Accountants’ Fears over the Millennium Bug’s Threat to Buyouts is Misplaced

United Kingdom

This article was written by John Naccarato, partner in our Aquisition Finance Group, and Dan Hamilton, partner in our Insolvency Group

If recent press reports are correct (e.g. Times 8th February 1999) the accountancy profession are asserting that they may not be prepared to sign Financial Assistance reports in venture capital deals because of the risks associated with the Millennium Bug. This may be a misplaced fear.

The report, which is an important element in the debt financing of most venture capital deals, requires the auditors of a company being acquired to comment on the statement, required to be made by its directors, that essentially the company will be able to pay its debts as they fall due during the year immediately following the acquisition. The auditors must confirm, in simple terms, that they are not aware of anything to indicate that that statement is “unreasonable in all the circumstances”.

Their (the accountants’) fear is that they will be sued if a company in respect of whom they have issued a report in these terms, is badly hit by year 2000 problems. They are apparently saying that almost all companies are unable to forecast the financial effect of the Y2K problem on them and that therefore they can not give the required confirmation.

It is almost certainly true that the greatest unquantifiable risk for companies lies not with their own systems (because sorting those out is normally the first step in any sensible Y2K policy) but with the impact on their business of the failures of their customers’ and suppliers’ systems. About this risk there can be no cast iron assurances for any company and it is one that is faced, to a greater or lesser extent, by the vast majority of companies.

However, if an accountant refuses to issue a Financial Assistance report he is saying that the directors of the company are “unreasonable” in believing that the company will be able to pay its debts as they fall due during the next twelve months. If the reason for saying this is because of a problem that affects all companies then the same statement must logically be equally true for all companies.

If therefore no company can reasonably say that it will be able to pay its debts as they fall due during the next twelve months then this gives rise to certain very serious questions the most important of which is whether the directors are incurring personal liability for wrongful trading under the Insolvency Act. This applies if at some time before a liquidation the directors know or ought to conclude that there is no reasonable prospect that the company will avoid going into insolvent liquidation and they do not take all steps to minimise the potential loss to creditors.

If the directors are mistaken in their belief that they will be able to meet their liabilities in the next twelve months then they are technically insolvent and if the steps they are taking vis a vis Y2K are not enough (which the accountants appear to be saying must be the case because it is impossible for most companies to assess the risk) they must consider what to do to minimise the loss to creditors, which typically means winding-up, receivership or administration.

Are the accountants really saying that since a large element of the risk affects most companies and there is little they can do about it, that most companies are insolvent? Should we all just shut-up shop now?!

Equally if these companies are technically insolvent how can auditors sign off on their accounts (in the ordinary course of events, not just on an acquisition) on a “going concern” basis?

We believe that the accountants are right to be worried about companies that are not doing everything they can to eliminate Y2K risks but for those that are, they should not be afraid to give the confirmations that are needed for the venture capital industry to function. If companies have taken or are taking every reasonable step to minimise the impact of Y2K, it should be reasonable for them to believe that they will be able to pay their debts.

Please contact John Naccarato with any enquiries Tel: 0171 367 3414, Fax: 0171 367 2000 and E-mail: [email protected]