Devaluation in a formal insolvency – the impact of costs
March 16, 2023
So far in our series on what a formal insolvency does to a previously solvent balance sheet and how it impacts stakeholder recoveries, we have looked at overall principles, shrinking non-current asset values, diminishing current asset recoveries and ballooning liabilities.
Now we turn to the contentious issue of the cost of an insolvency process. Unfortunately, there is little understanding in the commercial and financial worlds of what these cases involve in terms of professional work and the expenses, which have to be incurred. What is certain is that no matter how reasonable and justified the costs may seem to the insolvency practitioner (IP) handling the case, creditors faced with a loss will almost always view them as excessive to one degree or another.
The IP’s fees
These can be calculated on a ‘time cost’ basis based on time spent by the IP and their staff, as a percentage of the funds recovered or as a fixed fee. In the vast majority of insolvencies, the IP will only recover a percentage of their time costs, sometimes a small percentage.
A comprehensive guide to the role of an IP, the work they are required to do and how their fees are calculated and approved has been published by the UK trade association for IPs, R3. It can be found here.
Some of the tasks that must be carried out by IPs under the insolvency legislation may not be directly beneficial to the outcome for creditors but instead are in the interests of transparency (the extensive reporting requirements) and public policy (reporting on the conduct of directors and assisting in any action taken against delinquent directors).
Insuring and securing assets
All assets have to be insured and physical assets may require security protection.
Assets not already under the direct control of the insolvent company have to be secured, which may involve investigation, negotiation and relocation, with a range of consequential costs for legal advice, forensic tracing and the services of specialist agents. These costs will be higher where there are disputes over ownership.
Selling a business and its physical assets and collecting receivables all involve costs with a wide range of agents and in some instances, legal advisers. Examples are where there are property assets or where inventory is subject to retention of title claims by unpaid suppliers. Some realisations may involve stamp duty costs, such as on the sale of shares.
Ongoing occupation of the insolvent company’s premises could be necessary to facilitate continued trading, the storage and sale of physical assets or for administrative reasons. Rent, business rates, insurance, maintenance and other related costs will be ongoing. Vacating premises may trigger dilapidation claims by the landlord.
Ongoing trading may be justified to preserve the business for an eventual going concern sale, even if trading losses are incurred. It may also be necessary to protect trade receivable or maximise the realisations for inventory.
You may also be interested in: Why does insolvency reduce business value?
Accounting & IT costs
Adequately maintaining books and records is often a casualty of the severe pressures and difficulties in the period leading up to filing for insolvency. Bringing them up to date or standard and continuing will mean incurring professional and sometimes IT costs.
Agreeing tax liabilities or refunds will involve extra professional costs for taxation specialists or payment for the work and co-operation of the company’s former financial advisers.
Employee claims and issues
Agreeing employee claims will normally be undertaken by the IP and their staff, but where there are disputes and especially when matters have to be resolved through an employment tribunal, there will be additional professional costs.
It is common to keep on some staff, even where there is no ongoing trading. This can be to assist with asset sales, updating and maintaining accounting records or collecting receivables, as well as helping with the investigation of the affairs of the company, the resolution of disputes and identification of assets.
Pension scheme issues
It may be necessary to appoint independent trustees to any pension schemes and to take expert advice regarding the insolvent company’s obligations to its own schemes or connected schemes where it is part of a group.
There are a host of more minor overhead costs involved in running any insolvency case, including such items as statutory advertising, the cost of communicating with stakeholders, bank charges, storage costs, travel costs, etc.
All expenses incurred in an insolvency case are subject to regulation and creditor approval, sometimes in advance, in the same way as the IP’s fees. A comprehensive guide to these procedures has been issued by the Institute of Chartered Accountant in England & Wales. It can be found here.
The scale of costs
Costs vary according to the circumstances of each insolvency, so there is no rule of thumb on their quantum, nor their relationship to the recoveries made. However, because of the extensive mandatory compliance with insolvency legislation required of IPs, it is inevitable that the smaller the case and the value of its asset realisations, the higher will be the percentage absorbed by the costs.
If you are seeking professional advice for your business, Opus is here to help. You can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.