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Published on 10 December 2010 by Tony Groom

Save Your Company by Terminating Onerous Contracts to Cut Costs

Many directors are afraid of terminating contracts and agreements when their

companies are in financial difficulties normally out of a concern that termination will

lead to a cancellation payment that the company cannot afford.

If a company is experiencing fewer orders or lower sales, for example, generally it will

need fewer staff but the worry is that terminating contracts of employment will

trigger costs that include payment to cover the notice period, redundancy

payments and possibly payment of other contractual liabilities. Terminating contracts

with senior staff is often very expensive due to the compensation for their loss of

additional benefits often negotiated as part of their employment package.

Similarly, a reduction in orders may mean that the company only needs two of the

five fork lift trucks it has where terminating a hire purchase, hire or lease arrangement

ahead of the agreed contract period will trigger a termination settlement or a

contract termination liability. Many of the standard hire contracts only discount the

early settlement by 3% per year.

Equally it might now no longer be able to afford the 12-month advertising contract it

agreed six months previously. Even terminating contracts with advisers can be

expensive. One was the provision of human resources support by a national PLC that

had a termination clause requiring 60 months notice.

A company in financial difficulties does not have the surplus cash to meet these

obligations. But while it puts off terminating arrangements that it no longer needs it

continues to bear the costs, which is the reason many companies are in gradual

decline as they slowly run out of money.

K2 Business Rescue The Emergency Service for Business

Call Tony Groom on 0844 8040 540

However, it is often better to cut the cash flow if this reduces costs that mean the

business is viable: profitable with positive cash flow. There are remedies that can be

used if necessary to deal with the crystallised liabilities when a company cannot

afford them

It may be understandable that the business does not terminate the monthly hire or

staff costs if it feels it does not have the money to pay the termination costs, but

equally continuing to pay for the additional fork lift trucks might be at the expense of

other creditors, for example HM Revenue and Customs (HMRC), unless orders return

and sales increase to the point where those additional staff or trucks are needed

again.

The issue is business viability and often this is a false hope. While the company is

carrying the additional costs the business is not viable and too often directors are

putting off dealing with onerous contracts and arrangements.

How can a company deal with this dilemma? Everyone may accept with hindsight

that the early action would have avoided the problem building. However, it is with

good reason that businesses often put off terminating such contracts especially

when they believe they are about to get the order that justifies keeping the

additional capacity.

Actually, the directors need to take steps to deal with this if they wish to avoid

business collapse and running out of cash so that they can no longer trade.

Negotiating terms for informal arrangements with creditors is sensible. It may involve

negotiating terms of payment, such as a Time to Pay (TTP) arrangement with HMRC

for PAYE or VAT arrears, which have been very effective in helping companies out of

insolvency. However, the problem is that the company will have to make payments

out of future trading and if it has not looked at cutting other costs to help it return to

profitability it won’t be able to afford to keep to its TTP arrangement with HMRC.

Many companies leave it far too late to reach informal arrangements that would

have allowed them to terminate contracts before the company finally runs out of

money.

There is a solution that allows companies to terminate contracts and not pay for

them immediately on termination. A Company Voluntary Arrangement (CVA) avoids

liquidation of the business and closing it down. It allows for paying the contract

termination out of profits.

However, it can also be used to compromise the debt, for example by paying less

than 100p in £1. An HMRC TTP is only allowed at 100p in the £1, whereas a CVA

allows for less than that and can be stretched beyond the 12 months maximum the

HMRC normally allows for a TTP where CVAs allowing for payments over five years

are not uncommon.

K2 Business Rescue The Emergency Service for Business

Call Tony Groom on 0844 8040 540

Rescheduling payments through a CVA can mean paying as little as 30p, 40p or 50p

in the £1, as long as the payments are realistic and affordable. CVAs provide a real

opportunity for companies to terminate contracts, including hire agreements,

employment contracts and office leases.

For a company in difficulty enlisting the help of a business turnaround and rescue

adviser to establish whether it has a viable core, produce a plan for stabilising then

rebuilding, and help it to negotiate informal arrangements to pay creditors or formal

ones via a CVA can make all the difference between a business surviving or going

under.

We are not Insolvency Practitioners. We operate within the law to protect our clients and their wealth. Our team has worked for over 20 years to help stabilise and return hundreds of businesses to profitable growth. Once appointed, Insolvency Practitioners do not work for you, they work for creditors and use your company’s assets to pay themselves. We work for you, not creditors.

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