Just over 12 months ago, large parts of the global economy ground to a virtual halt due to government restrictions being put in place to control the Covid-19 pandemic. Many businesses’ activities were severely restricted and management teams battled to cut expenditure, conserve cash and renegotiate the terms of their banking facilities.  Requests by sponsors to defer deficit repair contributions (“DRC’s”) came thick and fast.

During the first wave of the pandemic, all signs suggested that, despite government measures to support the economy, there would be an uptick in corporate restructuring and insolvency activity. The Corporate Insolvency and Governance Act (“CIGA”) which came into force in June 2020 even provided new, flexible mechanisms for companies to restructure and compromise amounts due to their creditors.

There were a number of high-profile insolvencies in 2020, particularly in the retail sector. However, overall corporate restructuring activity declined significantly year on year. Statistics from the Insolvency Service show that the number of corporate insolvencies in England and Wales fell by 27% in 2020. This trend continued into 2021 when, despite the national lockdown, corporate insolvencies were down almost 50% in February 2021 compared to the previous year.

It is generally thought that the fall in corporate insolvency rates can be attributed to two key factors: i) the continued and extensive economic “life support” being provided by the Government, and ii) some easements to insolvency rules, including the suspension of penalties on directors for wrongful trading and the moratorium on winding-up petitions. Record-low interest rates are no doubt helping businesses to keep their heads above water too.

But is this the lull before the storm? UK GDP shrank by 10% in 2020 and is not forecast to return to pre-pandemic levels until 2022. It, therefore, seems inevitable that there will be an increase in corporate failures at some point.

Research by EY (link) recently identified 27 listed companies with DB schemes which issued three or more profit warnings (a lead indicator of financial distress) in the 12 months to March 2021 – 10% of listed DB scheme sponsors. 15 of those companies had benefitted from some form of government support e.g. furlough, government-backed loans or deferring payments to HMRC. Extrapolating those findings to the entire DB universe suggests that there are hundreds of schemes whose sponsors may be at risk of financial difficulties when government support schemes come to an end.

The million-dollar question is what the potential wave of corporate failures will look like. This is likely to depend on the manner in which government economic support schemes are wound down and easements on insolvency rules withdrawn.

The worst-case scenario would be a “tsunami” of corporate failures. This would cause a short-sharp shock to the economy and could seriously harm business confidence. The impact on pension schemes would also be severe. Whilst it is likely that the Government will want to take action to avoid this scenario, it is not off the cards completely, particularly if some other economic shock occurs.

Most restructuring advisors that we speak to believe that it is now more likely that there will be a sustained, but gentler, pick-up in corporate restructuring activity starting in the second half of 2021.  This would avoid the potentially acute pressure of a “tsunami” of restructuring activity. However, it could still be the case that we see a prolonged period during which many DB sponsors seek to restructure their liabilities and/or seek to compromise pension liabilities.

We believe that it is now more important than ever for trustees to properly understand and monitor the employer covenant and to look out for the warning signs of employer distress. This is not always straightforward – at a recent internal training session I identified over a dozen warning signs for my fellow trustees to look out for and there are probably many more! We truly value covenant advisors who take the time to get in touch when they see developments which could impact our scheme sponsors, particularly when outside of any regular covenant assessment or monitoring arrangements.

As and when sponsor financial distress moves from being a possibility to becoming a likelihood, it is important that trustees have put contingency plans into action and are ready to react in order to protect the scheme’s position. Early engagement with the PPF is also crucial in these circumstances. 20-20 Trustees has a dedicated group of restructuring experts, as well as trustees from a wide range of backgrounds. We are members of the PPF’s pre and post-insolvency panels and have acted for many schemes in circumstances of employer distress.