Going under

The method a company chooses to tackle its financial difficulties can influence whether the company survives, and what form that survival takes. Louise Butcher examines the implications this could have for business interruption insurers in light of the increased popularity of pre-packs and company voluntary arrangements.

In the fourth quarter of 2008, there were 4607 compulsory liquidations and creditors' voluntary liquidations in England and Wales — a 51.6% increase on the same period in 2007. Corporate insolvencies also soared, with receiverships, administrations and 'company voluntary arrangements' more than trebling. In the first half of 2009, 18% more companies went bust than in the same period last year.

As more businesses face these problems, there is a risk that insurers could accidentally pick up the bill for things that are not covered, or even keep a company alive through business interruption payments when it would otherwise go under.


Ways to go bust

When it comes to insolvency, it is easy to assume a company either exists or it doesn't. But there are many ways for companies to go bust, and many methods for them to stave off collapse. The route the company chooses can influence whether the company survives and what form that survival takes.

When a company with business interruption cover becomes insolvent, it is clear the insurer should be told because this affects the cover and the risk the insurer is exposed to. But whether a company's cover is still valid — and whether the insurer is even told about the insolvency — will vary from case to case.

A pre-packaged administration means that the best parts of the business survive, and the bad parts are discarded — normally liquidated. The bits that survive become a new company. With a CVA on the other hand, the corporate structure remains the same. But claims handlers and adjusters need to bear in mind that the business' risks may have significantly changed.

In the past, CVAs have typically been used by smaller, owner-managed businesses. But in this recession, a growing number of medium and larger businesses have been entering into them. One recent example is JJB Sports, which sold its fitness clubs for £83.4m, while its shoe business went into administration. As part of the restructure plan, JJB entered a CVA to settle the claims of landlords against 140 closed retail stores. The arrangement also varied the terms of leases on 250 other stores that stayed open.

The simple view is that insurance policies still apply if a company survives the process and cover stops if it does not. But this fails to take into account the grey areas where: a company is tackling insolvency, but is not yet insolvent; it becomes a new company; or bits of it survive while others do not. In these circumstances, policy wordings must be watertight if insurers want to avoid being liable for risks they did not think they were still covering.

And what happens when a company has an ongoing business interruption claim at the time it enters administration? In this situation, claims handlers and adjusters should watch out for any signs that continued losses may not be related to the business interruption loss.

For example, there was a recent case where escape of water prompted a business interruption claim from a bar business. At first, the numbers didn't seem too bad. But it soon became clear that the bar's performance was levelling out and that it remained deflated for some time after repairs were finished. The main concern was that the business might be in financial difficulties. This was confirmed towards the end of the indemnity period, when it became apparent the group that owned the bar had gone into administration.

In this case, the business interruption loss caused by the original escape of water was separated from the other factors the business was struggling with. But the experience showed how tricky it can be to separate a valid business interruption loss from the many problems associated with a failing business.


Unclear policy triggers

With a typical business interruption wording, policies are likely to recognise losses up to the point when a receiver, administrator or insolvency practitioner is appointed — and not beyond this. But insurers should make sure they do not pay out in full up to this point. Any interim payments under business interruption cover must be modified to account for factors such as lack of investment or distracted management, which inevitably contribute to losses but are entirely separate from the insured incident.

This may be tricky in the case of a CVA. The standard policy wording that captures the appointment of a receiver or insolvency practitioner may not capture the appointment of a CVA supervisor. If the company manages to solve its credit problems within the indemnity period and resume business as usual, then there may be no cut-off point for business interruption losses. And even if the CVA fails to put the company back on track, the cut-off point for payments is not at all clear.

In another case, a restaurant claimed for lost profits under its business interruption policy without telling the insurers that it had entered a CVA earlier in the year. Information from Companies House revealed that a CVA was in place; as a result, no payments were made. Clearly, the insurer should have been told about the CVA because it was likely to affect the insurer's view of the risk. But there is still a question mark over whether the insurers had to be told, and — if they did — when.

The insurance position following any administration or insolvency event — and particularly given the increasing popularity of pre-packs and CVAs — is complicated. And with companies facing such tough times, more of these murky cases will emerge. Insurers need to stay on the ball, and scrutinise each policy or claim on a case-by-case basis.


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