[co-author: Ryan Johnson, trainee solicitor]
The emergence of COVID-19 (the Coronavirus) at the end of 2019 has had an unprecedented impact on the global economic system. This alert focuses on the effect the Coronavirus pandemic is likely to have on small and medium sized businesses (SMEs), their lenders in the UK and the options available to continue trading and avoid insolvency. It will also consider recent measures that have been proposed by the UK Government to enable businesses to avoid insolvency during this pandemic, specifically the temporary changes to the insolvency rules and the financial support being offered by the UK Government.
Options to Consider if Your Business is Experiencing Pandemic Related Cash-Flow Problems
The UK Government has announced a series of reforms to the area of insolvency (which at the time of writing have not yet received Parliamentary approval and, as such, should not be considered law) and a large stimulus package to facilitate the cash flow of SMEs impacted by the Coronavirus.
Relaxation of Certain Insolvency Rules
On 28 March 2020 the UK Secretary of State for Business, Energy and Industrial Strategy (BEIS) announced that changes will be made to the current insolvency rules, to give businesses currently undergoing a rescue “space to breathe” to, potentially, avoid insolvency. These measures included a proposed relaxation of the rules allowing companies to continue trading, at the same time suspending wrongful trading backdated to 1 March 2020 for 3 months. This should assist directors of companies with financial problems. There is also a proposed moratorium on creditors enforcing their debt while the company seeks a restructure or rescue. The latter of these indicates that the Government’s intention is to afford businesses space to catch their breath (as was previously discussed in a consultation paper by the department for BEIS released in August 2018). It seems to be the intention of the Government to give businesses, that are going through formal rescue proceedings, the room to manoeuvre, with a view to exit insolvency proceedings and survive this pandemic.
These proposed reforms will also unburden Directors from personal liability if they continue to trade during these circumstances. SME directors should continue to exercise caution as it is not the intention of these measures to relax other fiduciary duties that directors are under by virtue of their position, including fraudulent trading and directors’ disqualification. SME directors should also continue to remined themselves of their remaining duties under the insolvency rules concerning distributions and take care to document all decisions that are made during this period.
Options to Continue Cash Flow
A paramount concern for many directors / shareholders of SMEs operating in (and outside) of the trade sector during the crisis will be: how will cash keep flowing through the business during this lockdown? The Government has recognised this concern with a recent announcement that SMEs would have the ability to obtain financial support through the Coronavirus Business Interruption Loan Scheme (CBILS). The CBILS can offer facilities up to £5 million for SMEs whose business has been disrupted by Coronavirus and is available in the form of term loans, asset finance, invoice finance and overdraft facilities. The scheme is being run by the British Business Bank, however the facilities are being offered by accredited lenders. These accredited lenders are also being encouraged to continue to lend to SMEs, with the Government committing to guarantee 80% of the value of each loan, covering the first 12 months of interest payments and lender levied fees.
The Financial Conduct Authority (FCA) has provided guidance to lenders when assessing the creditworthiness of SMEs applying for the scheme, contained in the Consumer Credit sourcebook. Lenders should not be prevented from financing a loan under the scheme if, at the time of application, the customer is experiencing exceptional financial pressure, and should take into consideration data on trading from before the pandemic and future projections. SMEs across all sectors (with some, limited, exceptions) are able to apply for the full amount under the scheme, on the proviso that certain eligibility criteria are satisfied.
Directors of SMEs should approach the above schemes with some caution and a measured sense of optimism as of 30 April 2020 it has been reported that of the 52,807 formal applications that have been made under the CBILS, only 47.84% of these had been approved (25,262). In addition to the low rate of approval, the process for applying for relief under the CBILS may not be moving quickly enough for some SMEs. This is understandable considering that the private lenders offering these facilities will be inundated with informal inquiries in conjunction with formal applications and that they are required to assess the creditworthiness of each customer before granting the loan.
In addition to the time delay of the CBILS is the fact that it has placed traditional lenders at the heart of the lending process, which includes all the regulation and risk assessments that come with it. Under traditional circumstances, it would be absurd for a commercial lender to lend to a SME with severe financial difficulties. This is clearly a problem for businesses of this size, particularly those involved in trade who may be reliant on these financial institutions’ lending to keep their businesses afloat.
In a recent “Dear CEO” letter from the FCA, the regulator urged the banks participating in the CBILS to ensure SMEs are treated fairly and that the regulator will take into account a recalibration of judgements and risk tolerance by banks when lending to SME under the current circumstances.
The Treasury has been quick to realise that the CBILS, while being a well-intentioned scheme to provide SMEs with much needed liquidity, has been mired with setbacks and allegations of unsuitability for the small businesses it was aimed at. An alternative scheme has been devised by the UK Government, enabling businesses of any size to apply quickly for a loan of up to £50,000, so long as that business is based in the UK and has been negatively affected by the Coronavirus. The “Bounce Back Loans” scheme was launched on 4 May 2020 and, like the CBILS, utilises a network of accredited lenders to provide this loan facility.
Once funds have been secured, or deemed unnecessary, other options should be considered to help SMEs weather the Coronavirus pandemic:
What happens if the business is unable to pay its rent bill?
The recently enacted Coronavirus Act 2020 contains provisions to temporarily protect tenants from aggressive debt collection strategies including a temporary prevention of forfeiture. Additional measure put in place include a temporary ban on statutory demands and on winding up petitions presented from 27 March to 30 June. This currently does not relieve commercial tenants from their obligations to make rent payments or mean that tenants should bury their head in the sand to avoid constructive dialogue with their landlord.
What if the business is struggling to pay staff?
While never a pleasant prospect to consider, some SME directors may wish to consider whether it would be a sensible decision to temporarily “furlough” members of staff, rather than consider redundancies. UK employers, regardless of turnover and size, will be able to apply for a grant from HMRC under the Coronavirus Job Retention Scheme, covering up to 80% of the furloughed staff member’s salary costs and is currently scheduled to run until the end of June 2020. Each business will need to consider the impact this will have and may need to seek professional advice on whether it is possible to benefit from this scheme.
What about the lenders?
This also seems to be a good time for lenders to exercise some imagination with regards to how they lend and how they can help to preserve an SME’s business. Thoughtful standstills and restructuring of credit should come into play.
Coronavirus is a rapidly developing and constantly changing crisis that is proving as hard to predict as it is to contain. The increasingly global economy, and the companies that trade in it, will, most likely, continue to shrink as a result of this pandemic, with UK SMEs involved highly likely to feel the negative impacts.
Companies concerned about the impact on the pandemic on the cash flows of their business should consider:
- What are the business’s current cash reserves?
- What options are available, such as the CBILS, or other government-backed schemes (not considered in this article)?
- Whether time is of the essence (we have seen that there is a considerable delay between application and approval of CBILS loans)?
- What actions can be taken if the business enters into insolvency?
- How to approach their lenders and other creditors in light of the above.