Calling in the administrators

We go behind the headlines unravel the mysterious process that is administration
Commercial awareness
Financial theory

The recent failings of several well known high street chains have made front page news as the onset of the economic downturn has left many firms within the retail sector struggling to survive. One industry which has come to the fore in this situation, albeit for very different reasons, is the professional services industry (in particular the 'Big Four' of Deloitte, PwC, Ernst & Young and KPMG) which has been called in to manage the administration proceedings for firms such as Woolworths, Zavvi and Whittard. Administration, though undoubtedly unpleasant for the firm involved, is a relatively common event in the business world, though obviously there are far more firms which enter the process in bad times than in good.

The onset of the economic downturn in 2008, however, has led to the largest number of profit warnings from public companies since 2001, according to Ernst & Young. The figure of 449 profit warnings issued by UK quoted companies last year was also 17% higher than for 2007. The worst is far from over, however, as the next 12 months look set to be equally hard, if not harder, on struggling businesses. The retail sector has had a particularly tough time in 2008 with a record breaking annual total of 52 warnings and a number of iconic high street names, such as Woolworths and Whittard entering administration.

What is administration?

Administration as a legal concept is a procedure under the insolvency laws of a number of common law jurisdictions. It functions as a rescue mechanism for insolvent companies and allows them to carry on running their business. The process - an alternative to liquidation of the company's assets - is often known as going into administration. In the UK, the administration regime is governed by the Insolvency Act of 1986. It states that an 'administrator' can be appointed without petitioning the court by the company or by its directors. Other creditors (firms or individuals owed money by the company in question) must petition the court to appoint an administrator. The administrator is a neutral party which must act in the interests of all the creditors and attempt to rescue the company whilst ensuring, as far as possible, that its debts are paid. If saving the company is impossible, it is the duty of the administrator to recover the maximum share of the money owed to each of the creditors. During this period of reorganising the company's finances the administrator usually steps in to run the business day to day rather than the directors of the company. This status grants the administrator the power to do whatever it deems necessary for the management of the affairs, business and property of the company. Often this will involve finding a buyer or an investor for the business.

Why put a company in administration?

Despite the alarming press attention usually associated with the administration process, it is in fact common and often effective means of rescuing a business which would otherwise go under, find itself bankrupt and be unable to pay back its creditors. In the UK, the administrators are called in by the company itself rather than any external body, recognising that it is usually the best option available to them in their time of need. In some cases, it may be that a brief spell in administration is all that's needed to get the company's cash flow back on track and trading again.

The owner of the business agrees with the insolvency practitioner to take the company into administration and buy back its assets at a discount while agreeing a percentage pay-out to the creditors.

Administration is not the only option open to a struggling company. There are other routes open to them, though these are often far less viable or attractive. The primary alternative is for the company to seek outside investment from a 'turnaround investor' - an investment firm with particular expertise in rescuing failing companies - in exchange for an equity share. The third option is for the business to simply fold - not an attractive option for the owner who will suffer a number of penalties preventing him from managing a company again in the near future, or the creditors who stand to get nothing. With he help of an administrator, all parties agree the best way to allow the company to survive, saving jobs and keeping the business flowing for all stakeholders.

Who are the administrators?

The 'Big Four' professional services firms all have established insolvency arms to their businesses. These have all been involved in the administration process of major companies in recent history. Lehman Brothers' administration was handled by PwC whilst KPMG handled the insolvency process for Leeds United F.C.

One of the most high profile cases in recent times was PwC's handling of Lehman Brothers' administration. Whilst the firm failed back in September of last year, the unwinding of Lehman Brothers' debts is still taking place and the likelihood is that it will take several years for all of its accounts to be fully settled with the relevant parties. At one point approximately 1,500 of Lehman Brothers' creditors, ranging from hedge funds to pension firms and lawyers, poured into the O2 Arena, the venue where the public auditing process was held. Despite the scale of the operation, as in any administration case, full due diligence had to be undertaken so as to correctly assess what proportion of the company's remaining assets was owned to each individual creditor. Tony Lomas of PwC who headed the administration, made the following comment: "I make no apologies: we're extremely nervous about the risk of disposing of client positions incorrectly. You won't be surprised that a number of counterparties have instigated or threatened to instigate litigation against the estate to reclaim assets. We recognised that as a risk and were concerned we simply don't give in to the person who shouted loudest."

As the economic gloom deepens, the relatively unpublicised world of administration will undoubtedly become more of a regular feature in the business press. The one upside to this is that graduates will be able to benefit from the experience gained by working on detailed administration cases. For soon to be graduates with an interest in the complexities of the corporate world, there may never be a more interesting time to join a professional services firm.

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