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Mishcon Academy: Digital Sessions - Reshaping Business and Relationships: Facing the New Financial Reality

Posted on 15 January 2021

In December, our panel comprised of Partner Paul McLoughlin, Partner Derval Walsh and Legal Director Samantha Kakati discussed how the COVID-19 pandemic forced businesses to take on debt - unforeseen and unbudgeted - in a period of acute uncertainty. After the rise of the so-called "zombie phenomenon" in 2008 – businesses were unable to grow or invest under the weight of unsustainable debt.

Our panel looked ahead to recovery and explained how companies managed this new debt situation successfully, discussed lessons from the 2008 financial crisis, explored the options available to borrowers, company directors, management teams and shareholders as they faced the dual challenge of managing creditors and repairing balance sheets.

Mishcon Academy: Digital Sessions are a series of online events, videos and podcasts looking at the biggest issues faced by businesses and individuals today.

The Mishcon Academy Digital Sessions.   

Derval Walsh, Partner

Mishcon de Reya

Hello, I’d like to welcome you to Mishcon de Reya today for this session which is Reshaping Business Facing a New Financial Reality.  Three of us will deliver the session: Paul McLoughlin who is a Partner of mine in our Dispute Resolution and Corporate Rescue team, and Samantha Kakati.  Samantha is a Legal Director in our Finance and Banking Disputes practice.  And my name is Derval Walsh, I am the Head of our Finance and Banking Disputes practice.  So, Paul if I can turn it over to you to start on topic number one, where are we today, the economic climate?

Paul McLoughlin, Partner

Mishcon de Reya

I think there’s been a lot in the press and in the news over the last few weeks reporting that the economy has recovered since the end of the first lockdown but it is still significantly behind where it was in February this year, and I think the latest figures that I’ve seen suggest that the economy is now 8% smaller than it was.  Clearly, we’ve had some very positive news over the last few weeks about a vaccine and we’ve seen a lot of rebound in markets and trading activity but I think you know certainly the messaging that I get from the people that I talk to is that there’s still quite a lot of uncertainty, we’ve got rising unemployment, I think that was always anticipated but we’re certainly seeing those figures coming through now.  We’ve got a significant overhang of corporate debt, in the sense that was there before the pandemic hit, it’s certainly been exacerbated by the pandemic particularly with Government support loans and clearly, we’ve still got the Brexit debate which is raging.  In terms of sectors, certainly the retail, leisure, hospitality, transport, casual dining, oil and gas, have taken a real hit over the last ten months.  On the flip side, there are certainly plenty of sectors which are doing very well on the back of the pandemic but I think on balance, more people are feeling pain rather than benefit.  So whether Government support measures that at some point in 2021 will start to rewind, particularly the VAT deferral scheme that was put in place earlier this year which is due to come to an end in March next year, the busines rates relief scheme, again which came in to support business during the pandemic is due to come to an end in April and I think for many businesses, the ability to effectively defer rents to landlords has been utilised, it was due to come to an end on the 31 December, I think last week it was extended so it’s now due to come to an end on the 31 March and the Government was very clear that that would be the last extension to restrictions on landlords.  2021 is going to be the year where a lot of businesses of different sizes will have to focus on how they resolve those problems.  On a positive note, there’s certainly a sense that there’s a better climate now for dealing with those problems than perhaps pre-Covid and it may well be the case that we find banks and creditors and HMRC being more supportive of businesses as they try and emerge from this crisis.

Samantha Kakati, Legal Director

Mishcon de Reya

We hear a lot about this rhetoric of a brave new world in 2021 and what does that actually mean.  I think the reality is, no one knows for certain but when we actually look at the changes on a sector by sector basis, what we start seeing is that a surprising number of those trends were actually already in motion and so actually whilst Covid has accelerated some changes and instigated some new ones, some of it was already there and we perhaps weren’t seeing it quite so plainly.  So, if you look at retail for example, I think we’ve all seen the news that the groceries shops in particular, those retailers, have had a really unprecedented year, if you look at Sainsbury’s for example, they’ve doubled their number of delivery slots and there have been third parties that have benefited from that as well in terms of the rise of Deliveroo or the providers who help deliver those groceries.  When we look at more high street retail, there are also some trends that have been a success in 2020 that were already in place.  If we look at Ikea for example, they’ve got a great reputation for being very forward thinking in the market and so they were really ahead of the curve when they first introduced their city centre smaller stores, originally as kitchen planning and then as collection points.  They’ve moved away from that model but what that does show is that people are already seeing that the status quo for how retail had worked, had already changed.  We were also already seeing a big shift online and so the challenges that that presented, for example one of the big issues with online retail is that there seems to be a little bit of a lag in actually assessing how your sales are performing, it seems to be that when people shop online, they tend to buy a lot more in terms of volume than they would in store and what that means is a larger number of returns and that makes it a lot more difficult to understand your financial position.  And then just kind of lastly to follow on with that in terms of trends, when we look at the travel industry, certainly we think straight away well that’s been impacted.  Airbnb back in the spring had to make 25% of its workforce redundant but that’s now recovered and only the other week and there’s been a real demand in more domestic travel so with Airbnb it’s been lots of people trying to get away to the countryside or out of the city.  So I think the takeaways in this brave economic climate, we need to just look at things a little bit differently.  There are opportunities out there but you need to understand where they are and to do that, we have to understand our business and our debts.

Derval Walsh, Partner

Mishcon de Reya

And if I could ask that’s what the borrower-lender relations issue, what to expect, what to look for?

Samantha Kakati, Legal Director

Mishcon de Reya

The borrower-lender relationship really tends on understanding the business, the stream of income and the security of the debt.  So agile is this buzzword we keep hearing about how businesses can survive.  Agile and adaptability is actually at odds with traditionally what’s most important for lenders which is certainty.  But that’s not to say it’s all doom and gloom, it’s a great time to then look at what terms were negotiated previously and perhaps even though neither of you might be, in particular 6.40 at the moment consider whether there might be something that’s better for both parties.  Well, lots of businesses will have revolving credit facilities and the key reason for that is the flexibility that it offers.  Often we see the revolving credit facilities because it’s intended to be flexible but banks will be quite lenient.  The issue that we might see now is that because there is such uncertainty, lenders may be more nervous and look back at what actually the terms of their documents say and I think it’s really important that borrowers understand what those terms are, what is the black and white position of the lender in terms of their rights, and have that in the back of their mind, not withstanding what commercial relationship there is. 

Derval Walsh, Partner

Mishcon de Reya

Thanks Samantha.  If I can just turn to Paul now just to talk about the profile of some of the lenders who are out there in the space and just give us his experience of, you know, the priorities that matter to those lenders. 

Paul McLoughlin, Partner

Mishcon de Reya

Most traditional lending banks now have specialist teams and departments for helping borrowers who are going through some kind of stress and they do tend to be operated and staffed by specialists.  There is a lot of difference between dealing with your standard relationship manager who is driven by building a relationship and dealing with a business support unit.  Put it very bluntly, a business support unit will be focussed on minimising the losses to the bank.  I think it’s fair to say that, you know, from 2008 onwards things have improved dramatically.  I think for most banks when they are faced with a problem with their customers, they do stop at a point where they want to try and work things out and resolve issues rather than simply force a borrower into some kind of insolvency process or enforce security.  Added to that, we now have, after 2020, a regime where there has been significant Government support to assist businesses who are struggling because of the pandemic and I think that in itself creates a fairly significant amount of political force which may see the banks being more sympathetic.  The key thing for any borrower is to understand its legal rights, it needs to understand what the options might be and by that I mean there has to be some sense of what is the business plan going to look like going forwards?  How will that business plan be funded?  What are the cashflows looking like going forwards?  And what is the balance sheet looking like?  But it’s really important that that thinking and that analysis is done before having those kind of conversations, you know, that does take some time but it’s worth looking at that now because by the time a business gets to the stage where liquidity is tight and it’s running out of money, frankly that is insolvency and it’s too late. 

Derval Walsh, Partner

Mishcon de Reya

We’re going to move onto the third topic for discussion which is a case study which is essentially a what not to do.  Paul, I think you’re going to start on this. 

Paul McLoughlin, Partner

Mishcon de Reya

The world of restructuring is littered with cases of businesses that have unfortunately ended up going into an insolvency process when it could have been avoided.  When shareholders or directors are facing these kinds of financial issues with their business, there is obviously a tendency to try and do whatever you can to save the business and quite often that involves putting in new money.  The example that I worked on a few years ago, it was actually a large retail group, the owner/manager of that business borrowed significant sums to expand.  When the market turned, he found himself in a position where it was very difficult to meet the interest and principal repayments on the bank debt and the bank were pushing for the shareholders to put in more money and the individual who had built this business from scratch, without thinking too much about it and without really getting the benefit of good advice, decided to invest a significant sum of money.  The Christmas trading period unfortunately wasn’t as good as expected and on the other side of the New Year, the banks decided that they could no longer support the business and of course because they had security, they were able to take enforcement action and appoint administrators who then sold the business for substantially less than the value of the bank debt.  What that meant for the owner-shareholders, is that they had pumped in that three million before the Christmas period and they lost it all.  Businesses will need liquidity, they will need new funding, they will need cash but it’s vitally important to think how that cash goes in.  Really, the message is, if new money has to go in, particularly from owner/managers, shareholders, directors, make sure that your investment is protected legally either by putting restrictions on other creditors and their ability to enforce or actually by trying to negotiate some process whereby if there is an insolvency or an enforcement that that new money comes out first. 

Derval Walsh, Partner

Mishcon de Reya

Paul, just some practical advice you would give to people who are in this type of situation.

Paul McLoughlin, Partner

Mishcon de Reya

I think the first thing is, is recognise who are your key creditors?  In practice, banks are the key creditor.  It’s really important that, you know, you don’t spend too much time having discussions about, you know, supply arrangements or supply terms and so on and so forth, it’s really the big financial creditors that will either carry your restructuring or break a restructuring.  The second point which is related is that for most banking facility agreements there may well be things that have happened over the last ten months which may well have given rise to an event of default and it’s really important for a director to recognise when that has happened and to take steps to address that.  From an accounting perspective, if there’s an event of default outstanding on the accounting reference date, when you come to file your accounts it can create problems because the accounting reference date is the date on which the accountants had to say what liabilities and what debt was due at that point in time.  And the third point is, there have been lots of initiatives from Government about supporting businesses.  One of those measures is in the new Corporate Insolvency and Governance act and it provides for a moratorium and it’s for any business and there are very few hurdles to get across to the get the benefit of that moratorium. 

Derval Walsh, Partner

Mishcon de Reya

Just from you Samantha, some practical advice.

Samantha Kakati, Legal Director

Mishcon de Reya

I think the key takeaway is engage early and do it in the right order.  First of all, have a look internally, understand your busines, and second of all, understand the framework that you are operating in with your financial documents and your legal position.  And it’s only once you understand that, you should then engage with the bank. 

Derval Walsh, Partner

Mishcon de Reya

I’d like to thank Paul and Samantha for their time and their insights today and I’d like to thank you all for joining us and I do hope that you have found it of use and I do hope that you assimilate some of the lessons and some of the learning, and I hope you are not in the situation where you ever have to apply them I should say, but if that situation arises, I hope you derive some benefit from today’s session.  So, thank you very much and let me wish you, on behalf of Mishcon de Reya, a very Happy Christmas.

The Mishcon Academy Digital Sessions.  To access advice for businesses that is regularly updated, please visit Mishcon.com.

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