Insolvencies: is our current system working?

Let’s start at the historical side of things.  We used to put debtors in prison until their debts were paid.  I think we have moved on a bit since then… As you probably know we now have systems of both personal and corporate insolvency and it’s here that I’d ask – is that system working in the majority of cases?

That isn’t just a philosophical – or even idle – question.  In trying to answer it, we also have to ask – what is the insolvency legislation for?  To my mind one of its purposes is to bring a tidy end to those cases where there is no hope of “survival”: let’s call this the undertaker function.  The second purpose is to get back to creditors whatever can be recovered in such a way that is broadly equitable between them:  the recovery function.  Thirdly, if there are businesses or parts of businesses that can be rescued then they should be rescued: the rescue function.

From my perspective, undertaking is working pretty efficiently.  I haven’t seen any proposals to put debtors in prison again!  But I’m not sure that the recovery or rescue functions are working as well as they should. There are many reasons for that including the availability of finance, timing, culture and costs.  Looking at these briefly:

Availability of finance:  not surprisingly, if one business has gone down, the existing lenders are going to start off with being reluctant to lend to any successor business unless they are really sure that the successor is going to be viable – and often if everyone was as sure as that, then the funding would have been available to rescue the business before the collapse.  So should we encourage no hope in this area about these problems?  In some cases suppliers to a business that is going downward much prefer to have a business to continue to supply (even if that meant writing off some debt) rather than writing off debt and not having a business to supply.  In technical terms, that might be Hobson’s choice.

Timing:  I’m afraid that this is pretty simple.  If people face up to their problems early enough something might be doable.  If they don’t, the chances are that it won’t.  So we need to encourage a culture where people can be more honest about the difficulties of their business.  That leads me onto…

Culture:  Here I’ll always remember a fundraising trip with a client to Texas nearly 30 years ago.  He made his pitch for funding, which went very well.  Afterwards somebody approached him and chatted about the product etc, and then said, “I hear you’ve been bankrupt”.  My guy said “yes”, his shoulders slumped and we started to think this opportunity was lost – until the Texan said “Great: what did you learn?”  We in the UK are light years away from that frame of mind.

Costs: All too often, complying with the legislation means that ordinary creditors get no recovery – so to that extent, the whole process fails ordinary creditors. They have lost all their outstanding debt and their customer – and that can’t be right. So, I think we need to start thinking of better ways to do these jobs, that improve the prospects of recovery and rescue.

We have to accept that businesses run into difficulties, often for reasons that are nothing to do with the hard work of those running them: for example, a key customer can go bust.  So I think we have to be more proactive about rescuing those businesses that can be saved, and that will only happen if there is a dialogue early enough.

Food for thought?

If you would like to discuss this, please contact, John Clarke.