Whilst we await further direction from the Government as regards relaxation of the lockdown measures and how businesses will be permitted to operate, almost all owner-managers will be considering the future of their businesses. Whilst some businesses will weather the storm with a manageable level of disruption, others may need to take more drastic measures in order to continue to trade. All those who survive will wish to do what they can to stabilise the business and protect valuable business assets going forward.
Below Clare Lang, Corporate Partner at mfg Solicitors LLP, answers a range of frequently asked questions raised by business owners regarding how they might restructure their businesses in the wake of the coronavirus crisis.
I have been advised that I should consider putting my company into administration and doing a “pre-pack”. What is a “pre-pack” and what are the benefits?
Administration is often depicted as a procedure used when a business is on the brink of collapse. However this is not always the case and administration can be a flexible rescue tool which, in the right circumstances, can be used to ensure the survival of your business.
A “pre-pack” is the process by means of which an insolvent company is put into administration and its business and/or assets are immediately sold pursuant to a deal arranged before the insolvency practitioner (or administrator) was appointed.
A pre-pack could be the answer if your company cannot pay its debts, but you still believe in the business - likely to be a common scenario as a result of the coronavirus crisis. Instead of putting more cash into the struggling business, a pre-pack allows you to use available cash to fund a new company. This new company then buys the assets of the old company and starts trading in its place.
Pre-pack sales are generally quick and smooth, compared with sales negotiated at arm’s-length after entry into administration. This can minimise price erosion caused by the loss of goodwill through a protracted insolvency and marketing process; often reduces the costs of the administration as the administrator does not need to find funds to trade the business; and generally results in a better return for creditors. Pre-packs can minimise the loss of confidence of suppliers, customers and employees; often saving jobs on the basis that there will be a continuance of trading without a break.
What are the criticisms of prepacks?
Pre-pack administration sales are often criticised because unsecured creditors are not aware of the transaction before it happens and have no opportunity to protect their interests by voting on the proposal. Also, pre-packs are sometimes criticised for lack of accountability, as the administrator sells assets before his proposals have been agreed by the creditors and without court approval.
Questions are sometimes raised regarding pre-packs’ ability to maximise returns for unsecured creditors, as the administrator selling the business and assets will not necessarily have tested their market value by advertising to interested buyers.
There is also the stigma of “phoenixing”. Creditors can be suspicious about pre-packs as the business is being sold back to the original owner-managers, seemingly allowing them to “asset-strip” the company or dump its liabilities. There are various disclosures that need to be made to creditors where a sale is to a connected party and if you are proposing a pre-pack you should consult a solicitor to ensure you do not fall foul of the sanctions for failure to make the required disclosures.
If I do a pre-pack, what debts will and won’t transfer to the buyer company?
Unless specifically assumed by the buyer company, trade debts will be left behind in the old company. Practically however, your new company may need to settle certain liabilities with key suppliers who are crucial to the business going forward.
Tax liabilities and liabilities to secured creditors and other funders will also remain in the old company.
Whilst the normal TUPE rules will apply and employees will automatically transfer to the buyer company and receive unfair dismissal protection, special rules apply in relation to certain employee debts.
In respect of employees that transfer to the buyer company, liabilities for wage arrears and pay for holidays taken will not pass to the buyer company, but will instead be paid by the Redundancy Payments Office (RPO) out of the National Insurance Fund (up to certain limits). The RPO will not cover statutory redundancy payments, pay in lieu of accrued but untaken holiday entitlements or notice pay however, as those employees will not have been dismissed.
Where employees are dismissed and the reason for dismissal is the transfer, the RPO will cover such employees’ wage arrears and holiday pay (again, up to certain limits). The RPO would not cover statutory redundancy payments and notice pay, as the employees would not have been made redundant. In addition, there may be claims against both the old company and the buyer company for unfair dismissal.
I’ve heard it is possible to make “permitted variations” to employees’ terms and conditions following a sale out of administration. What does this mean?
It is possible to agree certain changes to transferring employees’ terms of employment, if those changes are made with the intention of safeguarding employment by ensuring the survival of the business – these are known as “permitted variations”. For example, it would be possible to agree lower salaries or reductions in benefits following a sale of a business out of administration, provided such changes were agreed with employee representatives.
Notwithstanding any permitted variations, the relevant employees’ continuity of employment will be preserved.
Given the impact of COVID-19 on my company’s business, I am concerned about protecting valuable assets owned by my company from trade risk. What can I do?
A corporate reorganisation may be appropriate to separate out and protect certain assets, such as valuable property assets, from trade risk - for example by creating a parent company and transferring such assets out of the trading company and into the parent company.
It is important that assets are transferred at market value, appropriate valuations being sought to back this up, to avoid any risk of transactions being reviewed as transactions at an undervalue at a later date if the selling company were to enter into an insolvency process.
I want to restructure my business. Who do I need to seek advice from to plan the process?
Your accountants and tax advisers should be engaged at an early stage to draw up a plan for the reorganisation (typically driven by tax and funding considerations), setting out the proposed steps.
Accountants should be involved to review and assess the proposed transactions to be undertaken and how they are to be accounted for. If assets are to be distributed by way of dividend, the accountants should be required to confirm that your company has sufficient distributable reserves to fund the distribution.
Whilst tax relief is often available when transferring assets between group companies, your tax advisers should be asked to confirm this, seek clearance from HMRC if appropriate, and also give consideration to any potential stamp duty or stamp duty land tax liabilities that may arise on share or property transfers.
A corporate solicitor should then be engaged to review the proposed steps from a legal perspective.
All advisers should work together to put together a final plan that reflects your objectives and the tax, funding and legal considerations. Once drafted, the documents implementing the reorganisation should be reviewed from a tax perspective to ensure the desired tax treatment is achieved.
What insolvency issues do I need to consider in reorganising my business?
If there are concerns in relation to the solvency of your business, you should involve an insolvency practitioner as soon as possible.
The Government has announced new legislation will be introduced due to the COVID-19 crisis to grant a temporary suspension of the wrongful trading provisions, which will take effect retrospectively from 1 March 2020. Such legislation will allow directors to trade without personal liability even if there are reasonable grounds to suspect their company will become insolvent. There will also be a temporary moratorium for businesses which need to undergo a financial rescue or restructuring process, to prevent creditors from taking action to wind such businesses up.
Notwithstanding this, the Secretary of State for Business, Alok Sharma, has stated that "all of the other checks and balances that help to ensure directors fulfil their duties properly will remain in force." Accordingly, directors must continue to comply with their duties, in particular those owed to the company's creditors where the company is, or is likely to be, insolvent. Such duties should be considered as part of any restructuring process.
Even if there are no solvency concerns at present, it is important that assets are transferred at market value, to avoid the transfers being reviewable and potentially unwound on the basis of them being preferences or transactions at an undervalue should a company which is part of the reorganisation subsequently fall into liquidation or administration.
Do my employees to be told about the proposed reorganisation?
If a business which employs people is being transferred as part of a proposed reorganisation, then both the current employer and the new employer must adhere to the TUPE Regulations, which broadly provide that the employees’ contracts of employment automatically transfer to the buyer company on their existing terms.
All of the selling company's rights, powers, duties and liabilities under or in connection with the employees' contracts will pass to the buyer company and any acts or omissions of the seller company before the transfer will be treated as having been done by the buyer company. There are certain exceptions in this regard in relation to a sale of a business out of administration, when the Redundancy Payments Office will assume certain employee liabilities (depending upon the circumstances and subject to the relevant statutory limits), as mentioned above.
A reasonable time before the transfer, both the selling company and the buyer company must inform and (if applicable) consult with trade unions, elected employee representatives or (if there are less than ten employees) directly with staff in relation to the transfer or measures being taken in connection with it. The duty to consult only arises where the seller company is planning to take any measures in respect of affected employees, such as to make redundancies or change terms and conditions.
TUPE aside, employees may be sensitive to the implications of a reorganisation on their job security, so communications with staff will need to be carefully managed.
If the Coronavirus Job Scheme is being used, then the impact of the reorganisation on furloughed employees will need to be considered.
Do my funders need to know about the proposed reorganisation?
Funders holding security over affected companies or assets will need to be consulted in advance and their consent to the proposed transaction sought under the terms of their funding and/or security documents. They will want to be satisfied that their risk exposure or security position is not adversely impacted by the proposed restructure.
Where assets are being transferred to a separate group company, your funder is likely to require that additional security is put in place over the new company. Where such assets are property assets, you should check whether your funder will require a new valuation or report on title to be provided in respect of the relevant properties.
If you are proposing to sell your business and/or assets out of administration, your secured creditors such as your bank and any other charge holders will need to be consulted, as they usually need to consent to the release of their security as part of the process.
How can I finance my restructured business?
Along with traditional funding options, the Government has introduced a variety of new financing solutions, including the Coronavirus Business Interruption Loan Scheme; the Coronavirus Large Business Interruption Loan Scheme; and the Bounce Back Loan Scheme. Most major banks are offering such loan facilities, and further information is available on the Government website at https://www.gov.uk/business/finance-support and via https://www.mfgsolicitors.com/site/blog/mfg-blog/whatever-it-takes-to-minimise-covid19-impact-on-businesses.
I want to separate a division of my business from the rest of the trade, prior to selling such division to a third party buyer. What is such a buyer likely to be concerned about?
Where a pre-sale corporate reorganisation is undertaken to transfer part of a business into a separate company, a prospective buyer will usually conduct extensive due diligence and will request comfort that the transactions were properly undertaken, the correct assets and liabilities are held in the relevant company, and the reorganisation has not resulted in the target company inadvertently incurring liabilities (particularly tax liabilities).
If the buyer’s interest in a business is in valuable contracts with either customers or suppliers, the buyer will wish to scrutinise such contracts, having particular regard to clauses concerning force majeure (to check if there are any potential litigation issues and risks associated with those contracts). A buyer will also want to ensure it can take the benefit of such contracts, by checking the assignment and change of control provisions.
Where intellectual property or software is shared between members of the group, it may be necessary to licence back such intellectual property or software, or to grant new licences to the third party buyer to allow the continued use of such shared assets.
Where certain services are provided by the residual group to the company or business being sold, it may be necessary to put a transitional services agreement in place.
Do I need to tell my customers and suppliers about my business reorganisation?
Customers and suppliers will be concerned about their trading partners' financial stability and reliability arising from the reorganisation, particularly in the current climate. Accordingly communications with customers should be managed carefully.
Customer or supplier contracts may not be capable of transfer without a consent or waiver from contractual counterparties, although there may be carve-outs for intra-group transactions. Contract terms should be checked carefully before the transaction in question; and relevant consents can be sought in good time.
Do I need to tell my landlord about my business reorganisation?
You may need to get formal consent from your landlord in order to transfer any leasehold property. The terms of the lease will need to be reviewed to check if its transfer is permitted; and there may be specific requirements or conditions in relation to the financial standing of the proposed buyer.
Clare Lang is part of the Firm's Restructuring and Insolvency Sector. Contact Clare by email on firstname.lastname@example.org
We at mfg are committed to supporting you during these uncertain times, and know that you may have many questions about these matters and other factors affecting your business. Our specialist Restructuring and Insolvency Team is here to help – please do not hesitate to contact us if you need any assistance or guidance on 01562 820181.