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Corporate Insolvency Law
Over the past fifteen years corporate insolvency law in the UK has been radically reshaped mainly by means of the Enterprise Act. As a result corporate rescue has increasingly become a fashionable topic, which has long been a subject of global interest. It has been commanding very significant legislative, academic and professional attention.
Generally, insolvency is defined as the inability to pay debts as they mature, or as obligations become due and payable. In such situations a person may still have an excess of assets over liabilities, but will still be considered insolvent if is not able to convert the assets into cash in order to meet financial obligations.
According to Finch the rescue procedures in corporate insolvency involve going beyond the normal managerial responses to corporate troubles. Corporate rescue is seen as “a major intervention that is necessary to avert eventual failure of the company”. It aims at providing an alternative to liquidation proceedings for financially ailing but economically viable companies; it helps companies in difficulty take a breath by freezing the enforcement of creditors' claims for a prescribed period as well as to enable such companies to recover from the temporary cash flow difficulties.
When an attempt to rescue is not successful, the business of the insolvent company can be sold “as a going concern” (this concept will be discussed in detail further on in the research). Through this method, the creditors' claims are more likely to be satisfied to a greater extent than would be possible in an immediate liquidation where the assets of the debtors are usually disposed for the purpose of a quick realisation to creditors. Outside insolvency professionals may be involved in the rescue activity and take control over the assets and management of the company, or the existing management of the company may remain in control of the company. This can be either unsupervised or subject to supervision which will be undertaken by an outside insolvency professional who can be appointed by the entitled creditor or the court under the terms of relevant legislation.
Corporate rescue has become so popular that even unregulated investors, such as private equity investors and hedge funds, have increased their role as purchasers and creditors of troubled firms, and derivatives and other financial products have permitted these sophisticated investors to “participate out” their risks. Most importantly, there has been an enormous growth in merger and acquisition activity associated with troubled firms.
Background To Corporate Rescue
The UK government has long been concerned with the innovation and formulation of a modern and efficient corporate rescue system. The introduction of formal corporate rescue procedures in the UK can be traced back as far as 1870, but a sophisticated system of corporate rescue procedures did not develop until much later. The main reason for such a significant reform was the economic disaster in the 1970's.
Because of the weak bankruptcy and rescue law system, it was impossible for the corporate sector to rehabilitate in the face of a high volume of enterprise distress and the long term economic recession. Many countries that had been seriously affected by the impact of the crisis started reconsidering and improving their domestic corporate rescue regimes, especially through informal workouts. A typical model of the informal rescue arrangements was the “London Approach” which was first created and promoted by the Bank of England in the mid 1970's. This procedure has played a significant role in contributing to corporate recovery outside formal insolvency proceedings.
The informal rescue procedures were simple but unfortunately lacked protection for the company. The government, realising the need for more sophisticated rescue procedures, appointed the Cork Committee to review and make recommendations to both corporate and personal insolvency laws. The committee's report advised the provision of “means for the preservation of the viable commercial enterprise capable of making a useful contribution to the economic life of the country”. The report also observed;
“We believe that a concern for the livelihood and wellbeing of those dependent upon an enterprise which may well be the lifeblood of a whole town or even a region is a legitimate factor to which a modern law of insolvency must have regard. The chain reaction consequences upon any given failure can potentially be so disastrous to creditors, employees and the community that it must not be overlooked”.
With this aim in mind the Cork Committee set out a number of recommendations based on two proposed new procedures. These were the company voluntary arrangement and the administration order.
In the 1980's the recommendations of the Cork committee were implemented in the legislation. The company voluntary arrangement and the administration procedures were first introduced under the Insolvency Act 1985 and later on under the Insolvency Act 1986 where it accommodated the existing administrative receivership and the scheme of arrangement procedures.
Even though the legislature adopted the Cork Committee's recommendations, some departures were made from what had been originally recommended. This is because the initial format of these procedures was not fully conducive to an effective corporate rescue. Over the following years very few administration orders were made and only a low number of company voluntary arrangements were agreed each year. As a result a series of legislative amendments followed.
Research Aims And The Need For This Analysis
It is obvious that the appropriate solution to the financial difficulties of a company depends on the circumstances of the case; that is the nature of the problems, their severity and the means available for resolving them. For a long time the most commonly used corporate insolvency law procedures were the voluntary and compulsory liquidations. These aimed to provide an orderly winding up of the company facing financial difficulty.
However, since the Insolvency Act of 1986, the focus of reforms in corporate insolvency law has increasingly been on the avoidance of corporate failure and improvement of the rescue culture. An example of this is through the Insolvency Act 2000 where a statutory moratorium was introduced in order to make the Companies Voluntary Acts more attractive to small eligible companies that require salvage.
Another example is through the Government's White Paper document in July 2001 entitled: “Productivity and Enterprise: Insolvency - A Second Chance”. The paper proposed measures to modernise both personal and corporate insolvency law. Even though some of the most radical measures were reserved for personal insolvency, on the corporate side the focus was on promoting the rescue of viable companies and their businesses and this was done by encouraging productivity and enterprise as well as increasing accountability and the returns to creditors.
The Enterprise Act 2002 however is the main act that has brought some major reforms to corporate insolvency law and the earlier corporate rescue procedures that had been introduced by the Insolvency Act 1986. The aim of the Enterprise Act 2002 is to formulate a more rescue oriented and efficient administration regime that promotes “fairness, efficiency and accountability by the abolition of administrative receivership”. The provisions of the Enterprise Act 2002 on corporate insolvency came to force on the 15th September 2003 and have clearly provided for the most fundamental revision of both corporate and personal insolvency for over 20 years.
The main objective of this research is to look at the changes that took place in insolvency law after the introduction of the Enterprise Act 2002 with particular focus on the administration procedure. The dissertation focuses on the Administration procedure and how it came about to be the main corporate rescue procedure in insolvency law so as to draw conclusions whether or not it has succeeded as a rescue mechanism in this current economic regime.
In analysing the current administration procedure the dissertation will also pay specific attention to the pre pack sales in administrations. The pre pack administrations have become the focus of much attention in the current economic regime, (over the past few months pre - pack sales in administrations have received even more attention than the administration procedure itself) and recently there has been a great debate on whether the pre packs should be permitted (critics have argued that they create a certain amount of abuse).
The dissertation will give some details on the other rescue procedures as well so as to examine the weaknesses of the precious procedures and how administration came about to be the major corporate rescue procedure. However these procedures will not be explored in very much detail.
It should be noted that even though liquidation is a procedure in corporate insolvency law, this dissertation will be dealing specifically with the rescue procedures in corporate insolvency. For this reason even though liquidation might be mentioned here and there in this research, it will not be part of the insolvency procedures to be explained.
The Enterprise Act concentrated on two corporate insolvency proceedings, namely administration and administrative receivership. In support of the White Paper's call to promote rescue and collective insolvency procedures, the Enterprise Act streamlined the procedure of administration and removed (in most instances) the right to appoint an administrative receiver.
In addition, in order to provide a more equitable outcome for creditors, the Enterprise Act also abolished the Crown's preferential status in all insolvencies and introduced a mechanism (the “prescribed part”) in corporate insolvencies for the benefit of that abolition to flow to ordinary unsecured creditors, in cases with floating charges.
How Are These Aims Being Achieved?
This dissertation has been conducted through library based research. It primarily relies on a comprehensive review of existing literature, legislation, case decisions and official documents (governmental documentation). The dissertation also relies on insolvency scholarship mixed with journalism in order to get a clear update picture of the current economic regime.
The dissertation title indicates that this research is constructed upon the analysis of the insolvency procedures with relation to corporate rescue. Through the title of the dissertation two important methodological questions are required to be addressed before commencing with the analysis.
Is It Appropriate To Carry Out A Research On A Topic Relating To The Legislative Changes In Corporate Insolvency Procedures?
In order to answer this question we need to establish if it is appropriate to conduct a research on corporate insolvency law procedures in the first place. It is well known that corporate insolvency and more specifically, the corporate rescue laws are an important part of the bankruptcy laws of any country. This is because they are “a defining characteristic of a market economy”.
The market economy encourages using the resources available as well as competitive methods in order for the companies to achieve the maximum of economic value. This being the case it is completely normal to see companies getting into financial trouble (falling into insolvency) when business has not been going well.
Therefore, corporate failure is a common problem that any “market economy country” will encounter. Because of this, corporate rescue laws are created and developed in order to rescue the businesses that are in financial distress but viable economically. Corporate rescue is not only a legal procedure that helps in bankruptcy law, but is also a very important part of the economy. A research on this is highly appropriate because understanding corporate rescue will be of both academic value and practical significance because the current regime we exist in is market based economic regime.
It can be argued that the Enterprise Act 2002 aimed at a paradigm shift that is to make the UK the best place in the world to do business. The statute can be viewed in the context of the late 1990s economic boom that was fuelled by the technology and Internet sectors. At the same time however, the government feared a return of the economic downturn and recession of the early 1990s.
By analysing the legislative changes that have occurred in corporate insolvency law one can understand how administration procedure came to be the main rescue procedure in the UK. Through this analysis one can also draw a conclusion as to whether or not this rescue procedure has succeeded in the current economic regime (in dealing with the economic crisis that had been feared and had given rise to the idea of corporate rescue in the first place).
Why Does This Dissertation Choose The United Kingdom As A Research Object?
The UK has had long history of bankruptcy law among western industrialized countries since a statute of Henry VIII was enacted in 1542. In addition, it should be noted that the schemes of arrangement approach which is the first rescue oriented regime, was introduced by the Victorian legislation in 1870, and it had great influence on the insolvency law reforms of other industrialized nations.
The UK has structured a relatively advanced corporate rescue system which is being referred to by other countries worldwide. It is of great importance to do this analysis especially since the UK has undergone two dramatic reforms to its rescue regimes in the new millennium under the Insolvency Act 2000 and Enterprise Act 2002. Therefore doing an extensive research on rescue laws in relation to the present economic regime will have some value theoretically and practically. The research will enrich the corporate rescue theory not only for the UK but also other countries that look towards the United Kingdom (for example the developing countries). In addition, this dissertation will open a window for insolvency professionals, who can, with their experience build up on the ideas on whether the current rescue procedures in corporate insolvency are indeed the proper way to go in this current economic regime.
The UK government has been a pioneer, using corporate rescue practice to promote its insolvency law reforms towards a modern corporate rescue culture. The widespread acceptance and reference of the UK rescue regimes in other jurisdictions clearly shows that UK is the perfect country with which to base this research on when taking into account the central rules and policies in rescue regimes.
Outline Of The Dissertation
This dissertation makes extensive reviews of the corporate insolvency laws and reforms to rescue regimes. It explores how the UK has shaped its own rescue laws for their respective systems on the basis of differing circumstances and how they have balanced the bargaining power of every interested group in a rescue activity.
Although the dissertation is aimed at the changes brought about by the Enterprise Act 2002, and more specifically the analysis of the administration procedure in the current economic regime, the dissertation also touches on the other rescue procedures in corporate insolvency law. This approach is used so as to show how the administration came about. The explanation of the other rescue procedures along with their weaknesses (downfalls) helps in getting a clear picture as to why there was a need for further reform in corporate insolvency law.
In order to realise its research aims, this dissertation has been divided into five chapters. Chapter two explores the historical developments that have occurred in corporate rescue laws in the UK. This has been divided into two sections. The first part deals with the corporate rescue legal framework prior to the reforms in the 1980s. This part explains the schemes of arrangement procedure, the administrative receivership procedure and the London approach procedure. The second part deals with the two innovative rescue regimes in the Insolvency Act 1986 that were aiming towards a modern corporate rescue culture. Here the company voluntary acts procedure is explained as well as to why it did not succeed as the main corporate rescue procedure. Further reference is made to the insolvency Act 2000 and the reforms that took place to the company voluntary arrangements are explained. There is also an introduction of the enterprise Act 2002 as well as the new administration procedure.
In chapter three, the new administration procedure is discussed in detail and the position of the law is brought forward. In this chapter the Enterprise Act is discussed in further detail in relation to the administration procedure that exists in the current economic regime. Specific attention is paid to how the administration of companies takes place in order to get a practical sense of the issue. There is also an introduction of the pre pack administrations which are discussed further in chapter four.
The pre pack administrations are discussed in detail in chapter four. In this chapter there is a combination of the law and practice. It is a chapter that exposes the gaps found in the laws governing corporate rescue in the economic situation which the UK is facing at present. In this chapter the criticisms from the current administration procedure as well as the pre pack administrations are brought forward. Analysis made from the criticisms with reference to the extensive literature review is brought forward. The efforts that are currently being made to deal with the shortcomings of pre - packaged administrations are discussed and conclusions are drawn on whether they are succeeding. Again in this chapter there is still the argument about the advantages of administration over the other rescue procedures but clear criticism is still made as to whether it is the best procedure in dealing with the current economic regime. The Enterprise Act provisions are continually discussed in order to see if it has indeed managed to promote efficiency and transparency in so far as insolvency proceedings are concerned.
Chapter five is specific chapter dedicated to winding up the study. In this chapter there are general observations made from the dissertation where a conclusion is drawn on whether the administration procedure is appropriate for the current economic regime.
The Historical Developments Of Corporate Rescue Laws In The Uk
In order to understand the current administration procedure it is important to develop some knowledge on the other rescue mechanisms that the UK Insolvency Law has used in order to deal with corporate failure. This chapter is dedicated to the analysis of the corporate rescue procedures that existed before the current administration procedure namely the London approach, the schemes of arrangement, company voluntary agreements and administrative receiverships.
As briefly mentioned before in chapter one; the dramatic changes to the UK insolvency law did not take place until the 1980s. This is when the Insolvency Act 1986 was enacted under the recommendation of the Cork Committee. The Cork Committee, which was established in 1977, made a very comprehensive review of the existing insolvency law and as a result recommended two corporate rescue regimes; these were company voluntary acts and administration and were the first formal procedures of rescue culture in the UK
Before the legal reforms that were recommended by the Cork Committee there were some limited aspects in certain laws that somehow managed to provide solutions to the insolvent companies. An example of this was the schemes of arrangement which was created by the Company Law legislation in the late 19th century. The scheme of arrangement method was used to provide ground for the company in trouble along with its creditors for debt restructuring. Since there was no available insolvency law framework at that time this method was seen as an alternative to liquidation. Through this method the troubled company could reach a certain agreement with its creditors (company debt restructuring). Unfortunately this method was widely criticised as complicated and expensive.
Apart from the schemes of arrangement, the administrative receiverships also seemed to have some rescue oriented aspects although they were quite limited. The rescue procedure in the administrative receiverships was specifically in the cases where the claim of the floating charge holder was under secured. Here the receiver and manager continued trading in order to restore the company in trouble instead of just doing a quick sale in order to realise the claim of the floating charge holder.
The different social and economic conditions that took place in the UK after World War II are what encouraged the corporate insolvency reforms. For example, the oil crisis and the economic recession which occurred in the 1970s made the government take a look at the existing insolvency law. The insolvency law was seen to be ineffective when the crisis occurred because many companies had been liquidated and would have been restored had there been an effective corporate rescue law procedure in place.
Following the reaction from the economic crisis in the 1970s, the “London approach” was formed in 1977 under the bank of England. This became a well established voluntary procedure (informal rescue procedure) and proceeded under the consensual support of banks. The London approach is one the major informal rescue arrangements and is seen as the opposite to schemes of arrangement. It is an informal well functioning rescue solution to corporate failure and has managed to remain so even in the modern UK corporate rescue legal framework.
The Corporate Rescue Legal Framework Prior To The Reforms In The 1980s
Schemes Of Arrangement
The scheme of arrangement procedure is not a specialist insolvency procedure as such but has still been used to carry out many company restructurings. The procedure can be found in Part 26 of the Companies Act 2006 and has a very lengthy history which can be traced as far back as the late 19th century.
The scheme of arrangement provided a rescue procedure apart from the traditional winding up proceedings (liquidation) before company voluntary agreements (hereafter referred to as CVAs) and administration became available. The procedure can be used to buy out minority shareholders but can also be used to facilitate the reorganisation/restructuring of large companies facing financial trouble for example, Cape plc and British Energy plc.
The scheme of arrangement has also played an important part in the restructuring of insurance companies. The case of Re Hawk Insurance Co. Ltd explains how the approval of a scheme of arrangement is a three stage process. Firstly, is the application to the court for an order that a meeting should be summoned (this gives the opportunity for those affected to be present at the meeting). Secondly, the scheme proposals are brought up at the meeting to obtain approval (this ensures that the proposals are accepted by the majority). Thirdly, if the scheme proposals are approved by the majority, there must be a further application to the court for its sanction (The court's job here is to make sure the opponents interests receive impartial consideration). In the case of Re British Aviation Insurance Co Ltd, it is seen that the creditors' decisions always prevail. Lewison J pointed out in this case that it doesn't matter if the opposing creditors have reasonable objections to the scheme. Even if a creditor is equally reasonable in voting for or against the scheme the creditor democracy prevails.
One advantage of schemes of arrangement procedure is that there is no statutory requirement that the company needs to be insolvent or likely to be insolvent. Because of this the procedure can take place at quite an early stage.
It has been a continuous concern however that in the scheme of arrangement procedure the court's level of involvement is quite high making the procedure expensive. If we look at the case of Re Hawk Insurance Company Ltd and the case of Re British Aviation Insurance Company Ltd mentioned briefly above we can see that the court had a wide discretion to refuse to sanction an arrangement if it believes that some interested party is not being treated fairly and reasonably. This can happen even if the scheme has been approved by the meetings of creditors and members in every class. Furthermore, if the court feels that fraud has been established in the scheme of arrangement then it is entitled to nullify the scheme that had already been sanctioned earlier.
The procedure has also been repeatedly criticised for its complex voting structure. The members and creditors included in the scheme are actually divided into classes and the voting takes place within each class (The procedure is collective and all the interested parties are taken into account by the court).
Because of the disadvantages the scheme of arrangement procedure had especially in rescuing small companies, The Cork Committee still saw the need for further insolvency reforms and the introduction of other corporate rescue procedures.
The London Approach
The London Approach procedure is defined as:
“...a non statutory and informal framework introduced with the support of the Bank of England for dealing with temporary support operations mounted by banks and other lenders to a company or group in financial difficulties, pending a possible restructuring”.
The London Approach procedure can be traced back to the economic recession in the 1970s. The recession had a very bad impact on the companies at that time (especially multi bank based companies) and the general banking sector in the UK. Since there was no formal rescue procedure at that time, The Bank of England became involved in achieving an approach to the rehabilitation of a distressed company. This to a large extent relied on the cooperation, understanding, consensus and continuing support amongst the bank creditors.
Since the procedure started, The London Approach has succeeded in rescuing a great number of companies facing financial difficulty out of court even though the companies have a large number of bank creditors. The success of the London Approach has not only created a flexible and cooperative informal rescue arrangement for corporate recovery, but it has also provided a useful pattern that has been learned and imitated in many other developing countries despite their cultural and legal differences.
The London approach is seen as a set of principles rather than rules. It offers a flexible pattern of debt restructuring and relies on negotiation with banks and their collective financial support. The London approach provides a ground where informal restructuring can take place without any bad publicity impacting on the company on its financial status (when a large publicly held company falls into financial difficulties, the disclosure of its financial status brings fear to the creditors and may as a result cause difficulties in the rescue attempt).
In the London approach procedure there is a standstill (freeze) which covers all the debts (the standstill is a voluntary rather than a statutory process). The standstill restricts the lenders from taking individual action for debt enforcement or improving their positions relative to other creditors in terms of debt repayment or by way of security. It must take place over a relatively short period of time and should be under agreed limits that are measured by months.
The advantage of a standstill is that it enables a team of investigating accountants to gather information on the company's affairs. The information gathered then helps the lenders to decide collectively on whether or not restructuring can be done. During the negotiation, a lead bank is identified to act as a mediator (plays the role of resolving of any disagreement among the banks since there is no legal arbitration process when disputes arise). If the negotiation is successful the lenders will reach a consensus on the new financing agreement and the lenders will advance the loans for continued trading of the company experiencing financial trouble.
The London Approach has had a great influence over the informal reorganisation of the multi banked large corporations both at a domestic and an international level since its birth. Under the Bank of England the procedure has managed to save a lot of large companies and continues to do so to date.
Administrative receivership was essentially a creditor- oriented procedure which originated as a remedy to protect a person's interests in property (developed to protect the interests of the floating charge holder). It is a process of enforcing the debt by a secured creditor with a floating charge over the company's assets. The administrative receivership procedure was introduced in the late 19th century and from that time became a very large part of the UK financial structure.
The technique of the administrative receivership procedure is that the floating charge holder appoints “an administrative receiver” to take over the assets and business affairs (finances) of the company in trouble. The aim here is to trade the company out of financial difficulty in order to benefit all stakeholders. Since it is not always the case that the company can traded out of financial difficulty, the administrative receiver may attempt a quick realisation of assets. It is important to note here that the administrative receiver owes a primary duty to his appointer (that is the floating charge holder) so he needs to ensure that the charge holder obtains a better return.
In the past two decades, the administrative receivership procedure was highly criticised and a lot of issues were brought up as to whether receivership was a “rescue” procedure as such. The Cork Committee contributed tremendously to these thoughts:
“Such receivers and managers are normally given extensive powers to manage and carry on the business of the company. In some cases, they have been able to restore an ailing enterprise to profitability, and return it to the former owners. In others, they have been able to dispose of the whole or part of the business as a going concern. In either case, the preservation of the profitable parts of the enterprise has been of advantage to the employees, the commercial community, and the general public.”
One of the main concerns that were brought up concerning the administrative receivership procedure was that the receiver could be appointed at any time, and he owed his duties to his appointer. Because of this the receiver could discharge his duties without considering the interests of the general body of creditors. It was seen that only where a rescue attempt is encouraged that the administrative receiver operates for the benefit of all the stakeholders and that was only if the charge holder was under secured. In other words, the administrative receiver did not really care to maximize the realisation of the assets as long as the value of the remaining assets could satisfy the repayment to the secured lender.
Furthermore, another concern with the administrative receivership procedure was that the administrative receiver was not accountable to other creditors apart from the floating charge holder. There had been a continuous complaint from unsecured creditors that receivers look out for the interests of the bank that appointed them and not the interests of the business or the other creditors. The interests of the unsecured creditors were at the mercy of the action of the floating charge holder. This seemed unfair to the ordinary creditors who were in a weak bargaining position and as a result ended up being prejudiced.
The weaknesses recognised by the Cork Committee in the administrative receivership procedure directly resulted in the innovations of Company Voluntary Arrangements (CVAs) and Administration Orders which could be used in circumstances where there was an absence of a floating charge. The Cork Report recommended that reforms be made to deflect the administrative receiver's primary duties away from the floating charge holder to the general body of creditors. It was also recommended that the administrative receiver be made more accountable at times when the legislation failed to adopt this approach.
The Rescue Procedures In The Insolvency Act 1986 Aiming Towards A Modern Corporate Rescue Culture
Company Voluntary Arrangements (Cvas)
The CVA procedure was introduced in the 1985 - 1986 reforms of corporate insolvency law and was based on the recommendations of the Cork Report in its attempt to come up with a user friendly and inexpensive rescue device. The procedure was to help the companies facing financial difficulty come up with a reorganisation plan and reach an arrangement of indebtedness between the company and its creditors.
The important feature of this procedure is that it is voluntary and therefore provides easy access for the directors of the debtor to the rescue regime and eases the fear of wrongful trading liabilities. With this in mind, the company facing financial difficulty can potentially be cured at an early stage. Another attraction of the CVA procedure is that the directors remain in control of the company's affairs under the supervision of the proposed nominee, who later becomes the supervisor after the proposal is approved by the creditors' meeting and shareholders' meeting.
The CVA procedure is a simple, quick and unitary procedure quite different from the schemes of arrangement. The voting structure in CVA regime is simple since the creditors who are entitled vote on the proposed voluntary arrangement do so in a single class of meeting.
The CVA procedure is a contract based agreement that can usually be reached out of court. The court however still provides an overall supervision of the implementation of the proposals (it still somehow involves itself in the procedure in order to prevent unfair prejudice). The court's involvement facilitates the approval of rescue arrangements because the court is able to remove difficulties and avert unnecessary delay and litigation.
Despite the CVA procedure being cheap and simple it did not play the expected role in rescuing the companies facing financial difficulty. In fact the rescue procedure was largely underused. In attempt to figure out why the procedure was highly underused it was seen that the main weakness of the procedure was the lack of a moratorium.
In the absence of protection in the form of a moratorium, the CVA procedure became unstable and vulnerable and although this could be resolved by applying for an administration order, such a course of action would be extremely costly especially for small firms that are already in financial trouble and could not afford the expenses. Because of this, reform to the perceived deficiency of the existing lack of a moratorium became the main focus of the Insolvency Act 2000.
Major reforms brought to the original CVAs through the Insolvency Act 2000
The Insolvency Act 2000 introduced the long awaited moratorium that could make the CVAs more attractive to the companies facing financial difficulty. Through the Insolvency Act of 2000 the companies could now stay away from the enforcement of creditors under the protection of a moratorium and get recovery from temporary liquidity problems. The benefit of the 28 day moratorium was only available to small eligible companies that could at least satisfy two or more conditions that were specified in s 382 (2) of The Companies Act 2006.
The introduction of the moratorium reduced the petitions for winding up as well as the appointment of administrative receivers. It also restrained the enforcement action of individual creditors and created a fresh concern that the risk may lead to a greater loss than just immediate liquidation if the attempted CVA procedure failed to rescue the financially troubled company. With this in mind, the law set a mechanism to ease the creditors' concern regarding possible exploitation. To a large extent, reliance is placed on the independent insolvency practitioners to filter out the nonviable proposals. The nominee is required to scrutinise the company's assets, indebtedness and business affairs, and examine its financial status based on the information submitted by the directors. A vital judgment is then made by the nominee to assess whether there is a reasonable prospect that the proposed CVA can be approved and implemented, and whether the company is likely to have sufficient funds available to it during the moratorium to enable it to continue trading.
In addition to this, under the period of protection, the company is allowed to deal with its assets as long as there are reasonable prospects that any such transaction could benefit the company and the attempt to deal has been approved by the creditors' committee (or the nominee in situations where there is no creditor's committee). The dealing of assets ensures that there is adequate funding to enable the company to carry on its business.
Generally we can see that the reforms to the original CVA procedures aim to be more cost effective and efficient for small companies. However, the changes effected by the Insolvency Act, 2000 have as a result imposed more duties on the nominee, and in turn may force the nominee to liaise with the directors.
The administration rescue procedure was contained in part II of the Insolvency Act 1986 and was also a recommendation of the Cork Committee. The creation of administration procedure aimed to make up for the gap where there was an absence of a floating charge holder to initiate administrative receivership. The introduction of administration aimed to fill the shortcomings of schemes of arrangement and informal rescue arrangement, and intended to act as a collective rescue oriented approach. Administration was created mainly in the shadow of the floating charge; and therefore the powers of an administrator were similar to those of an administrative receiver.
A petition for an administration order could be presented by the company (through the shareholders in the general meeting), the directors (through the majority resolution of board), or any creditors in respect of the company. The creditors include the contingent and prospective creditors. The main attraction of an administration order was the effect of the statutory moratorium because it enabled the debtor to step away from legal actions.
However, the implementation of the administration procedure suffered from a number of perceived flaws that seriously affected its effectiveness (in other words it failed to realise expectations of it as the intended “flagship” of the rescue culture).
The first flaw was that the entry to the rescue procedure was seen as inefficient. It could be easily impeded by the veto of a floating charge holder by means of appointing an administrative receiver. The applicant for an administration procedure needed to prove that the company was insolvent or likely to become insolvent, and that there was a reasonable prospect that at least one of the four statutory objectives was likely to be realised.
For this reason there was a heavy burden of proof imposed in the preliminary stage making the professional fee for consultation and preparing the documents for judicial hearing to become extremely expensive. In addition, the court was very cautious to sanction an order, requiring deep investigation of the petition files and the professional advices, again making the process slow and expensive.
The administration procedure offered a rescue alternative to the company in times of financial crisis and provided the directors in the existing management with a continuing role in the business affairs of the company after an administration order was made by the court (through the new procedure the directors could now avoid wrongful trading liabilities and potential disqualification by applying for an administration order when the company was facing financial trouble). An outside insolvency and restructuring expert could interfere (in a timely manner) with the management of the troubled company under court's appointment and furnish an effective and feasible solution to its plight. As long as the companies were put into rescue proceedings at an appropriate time it was perceived that the companies facing financial difficulty stood a very good chance of being rehabilitated.
It is important to note, that the appointment of an administrator meant that the powers of the existing directors were displaced. In this procedure the administrator had the power to remove the directors and to appoint any new person to be a director of the company. This became a disadvantage because since the directors were scared of the amount of power the administrator would have they became reluctant to venture into the uncertain administration procedure. As a result in most cases the administration procedure became a last resort. It was not attempted and even if it was attempted it was only after the company had passed beyond the point of salvation.
There were still some other shortcomings that existed in the drafting and legislative implementation of the administration order. For example, the moratorium that was introduced was not completely airtight. Some creditors could still avoid the legal effect of the standstill (freeze). Apart from that, the provisions that existed were still quite unclear about the exit routes from administration. As Sir Kenneth Cork said “[the legislature] ended up by doing the very thing we asked them not to do. They picked bits and pieces out of [the Cork Report] so that they finished with a mishmash of old and new.”
The New Administration Procedure Formed Through The Enterprise Act 2002
The original administration procedure was changed by the reforms contained in the section 248 of The Enterprise Act 2002. This section in most instances replaced the old part II of the Insolvency Act 1986 and inserted a substantially new administration procedure known as Schedule B1 into the 1986 Act. The Blair Government went to work carrying out massive changes to the outdated and inefficient previous rescue procedure.
The reforms to the procedure aimed at creating a more desirable rescue culture so as to restore the companies facing financial difficulty, maximise the preservation of jobs, avoid the detrimental effects that would take place if corporate failure occurred and formulate a healthy entrepreneurial risk taking environment. The legislation was designed to strengthen the foundations of an enterprise economy by establishing an insolvency regime that encouraged honest, but unsuccessful, entrepreneurs to persevere despite initial failure. In other words, the aim was to promote a culture in which companies that could be rescued were, in fact, rescued.
The achievements of the reforms went beyond a mere recasting of legal rules including substantive rights and procedures. Instead they went as far as to reshape the property rights and bargaining powers of different actors whose attitudes and incentives had to change automatically in the new rescue network.
The reforms aimed to strengthen the foundations of the enterprise economy, change the traditional director blaming attitudes and offer honest but unfortunate or unsuccessful entrepreneurs a second chance in order to avert unnecessary loss. Compared to the old administration procedure, the newly reinvigorated administration procedure virtually abolished administrative receivership. It has accomplished the introduction of an out of court appointment mechanism which as a result creates easy and quick access to rescue procedures.
In addition, the abolition of Crown preference and the establishment of a ring fence fund aimed at enabling more assets to be available to unsecured creditors whose weak position had been improved. Moreover, the original complicated and awkward proceedings for coming out of administration have been streamlined by the new exit routes which are more fitting to carry out and could save time and money. This is all discussed in detail in the following chapter.
The New Administration Procedure
For any corporate rescue procedure to be effective and in line with international principles and standards it should be able to provide an easy, quick and inexpensive access to the rescue procedure for the companies facing financial difficulty and desperately seeking assistance for turnaround. A delay in the opening stage can cause problems to the initiation of rescue proceedings and accordingly the financially troubled firms may lose their optimal opportunities of being rehabilitated because time was wasted.
This chapter discusses the new administration procedure and the law as it is. Important features of the new administration procedure for example the existence of moratorium are discussed as well as the main objective (to rescue a business as an ongoing concern). It is in this chapter that the practice of the new administration procedure is analysed with reference and some comparison to the old administration procedure as well as the other rescue procedures that haven't been attracting too much attention lately.
In the old style administration procedure, applicants for this rescue oriented procedure had to present a petition for a court order. In other words, every administration order and appointment of administrator was made on the basis of a court hearing. Therefore, the old legislation was designed as a court driven regime and that created two main disadvantages. Firstly, since the procedure was court based it increased the work load of the judiciary which most of the time resulted in the delay of the proceedings and an increase in the costs. Secondly, the administration application could easily be blocked by a floating charge holder who was entitled to appoint an administrative receiver before the court made an administration order.
One remarkable innovation of the reforms made by the Enterprise Act 2002 was the introduction of an out of court appointment mechanism under the streamlined administration. Through this method, the qualifying floating charge holder, the company or its directors are entitled to appoint an insolvency practitioner as the administrator without the involvement of the court. The extrajudicial appointment provides the distressed debtor with quick and flexible access to rescue proceedings without a court hearing and it eases the concerns of the judiciary regarding a heavy work load and may accordingly avert unnecessary delays and cost.
Access To The Administration Procedure
The Enterprise Act 2002 inserted a new section into the old Act (Insolvency Act 1986) which restricted the use of administrative receivership. Before, administrative receivership was highly and comfortably used by banks and other financiers with a floating charge to take control of the assets and business affairs of the company in trouble, and enforce the loan contract by means of appointing an administrative receiver.
As a compromise, the floating charge holders now have the power to appoint an administrator out of court to act for the interests of all the stakeholders. The mechanism of an extrajudicial appointment of an administrator so far has been seen to balance the interests of the floating charge holders, whose power to appoint an administrative receiver was virtually abolished in respect of debentures created after 15 September 2003. This out of court route into administration is expected to be the usual mode.
According to the Insolvency Act the floating charge holder is not allowed to appoint an administrator if the company is already in administration, or a provisional liquidator of the company or an administrative receiver has been in office. In addition to this, the floating charge should be “enforceable”. This means that “the floating charge holder is entitled to call in their security”. The company or directors can also appoint an administrator out of court. This gives rise to successful outcome because the directors have the confidence to seek advice from outside insolvency specialists (without feeling that their jobs are on the line) at an early stage of the financial difficulty rather than gambling over risky commercial activities. The out of court route for the company or its directors is a radical innovation of the new administration regime which breaks the monopoly of floating charge holders over the power of the extrajudicial appointment of an administrator.
In order to prevent the abuse of the out of court appointment, the legislation has a series of restrictions on the company and its directors. Firstly, the company or its directors may only appoint an administrator when the company is insolvent or is likely to be insolvent. Through the existence of such a restriction the appointment prohibits prejudicing the interests of the holder of a floating charge. Prior to making an appointment, a written notice needs to be given to the holder of a floating charge who is allowed four choices:
(1) Consenting to the appointment;
(2) Making his own appointment of administrator if he so decides;
(3) Blocking this appointment by appointing an administrative receiver if it is allowed;
(4) And applying to the court for a court based administration.
A second restriction is that if the company has been in liquidation or a winding up petition has been presented or the company has been in an administrative receivership then it will be prohibited from out of court appointments. However, the legislation does not prevent the company and its directors from applying for an administration by court order in circumstances where a company is intending to enter into a second administration less than 12 months after a first one. The same applies if a company has entered an earlier CVA with the benefit of a moratorium within the previous 12 months.
The new administration procedure retains the court based appointment for which the company or its directors, or one or more creditors in respect of the company, are entitled to apply. The court can make the order under its wide discretion, if two conditions, respectively “the insolvency condition” and “the purpose condition”, are satisfied. Through this route the creditors are offered without a qualifying floating charge their only access to the administration procedure. For the qualifying floating charge holder, if he is able to produce evidence that the charge is enforceable then he can apply to court without needing to prove that the company satisfies “the insolvency condition”.
One feature of the new procedure is that a company that has already been in liquidation can enter into administration by court order. This flexibility is reflected in the following two circumstances: the first is where a qualifying floating charge holder is entitled to apply for an administration order in a compulsory liquidation and the second is where a liquidator may apply whether the company is in a voluntary or compulsory liquidation. In addition to granting the order, the court also has the power to dismiss the application, make an interim order or treat it as a winding up application.
In theory, it was expected that the administration appointment made by a qualifying floating charge holder outside court would become the most common rescue procedure and the floating charge holders would use administration as an alternative to the administrative receivership which had been restricted since the Enterprise Act 2002 came into force. Surprisingly enough though when looking from the judicial practice perspective it has been noted that the most predominant method of entry into administration now is an out of court appointment of administrator by the company or its directors under paragraph 22.
This observation can be explained by two factors. First of all, there might be no qualifying floating charge holders in the cases where the company or its directors make the administration appointment. In a survey led by Dr Sandra Frisby, it was observed that “in 30 % of cases where a paragraph 22 appointment was made there was no qualifying floating charge holder who could have appointed.” The second factor is that banks may not prefer to appoint administrators on account of reputational concerns. They do not want to be the appointers of administrators in dealing with their bad loans, and they also do not want to make hostile appointments that may incur the blame of other creditors.
This however does not necessarily mean that the banks as secured creditors with floating charges do not play any role in the administration appointments made under paragraph 22. The banks are the ones that advise and encourage directors of their distressed clients to make appointments instead of the banks just appointing directly, and accordingly the directors are willing to make the administration appointments because they can potentially avoid personal liabilities like wrongful trading. In addition, in the cases where the company or its directors appoint administrators, the banks tend to have a strong influence on the decision to appoint and on the identity of the insolvency practitioners.
Before deciding to make an appointment, the directors normally consult with banks and banks may introduce the insolvency practitioners or their firms. It can be found that although the administration appointments made by floating charge holders may be of a relatively low proportion, the significance and role of the secured creditors cannot be ignored.
It is of great importance that there be an automatic “stay” at the time the company is in administration. This moratorium is very protective and airtight in relation to the assets of the company. Because of the moratorium any debt enforcement and legal action is restricted unless it is permitted by the consent of the administrator or by a court order.
The statutory moratorium in the Enterprise Act 2002 covers two distinct stages. The first stage is where an interim moratorium is available for a company that is intentionally being put into administration. This provisional protection enables the troubled company to avoid drastic action by creditors and other interested parties in the period where the application for administration has been presented but not yet granted by the court, or an administrator has been appointed by a qualifying floating charge holder or the company or its directors out of court but the appointment has not yet taken effect due to the relevant requirements. The second stage of the moratorium commences from the time that the administration comes into effect and extends throughout the whole process of administration.
It should be noted that there is an automatic end to the appointment of an administrator (it must cease to have effect at the end of a one year period) and that after it ends there is no possibility of an extension. An extension can only be obtained during the time when the appointment of an administrator remains in force.
The automatic ending of administration after one year is a new feature that was introduced by the enterprise act 2002 reforms. It is a very significant feature because since the moratorium could shield the distressed debtor from debt enforcement and the repossession of goods, the time limit shows the legislature's concerns regarding possible detriment to the interests of creditors that might be caused if the debtor was provided with indefinite protection. The one year period can be extended by the consent of creditors for up to six months or by court order for a specified period.
It should also be noted that the insolvency practitioners could present a proposal to creditors for a voluntary arrangement when the company is already in administration. Rebecca Parry calls this the “opening of administration with a CVA as the exit route”. The combination of a CVA and administration creates an effective rescue procedure under which the financially troubled company can obtain the advantages of the CVA procedure and also attempt to reorganise the company within the protection of the moratorium under administration. From the perspectives of insolvency practitioners, the CVA under the shield of administration represents a genuine corporate rescue mechanism and such a strategy could make the company rescue more promising.
The Hierarchy Of Statutory Objectives
The one major change that the new administration legislation made is the establishment of a single hierarchy of objectives. This replaced the original four alternatives that were of equal weight and not mutually excluded.
According to the Insolvency Act, three statutory purposes are placed in a hierarchy and the company is sent into administration according to any one single purpose whether the administration appointment is made in or out of court. The administrator is required to undertake his functions with the objective of:
“rescuing the company as a going concern, or
achieving a better result for the company's creditors as a whole than would be likely if the company were wound up (without first being in administration), or
Realising property in order to make a distribution to one or more secured or preferential creditors.”
The emphasis of the new administration procedure is to rescue the company as a going concern, which is the primary purpose in the statutory hierarchy that the administrator has to pursue. “Rescuing the company as a going concern” means preserving the company as a legal entity, with as much of its business or undertakings intact as possible. If a proposal involves a sale of the whole business of the company and leaves the company as a shell to be liquidated, this proposal cannot be said to be in line with the wording of “rescuing the company as a going concern”. It is therefore necessary to distinguish between rescuing the business as a going concern and rescuing the company as a going concern, and the former cannot be brought within the primary statutory purpose. The wording of “rescuing the company as going concern” can be interpreted as indicating that “the company will emerge from administration with its solvency restored, or safeguarded at least for the short term, and with its existing business or some part thereof remaining intact and capable of being carried on outside a formal insolvency”.
The administrator is the one who analyses then makes a decision as to whether rescuing a company as a going concern is reasonably practicable or not. If a company is facing a short term cash flow problem and the major creditors in respect of the company, or any third party, is willing to inject funds for the troubled company to continue trading, then the administrator may conclude that achieving the primary purpose is reasonably practicable.
The Insolvency Practitioners tend to consider reorganising a financially distressed company by way of a combination of administration with a company voluntary arrangement in order to rescue the company as a going concern. The administrator cannot move on to pursuing the secondary purpose (which aims to achieve a better result for the company's creditors as a whole than would be affected in an immediate winding up) unless the primary purpose cannot reasonably be achieved.
If there is no prospect of new financing becoming available for the company to continue trading during the moratorium, the company will not be able to carry on its existing production programme and pay the wages and social insurance for the employees. In such circumstances, the administrator may think that the creditors will benefit more from a sale of the company's assets as a going concern than from a piecemeal sale of the assets in the liquidation proceedings.
If the first two statutory objectives are reasonably excluded, the administrator will have to go for the last objective which enables the administrator to dispose of the company's assets with intent to make a distribution to one or more secured or preferential creditors. The process of the last objective is quite similar to the abolished administrative receivership which intends to dispose of the property of the company by a quick sale and realise the claims of a secured lender who appointed the administrative receiver. However, the underlying policy aim between them is different because the new administration regime encourages collectivity and the administrator, whether appointed in or out of court, owes duties to the creditors as a whole.
In short, the hierarchy of statutory objectives in the new administration procedure aims to promote more cases where the companies are rescued as a going concern, but insolvency outcomes may not be in line with this initial expectation. Some surveys argue that the cases of company rescue according to the primary purpose are still extremely rare.
Administrators Roles In The Rescue Proceedings
The administrator, who is either appointed by a qualifying floating charge holder or the company or its directors out of court, or appointed under a court order, is an officer of the court, and is accordingly subject to the directions of the court. Once an administrator is appointed, he will take over the control and management of the company's property and business affairs from the board of the company, and will owe fiduciary duties and a duty of care and skill to the company and its creditors. The administrator must exercise his broad powers in accordance with the decisions made by the creditors' meeting and subject to the directions given by the court.
The administrator is required to always act in the best interests of the company and perform his duties for the creditors of the company as a whole rather than some specific interested party. In other words, the administrator shall pursue the maximum realisations of the creditors' claims and to the best of his ability try to preserve both shareholder value and employment as much as possible. Acting for the creditors as a whole represents the underlying policy of collectivity, which is opposed to individual enforcement in pursuit of realising the claim of a certain interested party at the expense of other stakeholders. In order to make the administration procedure quick and cost effective, the administrator is subject to a general duty to “perform his functions as quickly and efficiently as is reasonably practicable”.
Under the old administration regime, the administrator was required to produce a report to explain the financial status and business affairs of the company, and to support the view that the appointment of an administrator is appropriate. The new administration legislation abolishes the requirement of an independent report so as to reduce the costs of entry.
In practice however, to be on the safe side, the insolvency practitioners usually conduct a complete investigation of the company's property and business and understand the background of the company at a similar level to the old rule 2.2 report prior to the appointment, even if it is not officially required. The administrator submits a statement of proposals for pursuing the statutory purpose of administration as soon as is reasonably practicable after the administration takes effect, or in any event within eight weeks after the company enters administration. The eight week period can be further extended for no more than 28 days with the consent of all the secured creditors and a majority of unsecured creditors (and it can only be extended once).
It can be observed that the usual eight week time is shorter than the original three month period which was enacted by the 1986 Act. The time limit reduction aims to prevent the procedures being protracted and reduces the costs (expenses) especially for small firms. The time limit reduction is in line with the general requirement under para.4 for the administrator to perform his duties as quickly and efficiently as is reasonably practicable.
Creditors Meeting And Creditors Committee
The creditors' meeting has a significant authority and can approve or refuse the proposals produced by the administrator as well as challenge the administrator's conduct for the sake of collectivity and transparency. An initial meeting of creditors is usually called as soon as reasonably practicable after the administration takes effect, or in any event within a period of ten weeks after the company enters administration.
The initial meeting considers the proposals presented by the administrator and may approve them without modifications, or with modifications to which the administrator needs to consent. The court can direct, or the company's creditors (whose claims account for at least 10 percent of the total amount of the company's debts) can request a further meeting to consider a revised proposal. The court may make an order to cease the effect of the administration if the initial meeting of creditors does not approve the proposals or if the further creditors' meeting refuses to accept the revised proposals.
Although the creditors' committee is not compulsorily required, the insolvency practitioners see the committee as very important and reliable. The administrator could perform his duties more efficiently by taking into account the advice provided by the creditors' committee, whose members may normally be the key creditors. This can help him when he may need to justify his actions and avoid potential litigation.
Since the administration procedure provides a moratorium that aims to shield the financially troubled company from debt enforcement and repossession of property, there should be a time limit to the period of protection. Without a time limit administration may end up harming the interests of creditors, and make the procedure time consuming and expensive. Accordingly, there is an automatic end to the effect of the appointment of the administrator after a period of one year, even though this period can be extended under certain conditions. In addition, the court may terminate the effect of administration under the application of the administrator.
It has been argued that, at a practical level, one shortcoming of the old administration legislation was that it failed to provide a flexible route for coming out of administration. In the old administration regime, there was no link between the exits of administration and winding up proceedings or dissolution. Because of this, the administration had to be terminated under a court order and then the company was placed into liquidation. Undoubtedly, this process was a waste of time and money at the expense of creditors.
It should be noted that the new administration regime establishes two main features to address the failure of exits of the old administration. First, it provides the administrator with the power to make a distribution to a secured or preferential creditor of the company, or to a creditor who is neither secured nor preferential under the permission of court. Second, the new legislation builds a bridge to connect administration with creditors' voluntary liquidation and dissolution. Administration can be converted to voluntary winding up proceedings in the circumstances where the administrator thinks;
“(a) that the total amount which each secured creditor of the company is likely to receive has been paid to him or set aside for him, and
(b) that a distribution will be made to unsecured creditors of the company (if there are any).”
In addition to the above, the company can be placed directly into dissolution if the administrator thinks that the company has no property available for distribution to its creditors. The company will be dissolved at the end of three months following a notice of dissolution being sent to the registrar of companies by the administrator. Here again it is important to note that the conversion to creditors' voluntary liquidation or dissolution is subject to the decision of the administrator, and no separate order of ending the effect of administration and discharging administrator is required. During the process of conversion, no court order is necessary.
Pre Packaged Sales In Administration
The UK Insolvency legislation does not make any reference to pre packaged administrations. Nevertheless in recent years this device has become the centre of attention in the UK insolvency scene. A pre pack sale in administration has become the most popular approach when dealing with corporate difficulties.
Pre packs have existed for years now and were used to sell businesses when immediate urgent action was necessary. However, because of its increase in number over the past few years a lot of attention has been drawn to the procedure. As a result the procedure has received a lot of criticism. There has been a lot of debate on whether or not pre packs are an appropriate method of selling a business of an insolvent company especially when trying to get the maximum value of the company's assets for the benefit of all stakeholders. Since pre pack sales in administrations have been quite the centre of attention in the current economic regime it is only appropriate to discuss the mechanism further in the following chapter to figure out if the approach is appropriate in the current economic regime.
The Impact Of The 2002 Reforms On The Insolvency Outcomes
The new administration procedure has had a considerable influence on corporate insolvency outcomes, especially on the choice of insolvency proceedings. The number of administrations, including both court appointed and out of court administrations, showed a sharp increase from 2003 after the Enterprise Act 2002 came into force on 15 September 2003. Below is a demonstration showing the rise and fall of the rescue procedures over the past ten years. Specific attention should be paid to the year 2003 when the Enterprise Act came into force.
It has been said that the boost to the corporate rescue culture was by virtually abolishing the floating charge holder administrative receiverships. Such receiverships remain in some exceptional cases and in the circumstances where the floating charge was created. Practically, in some cases receiverships may still be used as a quick and efficient way to realise debts in the case where the secured lender is under secured and there is no property available for a distribution among the other creditors.
Pre Packaged Sales In Administrations
Pre - packaged administrations (hereafter known as pre - packs) are defined as “an arrangement under which the sale of all or part of a company's business or assets is negotiated with a purchaser prior to the appointment of an administrator, and the administrator effects the sale immediately on, or shortly after, his appointment.” In other words, pre - packs involve a pre arranged sale of a company facing financial difficulty which is executed immediately after the administrator's appointment (as soon as the company enters administration).
The pre - packs are agreed prior to the company being placed into administration under the assistance of insolvency practitioners and with the support of the company's bankers or injection of new venture capital. In a pre - pack structure, the insolvency practitioner (administrator) is allowed to sell the business without the consultation and approval of unsecured creditors and the leave of court, whether in the pre or post Enterprise Act 2002.
Because of this, to the unsecured creditor, a pre - pack is seen as a sneaky way to prejudice his interests and benefit those inside a company. It has been said that the pre - packs fail to maximise the returns for the creditors since the opportunity to expose the business to the market is lost in the rush to sell the business. Other than that there have been concerns brought forward on the morality and the effectiveness of the Insolvency practitioners making the pre - packs a subject of great criticism.
The legal authority for pre - packs
The Enterprise Act 2002 makes no provision for pre packaged sales being a permitted rescue procedure and therefore does not give a clear answer in relation to their legality. However, in the case of DKLL there was some development where pre packs started to be seen as a lawful restructuring tool. In this case the courts decided in favour of granting an administration order because it was reasonably seen that pre - packs would give the best possible outcomes for all concerned including the unsecured creditors. The court saw that the proposed sale;
(1) appeared to be the only way of preserving the jobs of employees;
(2) was likely to achieve continuity of the service provided to the partnership's existing clients, and finally
(3) would maximise returns for the creditors “as a whole”.
Apart from the DKLL case there was also earlier judicial support of pre - packs. This was in the case of Re T & D Industries Plc in which case the court held that the administrators have the power to sell the whole of the assets and business of the company before calling a creditors meeting and even without the need to go to court for directions. This case was decided pre Enterprise Act 2002 before the amendment of the administration regime but the same law also applies to the post Enterprise Act 2002. This can be observed in the decision of the case of Re Transbus International Ltd where the administrator had to be called to reach an urgent and important decision in his efforts to preserve the value in a viable business which would have otherwise have been lost. It is important to however, that these two cases were not pre - pack cases as such but were actually cases concerned an accelerated sale of the business (sale wasn't pre arranged).
Benefits Of Pre Packs
Following the introduction of the Enterprise Act 2002, there has been a very significant rise in pre-packs. It is not hard to determine the reasons behind the sudden popularity of the pre - packs. The reforms introduced by the Act, including the streamlined system of out-of-court entry into administration and the simpler exit routes have made it easier for pre-packs to be undertaken in practice. The process allows a speedy and confidential extraction of a viable business from an insolvent company. Under certain circumstances pre - packs can be the most appropriate method for example if a business is trying to protect a strong band or intellectual property. (The value would decrease if there was even a hint that the company was going under). The pre-pack has now come to serve an important role in contingency and recovery planning as ‘the divide between informal and formal (insolvency) continues to blur'.
Pre Packs Help Preserve More Jobs
According to Dr. Sandra Frisby there is clear evidence that pre‑packs perform in preserving employment (that is, a going concern sale of the business negotiated and arranged after the commencement of the insolvency procedure). In 92% of pre-pack cases, all of the employees were transferred to the new company. Frisby also points out that when extended receiverships/administrations take place in the run up to a business sale, the scarce resources will often mean that cuts have to be made - and employees are usually the first casualty. When it comes to pre packs however, since it is the instant sale of the business this issue doesn't usually arise.
Pre Packs Provide Better Returns For Secured Creditors
There is a high degree of certainty in a pre-pack and secured creditors enjoy a high degree of control. Because of this, the secured creditors find pre packs a more attractive alternative than other formal insolvency processes. It is understandable that the creditors feel they should be paid their debts in full. However it needs to be understood it is in the nature of insolvency that debts will go unpaid and that when dealing with companies facing financial difficulty the Insolvency practitioners work in a salvage situation instead of a normal business environment. This means that they try to make the best of a bad situation. With this in mind it should be noted that the creditors of a company in financial difficulty hardly receive any money owed to them if at all. In other words it is more important to consider what the creditors might expect to receive rather than what they are owed.
Research has found that the average returns to the unsecured creditors in pre packs were 1% while in straightforward businesses it was 3%. However the secured creditors fared considerably better in a pre-pack getting an average return of 42% compared to 28% in a business sale. For some cases, a pre pack would sell the shares to subsidiary companies. When that happens then all the creditors were to be paid in full.
Retention Of Value In The Company
When it becomes public knowledge that a company is facing financial difficulty (for example if it is placed under administration) it loses its reputation and it becomes hard for the business to retain the staff, suppliers and customers necessary to keep the company viable (for example, in the service industry since the value of the company is mostly based on the staff and the customer base rather than the tangible assets such as the buildings or products). Pre-packs may be a good option for service focused companies or those whose business is reputation- based or intellectual property based. In such companies, the value of the business can be diminished quickly by the hint of a formal insolvency.
Even if the company would eventually sell, if it is advertised in the market the risk of ruining the reputation is usually seen as far too great. In such cases the stakeholders are not prepared to risk devaluing their company. Here pre - packs are seen as an excellent method of dealing with a failing company while preserving its value. As long as the company is still valuable the Insolvency Practitioner can be able to negotiate the best possible price and as a result be able to secure better returns to the creditors.
Criticisms On Pre-Packs
Despite the merits that the pre - packs seem to have in pre determining the preservation of a company facing financial difficulty, the use of the pre packs has raised a lot of very important concerns especially in our current economy.
Pre - packs have been said to function as a means “by which powerful players can bypass carefully constructed statutory protections”. It has been argued that pre packs permit a certain amount of abuse especially since there is an absence of express statutory oversight along with the powers that the insolvency practitioners have to manage the debtor affairs and property. Apart from that, some questions have been raised with regard to the accountability of insolvency practitioners/administrators and the manner in which they are carrying out their functions. It has been argued countless of times that pre-packs cause the administrator to act in breach of his statutory fiduciary duties, and that the pre - packs sometimes put the administrator in a position where his various duties conflict in an unacceptable way.
The Administrator's Discretion
As has been discussed in the previous chapter when explaining the role of the administrator it was seen that he must perform his functions in the interests of all the creditors (as a whole) and as quickly and efficiently as is reasonably practicable. The Enterprise Act gives significant powers of discretion to the administrator. When the administrator feels it is not reasonably practicable to achieve the main objective then he must perform his functions with the secondary objective of achieving a better result for the creditors as a whole.
In a pre - pack however, the administrator agrees to a deal, settles on a price and after his appointment transfers the business. This being a rather speedy process it can easily be argued that it involves breach of duty. This is because by selling off the business in advance the administrator did not achieve the primary objective of administration (rescuing the company as an ongoing concern). Also since the administrator agreed to sell the business before he was even formerly appointed as administrator it can be argued that pre packs are aiming to achieve only the second or third objective of administration.
Administrator's Accountability To The Unsecured Creditors
The main difference that the Enterprise Act made is that an administrator could now be appointed out of court. Because of this, he can enter into an immediate sale of the company's assets without creditors' involvement or being scrutinised by the court. The administrator does not even need to consider the possibility of rescuing the financially distressed company prior to selling the business to the directors of the company.
The administrator has the statutory power to sell the company's asset without the requirement of convening a creditors' meeting or applying for the court's sanction even if he thinks that the unsecured creditors will be paid in full or no payment will be made to unsecured creditors. If an insolvency practitioner has prepared or made a pre pack deal, and has not evaluated other options, the administrator will be in breach of his statutory duty.
In short, a pre packaged administration is often, in essence, a management buyout (management buyout will be explained below) rather than a reorganisation of a company's debt structure and business affairs. The whole process of a pre pack may be under the control of secured creditors and it will not happen without the support of banks (the unsecured creditors are most likely to be left in the dark). According to Frisby, the creditors' rights of participation depend on the administrator and there is a strong possibility that pre - packs will affect those creditors who were excluded in the decision making process.
It should be noted however, that the Enterprise Act 2002 gives rights to sue an administrator. Because of this it has been argued that since the creditor has the right to challenge his conduct it leaves him vulnerable and therefore the decisions that he does make depend very much on his commercial judgement. This argument however was tossed aside because it was seen by previous case laws that courts are unwilling to second guess the administrators judgements.
Pre - Packs And The Management Buy Outs
Pre - packs have been receiving a lot of criticism when it comes to the management buy outs (MBO). The main reason for these criticisms is that even though the administrator might give reasons for the pre pack to take place the creditors may still feel that there was some abuse of power and it is still perceived that when pre packs are involved the business is not marketed in the right way and therefore the best market value is not obtained for the creditors.
Pre - packs receive even more criticism when it involves selling the business back to its existing management. This is because the first assumption that comes to mind will be that the market was not explored properly and also there was not an objective valuation of the business. Another reason for this criticism is that since the pre - packs involve a rather quick sale and it is done within a restricted time valuers rely on information provided by the directors (if the directors are interested in buying the business they may provide the information while looking out for their own interests). Selling to the existing management is a very sensitive operation especially since the unsecured creditors could also argue that the pre - pack allows the incompetent and dishonest management to benefit because they continue to own the business free from the original debt.
However, it can be argued that it has been noted that not many management buy outs involve abuse of the process and in most cases the directors work even harder (end pay an even higher price than they would have, had it been in an open market) sometimes to save the business given the special value the business has to them.
Removing Pre - Pack Abuse: The Statement Of Insolvency Practice 16
Historically there had been no obligation upon insolvency practitioners to report pre-packs as such. However, between 2004 and 2008 the number of administrations rose from 1,602 to 4,822 a year, and the results of the last six months' review would suggest that the number of pre-packs is likely to amount to approximately 1,250 this year.
At the time of the Enterprise Act 2002, it had not been expected that pre - packs would become such a big part of the insolvency mechanisms. Because of this, the regime offered a limited potential for effective regulation and execution of the pre - packs which as a result led to many issues of conflict for the administrator.
The debate on whether or not pre - packs are appropriate for our economic regime has been a continuous one for quite some time now. Pre - packs are acknowledged to be a good thing especially in the current economy but concerns continued to be raised over whether they are sound from a legal and ethical stance. It had been argued that the insolvency profession should take some steps to ensure that pre packs are safeguarded and that that no form of abuse takes place. This is because when pre - packs are undertaken correctly they protect jobs, supplier and customer relationships; afford the business a second chance and therefore preserve wealth directly for relevant stakeholders, and indirectly for the wider economy. Further suggestions included an effective control of pre - packs in the form of professional regulation or legislative reforms.
As one commentator remarks:
“A system of professional regulation of pre-packs might be furthered by extending the coverage of professional monitoring regimes so as to take on board pre-pack negotiations. This could be achieved by the issuing of professional guidance on pre-packs and a professional requirement that when Insolvency Practitioners construct a pre-pack and process it through an administration, they file a report on the negotiations that have been conducted . . . A system of monitoring by the Insolvency Practitioner's professional body might be combined with such a legislative change. Further legislative reforms might, if necessary, be introduced to place the Insolvency Practitioner's pre-pack auditing function on a statutory basis”.
As a result of the suggestions for regulation and concerns surrounding the pre - packs, a new Statement of Insolvency Practice 16 (England and Wales) on pre - packaged sales in administrations (hereafter referred to as SIP 16) became effective on the 1st of January, 2009. The statement was issued by Joint Insolvency Committee, and it requires an insolvency practitioner to provide transparency to the creditors about pre - packs. The statement also sets short timescales in which such information should be provided.
According to paragraph 8;
“It is in the nature of a pre - packaged sale... that unsecured creditors are not given the opportunity to consider the sale of the business or assets before it takes place. It is important, therefore that they are provided with a detailed explanation and justification of why a pre packaged sale was undertaken...”
With this in mind SIP 16 further sets out a list of information which the administrator needs to disclose to creditors (with subject to some exceptions). If the insolvency practitioner fails to disclose the information as he is required to do so in SIP 16 he could face disciplinary or regulatory action. Also the creditors who feel that the Insolvency Practitioner has not properly acted in their interests have the right and the power to complain to the regulators.
The recent judgement in the case of Kayley Vending Ltd shows that the current economy is dealing with the previous concerns raised on pre packs. The case shows the pre pack process when properly implemented. In this case the judge reached several important conclusions;”
in exercising its discretion as to the making of an administration order, the court should be alert to the risk of abuse of the pre - pack procedure given the apparent blessing that may be conferred by making an administration order;
the applicant must provide sufficient information to enable the court to judge whether the administration and pre pack are in the best interests of the creditors as a whole. To the extent that it is known or ascertainable at the date of the administration application, it is likely to be appropriate to supply the information to be sent to creditors in accordance with SIP 16 in most cases; and
the insolvency practitioner's costs of negotiating a pre pack sale, incurred prior to appointment, could be treated as an expense of the administration where incurring these costs benefits the creditors as a whole more than it does any other party.”
The Kayley Vending case can be seen as a representation of the SIP 16 because through this case the court sought to improve the transparency of the pre pack process. First of all through this case we can see that the court required sufficient evidence in order to exercise its discretion. Secondly, the court also held that the proposed administrators' pre appointment costs to be treated as an expense of the administration.
It should be noted however that the decision from this case only affects the administrations where appointment is made by the court. Following the Enterprise act most of the appointments are made out of court by the holder of a qualifying floating charge.
With that said it is important to note that currently because of SIP 16 measures are being taken against the abuse of pre - packs. Following its enforcement in January, 2009 measures are being taken proactively to see that administrators and directors have behaved in the right way. The report on SIP 16 explains that misconduct by the directors and insolvency practitioners is currently being dealt with through the effective enforcement regime that deals with misconduct by directors (that includes any attempt to abuse insolvency procedures for personal gain), the authorising bodies that provide strict guidance to the insolvency practitioners in the form of Statement of Insolvency Practice (SIPs) and also by SIP 16 which specifically deals with pre - packs and has introduced the requirement to provide creditors with critical information concerning the sale as soon as possible.
Chapter Five: Conclusions
This dissertation has attempted to explore the new administration procedure that came about after the introduction of the Enterprise Act 2002 to see if it is working in the current economic regime. In this study, the alternative rescue procedures were discussed explaining the reason why the administration procedure came to be so popular in insolvency law.
In an effort to explain the administration in the current economic regime pre - packaged sales in administration have also been discussed since they are currently the centre of attention in today's world of debt and insolvencies. The benefits of pre packs have been explained as well as the many criticisms that surround the mechanism. Attempts to deal with the abuse that pre - packs bring to the creditors and the economy in general has also been addressed as well as follow ups on the necessary attempts to deal with the abuse.
Looking back at the main objective of this dissertation one can ask; is the post enterprise administration procedure the right way to go or are new insolvency procedures needed in order to deal with the current economy?
According to Finch, some organisations certainly seem to believe that new methods should be explored. They even go as far as to suggest that the current rescue procedures have failed because they deal with an outdated set of challenges. In a proposal from The European High Yield Association (EHYA) it was suggested that most of the restructurings should occur informally. The proposal continued to say that administration will not be as popular in the years to come since informal rescue procedures are cheaper and take place faster.
Despite all the criticisms administration is still the most popular rescue procedure so far. The changes that came with the introduction of the Enterprise Act 2002 have certainly promoted the current rescue culture and the UK's insolvency legislation is seen by other European countries as a more creditor friendly and a less expensive process.
It is important to realise that failure is part and parcel of the risks in an economic society. In insolvency sometimes payment may be made and sometimes it will not be possible to make repayment to the unsecured creditors. This in itself is not an indication of abuse (It is simply the nature of insolvency that some debts will go unpaid).
It should also be noted that when a company enters a formal insolvency procedure the unsecured creditors are not usually able to influence the sale of the assets whether it is through pre packs or any other procedure. Because of this, pre packs are still considered the best way for an administrator to proceed.
This being said, pre packs are still at risk of being abused therefore the need for creditors to have the necessary information for them to make an informed judgement at all times is necessary. This has been managed by the Insolvency Service through SIP 16.
However, the new administration procedure currently has led to transparency and even the administrators are now documenting their reasoning when making decisions on how best to proceed in an insolvency case. Through the SIP 16 they are advised to engage in early consultation to ensure that the interests are not being abused.
The measures that have been taken to deal with the intent of abuse are efficient enough to guarantee results. More transparency will still be expected in the pre packaged administrations but the new administration procedure has managed to rise in the current economic regime. The downfalls are nothing that can't be addressed and dealt with. After all, it is generally known that you can't shut down a school just because a few children are misbehaving. As we can see, the setbacks in the new administration procedure are being dealt with.