With Four Seasons Health Care entering administration and Allied Healthcare proposing a company voluntary arrangement (CVA) towards the end of April, the spectre of insolvency is once again haunting the care sector.
And it is a spectre that is likely to be around for some time to come, as the Local Government Association estimates that, in the current financial year, there will be a funding gap in adult social care of around £1.5bn, increasing to £3.5bn by 2024/2025. Sector specific pressures include staffing costs which continue to rise, with the introduction of the National Living Wage for workers over 25 three years ago (and its rise in April of this year by almost 5%), the exodus of cheaper labour due to Brexit, the cost of pensions auto-enrolment, and the ongoing uncertainty regarding the status of sleep-in workers.
At the same time, funding for local authorities to pay for care is not increasing at anything like a high enough rate, and demographic pressures mean that funding has to be split between more end users.
Combined, this has created a perfect storm in the care sector, causing financial difficulties for providers of homecare and residential care alike, and on all parts of the size spectrum.
Why do financial problems matter?
Company directors need to be aware of their duties, and in particular how these shift where the company is experiencing financial difficulties. The directors of a company are at risk of personal liability to the company’s creditors if they allow the company to trade whilst insolvent and the company ends in formal insolvency. Once a company is insolvent, the directors owe a duty to the company to take care to protect the interests of its creditors.
The two main tests of insolvency are:
- The ‘cash-flow test’: The company cannot pay its debts as they fall due – ie. it has a liquidity shortfall.
- The ‘balance sheet test’: The liabilities of the company (including contingent and prospective liabilities) are in excess of its assets.
Failing either (not necessarily both) of these tests can mean a company is insolvent, and requires a shift in the way directors consider their duties.
In addition to the directors’ general duty to creditors when a company is insolvent, there are three other main areas of concern for the directors of companies in financial difficulties. These are fraudulent trading, wrongful trading and disqualification from acting as a director.
All of this should focus the minds of directors where a company is facing financial difficulties to ensure that they take appropriate advice – either legal or from an insolvency practitioner.
The Care Quality Commission (CQC) has a duty to monitor the financial stability of providers in England that local authorities would find difficult to replace in the event of a failure (typically those that are particularly large in size or specialism, either nationally or regionally). This is done via a scheme called Market Oversight. Providers in the scheme are subject to increased engagement and reporting requirements when suffering financial problems. Where a provider is assessed to be at the highest level of risk (Stage 6), CQC has the power to notify local authorities of the likelihood of business failure. For providers within the scheme, it is therefore essential to factor liaising with the Market Oversight team into contingency planning.
Finding a solution
If a company is facing insolvency, there are various options available to them. The option or process that is most appropriate in the circumstances will depend on the issues facing the company and whether these are resolvable, as well as the support any restructuring or standstill is likely to receive from creditors. Below, we discuss three possible options to achieve a rescue either of the company or the underlying business. Of course, rescue will not be possible or appropriate in all circumstances, but in businesses providing vital services it must be a first port of consideration.
Administration is primarily designed as a rescue process, with a view either to rescuing the company or the underlying business. If a company goes into administration, a licensed insolvency practitioner (most of whom are accountants) will be appointed to manage the company, with the benefit of a statutory moratorium, or ban, on enforcement by creditors (including HMRC and landlords).
Administration can be instigated in three ways:
- Notice being filed at court by the company or directors.
- Notice being filed at court by a secured creditor (which contains a ‘qualifying floating charge’).
- Application to court by the company or by a creditor (secured or unsecured) – although this last method of appointing an administrator is the least common.
It’s relatively rare for an administrator to manage to rescue the company (and for it to exit administration back to trading solvently), although this is sometimes possible when the administrator is able to elicit new equity investment. Selling the business and assets (or sometimes just part thereof) to new ownership is far more common.
This may take place as a ‘pre-packaged’ administration sale (or pre-pack). This occurs where the proposed administrator, prior to their appointment, works with the company to find a buyer for the business and assets, and sells them immediately on appointment. There has, perhaps understandably, been criticism and scrutinisation of this method of sale in recent years, against a backdrop of complaints that it is detrimental to the interests of unsecured creditors – particularly if the business is ultimately sold back to the incumbent management or owners via a new vehicle.
However, depending on the circumstances of the business in question, a pre-pack may represent the best chances of a continuation of the business. This can be of particular importance in a sector such as social care, where it is important for the service provided to end-users to transition with minimal disruption.
In addition, the regulatory bodies for insolvency practitioners have provided guidance (which has been in place for around ten years now, but has developed and expanded in that time) on the key compliance standards for pre-packs, and information that must be provided to creditors following a pre-pack sale – i.e. a Statement of Insolvency Practice 16 (SIP 16). This includes the standard of marketing (for the sale of the business) expected, known as the ‘marketing essentials’, and a requirement to explain how any strategy that deviates from these marketing essentials has delivered the best available outcome.
The Government has also put in place a body known as the Pre-Pack Pool, which a purchaser can voluntarily approach when that purchaser has previously been connected with the company in administration (eg. where it has the same management). The job of the Pre-Pack Pool is to assess and give an opinion on whether the new entity will be viable – the idea being that this provides some degree of comfort to the insolvency practitioner in concluding the sale and also the creditors that the business is not simply going to fail again.
Together, where an insolvency practitioner provides the information required of them by SIP 16 and also requires a purchaser (if connected) to seek an opinion from the Pre-Pack Pool, concerns around pre-pack sales are significantly mitigated.
Company voluntary arrangement
A CVA is a statutory contract to enable the company to adjust its debts so as to be able to keep trading during a short-term insolvency issue. It can be particularly appropriate where liquidity issues are created by one or more particular classes of debt (e.g. rent costs or pension liabilities).
CVAs have been used to varying long-term effect where the insolvent company has a portfolio of leases, with some establishments trading more successfully than others. An example would be a company owning multiple care homes, some of which are over-rented, and some of which are underperforming. A CVA might be proposed to temporarily vary the rent on the over-rented properties, and also close down underperforming locations.
To propose a CVA, a company would approach an insolvency practitioner to act as nominee (and ultimately, if the CVA is voted through by the requisite proportion of creditors, as supervisor). This means that the CVA is prepared with the assistance of an insolvency practitioner who is, by the time the CVA is proposed, satisfied that its purposes can be achieved if it is passed.
Standstill or restructuring of debt
Sometimes, it can be possible to agree a standstill (where a creditor agrees not to push for payment or take enforcement action) or restructuring of the debt (altering terms such as a payment schedule) outside of a formal insolvency process, which of course can impact on media focus and reputation, and also credit rating. Often, this will be done with advice from and support of a relevantly qualified accountant and/or lawyer, who will be able to assist with the approach to the creditor(s).
As can be seen, there are a range of options available for directors of companies facing solvency difficulties which may preserve the underlying business – particularly important where end users would be severely impacted by a disruption, such as in the care sector.
The most important point for directors to remember is to seek suitable legal advice, or advice from an insolvency practitioner, as early as possible where solvency issues are anticipated.
Julian Pallett is Partner and Head of Restructuring and Insolvency, and Pippa Hill is Director of Restructuring and Insolvency at Gowling WLG. Email: email@example.com Email: firstname.lastname@example.org Twitter: @gowlingwlg
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