Should we fear the zombie company apocalypse Image

Should we fear the zombie company apocalypse?

Posted: 30/10/2018

How do you spot a zombie company?

Zombie companies walk amongst us. They shuffle along, failing to realise that they are undead, relying on the inaction of creditors and low interest rates to mask their fundamental lack of profitability, poor growth prospects and inability to service their debts. Denied a swift, clean demise, they endure a twilight existence that deprives their living competitors of capital and opportunities.

Zombie companies are not a new phenomenon. The phrase was used to describe Japanese companies in the 1990s and was resurrected following the global financial crisis. It was originally thought that zombie companies were a product of the economic cycle, with each recession resulting in a zombie apocalypse that in turn lead to a cull of the zombie horde. However, it appears that the historically low interest rates have meant that many zombie companies have endured for far longer than is healthy for any economy.

What we can do about the zombie company apocalypse, or should we even do anything?

Insolvency law provides us with the tools to dispatch these zombies companies, but it may well be that the cure is to raise awareness amongst creditors of the opportunities to be found in putting these zombie companies out of their misery.

What threat do they pose? 

Zombie companies weaken economic performance by consuming resources and using them less efficiently. They are less productive, crowd out the growth of more industrious firms by depressing prices,increase costs by competing for resources, and stifle innovation. In limping on, seeking to service unsustainable debt levels, zombie companies generally invest less in technology and people causing industry and employees to stagnate.

Ordinarily you would expect competitive market forces to finish off these zombies but the power of the status quo, together with the long years of low interest rates, has enabled many to endure. In their desperation to survive, many zombie companies throw caution to the wind in trying to generate profits and new business, taking bigger risks in an effort to win business and at the same time driving down profits and starving living competitors of business. At the same time, these practices expose directors to the risk of accusations of wrongful trading and personal liability, unless they can reasonably rely on the “sunshine test” (ie a future turnaround in a company’s prospects) or point to professional advice that they have relied upon.

How do you kill a zombie?
A significant rise in interest rates would probably produce the greatest reduction in zombie companies, but that is outside the scope and wit of most law firms. As is a cultural change that recognises that the current social price of entrepreneurial failure is too high and instead embrace the concept of creative destruction, ie failing fast and learning from failures to create a successful business. It may be that an insolvency “rescue” mechanism, like administration or a CVA, is all that is needed to nurse a zombie company back into health. A director of a zombie company should seek expert advice from an insolvency practitioner on the best approach.

For other zombie companies where restructuring is not an option, the insolvency tools to finally bring an end to the living dead are well known and well established. The current issue is not with the English courts and insolvency regime, which are generally supportive of reasonable restructuring attempts or the liquidation of zombie companies, it appears to be the creditors themselves.

No-one expects creditors to take into account broader themes of reducing market competition to promote productivity, innovation and a better distribution of capital. A creditor’s sole focus is normally to try to recover as much money as possible, but the reality is that whether by a desire to avoid crystallising a loss or simply not wanting to incur the costs of a formal insolvency process, creditors are refusing to pull the plug. There are two main flaws to this approach. The first is that the costs of liquidating a company are not great and in the absence of a contested petition, fairly quick. The second is that such inaction may end up costing the creditors in the long run as they are too quick to discount any potential claims they might have, arising out of the circumstances of the zombie company and its demise.

It may be that a creditor has neither the appetite nor the resources to pursue a claim against dodgy directors or other culpable professionals, but this is where our experience in more innovative litigation funding can be used to unlock these claims and share the risks and the costs.

The dawn is coming

The uncertainty of Brexit and the likelihood that central banks will only be able to slowly wean economies off low interest rates, means that the forces of limbo that have created so many zombie companies are unlikely to change anytime soon. However, interest rates are already rising in the US and will rise further across the world and it is likely that this will be the tipping point for many zombie companies.

Creditors should not bury their heads in the sand waiting for the apocalypse to pass. Some potential claims are time limited and the longer a creditor waits, the more chance there is for the key evidence to be lost. For the enterprising creditors, there may well be opportunities to exploit and the means to share the risk of developing them. After all, if zombie movies have taught us nothing else, it’s better to navigate the apocalypse with a trusted group of experienced advisors rather than strike out on your own.

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Penningtons Manches Cooper LLP

Penningtons Manches Cooper LLP is a limited liability partnership registered in England and Wales with registered number OC311575 and is authorised and regulated by the Solicitors Regulation Authority under number 419867.

Penningtons Manches Cooper LLP