As all businesses are now entering a much more difficult economic landscape, you may be wondering how you can protect your company as much as possible from the greater risk of corporate insolvency.
Even if your company has a strong balance sheet and a buffer of reserves, the knock-on effects of economic hardship rippling through the supply chain can have a major impact on your own business. You may have a completely sound business, but it only takes one large customer to go pop and you will suddenly find yourself drawn into the fire.
There are many ways to mitigate against the implications of this happening, such as more stringent credit terms, better credit control and periodic vetting of customers. This will become all the more important as the economy contracts, although persuading customers to agree to revised terms may be easier said than done.
A more long-term structural solution is to undergo a simple corporate restructure by inserting a new holding company above the existing trading company. The trading company will become a wholly-owned subsidiary of the holding company and the shareholders will become shareholders in the holding company.
Once you have this structure in place, the trading company can transfer up to the holding company any surplus cash and any freehold property, significant plant and machinery, intellectual property or other valuable fixed assets. All assets transferred up can be leased or licensed back to the trading company, so from a practical point of view, nothing will change. The trading company continues as a going concern using the same assets.
The method of transferring such assets up to the holding company depends on your particular circumstances. The trading company cannot simply give the assets away.
If the trading company has sufficient distributable reserves, it can declare a dividend up to the holding company. If it is transferring assets up to the holding company, it can declare a “dividend in specie” of those assets equal to the value of those assets.
If the trading company does not have sufficient distributable profits, then it can sell the assets to the holding company for their market value, with payment for the price being deferred. The price can be set off against future profits dividended up to the holding company. This is less ideal, because until the price is settled in full, the value of the assets is not completely removed from the trading company’s balance sheet (as such value will be represented as a debt due from the holding company). However, the sooner this arrangement is put in place, the sooner you can start paying off this debt from future profits.
If the trading company subsequently encounters difficulties and is forced into insolvency, the cash and the fixed assets sitting in the holding company are protected from the trading company’s creditors. This is because, under the principle of limited liability, a creditor cannot pursue a shareholder for the company’s debts.
There are a few exceptions to this principle, specifically aimed at combatting companies taking advantage of it to avoid imminent insolvency and greater risk to creditors.
Therefore, it is important to stress that:
- the trading company will only be able to dividend up (either as cash or by assets in specie) the amount of its distributable profits; and
- the directors must satisfy themselves that any dividend will not affect the company’s ability to pay its actual and contingent liabilities as they fall due.
You must not use this tactic if you are already on the verge of insolvency, therefore, as it will be too late and the dividend may be challenged by the trading company’s creditors.
Once the holding company is holding cash, it can then declare its own dividends to the shareholders, or simply hold on to the cash for future use.
Taking this principle of holding surplus cash in the holding company further, if the trading company subsequently requires additional working capital, it can borrow cash from the holding company. The holding company can even take security from the trading company for this inter-company loan, such as a debenture. Therefore, even if creditors do pursue the trading company through an insolvency procedure, the holding company will rank ahead of them as a secured creditor in recovering the amount owed to it under the inter-company loan.
It is worth mentioning that these arrangements will probably need to be approved by the company’s bank, especially if the bank already has security from the trading company.
The bank may require separate security from the holding company and an intercreditor deed to ensure that the bank’s interests are not prejudiced by the arrangements.
We have implemented restructures like this for a number of clients. It is not a solution for all companies, so further advice is always required to fine-tune the detail and ensure you do not inadvertently put yourself in the line of fire.
If you would like more information about how we can implement this type of restructure for your company, please contact Nick Gabay on firstname.lastname@example.org or 01892 701236.