The increasing rates of insolvencies in Small and Medium Enterprises (SMEs) following the COVID-19 pandemic is continuing at a high rate, and England and Wales have seen the highest rates of insolvencies since 2009. Compared with the second quarter of 2022, the total of registered company insolvencies has increased by 13%. Compared with the first quarter of 2023, the rate of insolvencies has increased by 9%.

Specifically, corporate distress within SMEs is at its highest level since mid-2020, and the total debt owed by SME’s has risen by approximately 15%. In particular, it has been reported that this debt has increased by 21% for SMEs in the accommodation and food service sector. This industry accounted for 14% of company insolvencies in the last 12 months, as revealed by the Government’s Insolvency Statistics, released on 28 July 2023.

The hospitality sector has arguably been disproportionately impacted by COVID-19 restrictions, causing the industry to shrink by 18% from March 2020 to March 2023. Also, only 29% of SME borrowers are protected by fixed-rate deals when lending. This means that growing interest rates have had a profound effect on those SMEs with existing debt, with the interest rate rising from 3.2% to 5.6% in the last year.

Significantly, a number of SMEs are experiencing financial difficulties as a result of repaying Bounce-Back Loans, meeting Time to Pay (TTP) arrangements and the increasing rates of Redundancy Payment Claims.

Bounce Back Loan Schemes (BBLS)

BBLS were granted by the Government as financial support during the pandemic. The loans permitted borrowing between £2,000 and 25% of their turnover to a maximum of £50,000. Nationally, the cumulative value provided to SMEs through these loans was £47.4 billion.

Whilst BBLS initially had favourable terms, including a year of interest-free payments, the eventual repayment period has become a burden for struggling SMEs, limiting profitability. Currently, the Insolvency Service has recovered £1.1 million relating to BBLS fraud (to 31 May 2023). When HMRC has been seeking repayment of these BBLS, in many instances it has been found that they were obtained fraudulently, which has resulted in a number of director disqualifications.

More recently, it has been found that 11 sham companies were part of a group that fraudulently claimed UK-taxpayer funds and transferred the money to Hong Kong, claiming approximately £500,000 through the scheme. Significantly, the Insolvency Service has begun sharing information with office holders where a company has received support from schemes like BBLS, which enables them to investigate any possible fraudulent activity.

Time to Pay (TTP) arrangements

Due to the pandemic and its implications, many SMEs faced declining revenues and a diminished cash flow. The Government introduced TTP arrangements, to provide SMEs with a “lifeline” to manage their tax and debt obligations. The flexibility to defer tax payments and other debts helped ease immediate cash-flow pressures, allowing SMEs to allocate resources to essential expenses and maintain their operations.

TTP arrangements acted as a valuable support mechanism, preventing some SMEs from succumbing to insolvency during an economically challenging period. As of the end of March 2023, 912,233 businesses were subject to the TTP arrangements with HMRC. SMEs that deferred payments must now plan for repayment within the agreed-upon timeframe. Managing these repayments effectively, along with the dual burden of paying ongoing expenses, is crucial to avoid additional financial strain and potential insolvency risks down the line.

The unpredictable recovery timeline of the hospitality industry makes planning for these repayments challenging. Therefore, SMEs in the industry must carefully assess their financial position and forecast future revenues to negotiate realistic and sustainable TTP arrangements.

Redundancy payment claims

Further difficulties faced by SMEs are the increased rate of redundancy payment claims. Following the pandemic, it was essential for many SMEs in the hospitality industry to downsize their workforce or close completely. This has led to an increase in redundancy payment claims. Significantly, within three months of June 2023, 19,377 employee claims had been submitted.

As claims increase, businesses are faced with the financial burden of fulfilling their legal obligations to former employees. For many companies already grappling with paying back loans, reduced cash flow and profitability, this additional expense can further strain their finances and increase the risk of insolvency. It becomes challenging for businesses to simultaneously pay redundancy settlements and maintain their operational and capital expenditure needs.

While TTP arrangements and the BBLS provided crucial support to the restaurant industry during the pandemic, they also present significant challenges concerning insolvency. SMEs must navigate the complexities of debt and any redundancy repayments, managing financial resources and strategising for long-term recovery, which is not always possible in the current financial climate.

If you are dealing with an increase of these claims, it is essential you comply with employment law standards and regulations. Failure to do so can result in legal disputes, additional penalties, and damage to the company’s reputation.

If you are concerned about the financial health of your company, please contact Aman Sehgal.

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This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.