What are the Most Common Reasons for Businesses to go into Administration?

November 9, 2021

What are the Most Common Reasons for Businesses to go into Administration?

When a company is in financial distress and facing an insolvency procedure, it can consider a number of processes, primarily Liquidations, Company Voluntary Arrangements and Administration.

The Administration process has two key features unique to this type of Insolvency.

Firstly, is that an Administration has to achieve a statutory purpose, which are as follows:

  • Rescue the company as a going concern
  • Achieve better realisations than would be available in a liquidation or
  • Enable a distribution to be made to the secured and / or preferential creditors.

The first two objectives cannot be achieved within a liquidation, and indeed the second objective is a direct comparable between the two processes. Where the company has been advised by an Insolvency Practitioner that either of the first two objectives can be achieved, it will be because they have identified that based upon the circumstances of the company ultimately better realisations are available for the benefit of creditors as a result of the Administration process. This is the primary reason companies go into Administration, as company directors have a duty to act best in the interest of creditors when a company is facing insolvency.

The second unique feature of an Administration is that an Administration grants the company the benefit of a moratorium against all existing and future legal proceedings. This effectively serves to freeze the company’s position, and also acts as protective shield over the company and its assets whilst the Administrator deals with its affairs. The moratorium can only be bypassed by either an application to Court, which the Administrator is entitled to contest if appropriate, or with the consent of the Administrator, which may be given if the proceedings are either to the company’s benefit or are of no detriment to the company, but could be detrimental to third parties if the mortarium continued.

If, for example, a company’s premises were essential to the company’s operations, even if only in the short term, the moratorium prohibits landlords from evicting the company from these premises. An Administration is often utilised to facilitate a sale of the company. An administrator may therefore wish to trade the company within the administration, and as such use of its premises would be essential – for example a retailer could open to sell stock to the public.

Additionally, prospective purchasers will gain value from the ability to acquire and trade from the company’s premises, even if only the short term, which can significantly enhance the value of the company and/or its assets in the sale process.

Trading and selling a company in situ can therefore lead to higher realisations for the benefit of creditors. In a liquidation, the liquidator would not be able to utilise the Company’s premises.

Another example is that a creditor may be seeking to secure its indebtedness over some or all of the company’s assets.If successful, this would put that creditor in a better position than the company’s other creditors, who would not have the benefit of security. As the moratorium would freeze this action if it was obtained prior to any order of the Court being made, the creditor would not be able to obtain security, and thus leave the company’s assets available for the benefit of the company’s creditors generally.

Prior to identifying Administration as the best process for the company to undertake when facing an insolvency event, its directors will need to conclude if it is insolvent. The following are common challenges that the team at Chamberlain & Co have noted in relation to the forcing of an insolvency event:

  • A sudden and sustained downturn in trade, leaving the company with operational costs and funding lines that can no longer be maintained. Examples of such events are the Coronavirus Pandemic requiring many companies to cease trading, or if the company has a key client, such as Carillion, which enters into its own insolvency event, thereby losing a significant client.
  • Whilst the company may have a good core underlying business, an unanticipated significant liability may occur which cannot be funded from trading activities. An example of this would be if a construction company had an incident on site resulting in damages that were not covered by insurance.
  • Financial mismanagement. Many companies rely on external partners such as accountants and tax advisors to assist the company in dealing with its financial affairs and taxation. Where a failing arises in this advice, or advice is not followed, companies can have significant tax and similar liabilities arise which cannot be repaid in a timescale agreeable by HMRC.

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