What impact has the pandemic had on insolvencies?

According to recent figures, the number of UK insolvencies last year remained surprisingly low. The primary reason for this is self-evident: during the pandemic, troubled businesses were kept afloat by the UK government’s extensive Covid-19 support measures, including the bounce back loan scheme (BBLS) and the furlough scheme, which was described by Boris Johnson in January 2022 as ‘the biggest and most generous scheme of its kind anywhere in the world’.

Their aim was to prevent a liquidity crisis turning into a solvency crisis that would precipitate widespread business failure and permanent economic harm. The government’s primary policy objective was therefore to prevent viable businesses going under because of a liquidity crisis.

In addition, companies that found themselves in financial distress as a result of the pandemic and extended lockdowns were protected from creditor action through the Corporate Insolvency and Governance Act 2020. This was designed to ensure that viable businesses affected by the restrictions on trading during the lockdown periods were ‘not forced into insolvency unnecessarily’.

In line with the withdrawal of furlough and the BBLS, the restrictions on creditor actions have been phased out since last October. Beyond financial assistance through assorted schemes, the UK government also helped businesses with their cashflow by allowing them to defer tax payments.

No one can doubt that the unprecedented range of support measures given to businesses of all sizes and in every sector during the pandemic were well-intentioned. But despite the government being applauded by many for the speed and efficiency with which they were introduced and implemented, the wide-ranging assistance given to many companies can also be seen as reactionary and perhaps inadequately thought through by the Treasury in a very short timeframe.

Things could have been done differently, of course. When these support measures were first introduced, they should have been determined by a clear set of priorities and pre-requisites that was sector specific: arguably, money should only have been given to businesses that were directly affected by the consequences of the pandemic, such as those in the travel, tourism or hospitality sectors, and not those which felt little or no impact.

Manifestly, this was not the case – almost every business in every sector, within reason, could apply. They were able to do so regardless of how well they were doing by a simple process of self-certification, which has since led to a change in the law to allow directors to be personally liable in certain circumstances.

Fraud risk

Some argue that in designing these schemes, the UK government had to balance competing concerns: the risk that taxpayers’ money would be wasted by programmes that distributed funds quickly and widely, but were poorly targeted and open to fraud, against the risk of imposing onerous preconditions that created the risk of viable businesses going under and the economy suffering considerable long-term damage as result.

In opting largely for the former option, the government’s extraordinary magnanimity towards business inevitably opened the door to widespread abuse. Figures recently released by HMRC show that £5.8bn has been fraudulently obtained from furlough and other business support schemes since the start of the pandemic.

In response, the Treasury has announced that it will write off £4.3bn of this figure – or 75% of the total amount.  The extraordinary scale of the write-off suggests that the government should have been much more selective in determining the criteria of how loans were approved, and to whom they were made available, such as only accepting companies directly affected by the lockdown. Any other company asking for a loan should have been asked to give a personal guarantee by one or more directors.

Now that support measures are finally being taken away, there will undoubtedly be a further increase in insolvencies. Beyond those businesses which suffered because of the pandemic and are now feeling the effects of the withdrawal of government support, other post Covid-19 factors are also beginning to weigh heavily on them, not least surging costs, supply chain problems and staff shortages in a tight labour market.

With the advent of more insolvencies, it will mean undoubtedly many directors will be investigated into the circumstances of how and why the BBLS was applied for and what it was used for, which will raise many further legal arguments for both sides. The liquidator has many weapons at his disposal but likewise directors have many defences which can neutralise such attacks.

The net result of the unprecedented Covid-19 support mechanisms has been to allow many businesses, some of which have been labelled as zombie companies, to be kept artificially alive for nearly two years. During this time, they have continued to operate without any supervisory or audit role – another factor which means that the number of insolvencies will ultimately increase.

The number of recorded insolvencies has been steadily rising each month since last August. This increase will, most likely, continue to be spread out over several years as it will take time for the full effect of the government withdrawing or reducing its financial support measures to crystalise into more insolvencies. Meanwhile other factors – such as repayments due on government-backed pandemic loans and rising interest rates – will also begin to take effect.

Amid the gloomy headlines, however, there is another side of the business story of the past two years. Indeed, many companies have been able to flourish during the pandemic. Some have seen notable increases in profitability, not least professional services firms, which have been agile enough to adapt to home working or which are not dependent on customer facing services.

Through innovation and by adopting a nimble strategy, an impressive array of British companies has adapted well to the new market conditions: they have exploited opportunities to retain and win business by using a diverse range of technologies that are available.

Published in Accountancy Daily – 22 February 2022