The financial crisis started to have an impact in the UK in the summer of 2007. Initially, banks and other financial institutions, increasingly concerned about the solvency of their counterparts and/or the creditworthiness of their assets, stopped lending to each other on a large scale.

Liquidity dried up in the interbank market as a result and financial institutions soon started to hold on to their cash to meet their existing obligations. At the same time, they reduced their lending to businesses and individuals and lending became more expensive for borrowers, despite interest rates reaching historical lows. Businesses heavily reliant on the availability of credit were particularly affected, with many going into insolvency.

The crisis worsened in September and October 2008 when a number of financial institutions collapsed (especially a number of large US banks with operations in the UK, such as Lehman Brothers Inc.), while others were nationalised (such as Bradford and Bingley) or merged with government assistance (such as HBoS plc and Lloyds TSB Group).

Contagion from the financial markets has now reached most areas of the UK economy, pushing it into a recession.

To read more about the start of the financial crisis and its causes, see Financial crisis: Q&A (UK), What caused the financial crisis?.

The UK Government has taken, and is continuing to take, a variety of actions in its attempts to fight the financial crisis and bring an end to the recession.

For example, it has:

In addition, subject to EU state aid approval, the Government will provide:

For more details about these measures, see Financial crisis: Q&A (UK), What measures have the UK Government, Bank of England and the regulatory authorities taken to support the banks and the interbank lending market?: UK Government.

The following measures have been taken by the Bank of England:

The Bank of England has also set up an asset purchase fund which, from 2 February 2009, will be authorised by the Government to purchase from banks, other financial institutions and financial markets up to GB£50 billion of "high quality private sector assets", including corporate bonds, commercial paper, syndicated loans and certain asset-backed securities.

The Civil Justice Council of England and Wales has published a protocol setting out the behaviour the court expects of a borrower and lender before the start of a repossession claim in respect of a residential property.

The consequences of the Government's actions are still unclear at the moment. Their aim was to get banks lending to each other on the interbank markets again to bring liquidity back to the market. However, confidence has not yet returned and there is still some way to go.

The most tangible effects of the Government's actions are that banks that have participated in its recapitalisation scheme are, at least, unlikely to fail, despite their share price crashing (for example, the Royal Bank of Scotland (RBS), after posting the biggest losses in UK corporate history (about GB£28 billion), was bailed out by the government when its stock value plummeted. However, the scheme has meant that the government is now a major shareholder in many banks (for example, now owning about 68% of RBS) which, many argue, are now accountable to the taxpayer. The impact this will have on the business models, corporate governance and executive remuneration schemes in such banks remains to be seen.

The financial crisis has affected existing credit facilities in a number of ways, including the following:

In addition, lenders are very keen to renegotiate loan terms to include more stringent clauses (see below). Most borrowers, where they can, are resisting such overtures though.

For more information about the impact of the crisis on existing credit facilities, see Financial crisis: Q&A (UK), What impact has the financial crisis has on existing credit facilities?.

The financial crisis has had a severe impact on the terms of new credit facilities and commitment letters, including:

For more information about the impact of the crisis on new credit facilities, see Financial crisis: Q&A (UK), What impact has the financial crisis had on the terms of new credit facilities and commitment letters?.

The issues that arise if a bank is declared insolvent depend on the bank's connection to the other party.

Depositors in failed banks that are authorised by the Financial Services Authority (FSA) can recover up to the first GB£50,000 of their savings. Borrowers of a failed bank, however, cannot terminate their facility agreements and remain liable for their obligations under it (although set off is allowed where they are also a depositor at that bank).

If a bank fails that has outstanding obligations under a syndicated facility agreement that it cannot pay, it may be liable to pay damages to the borrower for breach of contract. The other lenders, however, are usually only liable for their own portions, so the borrower will have to take steps to find the lost funding or plan how to cope without it.

If the insolvent bank was also the facility agent in the syndicate, the other lenders are likely to want to replace it for practical reasons and to avoid any issue with payments channelled through it being considered part of the its assets. Usually it will resign.

If the insolvent bank is involved in a sub-participation, various issues arise depending on whether the bank is the lender of record or the sub-participant. If it is the lender and does not pass on payments to the sub-participant from the borrower, the sub-participant has no right against the borrower but has a claim against the bank in contract. If the bank is the sub-participant and cannot provide the funds to the lender to pass on to the borrower, the lender is still obliged contractually to fund the borrower. It may however be able to set off such amounts it has to provide to the borrower against any outstanding amounts owed to the insolvent bank as sub-participant.

The Law Society has published a practice note (updated on 30 December 2008 and again on 8 January 2009) giving advice to solicitors handling client funds on how to mitigate the risk of incurring any liability if such funds are lost as a result of a bank collapse.

To read more about the issues that arise if a bank is declared insolvent, see Financial crisis: Q&A (UK), What issues arise if a bank becomes insolvent?.

Investor appetite for commercial paper issued by banks has fallen and such investors have moved their money to perceived safe havens, such as gold and sovereign debt.

Net bond issuance has declined with the third quarter of 2008 seeing the lowest level of net issuance since the third quarter of 2005, although the Financial Times reported on 14 December 2008 that European non-financial corporate bond issuance surged in November and December 2008 with almost US$57.5 billion of bonds sold. The Financial Times also reported on 18 January 2009 that European companies had sold record volumes of bonds so far in the year, with US$15.2 billion of bonds sold by non-financial European companies in the second week of January 2009, and the first issuance in the European junk bond market since mid-2007.

Also, despite historically low base rates, bond spreads have increased. For example, the Financial Times reported on 1 December 2008 that recently National Grid had issued six-year bonds at 3.3% above the interbank lending rate (about seven times what it was paying before the credit crunch) and Daimler had issued three-year bonds at 6% above the interbank lending rate (nearly 20 times what is was paying in 2005).

To read more about the effects of the financial crisis on the debt markets, see Financial crisis: Q&A (UK), What impact has the financial crisis had on credit markets?.

In the equity markets, the volume of initial public offerings (IPOs) in the UK slumped in 2008, as it did globally, to its lowest level in both value and volume since 2003. With other sources of funding unavailable though, the Financial Times reported on 30 January 2009 that companies are turning to their shareholders for support, with a number of rights issues already having taken place in 2009 and forecasters predicting many more.

In regulatory terms, following widespread concerns that short selling was making the financial crisis worse and seriously threatening the survival of many financial institutions, the FSA introduced a ban and other measures relating to the short selling of financial stocks in June and September 2008. The ban on short selling expired on 16 January 2009. The obligation introduced requiring the weekly disclosure to the market of short positions has been maintained though, as the FSA continues to monitor the situation. For more information about short selling, see Financial crisis: Q&A (UK), What are the key areas for regulatory reform?: Short selling.

Credit default swaps (CDS) were previously used as a means to spread and reduce risk. However, they were largely unregulated and unperceived systemic risks and a lack of transparency has in fact meant that, in the current crisis, they have put many more organisations at risk. It is therefore widely expected that there will be greater regulation of the CDS market in Europe. The European Commission established an industry working group to make concrete proposals before the end of 2008 on how to mitigate the risks from credit derivatives, including CDS. Any EU legislative proposals that affect the derivatives market will impact on the UK regulatory regime. Consideration is being given to a number of areas, including:

Many hold inadequate regulation and/or monitoring of financial institutions responsible for enabling such organisations to carry out the practices that caused the financial crisis. Many areas are therefore currently being reviewed to close perceived gaps.

For example, the FSA, as well as reviewing its regulatory regime (see Financial crisis: Q&A (UK), What are the long-term regulatory implications for banks and markets?: Changes to the FSA's regulatory regime), launched a consultation in December setting out its proposals to introduce tough new liquidity and capital adequacy standards for certain financial institutions. It expects these to significantly impact their business models over the next few years. Similar reviews are being carried out in the EU and by the BCSB that are likely to also affect this (see Financial crisis: Q&A (UK), What are the key areas for regulatory reform?: Capital and liquidity requirements).

To read more about other areas being considered for regulatory reform that will affect financial institutions, see Financial crisis: Q&A (UK), What are the key areas for regulatory reform?:

A company should review its existing commercial arrangements and monitor the extent to which it is, or could be, affected by the financial health of its customers and suppliers. Having up to date information on customers and suppliers will enable companies to protect themselves in the most efficient way possible, though such information may not be readily available and may be difficult to obtain from a practical point of view. Talking to those closest to the customers (sales force) and suppliers (buyers) and watching out for signs of trouble, such as abrupt management departures (especially of managers involved with the finances of the company), will assist in anticipating any potential obstacles to the continuance of a company's own business cycle.

If a company is in any way concerned about the continuance of a business that is relies on, it should make contingency plans as early as possible. It should monitor inventory and consider how long it could continue if a critical supplier fails and whether it could find alternative sources of supply for key products and services.

The board should also review the company's insurance policies (including the D&O policy) and the status of its insurance providers. If concerns exist over the ability of customers to meet current and likely future payment obligations, the company should consider whether it has adequate credit insurance. The last quarter of 2008 saw a number of providers refusing to extend credit insurance on renewal dates. Companies may wish to investigate options elsewhere, if initial discussions with existing brokers do not appear favourable.

The board should seek advice on its contractual rights. Most contracts make some provision for termination in the event of insolvency or financial difficulty of a party. The triggers for such clauses very widely, as do the remedies that the contract then gives the parties.

The following restructuring options are commonly used by companies in financial difficulty:

For more on corporate debt restructuring see PLC Finance, Corporate debt restructuring: step by step.

Apart from considering its insurance policies to check if it has adequate credit insurance (see Question 9), there are a number of other options companies should consider when negotiating contracts with new customers or suppliers.

Companies should consider the payment terms when negotiating with new customers. They may want to require payment in advance or, if allowing payment by instalments, require a greater amount upfront and/or set shorter payment terms.

Instead of or in addition to these, depending on the circumstances, companies may want to consider protecting themselves by:

To protect itself against a potential new supplier having financial difficulty, a company may want to consider:

When dealing with a company in financial difficulty, a company will want to consider what is its best course of action in all the circumstances to minimise its losses. Such an action may be, for example, that it requests that the company pays off all outstanding amounts due, in return for which it will cancel its long term contract or continue to supply product. It may also ask the company to support its covenant strength by, for example, obtaining guarantees from directors or parent companies. It should also look to impose more draconian trading terms as a condition of continued trade. For example, it could reduce credit terms (or remove them altogether by requiring cash on deliver) or bolster any retention of title provisions.

The Insolvency Act 1986 contains provisions that allow insolvency practitioners to review and undo transactions of a company entered into in the run up to an insolvency process, if those transactions were to the detriment of the company's creditors. When dealing with a company in financial difficulty, the board of a solvent counter-party may want to seek advice on whether any of their actions could face a challenge in due course. The powers are wide ranging. For transactions with genuine third parties (the rules are harsher for transaction between companies in financial difficulty and those connected with them) the insolvency practitioner can review:

Also, any floating charges created by an insolvent company over its assets in the 12 months before it goes into an insolvency process will only secure obligations that arise after the date of its creation.

When a company enters a formal insolvency process, an insolvency practitioner takes over the management of its affairs. The insolvent company does not lose its legal personality in this process and can continue to transact and contract with third parties. All such contracts are with the insolvent entity, not the insolvency practitioner personally. As a result, the commercial risk in all such transactions lies with the third party. In addition, to protect his own personal position, the insolvency practitioner will require indemnities from the third party against the risk of his incurring personal liability and against losses to creditors arising from the insolvent company having entered into that transaction.

The quid pro quo for the allocation of risk to the third party is a discounting of the price of the transaction, which can present opportunities to acquire assets or businesses at a competitive value. When supplying goods or services to a company in an insolvency process, the supplier should ask that the insolvency practitioner agrees to meet their costs as an expense of the insolvency estate. The insolvency practitioner must pay such expenses from asset realisations before he distributes them to the holders of floating charges and unsecured creditors. Without the express agreement of the insolvency practitioner to pay such costs as an expense, they may rank only as an unsecured creditor claim and receive only pence if the pound (if anything) by way of return.

UK insolvency law does not recognise anything like the concept of "debtor in possession" (DIP) funding that is a facet of, for example, US insolvency practice.

The crisis in the financial markets has led to significant reductions in the price of loan assets being traded in the secondary market. This has created opportunities for borrowers (and their related parties) to buyback debt.

With share prices on average being far cheaper than they have been for a number of years, share buybacks are on the face of it a good way for a company to support its share price and demonstrate the board's belief that the market is undervaluing the company. However the dilemma for companies is that although shares appear cheaper, the freezing up of the credit markets, and the resultant difficulties in accessing debt finance, has meant that "cash is king" and companies are looking to preserve cash.

For more on debt or stock buybacks, including examples, see Financial crisis: Q&A (UK), Are any companies buying back their own debt or shares?.

There are numerous possible types of dispute that may arise out of the financial crisis, ranging from claims by the government to hold to account, financially or criminally, some of those who they consider to be responsible for the market collapse, through claims by investors or shareholders for misrepresentation or breaches of fiduciary duties, to claims by employees against their employers as their pension values have been wiped out.

For a detailed summary of the potential claimants, defendants and causes of action, including examples of any litigation that has arisen, see Financial crisis: Q&A (UK), What litigation is going to come out of the financial crisis?.

See Question 14.

In the first nine months of 2008, UK private equity buyouts numbered 503, compared to 672 for the whole of 2007, according to data compiled by the Centre for Management Buy-out Research. The aggregate value of those 2008 deals totalled just GB£17.1 billion, compared to GB£45.9 billion during 2007, at least in part due to the absence of the mega buyout, which played such a prominent part in the 2007 market.

The reduction is also due to the reduction in the level of finance available (from investors as well as banks), the difficulty in finding good deals in the present market, and private equity firms using this time to consolidate, refinance or renegotiate their existing debt, as well as potentially buying back some of it.

For more information about the impact of the crisis on private equity in the UK, see Financial crisis: Q&A (UK), What impact has the financial crisis had on private equity and leveraged M&A deals?.

M&A activity, like private equity activity (see Question 16), has seen a significant fall in both volume and value, mainly because of the unavailability of financing. Where financing is available, it is on more onerous terms and deals are taking longer to complete, so many potential buyers may be waiting for a more favourable time to make deals.

For more information about the impact of the crisis on M&A activity in the UK, see Financial crisis: Q&A (UK), What impact has the financial crisis had on private equity and leveraged M&A deals?.

Special considerations that apply when buying the assets of a distressed company include:

For details about these considerations, see Financial crisis: Q&A (UK), There must be some good opportunities to buy the assets of distressed or insolvent companies. Do any special considerations apply?.

No new restrictions have been imposed on foreign ownership or investment.

The Competition Commission does not have the power to waive competition requirements, but the Secretary of State is now able to act to by-pass the Commission so that a transaction can proceed. The recently enacted Enterprise Act 2002 (Specification of Additional Section 58 Consideration) Order 2008 (SI 2008/2645) adds maintaining the stability of the UK's financial system as a public interest consideration. This allows the Secretary of State to intervene in relevant UK mergers, if maintenance of the UK's financial system is at stake, so that they can take place without reference to the UK competition authorities notwithstanding that there may be competition issues. This was used to by-pass referral to the Competition Commission in the proposed merger between Lloyds TSB Group and HBoS plc.

No tax incentives have been introduced to encourage M&A activity in the UK.

Directors are generally not liable for the debts of a company. However personal liability may be incurred in certain situations, particularly during periods of financial difficulty for the company. As soon as the directors are aware that the company may face financial difficulty, they should seek external, legal advice (in addition to ongoing dialogue with appropriate accountants). Non-executive directors (and, in a number of cases, shadow directors) have the same duties and liabilities as executive directors, including those set out below, except that they are not subject to considerations arising from an employment relationship.

Directors are subject to duties contained within sections 172 to 177 of the Companies Act 2006 (2006 Act). In times of financial difficulty, their compliance with those duties comes under additional scrutiny. In particular:

Companies admitted to AIM which are incorporated under UK company legislation, or whose principal place of business is in the UK, will be subject to certain provisions of the Disclosure and Transparency Rules, as well as the AIM rules applicable to all companies admitted to AIM.

Directors of public companies must also continue to comply with the 2006 Act. In times of difficulty, directors should be particularly aware of the criminal sanctions for failing to call a meeting following a serious loss of capital. If net assets fall to half or less of the company's called-up share capital the directors must, within 28 days of becoming aware, convene an extraordinary general meeting to discuss the position and what steps, if any, should be taken to deal with the situation (section 656, 2006 Act).

Directors may be required to contribute to the assets of an insolvent company on the application of the liquidator where it appears that:

A director has misapplied, retained, become accountable for any money or other property of the company, or been guilty of misfeasance or breach of any fiduciary duty (section 212, Insolvency Act 1986 (IA86)). A court may also order the director to repay, restore or account for money or property with interest.

A director was knowingly party to the carrying on of business with the intention to defraud creditors (section 213, IA86). Fraudulent trading is also a criminal offence under section 993 of the 2006 Act.

Before the commencement of winding up, a director knew or ought to have known that there was no reasonable prospect that the company would avoid insolvent liquidation and did not, after that point, take every step with a view to minimising the loss to creditors from the company's insolvency (section 214, IA86). As with the duty to exercise reasonable care, skill and diligence under the Companies Act 2006 (see above), the courts will impose both an objective and subjective test to each relevant person. The potential for personal liability for wrongful trading is often a key concern of directors of companies facing financial distress, not least because it is difficult to be certain when the liability arises. Not only is it hard to say precisely when the directors incur the obligation to take every step to minimise the losses to creditors, it is at least as demanding to then determine what course of action will have the "least worst" impact on the company's creditors. As a broad rule of thumb, the more that directors base their decision-making upon the recorded advice of specialist advisers, the less chance there is of a liquidator successfully imposing personal liability upon them in due course.

The general principle that directors are not liable for the debts of a company does not apply to liabilities agreed to in a director's personal capacity. It is common for directors of private companies (particularly family businesses) to guarantee the liabilities of the company. In difficult times, any such director should be fully aware of his rights and obligations under the terms of the relevant guarantee(s).

In addition to the personal sanctions described above, the court may disqualify any director (or shadow director) of a company which becomes insolvent from being a director of a company if his conduct as a director makes him unfit to be concerned in the management of a company (section 6, Company Directors Disqualification Act 1986). In making its determination, the court may take into account a number of matters, including those statutory constraints referred to in this note.

The board should seek specialist legal advice as to the duties and responsibilities of directors in relation to a company facing financial difficulty (see Question 22). A court is unlikely to question the commercial merits of any particular decision, provided it is satisfied that directors acted in line with relevant duties. The statutory duty of directors to promote the success of the company for the benefit of its members as a whole is, in situations of threatened insolvency, replaced by a duty to act in the best interests of creditors (section 172(3), Companies Act 2006). Open dialogue with creditors on the company's survival planning may avoid the risk of any payment acceleration or other event of default options being exercised by creditors.

Directors should hold regular board meetings, attended by all directors, and ensure that detailed minutes of decisions are taken and circulated. Decisions ordinarily delegated to committees might more properly be taken by the full board.

Public companies listed on the Official List of the London Stock Exchange should ensure sufficient familiarity and absolute compliance with the requirements of the Listing, Prospectus, Disclosure and Transparency Rules. Companies admitted to AIM which are incorporated under UK company legislation, or whose principal place of business is in the UK, will be subject to certain provisions of the Disclosure and Transparency Rules, as well as the AIM rules applicable to all companies admitted to AIM.

There are widespread concerns that inappropriate bank remuneration schemes may have contributed to the financial crisis by encouraging bank staff and senior management to take excessive risks for short-term personal profit.

In the UK, the FSA has already increased its focus on banks' remuneration structures and bonus schemes. It will not get involved in setting remuneration policies or imposing restrictions on the level of bonuses paid by banks. However, the FSA does expect banks to be able to show that their remuneration structures are treated as part of, and are aligned with, their risk management strategies.

In October 2008, the FSA sent a "Dear CEO" letter to banks outlining its continued work on remuneration structures, together with its initial thinking on remuneration policies. The Annex to the letter sets out some high-level criteria for good and bad remuneration policies, and banks are urged to review their remuneration policies against the benchmark of the criteria. Regulated firms should be doing this now and should take immediate action if their remuneration policies are not aligned with sound risk management systems and controls.

The FSA visited recipients of the letter before the end of 2008 to check whether any bad remuneration policies were still in place, and to have discussions on what constitutes good practice in this area. In early 2009, it will give feedback on the good practices it has identified from these visits, and hopes to be able to report on the progress of international work in this area (the FSA is keen to develop a global framework on bank remuneration schemes, in order to stop executives from holding banks to ransom). At the same time, the FSA also plans to publish its findings from a general review of remuneration structures in the London market (on a no-names basis), with a revised statement on what it considers to be good practice.

At European level, at its October 2008 meeting, the Council of the European Union set out some high-level principles in relation to executive pay and called on Member States to put those principles in practice. It asked the European Economic and Financial Affairs Council (ECOFIN) to report back on decisions taken by Member States in this respect by the end of 2008.

The European Commission has launched a wide-ranging review to analyse the adequacy of regulation, oversight and transparency in the financial markets. Amongst other things, this review will cover executive remuneration (in particular, the need for reward structures to be more closely aligned to the real medium term benefits accruing to companies). The European Commission will report on its findings to the European Parliament and the Council of the European Union prior to the spring 2009 Council meeting.

The form of any European regulatory initiative on remuneration and the impact it may have on the UK regulatory regime remains unclear.

Most recently, following the move in the US to cap executive remuneration in financial institutions receiving help from the state at US$500,000, the UK Government has come under pressure to come up with a similar restriction, particularly for those banks in which it now owns significant stakes or is helping to fund. In addition, with banking bonuses being announced shortly, the matter has come under intense media and political scrutiny and the Government said it would carry out an independent inquiry to review the matter.