How Covid-19 bred a new generation of zombie companies

Zombie companies are businesses that earn just enough money to settle liabilities and keep creditors at bay, with no real ambition to generate a profit. While zombie companies tick away and serve no true purpose, they pose an unnecessary burden on the UK economy as they provide no economic benefit. As the pandemic threatened the viability of businesses and tested their tolerance to economic uncertainty, it bred a new generation of zombie companies.

Covid-19 stripped many businesses of their income and resources, placing their futures in limbo. Many prolonged their demise by plugging into Covid-19 financial support provided by the government. This not only bit into investment put forward for productive companies, but also reduced the likelihood of these directors seeking insolvency support.

To rescue or close a zombie company

Zombie companies earn just enough money to pay their bills, company loans and credit cards to prevent creditors from knocking on the door. While zombie companies are a ticking time bomb, they must seek to either rescue the business via a Company Voluntary Arrangement (CVA) or close the business.

The route that company directors take to close their limited company will be determined by whether the business is solvent or insolvent.

• Company strike-off – An easy and cheap company closure route for businesses with no debts
• Compulsory Liquidation: The company may be forced to liquidate due to a winding up petition launched by a creditor, although zombie companies often dodge this by paying the bare minimum to creditors
• Creditors’ Voluntary Liquidation (CVL): This is a formal liquidation procedure for insolvent companies, voluntarily initiated by the company director and administered by a licensed insolvency practitioner. During a CVL, money will be raised to settle the debts of the zombie company and any remaining debts will be written off. It is possible to liquidate a company with a Bounce Back Loan, although the funds must be used as prescribed
• Members’ Voluntary Liquidation (MVL): This is a formal liquidation procedure for solvent companies. This route is often more cost-effective for companies with retained profits of £25,000 or more

As zombie companies sustained operations by utilising government support, the government sped to close a loophole to tackle rogue directors from dissolving a zombie company with debts, such as a Bounce Back Loan.

The Rating (Coronavirus) and Director Disqualification (Dissolved Companies) Act – what does this mean for Zombie Companies?

The Rating and Director Disqualification Act was introduced in the wake of the Covid-19 pandemic to reprimand directors that dissolve companies to avoid paying company liabilities, such as a Bounce Back Loan (BBL). This Act grants the Insolvency Service the power to disqualify former directors that strike off a company with debts.

Although company strike off (dissolution) is a route reserved for debt-free businesses, the measure knuckles down on companies that fall through the cracks and hope to take advantage of the company strike off process, such as zombie companies.

As BBLs were provided with a government guarantee, the government will inherit the bill if a company with a Bounce Back Loan closes. Therefore, this device was introduced to prevent the improper use of the government guarantee and clawback money from rogue directors to reduce the number of Bounce Back Loans likely to go unpaid.

Why must company directors of zombie companies take note?

If a company director wishes to close a zombie company, they must seek a proper exit route, i.e., a formal insolvency procedure, for company debts to be dealt with in an orderly manner.

If a company director abandons their directorial duties, disregards creditor interests, and dissolves a company with debts, they could be pursued by the Insolvency Service.

• Action can be taken after the company has been struck off and it is no longer necessary to restore the company launch an investigation
• If a director is found to have acted improperly, they could be disqualified for up to 15 years, held personally liable for the debts of the company or even face prosecution.

Real Business Rescue’s quarterly insolvency statistics show a 21% improvement in the number of SMEs in significant financial distress, compared to Q1 2021. While SMEs mark their return from the pandemic, the greatest test will be to transition from the state of zombification to a state of purpose.