Insolvencies are low right now, but that doesn’t mean businesses are safe. Declan de Lacy explains why the number of insolvencies could rise in the future.
Is the current low rate of insolvencies like the sea retreating before a tsunami? This is the worst-case scenario envisaged by the European Systemic Risk Board in its recent paper on preventing and managing many corporate insolvencies.
Ordinarily, soaring unemployment rates and collapsing economic output are accompanied by rapidly increasing liquidations. The absence of this since March 2020 suggests that the Irish Government’s business supports have been effective.
However, recent reports by the Central Bank and the Central Statistics Office suggest low numbers of liquidations are not a sign of robust corporate health but, instead, reflect the delayed transmission of the economic shock through to insolvency rates.
The Central Bank reports that 26% of SMEs have made losses since the pandemic began and that 16% are in financial distress. More worrying is data from the CSO indicating that more than 16,000 businesses (7% of those surveyed) had their entire staff laid off since April 2020. Although restrictions directly prevented some businesses from resuming trade, it is likely that among those 16,000 businesses, economic viability prevented re-opening of some. As time passes, it becomes increasingly unlikely that this latter group will ever resume trading.
The recent decision to extend government schemes including the Employment Wage Subsidy Scheme, COVID Restrictions Support Scheme, and tax warehousing until the end of the year gives businesses affected by the pandemic additional time to assess their position and take remedial steps before supports taper off. It will be essential for businesses to revert to a viable business model based on sustainable costs and revenues during this period.
When the economy fully re-opens, many businesses will be viable on a day-to-day basis. However, they will have insufficient profit or liquidity to make good on debts incurred before or during the COVID-19 crisis. These debts are likely to include rent arrears and taxes warehoused during the pandemic. As creditors revert to more normal collection models, the survival of these businesses will depend on their ability to either restructure or reschedule their obligations. Historically, there has not been a viable process for SMEs to restructure their debts. However, the Small Companies Administrative Rescue Process, which will be introduced before the summer ends, is expected to provide a fast and fair rescue process for distressed SMEs. It is incumbent on accountants to familiarise themselves with this process and recommend it to clients for whom it is necessary.
In the last recession, many companies had to be liquidated because they had incurred large debts to finance credit to customers who ultimately did not pay. To avoid this happening again, businesses that advance credit must manage their exposure to customers whose viability is uncertain.
It is inevitable that as supports taper off and debt collection becomes more muscular, many companies will be unable to continue trading. The true number of companies fatally impacted by the pandemic will not be revealed until this happens.
Declan de Lacy FCA is an insolvency practitioner and leads the advisory and restructuring practice in PKF O’Connor, Leddy & Holmes Limited.