Free Insolvency Law Essay

Promoting the 'rescue culture' has become an all important feature of Government policy towards insolvancy law. However, this is without adequate consideration being given to the extent to which the moratoria available in both CVAs and Administrations may harm the pre-existing contractual rights of creditors. Discuss

Structure: Issues, Legal rules and application

  • Rescue culture under insolvency law
  • what is C V A and moratoria available under it
  • what is Administrations and moratoria
  • contractual rights of creditors, how they are protected

Introduction

The ultimate enforcement option of forcing the company into an administrative receivership was the most sought after tool any creditor with a security over a company's business and assets could have. This was the position until recently where the administrative receiver mainly was answerable to the debenture holder who appointed him. This was almost a proof of the UK's pro-creditor approach to insolvency situation. The Banks used to appoint receivers rather than support any sort of collective rescue plan for the company and reaslise those assets which could satisfy only their debt. There has been a major impact on how financial failure of a business is dealt with in the UK after the introduction of the Enterprise Act 2002. The rescue culture is reinforced by reforming the administration procedure

The Enterprise Act 2002 has attempted to restore the balance between the secured and unsecured creditors by heavily restricting the administrative receivership as an enforcement option and abolishing its use completely in most cases where secured lending after the Act becomes effective. The effective date when the Act becomes fully operational is 15 September 2003. Although the Act restricts or prohibits the floating charge holder from appointing an administrative receiver it does not prevent the appointment of fixed charge receiver. However, there is condition attached to such an appointment that they must vacate the office in case where an administrator is appointed. If a creditor holds a security which was in existence before the effective date then such a creditor could still retain their priority status and can appoint administrative receiver if he needs to enforce its security. Not only that, but the Act also gives right to secured creditors with a qualifying floating charge a new right whereby they are able to appoint an administrator without having to go to court. Some commentators have said that this could be perceived by the banks as loss of control and may consider levying extra charges on company's borrowing making it more expensive and difficult to obtain. Current practice is to consider rescing the company rather than enforcing security . The receiver tries to obtain best price on a sale and takes reasonable care while he is running the business and considers the fundamental issues which affect all creditors.

Analysis of new regime

The insolvency regime that was in place beforehand didn't offer enough clearness and accountability to the variety of stakeholders, especially to the creditors who have an interest in the affairs of the company. The Administration procedure is used to give a company a breathing space so as to assemble a plan of rescue or to give better returns for creditors. The formalities have been cut down and Company Voluntary Arrangements have been made more accessible to the companies.

The preferential treatment of some of the creditors was very attractive under the old regime and especially administrative receivership was used whenever secured creditors wanted to call off the debt. Under new administration procedures there are new rules regarding the distribution to all creditors which is examined in more detail below. The Act makes the new collective rescue procedures available to secured creditors more easily than before as these procedures are designed to be inexpensive and simple.

Only small companies are entitled to apply for a CVA moratorium but only if there are no formal insolvency proceedings already in place which lasts for twenty-eight days. During this time the proposals are considered by the creditors.

The statutory purpose of the Administration is to rescue the company as a going concern while achieve a better realisation of assets for the benefit of its creditors and to reaslise property to distribute amongst its secured and/or preferential creditors. If the purpose of the administration changes during its course, as these are ranked according to priority, then the administrator can vary it without having to apply to the court.

Administration

The legal purpose of an administration is the rescue of the company as a going concern. This course of action is available by court order if the court takes the view that the business of the company or at least a section of it should be saved. The court could also be of the view to a more beneficial realisation of assets than could be achieved if that company was wound up, or with a view to obtaining approval for a voluntary arrangement with the creditors of the company.

The company can present the administration order petition, or its directors, or by a creditor on the grounds that the company is not capable of paying of its debts or is likely to become not capable of paying its debts. As a result of the petition being presented a 'moratorium' is imposed on the company's debts and the creditors are not allowed to impose any security over the property of the company, but they can assign an administrative receiver, repossess goods and start or continue proceedings or levy distress against the property of the company. For the duration of this time the company is unable to be wound up.

Notification to everyone who is entitled to appoint an administrative receiver of the company must be done by the company directors or who is entitled to appoint an administrator of the company. The administrator would sell property to pay off secured and preferential creditors. This would not damage the creditors', as a whole, contractual rights unnecessarily. In WBSL Realisations 1992 Ltd Administrators could pay creditors on the basis of a notional winding up. The allocation was done on the basis of special circumstances of the preferential creditors of PLC and on a pro rata basis to the unsecured creditors. A qualifying Floating Charge (QFC) holder can appoint an administrator by giving two business days' notice at the court without having to prove insolvency of the company. QFC holder must prove that his security is valid and enforceable. As soon as he has done that an interim moratorium up to five days will start until he files a consent form from the proposed administrator.

Company Voluntary Arrangements

A major difficulty in bringing about corporate voluntary arrangements has been the complexity involved in holding off individual creditors whilst a rescue strategy is applied. By applying for an administration order a moratorium could be achieved. The problems posed by the often overwhelming difficulty in obtaining a moratorium have been sorted out by the Insolvency Act 2000. It includes provisions that allow an insolvency practitioner to put a moratorium into place for a short while without resorting to the court. The moratorium comes into effect the instant all the applicable documentation is filed at the court. This stops creditors from filing for a winding up petition during the period of moratorium. The floating charge cannot crystalise during the moratorium as it occurs regardless of the Bank's wishes.

Frequently in practice security holders such as Banks have to be pursued so that they hold back and don't enforce their security. Throughout the moratorium the company can dispose of property, which is the subject of security such as fixed or floating charge, and property in the possession of the company under a hire-purchase agreement.

The arrangement becomes binding on all creditors entitled to attend and vote at the meeting unless there is an appeal within 28 days on the basis of either procedural irregularity or unfair prejudice. If the C V A is appropriate then it will give higher returns to the creditors than would have been received if the company had gone into liquidation or receivership. C V As allow secured creditors such as, the holders of a fixed or floating charges, to leave the agreement without the need to enforce its security by appointing an Administrative Receiver. The creditors therefore maximise their interests and as well as this allows the company to continue trading.

This essentially preserves the creditors' contractual right to take the required action in order to recover the debt. In Tager v Westpac Banking Corporation [1998] BCC 73, Judge John Weeks QC, sitting in the Chancery Division said that the court has jurisdiction to extend the 28 day period for challenging the decision of a creditors' meeting to consider a debtor's voluntary arrangement.

The Equal treatment of all the creditors

The pari passu rule is said to be 'the foremost principle in the law of insolvency around the world'. It is believed to be 'all-pervasive', and its effect is to 'strike down all agreements which have as their object or result the unfair preference of a particular creditor by removal from the estate on winding up of an asset that would otherwise have been available for the general body of creditors.' Insolvency regimes have a main aim to get equal distribution for creditors unless a different class of preferential creditor is created. This priority to one class of creditor is usually acquired by putting to one side some of the available assets of the company. These are otherwise available for the general body of creditors. By controlling in this way, this class of creditors can keep the assets beyond the reach of general body of creditors and it could result in an adverse effect in rescuing the company.

The underlying principle behind this is the existence of the different types of secured creditors who take priority and hence their claims fall beyond its ambit. Even unsecured claims do not have application of pari passu principle. With the new insolvency regime, the priority of preferential creditors like the Crown has been eliminated but there is still questions regarding secured creditors.

Currently the law today allows a company to be able to grant security over all of its assets. Yet if the company imposes restriction on these secured creditors then it is likely that the credit facilities will become more expensive regardless of any rescue procedure in place. There is the possibility that it will become more difficult to obtain finance, which is less flexible. This could result in more personal guarantees and securities being demanded by the secured lenders from directors of the company in order to lessen their exposure. On the other hand when the company comes into financial difficulties then secured creditors would want their position protected, which could be detrimental to the unsecured creditors.

Administration of a company will benefit the unsecured creditors. The new provisions allow the administrator to be given new powers to make distributions to secured and preferential creditors. An administrator can create a Special Fund and this has been introduced exclusively for the benefit of unsecured creditors. The share of the assets has to be ring fenced for the unsecured creditors to preserve their contractual rights under the new regime. The amount being ring fenced for the unsecured creditors will depend upon the size of the company and the amount of creditors involved. However it is likely that 10% of the assets may be ring fenced for this purpose.

The Insolvency Act 2000, has made several significant changes, particularly to company voluntary arrangements and directors' disqualification. This is in an effort to strike a balance between enterprise and abuse of limited liability.

The new legislation's main thrust is to limit the use of administrative receiverships and extend and streamline the administration procedure. The holder of a floating charge is unable generally to appoint an administrative receiver. However a floating charge holder, or the company or the directors can get an administrator appointed through a court order. The main function of the administration is to rescue the company as a going concern.

The majority of creditors' informed and involved in the process of managing company's affairs. The new changes have been welcomed by the creditors due to the fact that the interests of all creditors have to be accounted for. However, under C V A the existing management stays in control and would want to increase the value of shareholders. On the other hand, under administration, the office holder is effectively running the company and has a statutory duty to consider the interests of all the creditors and not just one group of creditors. It is difficult to reconcile the pari passu principle and the propriety rights of creditors.

Company Voluntary Arrangement Moratorium

The 1986 Act introduced the company voluntary arrangement procedure as a means of rescuing companies. Yet, the recession of the early 1990s showed that it was not appropriate for a small company in financial difficulty. This was because there was no moratorium on creditors' action, before an arrangement could be agreed. So creditors were able to resort to their own recovery action for the debts against the company.

That rendered any proposed voluntary arrangement unworkable and the rescue attempts to collapse. There was a need to prevent other creditors' rights to take action during the period when the voluntary arrangements were being considered in order for the company's management to come up with a rescue plan for the creditors to consider.

Holding off individual creditors whilst a rescue strategy is put into place has been a major problem. A moratorium could be achieved by an application for an administration order . Under the Insolvency Act 2000 a small company's management has an option of a short moratorium without recourse to the court so long as the appropriate criteria are satisfied. This will stop creditors from taking enforcement action, initially for a period of up to 28 days while the proposed voluntary arrangement is put to creditors.

Also the management of the company especially the owners were very reluctant to use the administration procedure as they knew they would be displaced by the administrative receiver if the bank exercised its effective veto or by the administrator if the court appointed one. Cost issues needed to be considered as well.

Conclusion

When the company runs into financial trouble unless the lenders are willing to fund the company during the administration process to give it an opportunity to sort out its affairs, the administration is not going to work. The fixed charge holders still have a right to appoint a receiver and would be considered as more feasible option in certain circumstances. The only way the lenders can be kept happy is to offer asset based lending or some kind of debt-purchase lending which would give them flexible exit route and cost of borrowing to a minimum.

The new changes in the Enterprise Act are based on the principle of equity and efficiency. These are the collective insolvency proceedings in which all creditors take part and fixed and floating charge holders are not the only ones who have a say in it. Under these collective proceedings a duty is owed to all classes of creditors and an office holder has to account for his dealings with a company's assets to all creditors.

The new Act tries to strike a balance by introducing collective insolvency proceedings which would give all creditors an opportunity to participate. To a certain extent unsecured creditors now have a greater say in the whole process. They can also influence its outcome and ensure that secured creditors are not put at risk in any way. However, under these changes, creditors will not be able to enforce action for an initial period of 28 days.

The government has an intention to introduce legislation to provide for a moratorium to be part of the company voluntary arrangement procedure which was missing from C V As before.

As there are no precedents as yet the Insolvency Practitioners will have to run to the court for guidance under the new proposals which could increase the cost of administration and less money available for the creditors as a consequence.

Bibliography

  • www.insolvency.gov.uk/consultation
  • Department of Trade and Industry web site, s247(3) Companies Act 1985