The language of insolvency: why getting it wrong can harm struggling firms

An image of a shop with red signs saying that its closing down and everything must go

This article, written by John Tribe, Senior Lecturer in Law in our School of Law and Social Justice, University of Liverpool and Emilie Ghio, Lecturer in Corporate and Insolvency Law, The University of Edinburgh  was originally published in The Conversation:

Business failures are on the rise in Britain, with several high-profile names lost already this year. But since the 1980s, the UK has made it a priority to throw a lifeline to struggling companies. It appears, however, that these efforts to enhance the law are being hampered by sloppy language in the media, increasing the stigma around insolvency and potentially deterring businesses from seeking help.

Legal terms and concepts need to be accurate. The law of insolvency is no different.

Unfortunately, accuracy is often missing in insolvency coverage. MPs have used insolvency terms incorrectly, while media outlets, including the BBC, have a habit of referring to insolvency procedures in overly negative, and sometimes inaccurate, terms. In particular, the administration procedure, which is aimed at rescuing a company, is often discussed using words like “collapse”. This misleadingly associates it with the process of liquidation, which is aimed at removing a company from the market.

So what is the correct language to use when we’re discussing insolvency?

Corporate insolvency law

There are no fewer than six procedures which can be used by struggling companies.

They are found in the Insolvency Act 1986 (liquidation, administration, company voluntary arrangements (CVAs) and standalone moratoriums) and in the Companies Act 2006 (schemes of arrangement and restructuring plans).

Liquidation is used to gather in and sell the assets of the insolvent company for the benefit of its creditors – that is, the parties who are owed money by the insolvent firm. The liquidator then distributes the value of the assets among the creditors of the company in a ranked order, known as the “insolvency waterfall”. The liquidator replaces the board of directors and takes control of the day-to-day management of the company. At the end of the liquidation process, the company is dissolved and no longer exists. For example, Lloyds Pharmacy has recently gone through liquidation, and subsequently disappeared from high streets and Sainsbury’s stores.

Administration is a procedure that has been used by several high-profile names already this year, including Ted Baker most recently. The procedure was introduced in 1986 as a tool to rescue companies (that is, keep a firm afloat rather than liquidate it). Similar to the liquidation process, directors of the company are sidelined during administration and the administrator assumes day-to-day management.

There is also the Special Administration procedure, which is used for certain nationally important sectors, and which the Liberal Democrats have suggested for troubled Thames Water.

CVAs are another rescue procedure. It is a voluntary arrangement between the company and its creditors, supervised and approved by an insolvency practitioner (that is, someone who is licensed to act on behalf of an insolvent company). Crucially, a CVA is called a “debtor in possession” procedure because directors are left “in possession” (in charge) of the company – unlike in a liquidation or administration process. For example, after calling in administrators earlier this year, The Body Shop is now thought to be seeking a CVA.

The standalone moratorium (introduced in 2020) can be used by companies together with, or independently from, any other procedure. Directors are given 20 business days to assess their rescue and recovery options. During the moratorium, the company will continue to operate under the control of the directors and the moratorium allows them the 20 days’ breathing space from creditors.

The scheme of arrangement, regulated by the Companies Act 2006, is a procedure available to companies that are not yet insolvent. It is used as a debt restructuring tool or to alter the company’s financial obligations. Essentially, it involves a deal between a company and its creditors and shareholders. Think of it as something akin to an individual consolidating their credit cards, or arranging a plan to repay arrears.

Lastly, closely modelled on the scheme of arrangement, the restructuring plan procedure introduced in 2020 is available to companies that have encountered, or may encounter, financial difficulties that are likely to affect their ability to carry on business.

The reality of corporate insolvency

Clearly, the legislative priority in the UK over the past 40 years has been to promote corporate rescue and renewal. This should, in principle, be particularly useful to British businesses at a time when the UK has seen a record number of business failures, with no fewer than 26,595 corporate insolvencies in 2023. That figure is 14% higher than in 2022 and 43% higher than pre-pandemic levels in 2019. It is predicted that this number will rise to 33,000 in 2024.

With an increasing number of companies in financial difficulty, we might have expected that corporate rescue cases would have risen too. But this is not the case. Rescue cases have dropped from 10% in 2019 to a rather woeful 6% in 2023. That means that in 2023, 94% of these companies (by our calculations 21,961 in total) were liquidated.

This shows that while the law is here to help, something is preventing struggling businesses from using it. While there are more factors at play, it is clear that inaccurate wording, including misleading language by politicians and the media, play a very important role. The stigma around experiencing financial difficulties and the negative way this is talked about may prevent businesses from looking for help at a time when it would provide the greatest chance of turning things around.

This is not just an academic point but it has real-world ramifications. The economic climate is challenging enough for companies. Lumping further issues on to indebted firms really isn’t helpful.The Conversation

This article is republished from The Conversation under a Creative Commons license. Read the original article.