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09/10/2017

UK insolvency framework is OECD’s best for zombie-busting

An OECD* report has concluded the UK’s insolvency and restructuring framework is the most effective in the organisation at preventing a build-up of productivity-sapping zombie companies, says UK insolvency and restructuring trade body R3.

The report, ‘Insolvency regimes, zombie firms and capital reallocation’, says that zombie companies – struggling companies aged 10 years or older who cannot cover debt interest payments with their profits for three consecutive years – redirect investment away from innovative rivals, push up wages, and undermine productivity, and that an economy’s insolvency framework is a key factor in reducing zombie firm numbers and investment.

The report uses 13 key criteria to rank insolvency frameworks in 34 OECD economies according to their effectiveness at closing down zombie companies (and helping their capital and resources be re-used more effectively elsewhere), restructuring zombie companies back to financial health, or preventing zombie companies from developing in the first place.

Using these criteria, the UK’s insolvency and restructuring framework is by far the most effective at dealing with zombie companies, followed by the frameworks in Japan and Germany. Estonia’s framework is rated the least effective.

The OECD report notes that in the UK “personal costs associated with entrepreneurial failure and barriers to restructuring are low, while there is also a number of provisions to aid prevention and streamlining.”

Duncan Swift, deputy vice-president of R3 says: “Zombie companies are a big part of the productivity puzzle plaguing Western economies, so it’s encouraging the UK’s insolvency and restructuring framework is recognised as the best positioned to tackle problems caused by these unproductive companies.

“The insolvency and restructuring framework is a fundamental pillar of any economy. It makes sure resources – whether investment, people, or ideas – are being used productively and aren’t stuck in stagnating companies. The profession’s work keeps an economy competitive, helps new businesses thrive, and helps older companies adapt.”

Duncan Swift adds: “The OECD report highlights plenty of opportunities for other countries to reform and catch-up to the UK, so we need to keep adapting to remain ahead of the competition. Changes are already taking place within the profession: it would be very misleading now to think of the profession as only involved in business failure and closing down companies. Over the last decade or so, much of the profession’s work has been business rescue-focused while pre-insolvency restructuring work has become as important as statutory insolvency procedures.

“However, with other countries’ frameworks closing the gap and with Brexit presenting serious challenges to running cross-border insolvency and restructuring work from the UK, the government must act to help the UK remain an international insolvency and restructuring hub.

“Much-needed insolvency reforms first proposed by government in early 2016 have since stalled with no clear timetable for their introduction. The sooner the government acts to introduce its reforms, the better.”

Why the UK framework excels

The OECD’s report says that insolvency framework elements likely to increase zombie firm numbers include, among others:

  • high personal costs to failed entrepreneurs;
  • a lack of preventative or procedural streamlining measures;
  • indefinite stays on assets or the automatic dismissal of an insolvent firm’s management;
  • no option for creditors to trigger insolvency procedures;
  • absence of a ‘cramdown’ option that would tie dissenting minority creditors to a restructuring plan;
  • and a high degree of court involvement.

In the UK, a bankruptcy term for an insolvent entrepreneur will last a minimum of just one year, there are options for management to remain in control of an insolvent firm (in a Company Voluntary Arrangement, for example), procedures are time-limited, creditors can trigger procedures, and procedures operate mostly out-of-court.

In contrast to the UK’s framework, the report says that in the US, where the framework is heavily court-based, “personal costs to failed entrepreneurs and barriers to restructuring are relatively low, but preventative and streamlining measures are generally lacking.”

The report scores insolvency frameworks out of 1, where a score of 1 indicates a less effective framework and a score of 0 indicates a more effective framework. Overall, the UK scores approximately 0.1, relatively well-ahead of its closest rival Japan on approximately 0.25.

How many zombies are there?

The report also estimates that 7.5% of UK capital is “sunk in zombie firms” (the 5th lowest of 15 countries for which data are available, behind Slovenia, France, Japan, and Finland).

R3’s own most recent survey of UK businesses (conducted with BDRC Continental in April 2017) found that 5% of UK companies were only paying the interest on their debts and not repaying the debt itself – another measure of a company’s ‘zombie’ status.

Duncan Swift comments: “While an insolvency framework exerts downward pressure on zombie firm investment and numbers, there are plenty of factors in the UK pushing in the opposite direction. Record low interest rates and, since the financial crisis, unprecedented levels of forbearance from traditional sources of credit, like banks, have helped otherwise uncompetitive companies survive.”

Insolvency frameworks ranked by the OECD according to their effectiveness at dealing with ‘zombie companies’ – lower scores indicate a more effective framework (Source: OECD; see report for more detail)

Share capital ‘sunk’ in zombie companies in 2013 (Source: OECD; see report for more detail)

Planned government reforms stalled

In May 2016, the government proposed a series of reforms, many of which are backed by the insolvency and restructuring profession, to increase business rescue in the UK.

However, following the June 2016 EU referendum and the surprise loss of the government’s majority in June 2017, limited progress has been made on the reforms with the government’s last public comments being made in September 2016.

Proposals included the introduction of a business rescue ‘moratorium’ which would protect insolvent businesses from their creditors for a short period of time while they put in place a rescue or wind-down plan; a new court-based restructuring tool which would introduce a ‘cramdown’ option to the UK; and new rules which would prevent ‘essential suppliers’ from scuppering business rescues by withdrawing their supplies.

*Organisation for Economic Co-operation and Development

Notes to editors:

  • R3 is the trade body for Insolvency Professionals and represents the UK’s Insolvency Practitioners.

  • R3 comments on a wide variety of personal and corporate insolvency issues. Contact the press office, or see www.r3.org.uk for further information.

  • R3 promotes best practice for professionals working with financially troubled individuals and businesses; all R3 members are regulated by recognised professional bodies
     
  • R3 stands for 'Rescue, Recovery, and Renewal' and is also known as the Association of Business Recovery Professionals.