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Strengths and weaknesses of the administration order

Structure: Issues, Legal rules and application

Introduction:

  1. Identify the purposes for creating an administration order (i.e. corporate rescue)
  2. Identify the weaknesses of administration order (i.e. chargee is entitled to appoint their own receivers) (chargee will retain their existing place in the order of creditors) under old regime and changes proposed by the new provisions.
  3. Administration with the proposal for Company Voluntary Arrangement with the company’s creditors

Analysis

The Enterprise Act 2002 has a significant impact on how financial failure of a business is dealt with in the UK. The rescue culture is strengthened by streamlining the administration procedure which are court based. It also prevents lenders holding security over companies business and assets, including floating charges, from appointing a Administrative Receiver to realise assets to such an extent that it satisfies their debt. This was seen as UK’s pro-creditor approach. This does not prevent the fixed charge holder from appointing a receiver however if an Administrator is appointed then such a receiver has to relinquish his office.

The previous insolvency regime did not provide enough transparency and accountability to the range of stakeholders especially to the creditors who have an interest in a company’s affairs. The Administration is an important tool which can be used to give breathing space for a company in financial difficulty so as to put together a rescue plan or provide better returns for creditors. To achieve this the formalities have been reduced and administration as well as Company Voluntary Arrangements have been made more accessible to the companies.

Reasons for creating Administration Orders

The government’s intention was to deal with a company in financial trouble in a positive way when they introduced Administration. In order to protect itself from the threat of creditors’ action against itself, the insolvent company usually initiates the procedure. The primary aim of an administration is to rescue the company as a going concern. The main thrust of the Enterprise Act 2002 is to restrict the use of Administrative Receiverships considerably. It is also intended to extend and streamline the administration procedure.

This procedure is available by order of the court if the court takes a view that the business of the company or at least part of it should be saved or a view to a more beneficial realisation of assets than could be achieved winding up that company, or with a view to obtaining approval for a voluntary arrangement with the creditors of the company.

The petition for the administration order may be presented by the company, or its directors, or by a creditor, including the holder of a floating charge, on the grounds that the company is unable to pay its debts or is likely to become unable to pay its debts. As a consequence of the presentation of the petition a ‘moratorium’ is imposed on the company’s debts and creditors may not enforce any security over the company’s property, but can appoint an administrative receiver, repossess goods, start or continue proceedings or levy distress against the company’s property. The company cannot be wound up during this time.

In the first instance the administrator of the company must attempt to rescue the company as a going concern unless it is not reasonably practicable or it is not in the interest of the creditors. If this is the case then the administrator must seek to achieve a better result for creditors as a whole than company were to wound up in a conventional way. If we take an example of MG Rovers[1] the Administrators, KPMG, are desperately trying to rescue the company from its current financial situation by selling off its assets and trying to open up negotiations with Chinese company in order to either sell off the company as a going concern or to make better realisations of the assets for the benefits of the creditors as a whole. If none of the above options are found to be viable then they would seek to realise the property and make a distribution to secured or preferential creditors.

The grounds for petition are that the company is unable to pay its debts as defined in section 122 of the Insolvency Act 1986. If the directors are inclined to go ahead with it then they will have to swear an affidavit, setting out the grounds for the petition. This may be supported by a report from an independent insolvency practitioner who will also include his reasons for believing that the objectives set out can be achieved, that is the survival of the company, and the whole of its undertaking as a going concern. In addition to this, a voluntary arrangement or a composition in satisfaction of the company’s debt between the company and its members under section 425 of the Company’s Act 1985 could be reached. This could allow a more advantageous realisation of the company’s assets than would be effected on a winding up.

If the directors decide to make such an application for an administration, they must then notify everyone who is entitled to appoint an administrative receiver of the company or who is entitled to appoint an administrator of the company. This means they have to notify the bank and other floating charge holders as well as suppliers who have all monies retention of title clause. Under the new insolvency regime a creditors meeting will not be necessary as the company has sufficient property to enable every creditor to be paid in full eventually.

An administration order is able to save all or part of a company as a going concern. It can also support a company voluntary arrangement, agree to an arrangement as well as realising the company’s assets for a higher value than would have been obtained in a winding up.

Weaknesses of an Administration Order

A major problem in putting the administration in place has always been the difficulty in holding off individual creditors from taking legal action driving the company in to liquidation. An administration order would create a moratorium giving breathing space for the company. However, pursuant to section 9(2) of the Insolvency Act 1986 a notice of the application for administration order has to be given to any person who is entitled to appoint an administrative receiver.

A floating charge holder is entitled to appoint his or her own receivers even when an administration order is in place.

Once an administrative receiver has been appointed by the floating charge holder, it’s main priority is to realise and repay the lender and thus other parties are not attended to. Also such floating charge holders had the power to veto the appointment of an administrator over the company.

Therefore it is vital to have full co-operation and consent of fixed and floating charge holder in order for the administration to be successful. The old administration procedure was not easily available and when it was available only handful of companies were able to make use of it. Under the new scheme

Chargee will retain their existing place in the order of the creditors as they hold a security over the company’s business and assets they can control the process. If the charge holder is not persuaded to hold back from enforcing the security.

Partb

Reforms of the Enterprise Act 2002

The main reforms were:

  • The appointment of administrative receivers to be restricted to creditors who have floating charges that were created before the effective date and also for those who have floating charges that have been granted in capital markets.
  • Preference for the crown is abolished
  • Part of the proceeds from realizations will be given to unsecured creditors
  • Administrators are able to be appointed by holders of floating charges, the company and its directors.
  • Before a liquidator can begin proceedings, a sanction of the court must first be obtained.
  • More frequent review of the rates of interest put on deposits kept with the Insolvency Service Account. Commercial rates to be used.
  • Majority of bankruptcies to last no longer than 1 year.
  • Fewer restrictions on bankrupts.
  • Floating charge holder not allowed to appoint a receiver after a fixed date.

Before the Enterprise Act 2002 came into force the Administration procedure was slow, less flexible and difficult to access. The Government also claims that it wasn’t as fair.

Also before, the liquidator could bring about legal proceedings without the permission of the creditors. The powers of floating charge holders before was greater as they were able to appoint a receiver.

Vanessa Finch[2] evaluates in her article the potential contribution of recent reforms which have been implemented in a effort to further a rescue culture.

Under the new insolvency regime the holder of qualifying floating charge would be prohibited from appointing an administrative receiver however, they would be able to appoint an administrator without recourse to the court. This new provision applies to any floating charge which is created on or after the date these new provision came into force.

It is interesting to note that this obviously leaves open for the holders of the floating charges created before the new legislation came into force to appoint administrative receiver.

The law as it stands today allows a company to be able to grant security over all of its assets. However if the company imposes restriction on these secured creditors then it is likely that the credit facilities will become more expensive regardless of rescue procedure in place. It may become more difficult to obtain finance, which is less flexible. This may lead to more personal guarantees and securities from directors of the company being demanded by the secured lenders to reduce their exposure. On the other hand when the company runs into financial difficulties then secured creditors would want to protect their position, which could be detrimental to the unsecured creditors.

It should be noted that if a company enters into Administration then the benefits go to the unsecured creditors. Under new provisions the administrator has been given new powers to make distributions to secured and preferential creditor. A Special Fund, which an administrator can create, has been introduced exclusively for the benefit of unsecured creditors. In brief, share of the assets have to be ring fenced for the unsecured creditors to preserve their contractual rights under the new regime. It is not yet clear exactly how much will be kept aside for the unsecured creditors; my guess is that it depends upon the size of the company and the amount of creditors involved. However it is likely that 10% of the assets may be ring fenced for this purpose.

Under new legislation, the main thrust is to restrict considerably the use that can be made of administrative receiverships and extend and streamline the administration procedure. The holder of a floating charge loses the right generally to appoint an administrative receiver under a floating charge. On the other hand an administrator can be appointed by a court order, by a floating charge holder or by the company or its directors. The main purpose of the administration is to rescue the company as a going concern.

According to Marion Simmons, Q C[3], if a lender holds a floating charge which came into force before 15 September 2003 then that charge holder retains its right to appoint an administrative receiver. The charge holder also gains the right to appoint an administrator and is not weighed down by the fact that the new provisions do ring-fence assets to certain extent in favour of unsecured creditors. In situation where an administrative receiver has been appointed then it prevents the appointment of an administrator.

Conclusion

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

The new Act attempts to strike a balance by introducing collective insolvency proceedings which would give all creditors an opportunity to participate. To certain extent unsecured creditors now have a greater say in the whole process than before. They can also influence its outcome while ensuring secured creditors are not put at risk in any way.

The administration procedure and C V A are contracts between the company and its creditors which regulates the manner in which they wish to pursue the repayment of the debt and the time scale within which it should be completed. Although C V A is an invaluable tool in any company rescue it used to be one of the statutory purposes of an administration

The act has reduced the powers of floating charge holders, such as banks, now the new act aims to get rid of administrative receivership completely and so such floating charge holders will now not be able to appoint an administrative receiver (apart from in certain exceptions such as capital market transaction etc)

If these reforms are to work, there will be a need for a change in the attitude of the banks and also the insolvency practitioners, who work in conjunction with the banks, will have to change their attitude.

The Guildhall Chambers Insolvency Team[4] has pointed out that the judges will have to change their attitudes with regards to interpretation if this new regime of sorts is to work. Not only them but also future office holders will have to alter their attitude.

The fact that administration is being favoured over an administrative receiver will increase the success of administration order because lenders will be able to see that the company can be saved, so they are less likely to enforce their security as long as a reasonable proposal can be put forward to the creditors .

The fact that a section of the company’s net floating charge proceeds will be ring fenced and made available for distribution to the unsecured creditors and not to the floating charge holders, will further allow for Administration to succeed because the proceeds will be used to satisfy unsecured debts and thus the unsecured creditors are less likely to oppose the administration proposal. The act although is good news for unsecured creditors, will cause worry for secured creditors.

.

Bibliography

1. Department of Trade and Industry web site, www.dti.gov.org

  1. Insolvency Law 1986
  1. Enterprise Act 2000
  1. The Association of Business Recovery Professionals, R3
  1. Loose on Liquidators by Mike Griffith published by Sweet & Maxwell
  1. Central Law Training
  1. Business Law Journal, September 2003 pages 527-557 article by Vanessa Finch
  1. Business Law Journal, July 2004 pages 527-557 article by Marion Simmons, QC

1


Footnotes

[1] Rover Manufacturing Group, Current News hot spot in media

[2] Re-Invigorating Corporate Rescue published in Business law Journal by Sweet & Maxwell, September 2003 issue page 527 - 557

[3] Business Law Journal, July 2004 page 423 – 236 published by Sweet & Maxwell and Contributories

[4] Business Law Journal, July 2004 page 423 – 236 published by Sweet & Maxwell and Contributories


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