ISSUE 71: Credit Insurance News Digest

Anatomy of a Business Failure

By Greg O'Connell, Managing Director of Infolink Gazette

The aftermath - Palmer & Harvey McLane failure and the impact on creditors PWC recently published their statement of affairs for Palmer & Harvey, which revealed six debtor companies, with a total of £384,218,439.65, owed to 689 unsecured creditors. The largest of which, was Palmer & Harvey McLane Limited with debts to unsecured creditors of £353,045,000; dividend prospects for all except 3 of the 689 creditors are negligible.
The top 5 trade creditors are shown in the table below, and HMRC are owed over £26,000,000. A further 21 creditors were owed between 1 million and 5 million, and another 110 owed between 100K and 1 million.

IMPERIAL TABACCO LTD 118,540,079

GALLAGHER LTD 89,472,252

BAT (UK & EXPORT) LTD 28,473,702

PHILIP MORRIS LTD 19,935,187

COCA COLA EUROPEAN PARTNERS 13,449,552

According to ABI, trade credit insurers continued to support suppliers and provided an estimated £100 million worth of cover for firms supplying to Palmer and Harvey; the uninsured trade creditors will be left with nothing. And, of course, 2,500 employees have already lost their jobs. PWC describe the reason for the failure as being attributable to “poor financial results, along with cash management challenges”, they go on to say, “despite lengthy and constructive negotiations with stakeholders, efforts to restructure the group and mitigate the significant cash flow pressures ultimately proved unsuccessful.”
Greg Connell, Managing Director of InfolinkGazette commented, “it is easy with hindsight to claim that such a negative outcome for creditors was predictable, so at InfolinkGazette, we’ve prepared an analysis of what Palmer & Harvey creditors could have known about the financial stability of the group, prior to failure” Greg added, “as a footnote, we went on to look at what only came to light after the business failed.”
Known Risk Factors before the business failed:

The 2016 accounts show that the business was very illiquid, with a current ratio of 0.73 and a Liquidity Ratio of 0.45; by comparison, Tesco have a current ratio of 0.79 and a Liquidity ratio of 0.63. As a standalone risk factor, credit analysts might not be overly concerned by these ratios, accepting that short terms debts can exceed short term assets in this industry sector, but it would still have raised a warning flag.
The 2016 accounts showed the 4 th consecutive years pre-tax loss, with the losses increasing in size over the last three years. Three consecutive years losses, should be more than enough of a warning flag, for a company with a negative net worth.
The business was effectively “worthless”, the accumulated losses, had reduced the shareholders’ funds to a negative (£48,300,000), and after deduction of intangibles, the negative net worth was a staggering (£384,700,000). Factor in a (£270,600,000) working capital deficit and we have a very unstable company. This was a business that was funded entirely by its creditors, the owners had no capital in the business and that’s a very serious warning flag.
The burden of interest bearing forms of capital was highly significant; the 2016 accounts show long-term debt was £146,800,000, but of the £19,200,000 interest charge, £8,200,000 was payable to preference shareholders. This means the shareholders were in all but the name of the payment, taking an unaffordable £8,200,000 dividend each year from a loss-making company. The former chairmen Christopher Adams and Christopher Etherington, hold special preference shares, according to the latest list of shareholders filed at Companies House. These “B preference” shares pay out a fixed dividend twice a year. Company’s that don’t make enough money to fund their interest payments, the so called “Zombie Companies” represent an extremely high risk, particularly at a time when most commentators believe interest rates are set to rise.
Accounts for Palmer & Harvey McLane (Holdings), also show that Christopher Etherington received a £3,440,000 interest-free loan from the company’s employee benefit trust, to fund his stake in the company. This was only repayable on the sale of any shares held by him. It’s not illegal, but it raises a question mark over governance.
The closed defined benefit pension scheme, reported a deficit of (£5,300,000). Pension scheme deficits are commonplace, but funding the deficit is another call on cash, at time when it is clear that cash flow issues are acute.
There were 3 secured charges outstanding, and if you are an unsecured creditor, there won’t generally be much left to pay unsecured creditors, after preferred and secured creditors have been paid.

Commenting on the information available from the accounts, Greg Connell, Managing Director of InfolinkGazette, said, “the dismal financial position portrayed in the 2016 financial statement would have been revealed in October 2016, and all 7 warning signs were evident when the 2015 accounts were published in September 2016.” Greg added, “what creditors could not have known then, was that it was the company’s intention to re-state the 2016 accounts, audited by KPMG, when the 2017 accounts were presented.”
PWC revealed a significant number of material misstatements in the 2016 accounts, which would have increased the 2016 pre-tax loss from (£16,400,000), to (£28,500,000).
The misstatements included: Incorrect capitalisation of cost; incorrect accounting for royalty payments/stock valuation; and, incorrect recognition of supplier income.
The other crucial piece of information creditors couldn’t have been aware of, was that the company’s losses had increased to £63,800,000 in the 53 weeks to 8 th April 2017.
Greg Connell commented, “leaving aside the fact that the directors and shareholder of P&H have a lot to answer for, this business failure is a powerful lesson in the importance of Credit Insurance”. He added, “if credit insurance isn’t available on one of your clients, there is normally a very good reason why not and you might want to review the information available on your customer before continuing to supply on open credit terms.”
If any reader would like a free digitised copy of the unsecured creditors list, email Greg Connell at greg@connelldata.co.uk.

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