Zombie companies in danger from Covid-19

In an attempt to limit the economic fallout from Covid-19, the Government is rushing through parliament the Corporate Insolvency and Governance Act.

The new legislation, which recently came into force, proposes a raft of debtor-friendly measures aimed at curbing company collapses.

If we’re to kick-start the economy and stave off recession it’s essential that trade increases and unemployment remains low. Our Government has determined the best way to do this is to provide struggling businesses with a temporary lifeline.

The idea is to get consumers and businesses spending again by ensuring that companies continue to trade and employ people. Among other things, the Government’s proposal:

• Temporarily suspends the filing of statutory demands and winding-up petitions on Coronavirus-related debts
• Introduces a moratorium facility that provides companies with protection from creditors, and a 2-month window to form a rescue plan
• Prohibits termination clauses, and forbids creditors from stopping their supplies to a debtor company in an insolvency procedure

The Act introduces a moratorium that supports companies affected by Covid-19 by protecting them from creditors for up to 40 business days.

During that time, they should be able to accrue some profit and return to normal operations. At least that’s the theory.

Zombie companies

The reality, however, is quite different. In truth, Covid-19 has:

• Flushed out the large number of zombie companies trading while insolvent
• Revealed that very few businesses have enough cash reserves to facilitate more than 8 weeks of trading

If these were good businesses, reserves would have been accrued. A good business retains profits and is able to trade for up to 6 months functioning solely on cash reserves.

Sadly, in Britain there’s been an enduring culture of asset stripping without retaining any reserves for a rainy day. Consequently, our economy is home to tens of thousands of zombies that were doomed to eventually fail, irrespective of Covid-19.

Company closures are unavoidable. But proposals set out in the new Act help to ensure failures occur over time rather than immediately.

Only the fittest of the fittest survive under these circumstances, so expect an increase in mergers and acquisitions as medium-sized businesses align with larger companies and corporations offering shelter and cash.

Few traditional bricks and mortar small businesses will survive in the long-term as the online sector experiences unparalleled growth.

The sad thing about the Corporate Governance and Insolvency Act is that although well-intentioned, it sends the wrong message to zombies, many of whom will benefit from the new measures in the coming weeks and months.

During that time, they will continue to purchase supplies, attract more debt, and perpetuate a cycle of bad behavior by bringing losses to other businesses, and that can’t be right.