Day of Reckoning :

Insolvencies: The next pandemic?

When the UK government recently paid Cardiff Airport’s £42.6 million debt and then provided £42.6 million in grants, it was following the same path adopted by governments around the world to try to bring long-term stability to businesses during the pandemic.

Emergency measures like these were designed to protect companies during the pandemic and into the post Covid-19 era.

Such emergency loans – given to countless businesses large and small across the UK – also coincided with announcements by Chancellor Rishi Sunak that the British government was extending its £68 billion coronavirus emergency loan while the employment furlough scheme finally ended in July 2021.

Along with this aid he also included an extension of the £19.6 billion Coronavirus Business Interruption Loan Scheme and the £5 billion Coronavirus Large Business Interruption Loan Scheme.

However, while many global business people see rescue packages as laudable, restructuring and insolvency professionals warn it’s a solution that either pushes the problem into the future or – worse – creates zombie companies out of bad and good businesses alike.

In the UK, total company insolvencies for the first quarter of 2021 dropped by 22% compared to the final quarter of 2020 and were down a huge 38% compared to the same quarter in 2020.

Across Europe, North America and Asia it was a similar story throughout the pandemic. The number of insolvencies consistently dropped as a result of various government aid initiatives. In most normal economic cycles, there is often a lag between a financial crash and insolvencies, but the current lag has defied most predictions by insolvency professionals. Initially, they predicted a spike in late 2020, then early in 2021, now they’re saying the increase will be at the start of 2022.

So, the question: when is the wave of insolvencies going to happen – given that governments continue to bail out businesses – and what will be the extent of that wave?

The first casualties, according to insolvency professionals, will be those distressed companies that were insolvent pre-pandemic, but which were shielded from insolvency by the funding measures of various governments. These businesses are famously called “zombie companies”.

They are firms which have taken on a mountain of debt to fund losses, while relying on creditor forbearance to help them make ends meet. Unfortunately, that debt will need to be repaid and creditors will acquiesce no longer – and this list includes tax authorities, landlords and banks, among others.

This increase in zombie companies will comprise an estimated fifth of UK firms (21%), according to Onward, a UK-based research company. These firms generate just enough revenue to pay the interest on their debts – but not the debts themselves. They have existed primarily on the UK government’s £75 billion worth handouts and their survival has probably also contributed to the survival of their trading partners. For insolvency professionals across the globe, huge numbers of these zombie companies will start to fold not long after state aid has been withdrawn. And their demise could also mean the demise of other, more healthy but vulnerable businesses.

Across the EU, insolvency professionals are bracing themselves. According to the European Systemic Risk Board, which monitors the EU financial system, with the winding down of the EU-wide €1.5 trillion of public support measures, zombie businesses and their healthier counterparts could become insolvent overnight and trigger a recession, causing further insolvencies.

The ESRB said the current low rate of insolvencies could be similar to the sea retreating just before the tsunami hits the beaches. The ESRB has recommended EU governments take actions to mitigate the risk of a wave of corporate insolvencies, saying policy interventions should avoid supporting ‘zombie firms’ that could significantly slow down the post-Covid recovery.

Echoing sentiments made by insolvency professionals everywhere, the ESRB said governments should focus on helping only the healthy, viable companies once restrictions are lifted, ensuring distressed firms are quickly wound down.

What appears to be key for the future health of businesses and economies across the world is the role played by restructuring and insolvency professionals. Their help will be critical for business owners who want to throw off the zombie tag by breathing new life into their companies through restructuring. Likewise, they’ll be relied on to ensure assets of insolvent companies are recovered for creditors to reinvest in new businesses.

In this virtual series, IR Global members discuss the state aid in their jurisdictions that has helped to keep both healthy and distressed businesses afloat. They also predict where the world – and particularly their corner of it – will be headed in the next few months and years.

Conseillers contributeurs

  • David Foster
    Insolvency , Real Estate and Trusts & Estates in England

    David Foster

    silverDavid is a silver member
    Partner, Moore Barlow LLP
  • Francisco Rodríguez-Nepote
    Insolvency in Mexico

    Francisco Rodríguez-Nepote

    bronzeFrancisco is a bronze member