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Paul Zalkin, director at Quantuma, looks at the challenges when restructuring care homes.
The care home industry is in the news again for a number of different reasons, the first of which is generic concerns around ageing and the growing population. We are wondering how the state will fund care, especially for the elderly and we have questions about what the role of the individual will be in making provision for our own future. Life expectancy in the UK has been increasing steadily over the past 50 years and the consequence is that our needs are more complex and expensive at the latter end of our lives. Also, for some time, there has been a debate about the manner in which care homes are financed. Private facilities/larger groups are often financed using private equity (PE) structures, which means that typically businesses are loaded up with secured debt that provides them with a significant finance cost burden. Questions have been raised—is this an appropriate model for facilties where there is a significant degree of social utility? Is it sustainable to have businesses running facilities that vulnerable members of society require yet whose objectives are to maximise shareholder value whilst paying down massive secured loans?
Equally, there is much greater scrutiny nowadays on care homes following well publicised scandals which have led to greater transparency. People are better educated and can research the performance of individual care home operators. The public has begun to engage in the debate—if you are considering putting an elderly relative into a care home it is now easy to access information and reports about the facilities.
Finally, the most recent headlines have been precipitated by the introduction of the living wage, which for many homes will represent a major challenge to its long term survival.
In these varied ways, the care industry has sprung into public consciousness over the last decade.
In short, care home facilities already operating on the margins of profitability may struggle to absorb increased payroll costs and this may, in turn, lead to an increase in care home failures.
The greatest impact of the living wage will be felt by older care home facilities, which are often not purpose built, where there has been a reliance on minimum wage staff to help maintain marginal profitability. The living wage could tip them into significant financial distress. For older generation care homes a 2% or 3% increase in payroll will be the difference between ongoing success and failure.
Typically, one would expect the most vulnerable facilities to be those who are significantly reliant upon state or local authority funding as fee rates are lowest in that sub-sector.
There may also be a regional dimension because it is more likely that homes outside London and the South-East will have been paying minimum wage. In those cases, there will be an immediate and material increase in payroll costs now the living wage has been introduced.
It may not be those homes who have already been struggling that will suffer first. Homes already in operational and financial distress will typically be using higher than average numbers of expensive agency staff being paid above the living wage rates. As a consequence the living wage won’t necessarily hit them as hard homes which are only just profitable and reliant upon permanent, low paid staff.
The solution is not as simple as reducing headcount because in the regulated care home environment that is not always possible.
Once a home is closed we are no longer talking about restructuring, but rather are talking about liquidation—selling the property and equipment on a break-up basis. Generally speaking the going concern value of a home will be greater than the break-up value, although on occasions there may be a viable alternative use valuation. Restructuring a care home via an insolvency process is therefore often about keeping the facility open and trading while a buyer is found.
The most obvious challenge is that any care facility in financial distress usually needs funding for working capital and capital expenditure.
Distressed and insolvent care homes are generally loss making on a cash basis, which means that they need to be funded through the restructuring process, most commonly by the secured lender, thus enabling the insolvency practitioner to keep the home trading. Persuading a secured lender that there will be merit in proving further funding can be a challenge. However, the price differential between selling a closed home and a trading home (albeit a loss making one) usually supports the logic. One then has to hope that the valuation agents have done their sums correctly.
Working capital aside, homes in distress often have onerous and significant health and safety shortcomings which require immediate rectification for statutory compliance purposes. With that comes the need for significant capital expenditure. In one recent care home administration we were compelled by the Fire Brigade to replace an old wooden fire escape or face immediate closure—an event which would have thrown the entire administration strategy into disarray at great cost to the home’s residents and its creditors.
The role of the regulators and other public sector agencies is also fundamental to the success of any care home restructuring. Care Quality Commission (CQC) enforcement notices and other health and safety notices must be complied with, failing which an insolvency practitioner can be held personally liable for the consequences of the breaches. Equally, in the most extreme cases, CQC could close the home. It is therefore essential to develop and foster a close working relationship with CQC in order to ensure they are kept appraised of progress and the pace of improvements.
Local authorities or the regional clinical commissioning groups (CCGs) will be responsible for placing publically funded residents into the home. If they are dissatisfied or concerned with the service provision they may remove service users or embargo the home. An embargo of this sort means your source of income is gone, so you need to work closely with these agencies during the process to ensure the commercial strategy can be reconciled with their requirements.
During the restructuring process you also need to be mindful of adverse PR. Commercial restructuring is often not readily understood by local media, counsellors, MPs or families of residents, all of whom can create additional complications when undertaking a restructuring.
The CCG is absolutely critical, and it is very important to have a positive and open dialogue with them. This needs to be a priority when you take over a distressed care facility, because they can shut you down. You need to work with them and understand their requirements, the nature of their concerns and what they are asking you to do. It is imperative to have a discussion with them and work in partnership so that everyone achieves the same outcome, which in 90% of cases is looking to keep the facility open and transfer the business to a new owner who can invest in it and make it thrive. Local authorities are also very important as a lot of users are local authority funded so they are the source of your income. NHS CCG’s also fund residents in a variety of facilities. So there is a real need to work with these bodies and understand the issues in order to slowly build the home back up. Insolvency practitioners tend to work alongside specialist operators who have people on the ground and support or replace existing management team. It is important to work closely with all stakeholders.
The lawyers need to provide a clear analysis of the lender’s registered security and any factors which may frustrate a successful restructuring, for instance OpCo/PropCo structures where tension between competing ownership and stakeholder agendas may throw a sale into doubt. The lawyer can also offer assistance on health and safety type issues but, most importantly, the lawyers need to be able to negotiate effectively when it comes to the sale and purchase agreement. As ever they need to be very commercial and very practical.
I expect to see an increased failure rate for older generation facilities—as a result of things like the living wage. So many changes have been imposed upon the industry by regulators over last ten years and it is hard for older generation facilities to keep up with changing requirements. If an older generation facility cannot adapt to keep up with new regulations there is nowhere to go, and they will inevitably fail. There is a tension between the art of the possible and regulatory demands.
I would also expect to see increased stratification between high end private facilities and local authority/ government funded facilities.
The care industry also needs to deal not only with a growing elderly population but an ageing population with much longer life expectancy than many care facilities and structures were designed to cope with. This means there is ever increasing demand for people with much more complex nursing and mental healthcare needs—all these are vastly more expensive to fund than basic residential care.
Alongside this, I would expect an increase in domiciliary care, where people are looked after at home where care workers will come in to tend to them.
Paul Zalkin is a director at Quantuma, one of the UK’s fastest growing restructuring and insolvency specialists. Paul is a Chartered Accountant and qualified insolvency practitioner with over 15 years’ experience advising and assisting secured creditors, directors, shareholders and other senior stakeholders exposed to the challenges of business distress.
Interviewed by Lucy Karsten.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
If you are a LexisPSL subscriber, click the links below for further information:
Guide to insolvency in the care home industry
Trading a company in administration—the office-holder's point of view
Sale of business as a going concern—checklist of information
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First published on LexisPSL Restructuring and Insolvency
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