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Formal corporate rescue
Chapter One: Introduction
Recently, the environment in which corporate insolvencies are resolved has changed. In 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 become increasingly 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 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. 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. All of these changes have put pressure on the traditional approaches to corporate insolvency.
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 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, the scheme of arrangement procedures as well as the London approach.
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
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 has been introduced which makes the Companies Voluntary Acts more attractive to small eligible companies that require salvage.
Apart from that, the Enterprise Act 2002 has brought some great reforms with its main focus being on formulating 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. These provisions brought about major changes to the corporate insolvency regime that was introduced by the Insolvency Act 1986. As mentioned before, even though there had been previous amendments to the 1986 Act, like the provisions of the Insolvency Act 2000, the Enterprise Act 2002 has clearly provided for the most fundamental revision of both corporate and personal insolvency for over 20 years.
In July 2001, the Government published its White Paper, “Productivity and Enterprise: Insolvency - A Second Chance”. This paper proposed measures to modernise both personal and corporate insolvency law. While 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, thereby encouraging productivity and enterprise, increasing accountability and returns to creditors.
This dissertation is formulated upon a thorough exploration of the legislative changes in corporate insolvency law over the past years in relation to corporate rescue. It will be looking at the theoretical and practical issues of the current corporate rescue laws in the UK.
It is of no question 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. The most commonly used corporate insolvency procedures are voluntary and compulsory liquidation. These provide for an orderly winding up of the affairs of financially distressed companies and are both generally terminal for the company involved.
These liquidation procedures were left relatively untouched by the Enterprise Act which instead concentrated on two alternative 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, 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.
The key objective of this research is to analyse the current UK corporate rescue laws with particular emphasis on the administration and how it came about to be the main rescue procedure in corporate insolvency law. The dissertation furthermore, pays specific attention to the administration procedure to see if it is appropriate for the current economic regime. There is also an overview of the other rescue procedures as well in order to examine the weaknesses and inadequacies of the rescue regimes.
Due to the high profile instances of companies that have been in need of rescue in the recent years administration represents the second most important corporate insolvency regime (the first being liquidation). It should be noted that even though liquidation is a procedure in corporate insolvency law, this dissertation is 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 explored.
How are these aims being achieved?
This is an empirical researched dissertation and 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 specifically at the impact of the legislative changes in the corporate insolvency laws and although it focuses on the administration procedure, the dissertation also touches on the other rescue procedures in corporate insolvency law. The dissertation takes this approach so as to explain how the administration procedure came about to be one the most important procedures in corporate insolvency law.
In order to realise the research aims this dissertation has five chapters. Chapter two, which may be described as the literature review, explores the historical developments that have occurred in corporate rescue laws in the UK. It explains the corporate rescue legal framework before the reforms of the 1980's, the rescue procedures in the Insolvency Act 1986, the reforms that took place in the Insolvency Act 2000 and how it changed the Company Voluntary Arrangements as well as an introduction of the Enterprise Act 2002 and the new administration procedure.
Chapter three is a follow up on chapter two. Here the administration procedure is discussed in more detail and the position of law is brought forward. In this chapter the Enterprise Act among other legislations are discussed and specific attention is paid to how the administration of companies takes place in order to get a practical sense of the issue.
Chapter four is a combination of the law and practice. In a way 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 literature review are brought forward. The challenges posed by the current economic crisis and the efficiency of the insolvency law also are explained in this chapter as well as the further need for reforms. 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 if it is the best procedure in dealing with the economic crisis. The Enterprise Act is also 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 a specific chapter dedicated to the conclusions and recommendations that result from the dissertation. In this chapter there are general observations made as well as suggesting further reforms on the law governing insolvency in terms of the administration procedure.
Chapter two: Historical developments of corporate rescue laws in the UK
The corporate rescue legal framework prior to the reforms in the 1980s
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 are company voluntary acts and administration and represented 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. 
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 quite high making the procedure expensive. From the case of Re Hawk Insurance Company Ltd and the case of Re British Aviation Insurance Company Ltd mentioned above we can see that the court has 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.
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 owes his duties to his appointer. Because of this the receiver discharges his duties without considering the interests of the general body of creditors. It is only where a rescue attempt is encouraged that the administrative receiver operates for the benefit of all the stakeholders if the charge holder is under secured. This means that the administrative receiver does not have sufficient incentives 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 is that the administrative receiver is not accountable to other creditors apart from the floating charge holder. It has been a continuous complaint from unsecured creditors that receivers looked 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 are at the mercy of the action of the floating charge holder. This is unfair to the ordinary creditors who are in a weak bargaining position and as a result may end 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 “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 multibank 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 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, which plays the key role of resolution of any disagreement amongst banks, since there is no legal arbitration process for their disputes. After a successful negotiation, all the lenders will reach consensus on a new financing agreement, which typically requires the lenders to advance loans pro rata for continued trading of the company experiencing financial trouble.
In addition, it is commonly proposed that all the lenders will share the costs and expenses for the expertise and negotiation on an equitable basis. The proposal of restructuring may include a variety of measures to reorganize the debt structure of the ailing company, such as the reduction of claims pro rata or a debt equity swap. It should be noted that the London Approach has significant influence over the informal reorganization of multi banked large corporations domestically and internationally since its birth. It has been observed that the Bank of England “has been actively involved in over 160 cases since 1989, but this is only a small proportion of the company workouts which have taken place”.
Two innovative rescue regimes in the Insolvency Act 1986 towards a modern corporate rescue culture
Company Voluntary Arrangements (CVAs)
The CVA regime was first introduced by Part I of the Insolvency Act 1986, based on the recommendations of Cork Report which attempted to formulate a “quick, user friendly and inexpensive” rescue device that could enable financially ailing companies to draft a reorganisation plan and reach a binding composition or arrangement of indebtedness between the company and its creditors. One important feature of this pro debtor approach is voluntariness, which provides easy access for the directors of the debtor to the rescue regime and enables them to ease the fear of wrongful trading liabilities. In this regard, the financially distressed but still viable company can potentially be cured at an early stage. Another attraction of the CVA is that the directors remain in control of the company's affairs under the assistance and supervision of the proposed nominee, who later becomes the supervisor after the proposal is approved by the creditors' meeting and shareholders' meeting.This mechanism is quite close to the “debtor in possession” model of the US Chapter 11.
In contrast to the court driven schemes of arrangement approach, the CVA procedure is simple, quick and unitary. The vote structure in CVA regime is simple because the creditors who are entitled shall vote on the proposed voluntary arrangement in a single class of meeting. It should be noted that the nature of a CVA is a contract based agreement, which is normally reached out of court. However, it does not mean that the court never involves itself in the procedures. Fundamentally, the court performs an overall supervisory function over the approval or implementation of the proposal. The primary role for the court is to prevent unfair prejudice. The court's involvement could facilitate the approval of rescue arrangements because the court is able to remove difficulties and avert unnecessary delay and litigation.
The CVA procedure did not play the expected role in rescuing companies in financial difficulty, because the official statistics have shown that it was largely underused. A series of shortcomings which may block the use of the CVA were explored.It was indicated that the principal weakness was the lack of a moratorium. The struggling debtor was normally exposed to the debt enforcement of individual creditors who intended to get ahead of the game between the petition for a CVA and the approval of the proposal. Other interested parties who hold property rights against the debtor's assets, such as assets which are transferred by a sale on retention of title terms or which are subject to a lease, are entitled to repossess their property. In the absence of protection in the form of a moratorium, the CVA regime proved to be unstable and vulnerable. Even though this problem could be resolved by applying for an administration order, such a course of action would be extremely costly especially for small firms which cannot afford the expenses. Therefore, reform to the perceived deficiency of the existing lack of a moratorium became a focus of the Insolvency Act 2000.
Major reforms to the original CVAs Insolvency Act 2000
The Insolvency Act 2000 effected the long awaited introduction of a moratorium which could make the CVAs more attractive to the financially ailing companies which could stay away from the enforcement of creditors under the protection of a moratorium and get recovery from temporary liquidity problems. It is appropriate to note that not every company could obtain the benefit of the 28 day moratorium, which is only available to the small “eligible” companies that should at least satisfy two or more conditions specified in the s 382 (2) of Companies Act 2006 which replaced s 247 (3) of Companies Act 1985. The effect of a moratorium will not only impede any petitions for winding up and administration and the appointment of administrative receivers, but will also restrain the enforcement action of individual creditors and repossession of property which is legally possessed under a conditional sale or lease.
Undoubtedly, from the perspective of creditors, the imposition of a moratorium will increase risk which may lead to more loss than immediate liquidation if the attempted CVA fails to rescue the financially troubled company. It should be noted that the law needs to 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 scrutinize the company's assets, indebtedness and business affairs, and examine its financial status based on the information submitted by the directors. A vital judgment should be 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, in terms of disposal of assets 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 the circumstance of there being no creditors' committee. This could ensure adequate funding to enable the company to carry on its business. In general, the reforms to the original CVA aim to be more cost effective and efficient for small firms. However, the changes effected by the 2000 Act have imposed more duties on the nominee, which may force the nominee to liaise with the directors.
The administration regime was another innovation which was contained in part II of the Insolvency Act 1986 under the inspiration of Cork Report. The creation of administration procedure aimed to make up for the lacuna where there was an absence of a floating charge holder to initiate administrative receivership, which was viewed as a rescue vehicle by the Cork Committee. It has been aforementioned that the schemes of arrangement was long drawn and expensive, and the informal workout could not bind dissenting creditors, for which reasons the introduction of administration purported to fill the shortcomings of schemes of arrangement and informal rescue arrangement, and intended to act as a collective rescue oriented approach. It should be noted that administration was created in the shadow of the floating charge, and the powers of an administrator were similar to those of an administrative receiver.
The petition for an administration order could be presented by the company (shareholders in the general meeting), the directors (majority resolution of board), or any creditor or 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, which enabled the debtor to step away from legal actions.
However, the implementation of the administration regime suffered from a series of perceived flaws which seriously affected its effectiveness and meant that it failed to realize expectations of it as the intended “flagship” of the rescue culture. First of all, the entry to procedure was inefficient. It could be easily impeded by the veto of a floating charge holder by means of appointing an administrative receiver. The applicant 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 realized. In this regard, a heavy burden of proof was imposed in the preliminary stage, in which the professional fee for the consultant and preparation of the application documents for the judicial hearing were extremely costly. In addition, the court was very cautious to sanction an order, requiring deep investigation of the petition files and the professional advices, which made the process slow and expensive.
In addition, the administration regime 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 the administration order was made by the court. Directors could avoid wrongful trading liabilities and potential disqualification by applying for an administration order when the company is in 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. It was perceived that four out of five financially troubled companies could be rehabilitated if they were put into rescue proceedings at an appropriate time. It is noteworthy, however, that the appointment of an administrator meant that the powers of the existing directors would be displaced. Moreover, the administrator was entitled to remove the directors and to appoint any new person to be a director of the company. The ceding of powers would affect the psychology and decision making of directors who might be reluctant to venture into the uncertain administration procedure. Such incentive would have a negative impact on the success rate of the administration regime, since Fletcher notes that in many instances “administration was not even attempted or, if attempted, was resorted to only after the company had passed beyond the point of salvation.”
Furthermore, there were still other shortcomings existing in the drafting and legislative implementation of the administration order. For instance, the moratorium was not completely watertight because certain creditors could avoid the legal effect of the freeze. In addition, the provisions were unclear about the exit routes from administration. Just 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 recasting of administration regime Enterprise Act 2002
The original administration procedure was reinvigorated by the reforms contained in the Enterprise Act 2002, Section 248 of which has in most instances replaced the old part II of the Insolvency Act 1986 and inserted a substantially revamped administration regime as Schedule B1 into the 1986 Act. Massive changes were carried out to the outdated and inefficient rescue vehicle by the Blair Government.
The reforms aimed to foster a more desirable rescue culture so as to restore financially distressed enterprises, maximize the preservation of jobs, avoid the detrimental effects of the chain reaction of corporate failure and formulate a healthy entrepreneurial risk taking environment. It is praiseworthy that the achievements of the reforms went beyond a mere recasting of legal rules including substantive rights and procedures. They reshaped the property rights and bargaining powers of different actors whose attitudes and incentives had to change automatically in the new rescue network.
The most important point is that the reforms may 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 with the old regime, the newly reinvigorated administration regime virtually abolished administrative receivership. It has accomplished the introduction of an out of court appointment mechanism which creates easy and quick access to rescue procedures.
In addition, the abolition of Crown preference and the establishment of a ring fence fund could enable more assets to be available to unsecured creditors whose weak position has 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.
Chapter three: The rise of administration procedure
Access to the administration procedure
An effective corporate rescue regime which is in line with international principles and standards should provide easy, cheap and quick access to the rescue procedure for the financially distressed companies which are desperately seeking assistance for turnaround. Any delay in the opening stage may cause detriment to the initiation of rescue proceedings and accordingly the financially troubled firms may lose their optimal opportunities of being rehabilitated by the waste of time. According to the old style administration procedure, applicants who intended to trigger 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 undoubtedly it had two major disadvantages. Firstly, this court based administration increased the workload of the judiciary, which could result in delay in the commencement of the proceedings and an increase in the costs. Secondly, the administration application could be easily blocked by a floating charge holder who was entitled to appoint an administrative receiver before the court made an administration order. It should be noted that one remarkable innovation of the reforms made by the Enterprise Act 2002 is the introduction of an out of court appointment mechanism under the streamlined administration. 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, eases the concerns of the judiciary regarding a heavy work load and may accordingly avert unnecessary delay and cost.
The Enterprise Act 2002 inserted a new section into the Insolvency Act 1986 which severely restricts the use of administrative receivership, which was highly and comfortably employed by banks and other financiers with a floating charge to take control of the assets and business affairs of their ailing customer, and enforce the loan contract by means of appointing an administrative receiver. As a compromise, the floating charge holders are vested with the power to appoint an administrator out of court who should act for the interests of all the stakeholders. This mechanism of the extrajudicial appointment of an administrator seems to balance the interests of the floating charge holders, whose power to appoint an administrative receiver has been virtually abolished in respect of debentures created after 15 September 2003, and it is expected that this out of court route into administration may be the usual mode. It should be noted that the floating charge holder is not allowed to appoint an administrator where the company is already in administration, or a provisional liquidator of the company or an administrative receiver has been in office. In addition, the floating charge should be “enforceable” which means that “the floating charge holder is entitled to call in their security”. The company or directors are also empowered to appoint an administrator out of court. Such mechanisms may give the directors the right incentive to seek advice from outside insolvency specialists at an early stage in the cycle of decline and to pursue a successful rescue outcome, rather than gambling on 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.
It should be noted, however, that the legislation imposes a series of restrictions upon the company and its directors in order to prevent the abuse of the out of court appointment. First of all, the company or its directors may only appoint an administrator when the company is insolvent or is likely to be insolvent. Such an appointment is prohibited from prejudicing the interests of the holder of a floating charge. Prior to making an appointment, a written notice should be given to the holder of a floating charge who is allowed four choices:
- simply consenting to the appointment;
- making his own appointment of administrator if he so decides;
- blocking this appointment by appointing an administrative receiver if it is allowed;
- applying to the court for a court based administration.
In addition, the anti abuse provisions include prohibition of out of court appointments where the company has been in liquidation or a winding up petition has been presented or the company has been in an administrative receivership. This route is not available for a company which is intending to enter into a second administration less than 12 months after a first or which has entered an earlier CVA with the benefit of a moratorium within the previous 12 months, but the legislation does not prevent the company and its directors from applying for an administration by court order in these circumstances.
The revamped 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. This route under court order offers creditors without a qualifying floating charge their only access to the administration procedure. In terms of a qualifying floating charge holder who is able to adduce evidence that the charge is enforceable, he may apply to the court without the need to prove that the company satisfies “the insolvency condition”.
An important feature of the new procedure is that a company which has already been in liquidation can enter into administration by court order. This flexibility is reflected in the following two circumstances, where a qualifying floating charge holder is entitled to apply for an administration order in a compulsory liquidation; and a liquidator may apply whether the company is in a voluntary or compulsory liquidation. In addition to granting an order, the court has the power to dismiss the application, make an interim order or treat it as a winding up application.
In terms of theoretical reflection, it was expected that the administration appointment made by a qualifying floating charge holder outside court would become the most common mode and the floating charge holders could use administration as an alternative to the administrative receivership, which has been severely restricted since the EA 2002 came into force. However, from the perspective of judicial practice, it is indicated 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. Two factors may explain this finding. First, there might be no qualifying floating charge holders in the cases where the company or its directors make the administration appointment. In the 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.” Second, banks may not prefer to appoint administrators on account of reputational concerns. Banks neither want to be the appointers of administrators in dealing with their bad loans, nor do they want to make hostile appointments which may incur the blame of other creditors. However, it does not necessarily indicate that the banks as secured creditors with floating charges do not play any role in administration appointments made under paragraph 22. Banks tend to encourage directors of their distressed clients to make appointments instead of 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, banks may have a strong influence on the decision to appoint and the identity of the insolvency practitioners.
Before deciding to make an appointment, the directors may 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 secured creditors cannot be ignored.
It is noteworthy that there is an automatic stay as the company is in administration. This moratorium is very protective and watertight in relation to the assets of the company, towards which any debt enforcement and legal action is restricted unless it is permitted by the consent of the administrator or a court order. This statutory moratorium covers two distinct stages. An interim moratorium is available for a company which 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, which must cease to have effect at the end of one year period, and there is no possibility of a retrospective extension after this one year period expires. An extension may only be obtained prospectively during the time when the appointment of an administrator remains in force. The automatic ending of administration after one year is a new feature which was introduced by the 2002 reforms. Since the moratorium could shield the distressed debtor from debt enforcement and the repossession of goods, this time limit indicates 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 is important to note that the insolvency practitioners could present a proposal to creditors for a voluntary arrangement when the company is already in administration. This combination of a CVA and administration creates an effective rescue mechanism under which the financially troubled company can obtain the advantages of the CVA procedure and attempt to reorganize 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
One major change introduced by the new administration legislation is the establishment of a single hierarchy of objectives, which replace the original four alternatives that were of equal weight and not mutually excluded.
Three statutory purposes are placed in a hierarchy and the company is sent into administration according to 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
- realizing property in order to make a distribution to one or more secured or preferential creditors.” 
The emphasis of the new administration is to rescue the company as a going concern, which is the primary purpose in the statutory hierarchy that the administrator has to pursue. The true meaning of ‘rescuing the company as a going concern' is the preservation of 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”. Thus, it is 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”.
Whether rescuing the company as a going concern is reasonably practicable or not depends on the subjective analysis and judgment of the administrator. 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 continued trading, it may make the administrator conclude that achieving the primary purpose is reasonably practicable. The IPs tend to consider reorganizing 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 effected 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 this circumstance, 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 realize 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 case of company rescue according to the primary purpose is rare.
Administrator's 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 accordingly the administrator is 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 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 realizations of the creditors' claims and 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 realizing 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 with a view to reducing the costs of entry. However, in practice, insolvency practitioners tend to 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 shall submit 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, and this reduction of time limit purports to prevent the procedures being protracted and costly for small firms and 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 is entitled to approve or refuse the proposals produced by the administrator and challenge the administrator's conduct for the sake of collectivity and transparency. An initial meeting of creditors must be 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 should consider the proposals presented by the administrator and approve them without modifications, or with modifications to which the administrator consents. 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 fails to approve the proposals or the further creditors' meeting refuses to accept the revised proposals. Although the creditors' committee is not compulsorily required, it is important and reliable from the perspective of insolvency practitioners. The administrator could perform his duties by taking account of the advice and soundings provided by the creditors' committee, whose members may normally be the key creditors, in order to justify his actions and avoid potential litigation.
Since the administration procedure provides a moratorium which 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. Infinitely protracting administration may do harm to 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 was 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. Thus, 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 previous 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
- “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
- that a distribution will be made to unsecured creditors of the company (if there are any).”
In addition, 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. It should be noted 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 administration
A pre pack sale in administration has become a popular approach to dealing with corporate difficulties. A pre packaged administration is basically a process where the business of a financially distressed company is sold commonly to its incumbent management team, as soon as the company enters administration. The pre pack deal has been agreed prior to the company being placed into administration under the assistance of insolvency practitioners and with the support of the company's bankers. In a pre pack structure, the insolvency practitioner/administrator is allowed to sell the business to the company's management team without the consultation and approval of unsecured creditors and the leave of court, whether in the pre EA 2002 or postEA2002. Although the company's business may be saved intact and employees may preserve their jobs in a pre pack arrangement, the interests of ordinary unsecured creditors will be jettisoned because the key point of a successful pre pack is to buy business free of some or all of the unsecured debts. This is to say that the intended inside buyers, secured creditors and insolvency professionals will benefit from a pre pack administration at the expense of the interests of unsecured creditors. Normally, a pre pack sale will be completed immediately after the appointment of an administrator. The functions of the creditors' meeting may be undermined because the sale has been finished before the creditors' meeting would be convened. The pre pack sale might be denied if a creditors' meeting was called to consider it. In addition, it should be noted that a pre packaged administration is not in accordance with the primary purpose in the statutory hierarchy, which is to rescue the company as a going concern. A pre packaged administration pursues a sale of business as a going concern which could achieve a better result than would be achieved in an immediate liquidation. In a pre pack, an insolvency practitioner to be appointed as administrator may not 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 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 prepackaged administration is often, in essence, a management buyout rather than a reorganization 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 impact of the 2002 reforms on the insolvency outcomes
The revamped administration regime has had a considerable influence on corporate insolvency outcomes, especially on the choice of insolvency proceedings. It is demonstrated by Figure 4.2 that the number of administrative receiverships declined from 2001 to 2007 and 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. Clearly, the trend which is illustrated by the Figure is in accordance with the original expectation and the underlying policy aims which purported to boost the corporate rescue culture by virtually abolishing the floating charge holder friendly administrative receiverships. Such receiverships remain in some exceptional cases and in the circumstances where the floating charge was created prior to 15 September 2003. At the practical level, the receiverships in such cases may still be used as a quick and efficient way to realize debts in the case where the secured lender is under secured and there is no property available for a distribution among the other creditors.
The trend of more administration appointments and less administrative receiverships is in line with the original expectation, but a trend of administration being used as a substitute for liquidation is a new finding which has been investigated by some scholars. Several reasons may explain this effect. First, the decision of House of Lords in Re Leyland DAF overrode the ruling which was originally established in Re Barleycorn Enterprises Ltd, and held that the expenses of liquidation, which used to be paid in priority to floating charge claims, are not payable out of the proceeds of the assets subject to a floating charge. The reversal of this ruling may motivate insolvency practitioners to choose administration rather than liquidation because the administrator's expenses and remuneration are payable in priority to any security.
It should be noted that this motivation is likely to be temporary since the Companies Act 2006 re establishes that liquidation expenses are payable out of the assets subject to a floating charge. The second reason which makes the insolvency practitioners favour administration over liquidation is that a company without assets available for a distribution among creditors can be sent straight into dissolution under the new legislation. In addition, the new administration procedures enable the administrator to dispose of the company's assets and make a distribution. Therefore, administration could be the best alternative for creditors especially for secured and preferential creditors in the circumstances where the administrator could make a quick sale of the company's assets to realize their claims before the initial creditors' meeting is summoned.
Corporate restructuring law in the UK
This chapter looks at the main features of corporate restructuring law in the UK, namely: receiverships, administrations and company voluntary arrangements (CVAs) plus schemes of arrangement under the Companies Act. Attention is principally directed at administration. First however, it is necessary to set the law in context.
In the last decade corporate restructuring law in the UK has been radically reshaped - principally by means of the Enterprise Act. The Act must be seen against the backdrop of the stakeholder rhetoric of the ‘New Labour' government elected in 1997. One might argue that the Enterprise Act 2002 aimed at a paradigm shift - 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. There was a feeling that suitable mechanisms should be in place to prevent or at least to mitigate the consequences of banks ‘cutting up rough' in any future recession. Traditionally the main remedy available to a secured creditor has been the appointment of a receiver over the assets of a company. Although designated by statute as an agent of the company this is a very curious and unusual form of agency since the main function of a receiver is to realise the secured assets for the benefit of the secured creditor who made the appointment.
To the ‘New Labour' government, receivership was seen as too heavily creditor-oriented. Essentially the concern was that the economic recession of the early 1990s had been prolonged by banks exercising their power to appoint a receiver with a view to protecting their investment. Consequently, the effect of this was to drive too many companies unnecessarily into insolvency. Receivership was not seen as sufficiently responsive to the concerns of other stakeholders involved in the corporate process. The Enterprise Act abolished the right to appoint a receiver over substantially the whole of a company's business, in the generality of cases. In addition, the administration order procedure for insolvent companies, introduced by the Insolvency Act 1986, was strengthened and explicitly designed to promote corporate rescue. Even the title of the legislation suggests a new social order. Whereas before we had insolvency legislation now we have enterprise law. 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 law was moved in the direction of the corporate reorganisation provisions in Chapter 11 of the US Bankruptcy Code but still with some significant differences. The objective was to borrow the best features of the US system but, at the same time, avoiding the pitfalls. The US Bankruptcy Code has traditionally been seen as very ‘pro-debtor' in that proceedings are almost always begun by a voluntary petition filed by the corporate debtor. The filing brings about a moratorium on enforcement proceedings against the debtor or its property and the incumbent management normally remain in place during the early stages at least of the reorganisation proceedings.
By way of contrast, the pre-Enterprise Act English law is seen as pro-creditor - a banker's Valhalla. While the Enterprise Act has repaired the main perceived defects, nevertheless the new procedure falls considerably short of the US regime. Administration still involves handing control of the company over to an outsider and, moreover, there is no method by which secured creditors can be ‘crammed' down, i.e. forced to accept a reorganisation plan against their wishes. The possibility for ‘cram down' is a feature of the US system.
On the other hand, the legislation has won plaudits and with one commentator remarking that:
The government deserves much praise for seeking out this middle ground between, on the one hand, the ancient regime in the UK, dominated by the banks through the instrumentality of receivership and, on the other, Chapter 11 with its increasingly criticised partisanship favouring the debtor. If, as is to be hoped, all interests - secured and unsecured creditors, management, investors, insolvency practitioners - give this reforming Act a fair wind, we may yet see the most dynamic insolvency regime in the world.
BUSINESS RESCUE IN THE UK - RECEIVERSHIP
Administration in the UK grew out of
THE DEMISE OF RECEIVERSHIP AND THE RISE OF ADMINISTRATION
In the 1990s receivership went out of fashion in the UK. In the recession of the early 1990s the feeling was that banks had pushed companies unnecessarily into insolvency by being unduly precipitate in the appointment of receivers. Banks were alive to this perception by centralising the way in which they handled distress companies so as to avoid the uncoordinated dumping of bankrupt assets on to the market with a consequent depression of asset prices and recovery rates. The broader political and business dynamics also changed.
Increasingly, the receivership model was seen as too creditor-centred and insufficiently responsive to the concerns of other stakeholders. The ‘New' Labour Government elected in 1997 embarked on a review of Business Rescue and Company Reconstruction mechanisms. This review identified the function of an insolvency code as being to reinforce the working of the market in bringing about the efficient allocation of resources. This could be done through providing a framework within which companies and their businesses could be ‘rescued' where rescue maximised total economic value and secondly, to achieve an orderly liquidation of assets where liquidation was appropriate. The perceived stranglehold enjoyed by secured creditors over company rescue procedures was seen as potentially contributing to the non realisation of these broad strategic objectives.
The Government White Paper Insolvency - a Second Chance (July 2001) took up the same theme, stating Administrative receivership which places effective control of the direction and outcome of the procedure in the hands of the secured creditor is now seen by many as outdated. There are many other important interests involved in the fate of such a company, including unsecured creditors, shareholders and employees. We propose to create a streamlined administration procedure which will ensure that all interest groups get a fair say and have an opportunity to influence the outcome.
The Enterprise Act 2002 followed on from this White Paper and revamped the existing structures so as to enhance the value of ailing enterprises. The Act was designed to strengthen the foundations of the economy, with even the title of the legislation suggesting a new social order. In the majority of cases, the legislation abolished the right of an all-assets floating charge holder to appoint an administrative receiver. The statute also adopted the existing administration procedure, first introduced by the Insolvency Act 1986, and turned it into something that was more specifically geared to the purpose of corporate rescue. On the other hand, secured lenders did win some significant concessions from the government during the passage of the legislation. This has led some observers to suggest that administration under the Enterprise Act 2002 is best understood as ‘receivership-plus'; in other words, receivership with a few add-ons such as somewhat wider duties. Another analysis approaches administration with the concept of transmutation in mind. On this view, the new legislative dispensation is best described as a ‘transmutation' or ‘merger' of the administrative receivership and administration procedures rather than as being the end of administrative receivership.
There are still a significant number of residual cases where administrative receivers may still be appointed. These are set out in ss 72B-G Insolvency Act 1986 and, in the main, cover ‘exotic' high-end financing transactions and sector-specific financing, particularly in the context of public-private partnerships. Section 72B refers to capital market investments where a party incurs or, when the agreement was entered into, was expected to incur, a debt of at least £50m under the arrangement; s 72C is about public-private partnerships with step-in rights; s 72D utilities; s 72DA urban regeneration projects; s 72E financed project companies including step-in rights; s 72F charges in connection with financial markets; s 72G registered social landlords; s 72GA protected railway companies. If an economic recession bites, financial institutions are likely to make full use of the potentialities offered by these provisions. Perhaps the greatest potential is offered by s 72B - the capital markets exception - and s 72E - the project finance exception, though reliance on the provision failed in Feetum v Levy, both before Lewison J at first instance and in the Court of Appeal. Section 72E(2)(a) provides that a project is a ‘financed project' if under an agreement relating to the project a project company incurred, or when the agreement was entered into expected to incur, a debt of at least £50m for the purposes of carrying out the project. In Feetum v Levy there was no expectation that the company would borrow at least £50m and therefore the exception did not apply. Moreover, it was held that there were no ‘step-in rights' within the meaning of the provision. Under s 72E a project has step-in rights if a person who provided finance in connection with the project had a conditional entitlement under an agreement to (a) assume sole or principal responsibility under an agreement for carrying out all or part of the project, or (b)make arrangements for the carrying out of all, or part of, the project. In Feetum v Levy the debenture stated that any administrative receiver appointed was the agent of the company and not of the lender. Therefore, if the receiver decided to carry out the project, the borrower would be treated in law as carrying it out or as making the necessary arrangements to do so. The lender was not entitled to make the arrangements to carry out the project for it was dependent on the discretionary decision of the receiver. Consequently, the project was not one in which there were step-in rights. On the other hand, Lewison J did say that the project finance exception should not be limited to project finance provided by banks.
The Court of Appeal confirmed the general attempt thrust of the first instance decision though Jonathan Parker LJ eschewed any attempt at a comprehensive or exhaustive description of the kinds of rights which may constitute step-in rights for the purpose of the statute. He pointed out, however, that an agreement under which a financier has step-in rights need not be the same agreement as that under which an administrative receiver is appointed. Also, the agreement with step-in rights may be an agreement with a different project company other than the project company in respect of which the appointment of an administrative receiver is made. Thirdly, more than one financier may have relevant step-in rights over the same project. Nevertheless, the most important point to draw from the case is that the power to appoint an administrative receiver should not be equated with step-in rights. Otherwise, the inclusion of a requirement for step-in rights would become superfluous.
DEFECTS IN THE ORIGINAL ADMINISTRATION PROCEDURE
Administration in its original guise has been described as a ‘hybrid procedure combining the exceptional powers of floating charge receivership with an altered set of objectives, based on collectivity of approach and a rescue oriented mission'. The administration procedure was, however, characterised by a number of features which curtailed its effectiveness.
Firstly the procedure was very heavily court-centred. Only the court could appoint an administrator on application made by the company or its creditors.
Secondly, the holder of a general floating charge over company assets had an effective veto on the making of an appointment. Largely this was because administration was seen as an alternative to receivership.
Thirdly, there were no overarching statutory objectives. Section 8(3) Insolvency Act 1986 set out various purposes for whose achievement an administration order might be made, namely: a. the survival of the company, and the whole or any part of its undertaking, as a going concern; b. the approval of a voluntary arrangement; c. the sanctioning of a compromise or arrangement between the company and its creditors; and d. a more advantageous realisation of the company's assets than would be effected on a winding up. An administration order could specify more than one purpose, but the legislation did not specify whether one purpose could take priority over another.
Fourthly, there were gaps in the statutory moratorium that was designed to give an ailing company a breathing space to negotiate its way out of difficulty. After the presentation of a petition for the appointment of an administrator, and during the currency of administration, there was an embargo on the enforcement of security rights and other claims against the company. Although extensive, this embargo did not cover situations where a landlord of premises occupied by a company forfeited the lease for breach of covenant and peacefully retook possession. After some uncertainty and vacillation, the courts held that a landlord's right to forfeit a lease for breach of covenant by peaceful re entry did not fall within the definition of security. A right of re-entry was not security over a lease but simply a right to terminate the lease and restore the landlord to possession of its own property.
Fifthly, there were no time limits apart from a requirement to hold a meeting of creditors within three months of appointment and to lay a statement of the administrator's proposals before such a meeting. The period could be extended by the court. The administration did not come to an end automatically within a certain time-frame or when a particular event occurred. There was always the possibility that administration might drag on indefinitely, though an administrator was required to apply to the court for the order to be discharged if it appeared that the purpose, or each of the purposes, specified in the administration order had been achieved, or was no longer capable of achievement.
Finally, the exit routes from administration into liquidation were procedurally difficult and cumbersome to negotiate. For example, creditors' voluntary liquidation is a more cost-effective alternative than compulsory liquidation under the control of the court but there were considerable difficulties in going down the creditors' voluntary liquidation route.
REMODELLED ADMINISTRATIONS AND THE LEGISLATIVE REFORMS INTRODUCED BY THE ENTERPRISE ACT 2002
In the main, the perceived difficulties of administration have been addressed in the Enterprise Act 2002 or to a limited extent in the Insolvency Act 2000. Firstly, there are now three routes into administration. One route is through out-of-court appointment by a qualified floating charge. The second is by the company itself making its own out-of-court appointment on giving prior notice to a qualified floating charge holder. The notification requirement affords the floating charge holder the opportunity to make its own appointment. The third option involves going to court, but considering the alternatives this route is unlikely to be invoked very often. A possible scenario is where a company has no substantial secured borrowings but unsecured creditors are dissatisfied with existing management and wish to see corporate restructuring proceed under the helm of an outsider.
On the second difficulty, at the risk of over-simplification it may be fair that the Enterprise Act has replaced the floating charge holder's veto on administration with a veto on the identity of the proposed administrator. For example, there is provision that where an administration application is made by somebody other than the qualified floating charge holder the latter may intervene in the proceedings and suggest the appointment of a specified person as administrator. The court is mandated to accede to this application unless it thinks it right to refuse the application ‘because of the particular circumstances of the case'. Furthermore, under para 35 the court is required automatically to accede to administration applications made by qualified floating charge holders and there is no threshold insolvency test in the case of such applications.
Floating charge holders might seek a court appointment in cases where an administrator may be called upon to take control of company property or perform other functions in a foreign jurisdiction. Schedule B1 para 5 provides that an administrator is an officer of the court (whether or not he is appointed by the court). Nevertheless, a foreign tribunal may not accord recognition to an administrator appointed out of court.
Thirdly, on statutory aims under the new regime, whatever the method of appointment, an administration has the overriding objective of rescuing the company as a going-concern. Where however, this is not reasonably practical and/or it is not in the interests of creditors (as a whole) for the company to be rescued as a going-concern, then the administrator's mission is to achieve a better result for the company's creditors (as a whole) than would be likely if the company were wound up. If neither of the above is reasonably practical, then the final objective is to make a distribution to one or more secured or preferential creditors. An administrator is subject to an overarching duty to exercise his/her functions in the interests of creditors as a whole and, in realising the property secured, not unnecessarily to harm the interests of creditors as a whole. The statutory language is clearly different and, superficially at least, the administrator has a different set of functions to perform than the old style administrative receiver. Nevertheless, one of the main functions of administration is still making distributions to secured and preferential creditors. If this is done and the person appointing the administrator is the floating charge holder, then the similarities between administration and old-style administrative receivership seem very strong. It has been suggested that the administration procedure protects the interests of secured creditors as well as, if not better than, administrative receiverships. It offers a more effective set of tools overall for dealing with an insolvent company than does receivership.
Fourthly, during administration a moratorium preventing creditors (including floating charge holders) from enforcing their debts comes into effect: no enforcement of security, or legal proceedings, can be taken against the company without the consent of the administrator or the court. The gaps in the statutory moratorium were largely closed by the Insolvency Act 2000 which extended the moratorium to catch a landlord's right of forfeiture by peaceable re-entry.
The Enterprise Act 2002 also imposes reasonably strict time limits for the completion of the administration process and facilitates the smooth transition from administration to liquidation and dissolution. Administration in the UK has traditionally not been a stand-alone procedure in the same way that Chapter 11 is in the US. It is more a gateway to other procedures whether this is an agreement with creditors through a company voluntary arrangement or scheme of arrangement or the liquidation and dissolution of the company. The Enterprise Act however, offers the possibility that administrations may function on a stand-alone basis since it permits a company to proceed straight from administration to dissolution without going through the intermediate stage of liquidation if there are insufficient assets to make distributions to unsecured creditors. The administrator is given power to make distributions to secured and preferential creditors and also, with the leave of the court, to unsecured creditors. The threshold for the exercise of such power is subjective - what the administrator thinks is likely to assist the achievement of the purpose of administration. This implies that the administrator must use commercial judgment but early strategic planning is needed about the way in which the administration is intended to end. Information about exit options should be included in the administrator's proposals to creditors. The fast-track route from administration to dissolution requires the filing of a notice with the registrar of companies, with dissolution deemed to occur automatically three months after the filing though there is a mechanism whereby this period may be extended.
It seems clear from the structure of the legislation however, that in the normal run of cases, administration should not be used as a procedure that substitutes for liquidation.
Professor Keay asks:
Is it necessarily a bad thing if administration is sought to be used as a substitute for liquidation? The answer is not clear. It is probably ‘no' and ‘yes'. The answer is ‘no' if, ultimately, the creditors get a better deal with greater dividends and a quicker pay-out. The answer is ‘yes' if administrations are used to circumvent some of the investigative processes that are usually undertaken in liquidation, and conduct that is inconsistent with commercial morality is being perpetrated, and not being uncovered.
Administration is intended as a fast process with the administrator performing his functions as quickly and efficiently as is reasonably practicable whereas liquidations may be more long-drawn-out affairs. The liquidator has certain powers that are denied to administrators. The conduct of the directors may warrant further scrutiny in which case the move to liquidation is appropriate, for only a liquidator, and not an administrator, may bring proceedings against directors in respect of fraudulent or wrongful trading by the company. Moreover, under s 178 of the Insolvency Act, a liquidator but not an administrator may disclaim onerous property. For the purposes of the section, ‘onerous property' means any unprofitable contract and any other property of the company which is unsaleable or not readily saleable or is such that it may give rise to a liability to pay money or perform any other onerous acts. It can include statutory exemptions or licences, such as a waste management licence. In Manning v AIG Europe. the Court of Appeal considered the meaning of ‘unprofitable contract' and decided that the critical feature was whether ‘performance of the future obligations will prejudice the liquidator's obligation to realise the company's property and pay a dividend to creditors within a reasonable time'. Under s 178(6), any person sustaining loss or damage in consequence of a disclaimer is deemed a creditor of a company to the extent of the loss or damage sustained and may prove for that loss or damage in the winding-up of the company./
THE CONDUCT OF ADMINISTRATION
An administrator may do all the things necessary for managing the company's affairs while making investigations and inquiries so as to formulate proposals to achieve the statutory goals. Normally, the creditors should be afforded an opportunity to consider and review what the administrator proposes to do. The legislation makes the assumption that, in exchange for the moratorium, creditors are to have an important say in the conduct of the administration.
Creditors and members must be sent a copy of the administrator's proposals at the latest within eight weeks of the company entering into administration and under para 51 an initial creditors' meeting must be held within the following two weeks though this time limit can be extended by the court or by the creditors. The statement of proposals will necessarily be a detailed document setting out the history of the company, its present financial position and future plans during the administration as well as providing sufficient financial information to enable the creditors to decide whether or not they should approve the proposals. The time-scales are intended to reflect the day to- day practicalities of administration. Unrealistically short periods would mean a significant number of court applications for extensions of time leading to more costs being incurred and greater inconvenience for insolvency practitioners and creditors. It should be noted however that the administrator must perform the statutory functions as quickly and efficiently as is reasonably practicable.
An administrator has power to dispense with the requirement to hold an initial creditors' meeting if s/he believes either that the company is fully solvent, i.e. the company has sufficient property to enable each creditor to be paid in full, or where the company has insufficient property to make a distribution to unsecured creditors other than by virtue of the statutory ring-fencing provision in s 176A Insolvency Act 1986. The decision whether to hold a meeting is based upon the administrator's subjective assessment and, in the opinion of certain commentators, is ‘ripe for abuse'. On the other hand, an administrator can be forced to hold an initial creditors' meeting if so requested by creditors whose debts amount to at least 10 per cent of the company's total indebtedness. The creditors' meeting may perform an important accountability function particularly where the administrator has been appointed out of- court by a floating charge holder. It can play a part in ensuing that more than lip-service is paid to the administrator's obligation to perform his functions in the interests of company creditors as a whole.
During the parliamentary process however, the government successfully resisted an amendment that would have made an initial creditors' meeting mandatory in all instances. A government spokesperson suggested that the proposal would add unnecessarily to costs, burden the courts and reduce the returns for those creditors who did have a financial interest . . . [T]he virtues of creditors' meetings are grossly exaggerated. It costs a lost of money for the boss of a small company to attend a creditors' meeting, possibly more than he is owed.
Subsequent empirical evidence has borne out the supposition that unsecured creditors have little desire to play a central role in insolvency decision making. According to a study conducted on behalf of the Insolvency Service:
‘Interviewees unanimously reported that creditor meetings are always very poorly attended, and that they strongly suspected that when reports, proposals and progress reports were sent out these were dispatched without ceremony to a cylindrical filing cabinet under the desk which is emptied daily'.
It must be said also that the creditors' meeting has limited powers. It can accept the administrator's proposals in their totality but any modification suggested requires the administrator's consent. Where administrator and creditors cannot reach agreement, the matter must be referred back to the court and the latter can make any order that it thinks fit including allowing the administration to proceed despite the creditors' opposition. It may also make a winding up order on a winding-up petition that has been suspended while the company is in administration. The administrator's role after approval of the proposals is to manage the company in accordance with the proposals. There is provision for the administrator to summon further creditors' meetings if directed to do so by the court or so requested by creditors owed at least 10 per cent of the company's total debts. Ordinarily, any proposed substantial revisions to the proposals must be put to a creditors' meeting but it has been held that the court has jurisdiction itself to authorise deviation from the original proposals in an exceptional case, e.g. where the delay involved in convening a meeting could be fatal to the chances of success of the revised proposal. If revised proposals are not approved, the administrator can continue to follow the old proposals, or, if experience leads to the conclusion that the purpose of the administration is incapable of achievement, then an application can be made to the court for the administrator's appointment to cease to have effect.
The basic model of creditor consultation and approval of proposals ignores, however, the possibility of circumstances arising where the administrator should act very quickly, perhaps even before there is an opportunity to convene a meeting of creditors. The administrator might be offered a favourable price for the business that is conditional upon a sale being concluded in accordance with a tight timetable. The legislation gives the administrator wide powers, even before approval of proposals by the creditors, and it has been judicially affirmed that these powers extend to selling off the company's business prior to the holding of the creditors' meeting. Lawrence Collins J addressed this issue in Re Transbus International Ltd.
He said: ‘I am satisfied that a better view would be that administrators are permitted to sell the assets of the company in advance of their proposals being approved by creditors.
. . . Para 68(2) of the Schedule requires the administrators to act in accordance with directions of the court ‘if the court gives [them]'. This appears to be a deliberate choice to adopt wording that mirrors the interpretation which Neuberger J had put upon the previous provisions [in Re T & D Industries plc] . . . [T]he same policy arguments apply.
Lawrence Collins J said that the Enterprise Act reflected a conscious policy to reduce the involvement of the court in administrations. He also noted that in many cases the administrators are justified in not laying any proposals before a creditors' meeting, e.g. where unsecured creditors are going to receive no payment.
OBTAINING CREDITOR APPROVAL AND VARYING CREDITOR RIGHTS
Creditor approval of proposals requires a simple majority of votes cast as measured by the amount of the outstanding indebtedness although the proposals may not result in non-preferential entitlements being paid ahead of preferential entitlements or one preferential creditor of the company being paid a smaller proportion of his debt than another. More generally, respect for proprietary rights is clearly demonstrated by para 73(1)(a), which provides that an administrator's statement of proposals may include any action which affects the right of a secured creditor of the company to enforce its security.
Secured creditors' rights are inviolate in this respect. Moreover, changing the substantive rights of creditors of whatever kind cannot simply be done by means of approval of proposals in the administration context. Such proposals have no effect on creditors' rights and are not the equivalent of a Chapter 11 reorganisation plan. Something more has to be done before creditors' rights can be discharged or varied without their consent.
One option for overcoming objections is a scheme of arrangement under the Companies Act; another possibility is a voluntary arrangement under the Insolvency legislation. A third possibility is a voluntary arrangement coupled with a moratorium also under the Insolvency legislation but this alternative is not likely to be part and parcel of an administration since it comes with its own moratorium on individual creditor enforcement actions. The latter procedure is restricted to small companies and is conditional on the directors producing sufficient evidence that the proposed CVA had a reasonable prospect of success and that the company is likely to have sufficient funds during the moratorium to enable it to carry on business.
SCHEMES OF ARRANGEMENT UNDER THE COMPANIES ACT
The DTI/Treasury Report on Company rescue and Business Reconstruction Mechanisms has described schemes of arrangement under the Companies legislation as complex and difficult to organise, demanding of expensive legal resources and generally the preserve of larger companies. If the scheme is carried through during administration however, then some of the difficulty and complexity is removed because of the statutory moratorium.
COMPANY VOLUNTARY ARRANGEMENTS
Company voluntary arrangements under Part 1 Insolvency Act 1986 are based upon a proposal to the company and its creditors for a composition in satisfaction of its debts or a scheme of arrangement of its affairs. The proposal must provide for some person to act as trustee or otherwise to supervise its implementation. That person is referred to as the ‘nominee' and must be a licensed insolvency practitioner. While not required to do so, an administrator may be designated as the nominee and this is usually the case. The nominee must then summon meetings of the creditors and shareholders to decide whether to approve the proposal. The meetings may modify the proposal in certain respects, but the modifications must not be so extensive as to change the character of the proposal so that it is no longer a composition in satisfaction of the company's debts or a scheme of arrangement in respect of its affairs. Also, the meetings are specifically prohibited from approving any proposal that would interfere with the rights of a secured creditor to enforce his security or with the priority of a preferential debt unless the secured or preferential creditor concurs.
Before amendments made by the Insolvency Act 2000 both the creditors' and shareholders' meetings had to accord approval but this is no longer the case. The effect of s 4A is that where different decisions are taken at each of the two meetings the decision taken at the creditors' meeting shall prevail, subject to the right of a member to challenge this conclusion in court within 28 days of the creditors' meeting. On such an application, the court has wide discretionary powers including the power to make such order as it thinks fit.
If the voluntary arrangement is approved by the requisite majorities, it: 1. takes effect as if made by the company at the creditors' meeting; and 2. binds every person who, in accordance with the Insolvency Rules, had notice of, and was entitled to vote at, the meeting (whether or not the person was present or represented at the meeting) or would have been so entitled if the person had notice of it as if he were a party to the voluntary arrangement. Creditors with unliquidated or unascertained debts are entitled to vote at the meeting provided the chairman agrees to put an estimated minimum value on these debts, as well as creditors whose debts are liquidated and presently due. Once a voluntary arrangement has been approved, the nominee becomes its supervisor, whose role it is to carry out the functions conferred by the arrangement. The supervisor must notify all creditors and members who are bound by the arrangement when the arrangement is complete and also provide them with an account of receipts and payments. The decision to approve a voluntary arrangement may be challenged through a court application made not later than 28 days after the results of the meetings were reported to the court. The challenge may be based on the substantive ground that the arrangement unfairly prejudices the interests of a creditor or shareholder of the company, or may relate to material irregularities at, or in relation to, either of the meetings. A procedural irregularity does not invalidate the approval given at a meeting unless it is the subject of a successful statutory challenge. Where the court is satisfied that grounds for challenge are made out, it may revoke or suspend approvals given by the meetings and direct the summoning of further meetings, either to consider a new proposal from the original proposer or to reconsider the original proposal.
The court itself has no power to devise a new proposal for consideration. The supervisor has a general right to apply to the court for directions in relation to any particular matter arising and may also apply to the court for a winding-up order to be made. Such an application may become necessary if the company fails to fulfil the terms of a CVA whether by failing to meet a payment due to creditors, or otherwise.
There has been substantial litigation concerning the effect of subsequent liquidation on the CVA and the status of funds collected by the CVA supervisor prior to liquidation. It was held however, in Re NT Gallagher & Son Ltd that so long as the terms of the arrangement were clear, funds collected by a supervisor were held on trust exclusively for the benefit of the CVA participants. Moreover, the fact that the CVA proposal did not use the terminology of ‘trust' was not material.
The fate of the CVA trust and its survival on liquidation depended on the terms of the arrangement. The court said that to treat a trust created by a CVA as continuing notwithstanding the liquidation of the company did not produce such unfairness to post-CVA creditors so as to warrant a termination default rule. Peter Gibson LJ observed:
“Further, as a matter of policy, in the absence of any provision in the CVA as to what should happen to trust assets on liquidation of the company, the court should prefer a default rule which furthers rather than hinders what might be taken to be the statutory purpose of Part 1 of the Act. Parliament plainly intended to encourage companies and creditors to enter into CVAs so as to provide creditors with a means of recovering what they are owed without recourse to the more expensive means provided by winding up or administration, thereby giving many companies the opportunity to continue to trade”.
It should be noted that creditors whose debts have not been fully discharged by trust moneys brought into being through a CVA may prove for the balance in the liquidation.
CVAs VERSUS SCHEMES OF ARRANGEMENT
In general, it is more advantageous to make use of company voluntary arrangements under the insolvency legislation than schemes of arrangement under the Companies Act for the process is administratively simpler and less cumbersome. Creditors in a CVA are dealt with as a single collective group and not as members of separate classes. Moreover, there is no need for two separate applications to the court. Formerly, it was the case that unknown creditors could be bound by a scheme of arrangement but not by a CVA but the Insolvency Act 2000, however, makes the CVA binding on creditors who were not given notice of the meeting.
UK Insolvency legislation does not make any reference to pre-packaged administrations though, superficially at least, the pre-Enterprise Act decision in T & D Industries as well as the post-Enterprise Act case Transbus International facilitates their use. In T & D Industries it was held that an administrator had power to sell the assets of a company prior to obtaining creditor approval.
In Transbus International it was confirmed that, notwithstanding the slight difference in statutory wording, administrators under the new regime retained the power to dispose of corporate assets before creditor approval. Nevertheless, it could be argued that there is a difference between the situations envisaged in these cases and a pre-packaged disposal. ‘The crucial difference is that in a pre-pack the decision is made before the administrator is in office. He or she has not considered the possibility of rescuing the company qua administrator before making the decision to sell the business.'
Although there is no specific legislative or judicial authority for pre-packaged administrations, recent years have seen their burgeoning popularity. The pre-pack has emerged with a bang as a new effective device on the UK insolvency scene:
The pre-pack has grown in popularity in the United Kingdom in parallel with the growth in ‘live side' or ‘pre-insolvency' approaches to corporate troubles. Increasingly it has become practice to deal with corporate difficulties in advance of collapse - a trend that has been encouraged by such developments as the embedding of a rescue culture in the United Kingdom; the emergence of better financial forecasting systems; a shift of approach from debt collection to financial risk management; the increased willingness of major lenders to take steps to prevent corporate disaster; and the emergence of a new cadre of turnaround professionals. The pre-pack has come to serve an important role in contingency and recovery planning as ‘the divide between informal and formal (insolvency) continues to blur'.
As part of this phenomenon debt trading during corporate restructurings has become more and more popular:
“Now, it's not uncommon to see banking syndicates and other stakeholder groups such as bonds and mezzanine transformed through the life of a restructuring as distressed debt investors take the place of the original par lenders. So many of the recent major changes we have seen in the restructuring world have originated from the US - following a ‘wall' of US money that has been lent to and invested in the UK and continental European markets . . . And it is US market practices that have brought the rapid rise in distressed debt trading and investing”.
Moreover, there has also been a development of ‘whole business solutions', where an investor such as the distressed investment department of an investment bank ‘may seek to acquire all of the capital structure of a company at a discount rather than just a small piece.' Specifically on pre-packs, it appears that there has been a significant rise in their number since the Enterprise Act came into force. The Enterprise Act 2002 itself was neither intended to prompt a surge in the use of pre-packs nor was it meant to reduce their use. Nevertheless, 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.
If the heads of a deal for the sale of company assets have been thrashed out in advance of the appointment of an administrator, the administration procedures can then be carried through at maximum speed. 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. In a pre-pack, the corporate assets may be sold off to the existing management team. The secured creditors are then paid off out of the proceeds of the sale but agree to maintain lending facilities in place with the new corporate entity that has taken over the assets of the company. Effectively to many outside observers, the old company is trading on, albeit under a slightly different guise, but having shed its unsecured debt.
There is a high degree of certainty in a pre-pack and secured creditors also enjoy a high degree of control. For these reasons, secured creditors may consider it a more attractive alternative than a protracted formal insolvency process. In the eyes of some commentators, therefore, pre-packs function as a means ‘by which powerful players can bypass carefully constructed statutory protections'. It is argued that in a pre-pack the market will rarely have been properly explored and consequently, the business may be sold at an undervalue.
In certain circumstances it may be commercially justifiable to sell the business back to management or some other connected party particularly where the original management seem the only potential buyers in the market.
Nevertheless, the practice may have given pre-packs a bad name since the suspicion is that corporate insiders are benefiting at the expense of outside unsecured creditors. It may be true that abuse has taken place in only a handful of cases and this has been occasioned by some ‘professional bad apples'. But these exceptional cases have fuelled a feeling that the rise of pre-packs will generally enhance the interests of insiders, professional advisers and secured creditors at the expense of smaller unsecured creditors and outside shareholders.
The administrator plays an indispensable part in the pre-pack procedure. As an agent of the company, the administrator is in a fiduciary position and moreover, has a statutory duty to consider rescuing the company. If, prior to becoming administrator, the same individual is bound by a pre-pack agreement to sell the business to an existing management team, then he has fettered his discretion. His objectivity appears to be impaired by a potential or actual conflict of duties. In order to avoid the allegation of abuse, an administrator who is considering a pre-pack must be satisfied that (1) in the circumstances, a rescue of the company is not reasonably feasible and the only option is to sell the business as soon as possible; (2) the pre-packaged plan will produce the best result for creditors as a whole. The relative absence of statutory provisions suggests that policy makers have not ‘caught up with the mismatch between the market and the statutory scheme' and it has been argued that effective control of pre-packs in the form of professional regulation or legislative reforms is needed.
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 IPs 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 IP's professional body might be combined with such a legislative change. Further legislative reforms might, if necessary, be introduced to place the IP's pre-pack auditing function on a statutory basis.
On the other hand, an extended system of control is not a panacea and extending statutory regulation into what is, at the moment, a pre-formal or informal area of rescue work would be likely to increase costs and procedural complexity as well as undermining the advantages of these procedures as a means of bringing about corporate turnarounds. It has been argued that some of the perceived lack of controls may stem from the seamless way in which an administrator can get transformed into a liquidator under the Enterprise Act and that the appointment of an independent liquidator is needed to review the conduct of prior officeholders including administrators and directors. This reform alone, however, would not be sufficient since a company may move under the Enterprise Act from administration to dissolution without a liquidator ever having been appointed! Moving from administration to dissolution is possible without a company going through the intermediate stage of liquidation.
This chapter has looked at corporate rescue procedures (broadly understood) in the UK. Certain conclusions follow from this account. Firstly, the traditional adage that UK law in this area is pro-creditor whereas US law is pro-debtor may be something of an over-simplification but, like many generalisations, it may contain a grain of truth. Certainly, in the UK the emphasis in corporate insolvency procedures, if they are concerned with ‘rescue' at all, has been about saving the business, rather than the company shell. Administrative receivership exemplifies this par excellence in that it is basically an auction procedure, followed by a distribution of realisations by way of dividend to the secured creditor who appointed the receiver, after which the company usually goes into winding-up. Administrations are also often employed as a delayed break-up and liquidation of the business in practice. Moreover, in administrations (and also in administrative receiverships) shareholder claims are not formally considered at all. There is no provision for meetings of shareholders and creditors alone are involved in the approval of proposals. The CVA is a bargaining procedure and may be used to negotiate a rehabilitation plan between creditors and shareholders, but most CVAs are concluded in association with an administration and, in practice, CVAs may not in fact involve reorganisation of the company, instead focusing on going concern sales or disposal of particular assets. The so-called rescue system in the UK is therefore quite market-oriented. The practice tends to centre on saving businesses rather than corporate shells.
The sale of businesses as operational going-concerns or alternatively, the piecemeal realisation of assets if that process makes creditors better off are all seen as part and parcel of the ‘rescue culture' in the UK. Corporate rehabilitation and debt restructuring does not describe the whole universe of the ‘rescue culture' at least to UK practitioner eyes. Practitioners have also become adept in using administration and CVAs as more efficient liquidation tools rather than rehabilitation regimes in practice. While this would not be considered a ‘reorganisation' in the traditional American sense of the word, a delayed break-up is still a ‘rescue' to English eyes.
Another major point of comparison is that the management of insolvency cases in the UK is dominated by insolvency practitioners while in the US the bankruptcy courts appear to play a more central role in bankruptcy administration. Also in the UK, accountants gain control of the insolvency market whereas lawyers dominate the insolvency sector in the US.
Because of the courts' general jurisdiction over bankruptcy administration and their close supervision of all aspects of corporate insolvency, reorganisation in the US is largely lawyer-driven. Accountants exercise far less direct control over the governance of insolvency than do their UK counterparts. 
A third general point is that there appears to be some convergence in practice between the US and UK. Increased recourse to informal restructurings may be some evidence of this. The last couple of years have also seen the rise of the pre-packaged administration in which the main contours of the proposed administration have been mapped out in advance before the company enters the formal process. This follows on from the earlier rise and use of pre-packaged Chapter 11s in the US. The avowed purpose of the Enterprise Act 2002 has been to tilt UK law in a westerly direction borrowing some of the features of Chapter 11 but, at the same time, avoiding the US law and practice in a UK direction.This theme is developed in the next chapter.