Insolvency risks and mitigation steps for farm businesses

A raft of issues including finance, employment and other costs, supply chain problems, climate change and international trade friction all combine to make business increasingly volatile.

Challenges can come from within, through poor management, inadequate risk assessment and, in some rare cases, fraud.

In other circumstances external threats, for example through the failure of a customer business, or a change in trading terms, puts another business in jeopardy.

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While few farm businesses end up in liquidation or administration, the financial challenges that lead to insolvency are rising and farmers need to take proactive steps to safeguard for the future.

This is according to Jane Henderson, senior associate in the restructuring and insolvency team at law firm Thrings.

“People tend to think ‘it won’t happen to me’,” says Jane. “But it might happen to your supplier or your customer and it’s something farmers need to know about.”

Insolvency is where a company, individual or partnership cannot pay their debts and other financial obligations as they fall due, or when their liabilities exceed their assets.

There are two forms of insolvency:

Cashflow insolvency: An inability to pay debts when they are payable, due to lack of cash, even though assets may exceed liabilities.

Balance sheet insolvency: When the debts of an individual, company or partnership are greater than total assets.

Mark Cullingford is a Thrings partner and leads the firm’s restructuring and insolvency team. “Failure is not always because there’s a structural problem with a landowning farm,” he says.

“The farm is probably balance sheet solvent because, in general, lenders to farmers don’t lend at a loan-to-value ratio that exposes them to a significant risk of balance sheet insolvency.

“What tends to happen is circumstances in which there might have been cashflow insolvency arising from supply chain default, for example in the case of dairy processor failure.”

Personal liability – possible impact on partnership

In other cases, agricultural businesses have been adversely affected by one partner’s insolvency which exposes some or all of the partners to personal liability which then infects the partnership.

Mark gives the example of a father in an arable farming partnership who diversified on his own account into a new product for which he secured a retail contract.

He then geared up and invested heavily to expand in order to supply that contract. However, the following year the contract was not renewed.

“All the borrowing for that lone trader business was secured over the farm because it was the same bank with an ‘all monies’ charge.

“Ultimately it infected the partnership and we had to restructure the partnership over a few years to deal with the father’s bankruptcy,” says Mark.

Other examples include investment in alternative energy projects that failed to ever work. 

Other pressures have come from disputes over ownership of grain held in a partnership store, personal and matrimonial liabilities, and poor succession planning on death which can lead to pressure on the farm in dealing with a capital claim for one partner’s assets.

Second loans for the development of land or property have led to receiverships and in other cases action is taken by creditors because of individual insolvency caused through credit card or tax debt.

Where there is the threat of enforcement, it is generally the case that, as a whole, the partnership can continue to survive but will have to realise assets in order to pay liabilities, says Mark. Future viability is then a concern.

Personal impact

Insolvency is something few farmers have contemplated having to deal with, and because most are sole traders or in partnership rather than a company, it becomes a lot more personal and significant, he says.

Farming cases often have added complexity because they can involve more informal understandings, such as a farmer appearing to be a sole trader when legally they are in partnership with their spouse.

Understanding whether a liability is a partnership or personal liability is key.

Tax issues add complexity

Because individual and combined (partnership) estates are often involved, there are much more complicated personal tax issues too, Mark says, with the sale of jointly owned assets often triggering a capital gains tax liability for every partner.

There is also a real level of value destruction simply because capital assets have to be sold to pay the liabilities, often without the time to maximise their possible value.

“One of the most important things is that the earlier people get advice, even if that advice is just contingency planning, the more likely the stakeholders in the business or the assets will suffer less total loss.”

For example, as an alternative to a sale, a sale and leaseback arrangement may be possible, or the conversion of Agricultural Holdings Act tenancies to farm business tenancies has also been used to realise value but permit farms to continue. 

However, these need time to plan, not only because of the impact on the family but also because of the tax implications, especially capital gains tax.

Delay destroys value

Delay in getting advice is likely to narrow the options and give less time to implement them. It also means creditors are more likely to take action, says Mark.

“Most of the cases I have come across are led either by an unexpected event or long-term structural decline when a business hasn’t changed to meet circumstances or has not planned for generational change – that can impose a real heavy burden,” says Mark. 

“The assumption seems to be that farmers will have to sell land to meet claims and tax liabilities, but not every exit needs to have that knee-jerk reaction.

“Many insolvencies are about improving cashflow and realising some assets. Farming assets are less easy to realise quickly, for example, livestock, growing crops that may be subject to forward selling agreements, contract farming where you might have other people’s grain stored, dairy farms with TB.

“With the right approach and processes and time farmers have been able continue to manage to farm even in a receivership and as long as sufficient control and co-operation in place, they can get paid for doing it.”

Customers at risk 

Knowing when to say no can be the most important factor in dealing with a customer who may be at risk or where terms are being changed to the detriment of a supplier, says Duncan Swift, restructuring and insolvency partner at accountant Azets.

He has extensive experience in farm and supply chain issues and is seeing more financial distress in farming and horticulture businesses.

On top of the familiar pressures are the prospect of tariffs, vote-winning cheap food policies and the threat of imports produced to lower standards.

“Self-sufficiency is dropping, there are fewer, larger farms and at the same time there are increasingly tempting offers to switch productive land to non-food, energy and other alternative uses,” Duncan says.

Retail pressures

The post-pandemic landscape was fairly bleak and it is still bleak, he says.

“This is not helped by the first shots being fired in a supermarket pricing war, particularly in the fresh produce aisles, with items like carrots on offer for 7-10p/kg, which is well below cost of production.

Sharper tactics are being observed by the Groceries Code Adjudicator, for example ­de­listing, short notice changes to trading terms and longer payment terms. Processors are under the same delisting threat.”

Many producers are hoping this year’s weather might rescue what look like poor prospects in budget and cashflow terms, he says.

“There’s a fair amount of refinancing and restructuring of business going on and sales of non-core assets.

“It’s very difficult to pull out stats on it because with most farm businesses being sole traders and partnerships, rather than companies, they are not caught by the records.

“Banks are not pushing at the moment but are encouraging some businesses to take advice.”  

Good admin is essential so that a business can be prepared, knowing its own state and its ability to weather any storm brought on by the failure or difficulty of a supplier or customer, he says.

“Understand the financial dynamics of your business, trading and cashflow, including gross margin analysis of key crops and of key customers.

“You need a dashboard of information and remember you have the right to be able to choose your customer.

“Saying ‘no, we can’t do that’ on the basis of good financial information and walking away may bring a feeling of immediate loss, but you might find that buyer more respectful further down the line.”