy restrictions, which includes a provision that they be precluded from acting as director of a limited company for the period that they are ‘undischarged’.

Restrictions, DROs and IVAs: explained

Ordinarily, in the absence of any wrongdoing, an individual will be subject to these restrictions for a period of 12 months, with the ability for these to be extended if appropriate. A similar restriction applies in the event of an individual applies for a DRO and it is worth noting that Bankruptcy or a DRO can also have implications on professional qualifications and eligibility for certain roles (particularly in the finance sector). 

The above being said, bankruptcy may be the appropriate route for a contractor who has few assets and is not intending to operate through a limited company. But a DRO is only appropriate for individuals who have debts of under £30,000, less than £75 per month surplus income (after reasonable expenses), and assets of under £2,000 (excluding a vehicle valued at up to £2,000).  If these criteria are not met, then an individual must consider either Bankruptcy or an IVA.

An IVA is an alternative to bankruptcy, which I have covered in some detail in an earlier article.  Broadly speaking, this is appropriate if an individual has projected surplus income which is sufficiently certain for them to be able to offer up a certain amount on a monthly basis, in full and final settlement of their debts. In addition (or instead of) they may also be required to introduce other assets into an IVA to present (assisted by an insolvency practitioner), an outcome which is favourable for creditors compared to bankruptcy.

Fortunately, there is no preclusion on an individual who is subject to an IVA acting as director of a limited company, and this is often a relevant consideration when providing advice as to an individual’s options. While an IVA may still be disclosable in certain sectors, it is also usually looked upon more favourably than a bankruptcy.

Yet for an IVA to be accepted, 75% of creditors must agree to the terms, and this is voted upon at a meeting of creditors convened as part of the process. It is open to creditors to propose modifications at the meeting and, if implemented, a ‘supervisor’ (who must be a qualified insolvency practitioner) will oversee the implementation of the IVA. However if an IVA fails, the supervisor will usually be duty-bound to petition for the bankruptcy of the individual to which it relates.

Finally, it doesn’t have to be lonely this Christmas

In any of the above situations, contractors will be well served to take advice from suitably qualified professionals, such as their accountant, an insolvency practitioner or a solicitor. While it can seem a lonely place to be an individual or director facing financial difficulty, and particularly at this unforgiving time of year -- if the BoE’s alert rings true, help is out there and very often just talking through the issues will go some way to alleviating the pressure inevitably being felt and often wrongly seen as insurmountable.