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Promoting collective approach to rescue; in association with R3 Julian Gill advises struggling businesses on the best ways to avoid insolvency.

Byline: Julian Gill

WE MAY be enjoying benign times in the economy, yet administration figures rose by 26% in 2006, compared with 2005, and this trend seems set to continue into 2007.

Scratching the surface of the problem reveals a whole range of reasons as to why we have seen such a marked increase, ranging from the cost of complying with new regulations to adapting to fluctuations in economic conditions.

However, the overarching factor at work is the change in insolvency culture brought about by the Enterprise Act 2002. This effectively abolished administrative receiverships (with certain exceptions) and made the administration process quicker and less costly.

Overall, the introduction of the Enterprise Act has had a positive effect in promoting a more collective approach to business rescue with the removal of preferential creditor status of certain government claims and the effective abolition of administrative receivership (a debenture-holder driven process).

We now have a new style administration - a court appointment where the appointee must act in the best interests of all creditors.

This means unsecured creditors now have more of an interest in insolvent businesses. It is this enhanced interest which brings with it a desire to support rescue packages out of administration, providing a better return than liquidation.

In many cases, companies in administration continue to trade under the control of the administrators and a sale of the business as a going concern is achieved.

Such going concern sales can prevent operational closures, minimise staff redundancies and improve the overall return to the creditors.

However, even though there are opportunities to avoid insolvency, there will inevitably be failure.

But what should senior managers do when problems emerge? And to whom should they turn for advice?

The crucial thing is to act at the first sign of a problem, and quickly. There are two solvency tests for a business heading into potential insolvency territory.

The first is a cash flow test to ensure there is enough cash to meet debts as they become due. The second is a balance sheet test - generally a more complex exercise - to establish whether the assets exceed the liabilities.

These solvency tests may be critical not only to the business and its creditors, but to an individual's personal liabilities as a director. If the business is simply underperforming and is not yet in any real danger of insolvency, the best approach may be to engage an experienced turnaround practitioner - probably a member of the Society of Turnaround Professionals (STP), a sister organisation to R3.

However, the business's financial problems may already have gone too far for this approach. Again, the warning signs vary, ranging from the breaching of bank covenants to the serving of a winding-up petition.

In such cases, the director(s) must take a series of proactive steps to minimise the risk of personal liability. If the business does slip into formal insolvency, the administrator or liquidator will assess whether the directors did everything possible to protect the interests of creditors.

The first step to take is to engage appropriate external professional advice immediately - including insolvency advice, both legal and accounting, from members of R3.

Many directors are concerned about taking on the extra costs of this advice at a time when the business is struggling. But, if the worst happens, the directors will be more heavily criticised for not having taken this step. Equally importantly, the right adviser can make the difference between a fresh start and a liquidation.

Once they are on board, the advisers will guide senior management in protecting the interests of both creditors and directors.

This includes ensuring that financial information is accurate and up to date, and is discussed at regular board meetings. If the right quality of management information is not available, then personnel and systems must be put in place to provide it.

The board should also study regular forecasts of cash flows and shortfalls, and keep large creditors informed about any corrective restructuring or disposals.

A general cost-cutting drive should include a moratorium on major new expenditure and a detailed review of third-party contracts.

Directors may even show willing by reducing their drawings. If these actions fail to prevent collapse, then the board should have a solid fallback plan based on sound insolvency advice.

Ultimately, the real key to reversing the upward trend of administrations is for directors to get the right advice fast.

Owner managers should remember that there are professionals readily to hand who can not only save the business, but improve it.

Julian Gill is North-East Regional Chairman of R3 and partner in Watson Burton LLP.


HEED WARNING SIGNS: Taking expert advice is the first step to avoiding insolvency.; SOUND ADVICE: Julian Gill.
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Title Annotation:Business
Publication:The Journal (Newcastle, England)
Date:Jun 21, 2007
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