Chris Corbin and Jeremy King, part owners of the company that owns the famous Wolseley restaurant had their company pushed into administration by its co-owner and major lender, having been in default since 2020, and now owes £38m. Administration might not have come as a surprise to anyone in that case.

However, directors and shareholders will not usually get anything like as much notice of a lender’s intention to appoint administrators and will frequently get none at all, as  Insolvency and Asset Recovery Partner Tim Symes explains here.

Borrowing in return for pledging a piece (or all) of the business as security is par for the course. It’s known and understood, and without it, the lending simply wouldn’t be made.

But when a company goes into administration, it’s drastic. Directors are ignominiously stripped of their powers, staff can be made instantly redundant and the business sold, leaving the company as a worthless shell.

In administration before you know it – literally

Unless they’ve experienced it first-hand, directors and owners may not realise just how easily a secured lender can put their company into administration. The first they may become aware of it is when insolvency practitioners turn up at their premises and announce they are now in charge.

What do you mean without notice?

A common misconception is that the lender must always give notice before appointing administrators. It’s a dangerous one to hold and is simply not reflected in most modern security documents.

Most security documents allow the lenders to appoint administrators immediately and without any notice all. In practice, a lender’s lawyers may recommend giving a very short notice period, if only to dispense with any wrangling about notice down the line. However, that notice letter may simply demand the principal sum and say nothing of the lender’s intention to appoint administrators if it isn’t paid. And an hour’s notice might be all they get, even if notice is required, before administrators then get appointed.

And the paperwork side of things? All a lender has to do is electronically send in a form to the High Court, and the appointment is made – instantly.

What can come as a rude shock to directors and owners is not just the speed with which their business can be put into administration but the justification to appoint administrators in the first place.

Accidentally putting your company into default

The ‘justification’ to appoint is in the detail of the lending documents, known as ‘events of default’. The events of default can be numerous and wide-ranging, and directors are well-advised to be familiar with them. The obvious ones concern non-payment of the capital or interest on the due date. That’s understandable: we fail to repay, we expect consequences.

It is the seemingly less serious events of default that can be breached inadvertently, and so are much more dangerous.

Let’s suppose the finance director foresees a cash flow ‘blip’ coming down the tracks, which could mean a slight delay in making the next payment to the lender. So they approach the lender and ask if they will agree to a slight delay. A prudent step, surely? Maybe not. The mere fact they have made that request could be seen as evidence that the company is unable, or may become unable, to pay its debts as they fall due. It is not uncommon for this to be an event of default itself. So, instead of avoiding a triggering of security, the finance director has created one.

Other defaults

We frequently see provisions that say a failure to comply with any of the provisions of the lending facility is an event of default. So, say, being a day late with financial reporting obligations to the lender could trigger a right to appoint administrators.

A change of control at board or member level, which the board may see as a neutral or even positive step for the business, can also be an event of default triggering administration.

The types of events of default invariably run much longer than the examples above. The bottom line is if there is one section directors should read and understand, it’s the events of default section of the lending documents.

No insolvency required

A further surprise to many directors is that the company doesn’t have to be insolvent to be put into administration by its secured lender. So long as an event of default has occurred, and that event has triggered the right to appoint, that’s enough.

Loan to own – abuse of power by lenders?

Lenders appoint administrators because they have a legitimate concern their lending is at risk, and administration is the best way to protect it. However, there are lenders whose motive may be to appropriate the business. This is otherwise known as a form of ‘loan to own’ scheme, by using administration as a way to do it.

Let’s say a company has a competitor with an eye on its rival. It can see that its rival is in distress or heading that way, and so it buys the debt from the current lenders. The current lenders may be happy to exit and even discount the debt. Now the new lender stands in the shoes of the old lender, and it puts the company into administration. It hopes it can buy the business out of administration, achieving not only the destruction of its rival but the acquisition of its business.

This is a risky strategy for the lender, as it has no ‘first dibs’ on buying the business despite having chosen the administrators it put in for that very purpose. The administrators will be bound to achieve the best deal for the business, which may or may not be the one offered by the appointing lenders.

Conclusion

If relations are predicted to strain with the lender, it is critical for the board to get in front of the situation. That could mean agreeing to restructure the facility with, crucially, agreement that any previous and upcoming defaults are waived or terms modified, or arranging new finance to take the incumbent lenders out of the situation altogether.

All lenders are not the same. The vast majority will play fair and not take the nuclear option of appointing administrators unless they see their lending under legitimate and acute threat. However, simply hoping positive mood music will continue to be played in the lender’s camp after events of default have occurred is a risky strategy.

It is better if directors understand exactly what the company’s obligations are under the lending documents before the grant of security. They should push for changes to the terms where those events are too onerous and put in place a compliance regime that not only seeks to meet the obligations but raises a red flag in good time before they are at risk of not being met so that they can do something about them.

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This communication has been authorised by Arthur J Gallagher Insurance Brokers Limited for the purpose of s21 of the Financial Services and Markets Act 2000