The UK insolvency regime began preparing for the 21st century with the Cork Report in 1982. That led directly to the Insolvency Act 1986, introducing the rescue mechanisms of administration and voluntary arrangements. Major refinements followed with the Enterprise Act 2002, enhancing the new mechanisms and facilitating the constructive use of insolvency procedures.

Since then, however, it has not been entirely plain sailing:

• administration is widely seen as terminal: "going bust" is a common media description although the procedure is designed as a temporary opportunity for restoration;
• the effectiveness of administration has been seriously blunted by various rent, pension and other claims being elevated to the status of administration expenses, payable before creditors;
• similarly, TUPE (the implementation of the European Acquired Rights Directive) and its application by employment courts has stymied business rescue and failed to preserve employment;
• pre-pack administrations have been occasionally abused and widely misunderstood; and
• an erroneous perception of insolvency practitioners charging huge fees whilst failing to act in creditors' best interests has been allowed to emerge.

Many of these challenges can be attributed, at least in part, to the insolvency profession not explaining itself sufficiently well, either generally or in individual cases and either to creditors and other stakeholders or to the media and politicians.

The influencing of legislative change has certainly improved, led by the trade body, R3, whose recent success in persuading the government to abandon its ill-advised proposal to require 3 days' notice of business and asset sales to related parties is noteworthy.

However, more needs to be done to remedy defects in the law. Take for example the undue emphasis on rescuing the company (usually a valueless capital structure that is no longer fit for purpose) rather than the business, the craftable value creation unit at the heart of the enterprise, which can often be restored to health, perhaps under different ownership. More specifically, incursions into the administration expense regime need to be halted to restore the value of administration as a rescue tool. Goods and services actually used during an administration are proper expenses that should be paid, but contracts should be terminable by administrators (with damages constituting an unsecured claim). Post-insolvency Financial Support Directions from the Pensions Regulator should also, statutorily, constitute an unsecured claim. TUPE should be revised at least to exclude liquidation and liquidation-type administration sales.

Another area where legislative change is necessary is insolvency practitioner regulation. We need a single regulator that is and is seen to be independent and effective. Nothing less will do, despite the self-interested argument of some of the existing self-regulatory bodies.

The final area for improvement is a cultural issue for many practitioners. The art of communicating - through whatever might be the best medium - to all the relevant stakeholders in the distressed environment of a formal insolvency, where many have lost money, is often neglected by practitioners. They do so at their peril. This is especially so because a few communication failures damage the whole profession. The debacle of poorly explained IPs' fees and the contortions of the legislation and professional guidance on disclosure that were imposed because of public dissatisfaction is a case in point. IPs of course also need to communicate publicly - and in this age of instant 24/7 media coverage that is a skill to be learnt and honed.

Has the rescue culture lost its way? We certainly need more appropriate legislation, but the impetus for the right changes must come from the insolvency profession.

 

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After examining the use of pre-packs as an insolvency tool, the government has abandoned the idea of legislating to give notice to creditors in all pre-packs and concluded that:

"Pre-pack sales can offer a flexible and speedy means of business rescue and when used appropriately can be the best way of maximising returns for creditors."

The challenge that the Minister has laid down to insolvency regulators is to ensure that pre-packs are used "appropriately".

This is the right result, but insolvency practitioners should respond by using pre-packs well and, most importantly, explaining clearly and promptly why each pre-pack produces the best outcome in its particular circumstances.

The written ministerial statement issued on 26 January 2012 (extracted from Hansard) follows:

WRITTEN MINISTERIAL STATEMENT
EDWARD DAVEY, MINISTER FOR EMPLOYMENT RELATIONS, CONSUMERS AND POSTAL AFFAIRS; DEPARTMENT FOR BUSINESS, INNOVATION AND SKILLS
PRE-PACKAGED SALES IN INSOLVENCY
In March 2011 I announced that we would be taking steps to improve the transparency and confidence of pre-pack sales in insolvency. We subsequently consulted interested parties on measures targeted at the sales of assets in insolvent companies where these are sold to connected parties (such as the directors or their close associates).
Pre-pack sales can offer a flexible and speedy means of business rescue and when used appropriately can be the best way of maximising returns for creditors. However, everyone who is affected by insolvency is entitled to have confidence that insolvency procedures are used fairly and that insolvency practitioners deliver the best possible outcome for all creditors.
It is apparent that concerns remain about the use of pre-pack sales, particularly where the assets are sold to a connected party – something that is often referred to as ‘phoenix-ism’. I am concerned about the potential for sales to be effected at an undervalue, particularly in smaller-value asset sales, where unsecured creditors may receive less than they should. I also believe that it is important to consider the effect of pre-pack sales on competitors in the market.
Following the announcement, BIS officials have discussed the merits and practical application of the proposed measures with a range of interested parties, including secured and unsecured creditors, insolvency practitioners, and business representatives.
Having taken account of all the issues, however, the Government is not convinced that the benefit of new legislative controls presently outweighs the overall benefit to business of adhering to the moratorium on regulations affecting micro-business which is an important plank of this Government’s deregulatory agenda. As much of the concern was related to small businesses, I do not consider that measures should be introduced just for businesses other than micro-businesses. It is for this reason that I am today announcing that the Government will not be seeking to introduce new legislative controls on pre-packs at this time.

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The government consultation Reform of the Process to Apply for Bankruptcy and Compulsory Winding Up, which proposes adjudication by Insolvency Service staff rather than a court hearing of most petitions for bankruptcy and companies winding-up, has begun to trigger debate.

The High Court's Chief Bankruptcy Registrar and the Insolvency Service's Director of Policy have recently exchanged views through Accountancy Age.

I confess to favouring the view of the learned judge. As I write, the consultation has 12 days left to run, closing on 31 January 2012. The government (through the Insolvency Service's Policy Unit) welcomes the views of all interested parties.

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The failure of directors to notify the company, in accordance with Paragraph 26, Schedule B1, Insolvency Act 1986, of their intention to appoint administrators does not necessarily render the administrators' appointment invalid.

In two carefully considered judgments in cases heard on consecutive days in November 2011, the most recent of which was handed down on 21 December:

Virtualpurple; and

Bezier:

Mr Justice Norris explains how he has been able to clarify the previously unsatisfactory state of the law.

We noted in May the surprising and unhelpful Minmar decision. Like me (but he expresses it far more eloquently in Virtualpurple), Norris J prefers the decision of HHJ McCahill QC in Hill v Stokes Plc [2010] EWHC 3726.

In Bezier, Norris J held that delivery of the notice of intention to appoint to the company's solicitors was adequate, notwithstanding the apparent requirement of the Insolvency Rules that service on the company be effected by delivering the notice to its registered office.

What a sensible way to end the year! Christmas greetings and best wishes for 2012 to all our readers.

Chris Laughton is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this post are personal to the author. If you would like to discuss the contents of this post with Chris, you can call him on +44 20 7353 1597.

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In a statement on insolvency practitioner regulation today (20.12.11) The Minister for Employment Relations, Consumers and Postal Affairs [and Insolvency] recognised strong stakeholder support for an independent single regulator. Announcing the government's response to the consultation on insolvency practitioner regulation, which closed in May 2011, he said he could see the merits of a single independent regulator.

I thought 6 months ago that a single independent regulator was an unattainable ideal and I am delighted that the idea has gained traction. Many IPs support the concept individually and R3, the trade association, is now said to be looking forward to working on it with the Minister. 

Whilst the Insolvency Service will first: 

"work with the profession and interested parties to see if there is a way to reform the system so that it delivers better against our objectives without such significant change"

there is at least now a real prospect of achieving regulation that is and is seen to be effective and independent. Such an outcome is good for the profession as well as for all those who encounter it.

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In his quest for economic stimulus in the Autumn Statement, George Osborne failed to drive banks and borrowers to put the assets and resources of moribund businesses to good use.

For many months now observers have commented on the zombie companies that clog up our economy. Adam Posen of the Bank of England’s Monetary Policy Committee draws a parallel with Japan in the 1990s being stalled by unproductive borrowers on whose loans the banks could not afford to take losses. Although Posen’s observations were seeking to promote central bank monetary stimulus in continental Europe, the Bank of England has been expressing concerns about domestic bank forbearance since June 2011.

The many companies with low or no profitability or cash flow are adding nothing to the economy. Yet they tie up resources. Banks are increasingly concerned about zombie companies, but it is getting no easier for either the banks or their customers to generate positive growth. Without growth there will be no economic recovery.

The banks should stop holding on to this unproductive debt. The pretence that it is worthy of recognition in the banks’ capital ratios must be abandoned. The companies need freeing from the burdens of their creditors through an insolvency process, if they cannot be turned around

Although lending banks are feeling pretty bruised and the Bank of England is insisting they build up their financial buffers to withstand the current “extraordinarily serious and threatening situation”, tightening the definition of non performing loans so that loans to zombie companies are not counted towards the banks’ capital adequacy would have a number of benefits.

In the long term banks’ balance sheets would be strengthened. The business and resources that would be recycled through turnaround or insolvency would stimulate the economy, with entrepreneurs free from unpayable debt burdens once again being able to generate wealth.

Chris Laughton is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this post  are personal to the author. If you would like to discuss the contents of this post with Chris you can call him on 020 7353 1597. 
 

 

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Restructuring & Insolvency is an integral part of Mercer & Hole’s business. A very busy period when our core skills of constructive use of insolvency procedures, stressed corporate advisory work and solvent restructuring have been in high demand, has prompted us to grow our Restructuring & Insolvency teams.

We are now looking to employ a senior administrator, to be based in our St Albans office.  The successful candidate is likely to have at least 4-5 years of insolvency administration experience and be able to administer a portfolio of cases. The role mainly involves corporate insolvency and candidates who have gained the CPI qualification or are part ACCA qualified would be desirable.  Good organisational and communication skills are essential.

Principally reporting to a manager, but also directly to a partner, the senior administrator's duties will involve the general daily conduct and progression of administrations, members and creditors voluntary liquidations, compulsory liquidations and company voluntary arrangements, together with some assistance with advisory cases.

To apply for the vacancy, please send your CV and covering letter, with current salary details to:  Kate Watt, HR Officer at recruit@mercerhole.co.uk.

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Financial Support Directions and Contribution Notices issued by The Pensions Regulator after a target company has gone into administration give rise to liabilities that rank as administration expenses under Rule 2.67(1)(f) Insolvency Rules 1986.

So found the Court of Appeal as it dismissed the appeals in the Nortel and Lehman cases.

In a serious blow to the rescue culture, the court found that it could not under the relevant statutes classify such liabilities as provable debts and, since classifying them as debts payable only once other creditors had been paid in full (the "black hole" result) cannot have been the intention of Parliament, classifying them as administration expenses was the only option.

It seems likely that the decision will be appealed to the Supreme Court, but the Court of Appeal gave some indications that the underlying statute fails to achieve what perhaps it might:

30. Given the precedent set in relation to section 75 by the 1995 [Pensions] Act, and given the relationship between the obligation under a financial support direction and the liability under a contribution notice, on the one hand, and the section 75 debt on the other, it might not have been surprising to find that the 2004 [Pensions] Act provided that the liability under a contribution notice was a provable debt in the insolvency of the relevant target company. One looks in vain for any such express provision in the 2004 Act.  

111. This conclusion does lead to some curious consequences. Given the close relationship between the section 75 debt and the liability under a contribution notice, it is odd to find that while the section 75 debt is provable in the insolvency of the employer, the contribution notice liability is payable with much higher priority as an expense in the insolvency of the target. It is the more odd that, as is not disputed, the employer can itself be a target, so that, by service of a contribution notice, it appears that the Pensions Regulator can produce a situation under which the priority of the relevant part of the debt is enhanced (to the extent of the amount payable under the contribution notice) from being merely provable (and expressly not preferential) to being payable as an expense. (The point of allowing for service of a financial support direction on the employer is said to be that, in particular circumstances, there may not be a section 75 debt, for example if there is no question of insolvency, but this argument from anomaly can be made, even if less strikingly, by reference to how the liability would rank if there were such a debt.)

      

112. On the other hand it might be said to be at least as odd, and a good deal more so, if the liability under a contribution notice had a lower priority than that of the section 75 debt, being relegated to the black hole, and if a potential target company could avoid the effect of the financial support direction regime by putting itself, or being put, into administration before any decisive step could be taken by the Pensions Regulator to impose any liability under this regime. Even if the issue of the Warning Notice is the critical stage, the possible target company (or at least the group) would be likely to have plenty of notice before that stage that the Pensions Regulator was interested in it, not least because it will have been the subject of requests for information under section 72 of the Act.

      

113. There is force in the argument that the potentially very large liability under an eventual contribution notice, and the open-ended nature of the obligation under a financial support direction, could be a serious impediment to the rescue culture which underlies the administration regime.

The troubling part of this judgment, to my mind, is its consideration of the justification for Parliament not having specified that the liabilities arising from financial support directions and contribution notices would be provable debts:

In a situation in which the regime applies, because the employer was either a service company or insufficiently resourced, then even if the targets are themselves insolvent, they may still have more assets available than the employer does, despite the insolvency. We were told that this is the case in the Nortel insolvency, where, apart from the effect of an eventual financial support direction and contribution notice, creditors of the targets would be expected to receive a significantly higher level of dividend than those of the employer. The legislation has a valuable and realistic purpose if it enables some redistribution of assets in such a situation, where otherwise the creditors of the targets would be able to share in a greater volume of assets, partly as a result of having had the benefit of services (including employees) provided by the employer, but without having to pay in full for the provision of those services, in particular without having to contribute appropriately to the pension liabilities in respect of its employees.

The reality is that Parliament gave relatively little thought to the liabilities being administration expenses. Why should unconnected creditors suffer more than the pension scheme (or the PPF)? It is no less a disincentive to the moral hazard of group companies passing risk to the Pension Protection Fund in the event of an employer's insolvency if the group companies attract massive unsecured claims.

This is a case where the statute needs to be changed.

Chris Laughton is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author. If you would like to discuss the contents of this post with Chris you can call him on 020 7353 1597. 

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A liquidator’s investigation into a family company resulted in the liquidator pursuing the directors (and other family members as de facto directors) for repayment of overdrawn loan accounts as well as compensation for misfeasance and breach of fiduciary duty.

The liquidator’s claim was based upon the incomplete books and records he had been able to obtain whilst the directors/family members relied upon oral evidence. The court considered the importance of written evidence not only for assessing credibility and supporting oral evidence, but also where it might be conspicuous by its absence and the inferences drawn.

The court considered that the liquidator had established a prima facie case and, given that the documents and records were under the control of the directors/family members, could presume that the claim would have been supported by documentation (that had gone missing).

Acting as liquidator we often face problems obtaining books and records which are necessary to carry out our investigation into the affairs of a company and the actions of directors. This case illustrates the importance of keeping full and proper records of account.

Caroline Stark is a Senior Manager at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Caroline you can call her on 01727 869141. Email Caroline Stark

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Insolvency Lawyers' Association's Response to the draft Insolvency (Amendment) (No.2) Rules 2011

I thoroughly endorse the Insolvency Lawyers' Association's response to the Government's proposed amendments to the law on pre-pack insolvencies, which is accessible at  http://www.ilauk.com/news/insolvency_and_restructuring_news/ and is reproduced below.

1. Introduction

1.1 This is the ILA's summary response to the draft Insolvency (Amendment) (No.2) rules 2011 (the "Draft Rules") published by the Insolvency Service on 16 June 2011. It has been prepared on behalf of the ILA by its Technical Committee (the "Committee").

1.2 The ILA provides a forum for c.450 full, associate, overseas and academic members who practise insolvency law. The membership comprises a broad representation of regional and City solicitors, barristers and academics, and overseas lawyers. The Committee is responsible for identifying and reporting to members on key developments in case law and legislative reform in the insolvency marketplace.

1.3 The Committee welcomes the opportunity to provide its view on the Draft Rules 2011 relating (amongst other things) to pre-packaged sales in administration and administration sales to connected parties.

2. General comments

2.1 In general, the Committee is in agreement with the policy objective of achieving greater transparency in pre-pack sales in administrations to address a perception that they can sometimes work to the disadvantage of unsecured creditors (the "Transparency Objective"). However, the Committee disagrees that the current Draft Rules represent a proportionate way of achieving the Transparency Objective. The Committee considers that the Draft Rules, if introduced, are likely to cause considerable damage to the business rescue market, ultimately resulting in reduced returns to creditors, an increase in job losses, and a consequential increased burden on the welfare state. These effects would be contrary to other stated policy objectives such as improving value for unsecured creditors. We understand from the stakeholder meeting that we attended on 21 June that we are not alone in our concerns.

2.2 Whereas the Draft Rules seek to address the concern as to "phoenixism" mentioned in the ministerial statement of 31 March 2011, by giving unsecured creditors a voice through the notice mechanism, the Draft Rules will likely create a new unfairness by enfranchising those creditors who are "out of the money" (a function of the insolvency itself) at the risk or expense of those who have an economic interest in the realisations. This unintended consequence might operate against the value maximising objective. There are few cases in which values improve (or even hold up) when the transactional momentum is paused.

2.3 The Draft Rules will make connected party pre-pack transactions at both ends of the value spectrum unworkable in practice, and will marginalise the use of a valuable business-rescue tool. Pre-pack sales to connected parties are used both by owner-managed businesses in situations where it often represents the best deal available to creditors (frequently, the only one capable of generating any going concern premium), as well as in high value group restructurings with syndicated lender groups, some of which migrate to this jurisdiction in order to be able to make use of it. The strong anecdotal evidence we have received from our members is that, if the Draft Rules are implemented, this is much less likely to happen.

2.4 The Draft Rules undermine the way in which pre-packs assist in retaining value. Once there is an announcement of an intended pre-pack to creditors, a business' value is likely to be eroded, and, without the certainty of a completed solution to the business' financial problems, its customers, suppliers and key employees may disappear. Valuable assets and contracts, for example licences may become terminable, with counter-parties able to walk away. It is difficult to predict with certainty what could happen in the 3 days after notice is given to creditors, but the risk of value destruction may cause the pre-pack buyer to offer less in the first place, or to reduce its price once notice is given. This so-called "gazundering" is a known phenomenon in the distressed market in which the seller is a forced seller. Without simultaneously addressing such things as "ipso facto" contract termination clauses, the Draft Rules are not a holistic approach to the objectives sought to be served. Indeed, a pre-pack notice of the sort envisaged by the Draft Rules will itself become a common termination trigger clause in commercial contracts.

2.5 Another major concern with the Draft Rules is the definition of "connected or associated party", which is broader than existing similar statutory definitions, including as it does persons connected with, or associates of, secured creditors and members. We think that this definition could have far-reaching and probably unintended consequences.

2.6 We are also concerned with how the Draft Rules might operate in practice. Supposing a creditor, on receipt of a 3-day notice of an impending pre-pack sale, does make representations: how should these representations be dealt with? By a costly application to the court? The court has made it abundantly clear that it prefers to leave commercial decisions to the office holders. It will not act as a "bomb shelter" for administrators (T&D Industries). Also, any delay caused by a creditor's response to a 3-day notice may cause a purchaser to walk away, forcing the insolvent company into liquidation (through lack of funding for a trading administration), resulting in lower returns to creditors. Creditors may be encouraged to adopt ransom positions by threatening formal objections to proposed pre-packs.

2.7 For these reasons, the Committee is not in favour of introducing the Draft Rules. We are in favour of a complete re-think of how the Transparency Objective should be addressed. Our preferred option would be to use a much simpler and less damaging mechanism, which already exists in the Draft Rules in principle. This is that the administrator certifies in his proposals to the creditors, that the pre-pack sale (whether or not to a connected party) represents the best value reasonably obtainable in the circumstances, and is in the interests of creditors as a whole. Good administrators will already satisfy themselves of this conclusion even if they do not all currently include it expressly in a statement to creditors, and so it should not be an unreasonable additional burden to them. And if the statement was unfounded, then an action would lie against the administrator to reimburse the estate for any deficiency (under paras 74 or 75 of Schedule B1 to the Insolvency Act 1986 or using the court's inherent jurisdiction in relation to the administrator as an officer of the court). This should eradicate any rogue IP activity, should not trouble diligent and competent IPs (who undertake significant due diligence to satisfy themselves that a pre-pack is the right option already), and it should give creditors the assurance that the pre-pack sale was genuinely in their interests, and that any creditor shortfall was as a result of the company's insolvency and not a consequence of the pre-pack. . In addition we do not have any objection, in principle, with a requirement that information equivalent to that which is required by SIP16 be filed at Companies House. We see both of these proposals as sensible and proportionate ways of addressing the Transparency Objective.

3. Specific comments

3.1 If, notwithstanding our general objections above to the current form of the Draft Rules, they are nevertheless to be introduced, we make the following specific comments.

3.2 Rule 2 (Review): The Draft Rules cannot sensibly be measured against the Transparency Objective: transparency is a perception, which cannot be measured empirically. And any attempt to review the Draft Rules, as suggested in rule 2, will require a funded research project of the sort previously carried out by Dr Sandra Frisby in order to measure returns to creditors. Notably, the study published by R3 in March 2010 entitled "Pre-packs and SIP 16" provided statistical evidence that pre-packs were by and large to connected parties, but resulted in 90% of jobs being saved and a better return to creditors. In light of the existing "success" of pre-packs, how do you plan to measure the impact of the Draft Rules?

3.3 Rule 4 (definition of pre-pack): We are concerned that this definition could lead to the decision on TUPE in OTG v Barke being overturned in respect of pre-pack sales. If the intention when entering into administration is that company's business will be sold via a pre-pack sale, then there is little scope for arguing that the primary objective of the administration is still (even momentarily) to rescue the company. This was one of the main reasons relied upon by the Judge in OTG v Barke. It might follow that reg 8(7) of TUPE will apply to pre-pack administrations, with the effect that employees cease to transfer automatically in pre-pack sales, resulting in a higher burden on the National Insurance Fund.

3.4 Rule 5(1)(b) (opinion that the pre-pack represents best value for creditors) (and in subsequent rules where the same drafting is repeated): The drafting of "...will achieve a better result for the company's creditors as a whole than anything else" is unreasonably wide and will act as a deterrent to IPs to accept appointments. It goes beyond the administrators' duty to achieve the objective in paragraph 3(b) of Schedule B1 to the Insolvency Act 1986 (i.e. a better outcome than liquidation). The prospective administrator can only provide an opinion based on the information provided to him by the directors, not an absolute statement that the pre-pack sale is better than "anything else". Moreover, if this wide duty on administrators is retained, this could lead to creditors reverting to the appointment of LPA receivers where assets are sold piecemeal instead of as a going concern, realising lower values, to the detriment of creditors. It should be replaced with a statement along the lines of the pre-pack sale representing the best value reasonably obtainable in the circumstances, and being in the interests of creditors as a whole.

3.5 Rule 6 (application to winding up): The inclusion of this provision is unnecessary and odd. A "pre-pack liquidation" does not make sense. In a CVL, the liquidator has no power to sell before the creditors' meeting, of which the creditors will have at least 7 days notice, and will be fully aware of the company's pending insolvency. Transparency, therefore, would not appear to be a problem. In a compulsory liquidation, the office holder is the Official Receiver until he organises a Secretary of State appointment himself or holds a creditors' meeting to make a liquidator appointment. It seems unlikely that the OR will become involved in a pre-pack liquidation sale. Therefore we do not expect liquidation to be used as a method to effect a pre-pack sale of a business.[1]

3.6 Rule 7 (definition of "connected or associated party"): Apart from the confusing footnotes (which are easily mistaken for grammatical errors), the Committee is strongly concerned that the definition used for connected party extends the existing definition in ss249 and 435 considerably and unjustifiably. These definitions are already some of the most complicated provisions to apply in practice and we do not think that transposing the existing difficulties with these sections (in particular s435) is sensible. To add another layer of complexity by introducing "secured creditors" is (a) not transparently justifiable (b) likely to lead to significant uncertainty in its application and (c) likely to make large financial restructurings which involve pre-packs impossible. Such restructurings are usually concerned only with the restructuring of the debt as between financial institutions and do not adversely impact on unsecured or trade creditors, in fact they have a positive impact on such creditors by ensuring the business continues and the trade creditors get paid.

3.7 Rather than adding further complexity to the definition of "connected or associated party", could the Transparency Objective be achieved proportionately and more simply by limiting the application of the notice provisions of the Draft Rules to sales to (i) directors, and/or, (ii) using the test in s216 (phoenix provisions), to companies or businesses in which the directors are directly or indirectly concerned or take part in the promotion, formation, or management? Arguably, the mischief that the Transparency Objective is seeking to eliminate is more closely aligned with the phoenix provisions than with other provisions where the "connected" and "associate" definitions are used. It would therefore be more consistent to use the phoenix criteria here than the suggested "connected or associated party" definition.

3.8 Rules 8 and 9 (Notice to Creditors): the definition of "open market" requires re-consideration. The language is not clear and is open to differing interpretations. For example, is it meant to refer to a full M&A process with financial advisers, a data room and an information memorandum (and if so, how is that appropriate for smaller businesses) or a smaller marketing exercise of contacting a few known prospective buyers to gauge interest. In our view, targeted marketing to identify potentially interested purchasers should be sufficient, rather than advertising in the open market. In addition, a full M&A process may not be feasible where the company is sliding rapidly into insolvency. Even if it is feasible, the disadvantage of the open market is that it will alert the company's suppliers, customers and employees, eroding the value of the business.

3.9 Rules 8-11 (information to be provided): We recall that the proposal from the previous consultation was to put SIP16 on a statutory footing. By comparison, the required information in the Draft Rules goes far beyond the equivalent information in SIP16. If the requirement is to ensure that SIP16 information is available to the public at large, then it would be simpler to require all pre-pack administrators to file their existing SIP16 report with their proposals at Companies House. Many already do. In any event, the breadth of information set out in the Draft Rules is likely to intrude upon the commercial confidentiality requirements of many purchasers, which will either deter interested parties and/or suppress the price offered.

3.10 In addition, in SIP16 there is an ability to withhold certain information in "exceptional circumstances". For business efficacy and by analogy, this exceptional circumstances option should be replicated in the Draft Rules, perhaps with the permission of the court. Otherwise, future headlines might announce that a deal that could have saved employees their jobs and returned value to creditors was made impossible by the uncommercially harsh requirements of the Draft Rules.

3.11 Carve Outs from Rules 8-11 : The problem that the Transparency Objective is trying to address concerns the (often perceived) impact on trade and supplier creditors of connected party sales, almost exclusively at the middle to lower value end of the market. We therefore do not think that it would detract from the Transparency Objective if the Draft Rules contained some or all of the following carve outs, all of which would assist in preserving the value of pre-packs as a business rescue tool (consistent with the ministerial statement's recognition of the utility and value of pre-packs):

3.11.1 The notice and information provisions in Rules 8-11 could be applied only to SMEs without significantly compromising the Transparency Objective. The value at stake in pre-packs used at the higher end of the market tends to provide its own checks and balances against the inappropriate use of pre-packs.

3.11.2 Another consideration would be to provide an exception from the 3-day notice provisions for pre-pack sales in which all creditors other than finance creditors are paid in full. Clearly the trade creditors' financial interests are protected by such a restructuring and so a 3 day notice period would not serve any useful purpose.

3.11.3 An exception from the 3-day notice provisions for pure holding companies would equally not dilute the Transparency Objective. The concerns driving the case for reform simply do not arise in these financial restructurings. As for 3.11.1, in these larger cases, the sophistication of the parties involved, the number of professional advisers and the value at stake provide their own checks and balances on the uses of pre-packs without the need for any further controls or restrictions.

3.11.4 Finally, and in any event, we consider that it is absolutely necessary to provide the court with a power to disapply the notice provisions in cases where it is in the best interests of creditors to do so. We do not expect that a court would use the power lightly, especially in view of its reluctance to be a "bomb shelter" for administrators, but it would provide a last resort option for administrators to try to salvage a deal for the creditors which might otherwise be in jeopardy.

3.12 The Draft Rules do not provide what the effect of a sale that is entered into in contravention of them (either because an incorrect, or no, rule 5 statement is provided, or because of a failure to give the requisite notice). Given the complexity of the definitions, it is conceivable that a distant connection with the purchaser could be missed. If a connection was subsequently discovered, what would be the effect on the transferred business, its employees, suppliers and customers? Should/could the sale be void or voidable several weeks, months or years after it took place? Would this benefit creditors of the insolvent company? It seems unlikely that a purchaser could rely on the usual bona fide purchaser for value without notice exception. The Draft Rules should prescribe the result of contravention, or at least give the court power to make such order as it thinks is just in the circumstances, rather than leaving the point uncertain.

Chris Laughton is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Chris you can call him on 020 7353 1597.  

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With continuing demand for its quality gravure printed products, the insolvency of the UK branch of a European network gives rise to an investment opportunity. With orders still to fulfil, cessation of trade was due to a lack of funds to buy consumables – not due the lack of orders.

Our TV channels are full of DIY programmes and people across the UK and Europe are getting more and more adventurous about making their house a home. Combined with the decline in new house sales, the renovation and redecorating market is burgeoning.

How extraordinary then that a successful UK wallpaper, ready-roll adhesive borders and wall sticker manufacturer should find itself in dire straights. The successful operation within a now insolvent European network, this factory and its staff based in northern England are keen to prove that UK manufacturing can rise like a phoenix again. I too am keen to see this local factory up and running soon. Having been appointed UK administrator, I am now working closely with the other European administrators to seek investors and the good news is that the secured creditor supports our initiative to put Cramlington back on the European interiors map.

So, what’s the story? A European chain of decorating factories has been put into administration and the UK factory operation in Cramlington, Northumberland is now up for sale. The company Alkor-Venilia, went into insolvency in Germany on 20 June 2011 and, on 14 July 2011, into administration in the UK, where it trades as H-A Interiors.

The company has operations in France, Italy, Spain, Austria, Belgium and of course, England. These assets present an excellent opportunity for the right business to scale up:

• H-A Interiors is a major UK ready-roll adhesive borders and wall sticker manufacturer with a fully fitted production plant – which includes 3 gravure printing presses based in Cramlington Northumberland.
• Capability to print full width wallpapers and sticky backed plastic.
• There are several production lines with unique capabilities – embossing, self stick coating, and water-based inks in main print lines.
• The company has valuable trademarks and a number of blue chip customers including household names in the UK like B&Q, Argos and Homebase.
• UK Turnover £9 million producing operating profit of £3.6 million FYE 31 December 2010.

Moreover, there is a community riding on this sale that are willing, talented and able to help an investor grow the business and benefit from decades of expertise, marketing know-how and manufacturing quality.

For further details and a non disclosure agreement, interested should make early expressions of interest known to the Joint Administrator Chris Laughton.
 

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HMRC’s latest comment concerning ‘Time to Pay’ (TTP) arrangements has stated that TTP will not be available where companies are paying out dividends to their shareholders. It is HMRC’s opinion that the cash should be used to pay tax before paying dividends the company can not afford!

This will clearly hit hardest those companies where directors have chosen to receive remuneration on a dividend basis rather than by way of salary. The adoption of HMRC’s stance means that two businesses in a similar financial position will receive different levels of support simply because of the way in which their directors have chosen to be remunerated. One has to question the fairness of this approach from a commercial standpoint, although it is quite difficult to argue against the principle taken by HMRC of not paying dividends when a company cannot meet its operating costs.

Even for those companies who do not operate a dividend policy, there is still the hurdle of persuading HMRC that remuneration levels are not 'excessive'. HMRC, when considering TTP applications will consider whether the level of directors remuneration is appropriate given the financial difficulties of the company. If they are not satisfied then clearly TTP will not be granted.

It is clear that HMRC are slowly but surely restricting the circumstances in which they are prepared to provide assistance with TTP. It was never intended that HMRC should be a long term source of funding but simply provide financial support at a time when all else has failed. HMRC are likely to continue to apply more stringent tests and future applications will require careful consideration before presentation to HMRC.

Peter Godfrey-Evans is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Peter you can call him on 01908 605552.   

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 The Insolvency Service is still "in listening mode" in relation to its February 2011 Consultation on Reforms to the Regulation of Insolvency Practitioners, according to a presentation on 15 June by its Director of Policy, even though the consultation is officially closed.

That better regulation is required is beyond doubt, but how to achieve it proportionately and cost-effectively, in a way that gives confidence to users of insolvency services and all those affected by insolvency, including the insolvency profession, is the challenge.

Recognising that a single independent regulator is an unattainable ideal, my principal suggestions - and this is a personal opinion - are:

• The Insolvency Service should concentrate on regulating the recognised professional bodies, rather than continuing to regulate a few IPs directly.
• That role should include acting robustly to ensure that the RPBs have entirely consistent systems and approaches to handling complaints, and that those mechanisms can be seen to be independent, technically competent, speedy and effective. In particular the sanctions levied in response to valid complaints must be consistent and should be explained publicly.
• The "super-regulator" role should also be highly visible, demonstrating how each RPB delivers the qualities described above.
• The Insolvency Service should be the public focus for regulation as a single gateway for complaints, which it would pass to the relevant RPBs, and it should publish any adverse findings, explanations and sanctions.
• Creditor participation in the insolvency proceedings is itself a significant and visible regulator protecting creditors' own interests. Being, on average, 25% of unsecured creditors and being more knowledgeable about insolvency than most, HMRC should (as part of joined up government) be obliged to take an active creditor role in formal insolvencies, in part as an encouragement to other creditors to do so.
• IPs should estimate the likely cost of an insolvency procedure at the start and, once the basis of their remuneration has been approved, should not increase their hourly rates without further creditor approval.
• IPs' fees, having been approved by the body of creditors, should not be subject to regulatory review at the behest of a minority of creditors, whose safeguard is the right to use the existing legislative provisions to apply to the court to object about remuneration.
• The proposed three day notice period to creditors for administration business and asset sales to related parties where there has been no marketing must be abandoned. It is too short a period to allow constructive participation and too long to prevent damage in those cases where value is being preserved by the sale. Less than 1% of pre-pack administrations have required regulatory action and this is a sledgehammer to crack a nut. The filing of SIP16 reports at Companies House, their earlier presentation to creditors and more effective regulatory action in the event of inappropriate phoenixism would be appropriate requirements to alleviate the perception that pre-packs are a significant source of mischief.

 

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Directors appointing administrators under paragraph 22(2), Schedule B1, Insolvency Act 1986 must give notice of intention to appoint to the company (pursuant to paragraph 26(2), Schedule B1, Insolvency Act 1986 and Rule 2.20(2)(d), Insolvency Rules 1986).

The "record of the decision of the directors" to make the appointment required by Rule 2.22 must be of a valid board resolution in compliance with the requirements of the company's articles at a meeting properly convened with notice.

So found Sir Andrew Morritt (Chancellor) in Minmar (929) Ltd & Teejinder Paul Chohan v Freddy Khalatschi & Martin John [2011] EWHC 1159(Ch), holding the appointment of administrators in that case invalid.

I am grateful to Lawrence Graham for drawing this decision to my attention.

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HMRC recently issued statistics for the Business Payment Support Service for the three months ended March 2011, their headlines, as you would expect, are the level of support they have provided to date and the reducing level of applications received since the scheme was introduced at the end of 2008.

A closer investigation of the statistics highlights an ever increasing level of applications being refused. During 2009 approximately 240,000 applications were received of which only 2.7% were declined. In 2010 the figures were 139,000 and 6.0% respectively, whilst the figures for the three months to March 2011 are 33,000 and 10.1%. Perhaps the most worrying statistics are revealed when one compares the first three months of this year to those of 2009 and 2010 with the number of rejections for the current year being 3,400 compared to 2,440 in 2009 and 2,369 in 2010, despite a 60% drop in the number of arrangements being applied for. There is no doubt that the trend is an increasing rate of rejection.

Notwithstanding this increase in the level of rejections, HMRC maintain that their criteria for considering applications has not changed since the inception of the scheme. They will support what, in their view, is a viable business. The reality appears to be that, when considering applications, they are requesting more detailed information which highlights concerns which would not have been apparent from a more cursory glance. Inevitably this has led to and will continue to lead to an increase in the rates of rejection.

Despite the increased rates of rejection there does appear to be a future for the Business Payments Support Scheme, HMRC continue to reaffirm that there is no intention to close it down. Realistically, however, gaining acceptance of an arrangement will continue to become tougher as HMRC carry out more thorough investigations into the viability of the applicants and not unreasonably wish to satisfy themselves that they are the bank of last resort and not simply a cheap form of finance.

If you are going to maximise your chance of success, be prepared, make sure your application withstands scrutiny by HMRC. Ensure the application demonstrates the viability of the business going forward and that you have exhausted alternative funding opportunities. Any inconsistencies highlighted by HMRC will impact on the overall credibility of the proposal. There can be real benefits in obtaining an independent review prior to submission to HMRC to maximise the chance of obtaining what may be a last lifeline for the company.

Peter Godfrey-Evans is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Peter you can call him on 01908 605552.  

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The balance sheet test for insolvency (section 123(2), Insolvency Act 1986), first addressed by the High Court in August 2010, has been revisited on appeal.

The first instance conclusion that each case should be decided on its legal (rather than accounting) merits has been strongly reinforced by the Court of Appeal in BNY Corporate Trustee Services Ltd v Eurosail - UK 2007 - 3bl Plc & Ors [2011] EWCA Civ 227.

The Master of the Rolls (Lord Neuberger) noted in his leading judgment that:

• "I do not consider that the question whether section 123(2) applies simply turns on the question whether the liabilities of a company (however they are assessed) exceed its assets (however they are assessed). In practical terms, it would be rather extraordinary if section 123(2) was satisfied every time a company's liabilities exceeded the value of its assets."
• "I find it hard to discern any conceivable policy reason why a company should be at risk of being wound up simply because the aggregate value (however calculated) of its liabilities exceeds that of its assets."
• "Subsection (2) was, in my view, included in section 123 to cover a case where. . . it is, in practical terms, clear that it will not be able to meet its future or contingent liabilities."
• "It is only when it can be said that the company's use of its cash or other assets for current purposes amounts to what may be vernacularly characterised as a fraud on the future or contingent creditors that it can be said that it "has reached the point of no return"."
• ". . . section 123(2) does not amount to a wholly new, relatively mechanical "assets-based", basis for seeking to wind up a company. . . the section can only be relied on by a future or contingent creditor of a company which has reached "the end of the road", or in respect of which the shutters should be "put up", imprecise, judgement-based and fact-specific as such a test may be."

In a concurring judgment, Toulson LJ noted that the "balance sheet" test is a judgment about:

• ". . . whether it has been established that, looking at the company's assets and making proper allowance for its prospective and contingent liabilities, it cannot reasonably be expected to be able to meet those liabilities. If so, it will be deemed insolvent although it is currently able to pay its debts as they fall due. The more distant the liabilities, the harder this will be to establish."

It is now beyond doubt that the balance sheet test is not a mechanistic or accounting exercise, but a judgment about whether a company will be able to pay its contingent and prospective creditors.

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Statistics recently issued by HMRC for the Business Payments Support Service (BPSS) since its inception confirm there has been a 45% drop in the number of arrangements approved for the first nine months of 2010 compared to the same period of 2009, whilst the level of rejections has doubled to 5.2% over the same period. A closer inspection reveals a rejection rate of 6.9% for the three months ending September 2010, indicating a significant upward trend over the last few months.

The information released highlights other changes in ways in which the Time to Pay scheme is being used by taxpayers. Whilst over the period from inception deferrals of up to three months have accounted for 60% of all arrangements, this has increased to 73% for the third quarter of 2010. The average value of each agreement throughout the period has remained static at about £17,000 with VAT deferrals accounting for just under half of all arrangements.

The overriding message is there has been and continues to be a general tightening on the availability of funding through the Time to Pay system. Following the release of this information HMRC continue to maintain that there has been no change in the principles applied when considering applications for Time to Pay agreements. Ultimately recovery of the tax due and viability of the business are their only concerns. The current view from professionals and businesses themselves however is that HMRC are demanding more information in support of applications and expecting businesses to demonstrate that they have exhausted all other potential sources of funding. Such sources include the use of company credit cards notwithstanding the penal level of interest they carry and the potential impact on the company’s viability.

In the coming months HMRC are likely to continue to make Time to Pay arrangements available to what they deem to be viable businesses thus maintaining their argument their policy has not changed. However the change which has led to the reduced availability of funding is that they have become more inquisitive, requesting more information and not accepting all the information given at face value. As a result the viability of more businesses has been called into question.

With economic conditions unlikely to ease in the months ahead, funds from all sources will remain difficult to obtain. Extended credit from the likes of HMRC will be subject to greater scrutiny, with businesses likely only to get one chance. It is therefore essential that a sound business proposition is made which can hold up to detailed consideration. Professional assistance in putting forward requests for funding is likely to help maximise the chance of success.

Peter Godfrey-Evans is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Peter you can call him on 01908 605552.  Email Peter Godfrey-Evans

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The administrators of 20 Lehman and Nortel companies face meeting Financial Support Directions (FSDs) and Contribution Notices (CNs) from The Pensions Regulator as an expense of the administrations because of the judgment handed down by Mr Justice Briggs.

The implications for the rescue culture are severe - unless the hope expressed by Briggs J

"that a higher court may find a way through or around the existing authorities"

is rewarded as the case is appealed.

The scope of the decision should not be underestimated. Any administration of a company that has been, at any time within the previous two years, an associate or connected to an employer with a defined benefit pension scheme shortfall, has a contingent expense, payable in priority to all other creditors (and the administrators' fees) that could amount to the whole shortfall.

Briggs J clearly reached his decision with considerable misgivings, recognising its unfairness and injustice. He observed, in relation to what he described as "a legislative mess" that

"the Insolvency Service or Parliament might wish to consider a suitable amendment, either to the Rules or to the 2004 Act, if persuaded as I have been that the conferring of super-priority as expenses upon the financial liabilities arising from the FSD regime is both potentially unfair to the target's creditors and inconsistent with a decision taken in 2004 not generally to elevate employees' pension claims above the claims of those creditors."

Such a judgment hardly clarifies the effect of an FSD on an insolvent "target". In reality, the interests of pension scheme members and the Pension Protection Fund have collided with the rescue culture like a wrecking ball.

The judgment merits reading for its detailed consideration of the interaction of insolvency and pensions law, for its analysis of administration expenses and the Toshoku principle, and for the finding that parliament legislated (probably inadvertently) for the pensions/insolvency interaction to be addressed by a mechanism that is not fit for purpose.

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1,800 redundancies have been announced today by the administrators of Rok plc and Rok Building Ltd. The redundancies are in the maintenance and improvements division throughout the UK and also in the construction business in Scotland.

On top of the 1,066 redundancies already announced at Rok in the last week, another 1,800 construction industry jobs being lost will be devastating for the individuals in question less than 6 weeks before Christmas, as well as being a blow to the industry and the economy. Worse, that is only part of the story. There will be many sub-contractors and suppliers who face the double whammy of losing what they're owed by Rok and losing future business from the closed operations.

Administrators have to act in creditors' interests. They cannot continue operating businesses unless they are making money or can be sold. Closure becomes the only option.

The speed of the collapse here is a bit surprising. The many interested parties we heard about last week did their due diligence and clearly decided that some parts of Rok were past saving. Could the directors have acted sooner, while those business units still had some value?
 

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Rok , the building and social housing repairs company was placed into Administration on 8 November, just 10 weeks after Connaught suffered the same demise.

Both of these companies were dependent upon public sector contracts, employed a large workforce and relied upon numerous suppliers and subcontractors, who are likely to feel the knock on effect. According to KPMG, in Connaught’s case, claims from unsecured creditor’s are likely to exceed £46m, with a further 50,000 'lost' invoices still to be considered.

The Administrators have said that there is no single factor responsible for Rok’s failure and that accounting problems and a profit warning earlier in the year also contributed to its problems. Some analysts believe that Rok’s problems were unlikely to be related to its profitability but triggered by cash flow issues.

This would support the current reports appearing of large companies pressurising the supply chain for savings and extended credit terms.

So, how can smaller companies further down the chain protect themselves?

When extended credit terms are requested, at the very least, they should be querying the reasons behind the request and undertake some basic due diligence to check the viability of the contracting business.

It may also be a good time to review the credit management process from beginning to end and ensure the following safeguards are in place:

• Account opening procedures are effective and provide a view on risk
• Ensure that there is a process for monitoring accounts once they are set up
• Make effective use of credit limits
• Review the collections strategy and credit control process
• Ensure policy is communicated and being adhered to

If potential problem accounts are highlighted that would have a devastating impact on the future viability of the business then early action should be taken and advice sought.

Steve Smith is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Steve you can call him on 01727 869141. Email Steve Smith

 

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Connaught PLC's administration illustrated the risk to private sector business of public spending cuts (Connaught collapse blamed on government spending cuts). That risk is further highlighted in research, statistics and commentary from such diverse sources as R3 (The Association of Business Recovery Professionals), the TUC and Boris Johnson.

The key finding of R3's new research, based on telephone interviews with small business owners in August 2010, is that:

"One in ten or 150,000 small businesses say they are in danger of going into insolvency should their public sector contracts cease."

The Trades Union Congress forsees a big drop in business and consumer confidence:

"Analysis of public accounts shows that in 2008/9 . . . spending on the private sector (at £236 billion a year) took 38p of every £ raised in tax."

"the private sector will inevitably be hit" by the cuts outlined in HM Treasury's Spending Review.

Boris Johnson writes in The Telegraph:

"around about Christmas. . . businesses of all kinds [will] start to feel the chilling effects of cuts in public spending".

The 150,000 SMEs at risk of insolvency should certainly be taking early advice to avoid financial distress, but so too should the rest of the 500,000 SMEs that are reliant on public sector contracts (according to R3's research).

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The impending administration of the FTSE 250 social housing company, Connaught PLC, is widely reported today. This tangible illustration of the effect government spending cuts can have on industry poses questions about the future of the UK economy. There will be a knock-on effect as the company's customers, suppliers and sub-contractors, its 10,000 strong workforce and the social housing sector as a whole will be hit.

There may be additional reasons for Connaught's failure, but what other companies (along with their suppliers and sub-contractors) are going to suffer because of government spending cuts? According to The Guardian:

 "the schools IT company RM Group has recently said that contracts worth £200m are at risk, while the construction firm Balfour Beatty and telecoms group Cable & Wireless Worldwide have also warned about the impact of spending cuts".

Companies large and small should by now have taken steps to identify exactly how reliant their business is on public spending – both directly and indirectly. They have to find alternative revenue streams to replace deferred or cancelled government contracts, and must manage their own costs if they are to avoid failure themselves. 

Directors and business owners worried about this or other financial stress need to act early, discuss the problems with the company’s funders and seek professional advice on restructuring the operations, revenues, costs and/or balance sheet of the business in order to stand the best chance of continuing trading through any possible double dip recession. 

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A recent Freedom of Information Act request revealed that Premier League and Championship Football clubs between them owed nearly £4million to HMRC under ‘Time to Pay’ (TTP) agreements. Such information may soon be a thing of the past as HMRC has advised that it is currently ‘considering the release of statistics for TTP’ and that whilst the review is ongoing it is unable to provide statistical information for the Business Payment Support Service which operates all TTP arrangements.

Since inception of the service the statistical information released by HMRC has confirmed the extent to which businesses have been able to defer taxes due, thereby providing a cashflow advantage to the recipients. HMRC has also been keen to demonstrate the high level of successfully completed arrangements. Without the availability of such information there will be little evidence to support the success or otherwise of the scheme going forward. Recent high profile administrations have revealed the existence of substantial TTP arrangements which have clearly failed and must impact upon the overall success of the scheme.

A lack of information will result in increased speculation as to the future of the scheme not withstanding HMRC is continuing to maintain that the criteria for considering TTP applications has not changed. Whilst a wholesale withdrawal of the scheme must be considered unlikely, a tightening up of the availability of credit may well be in the offing. Additional supporting information and greater monitoring of compliance in respect of applications are likely to lead fewer businesses successfully benefitting from TTP arrangements.

Such uncertainty regarding the strategy of HMRC has not been helped by what appear to be recent mixed messages relating to TTP. Since April this year HMRC has been able to insist on the receipt of an Independent Business Review where the debt involved exceeds £1million. It has recently been reported that only one such report has been delivered and that HMRC did not agree with its proposals. If this is correct then there must be further concerns about the level of recoveries likely to be achieved under the scheme.

The expectation must be that in the absence of positive support by the Government and HMRC, many businesses will fail to achieve the necessary TTP funding and others will suffer the sudden withdrawal of previously agreed facilities leading to an unwelcome increase of business failures in the months ahead. Even if that support is forthcoming, applications for TTP arrangements will be subject to greater scrutiny and hence professional assistance should be considered when making such applications to maximise the chance of success.

Peter Godfrey-Evans is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Peter you can call him on 01908 605552. 

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Rubin & Lan v Eurofinance involved a "novel, though we believe inevitable and desirable, development of the common law" (according to Lord Justice Ward). Founded on the principles of modified universalism (insolvency proceedings are collective, dealing with all assets for all stakeholders, but jurisdictional differences cannot be ignored), it builds on the relatively recent House of Lords cases of Cambridge Gas and HIH Insurance.

In essence a foreign insolvency representative can have the English courts enforce a foreign insolvency judgement (such as recovery of a transaction at an undervalue or a preference) in circumstances where they would not be able to enforce an ordinary foreign judgement.

What the Court of Appeal has said, in simple terms, is that there are some special features of insolvency law that are universal and should be recognised and assisted by the English courts, wherever the insolvency proceedings originated.

More foreign insolvency representatives can be expected to seek the assistance of English (and other Commonwealth) courts.
 

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We all know the definition of insolvency for a company - or do we?

The cashflow test - unable to pay its debts as they fall due - is relatively uncontroversial, but the balance sheet test is more difficult.

Section 123(2) Insolvency Act 1986 has rarely been subject to judicial interpretation, moving the Chancellor (Sir Andrew Morritt) to say in BNY Corporate Trustee Services Ltd v Eurosail- UK 2007- 3BL Plc & Ors [2010] EWHC 2005 (Ch):

"this appears to be the first time the proper interpretation of the requirement in s.123(2) to "[take] into account [the company's] contingent and prospective liabilities" has required such close consideration."

 Read the judgement for the detailed perspective, but the three key points about the balance sheet test are:

1. Only present (ie excluding contingent and prospective) assets should be taken into account in the balance sheet test and those assets may include items not on the company's balance sheet such as unresolved claims in litigation.
2. Contingent and prospective liabilities should not necessarily be taken into account at face value.
3. The balance sheet test is a legal assessment, not an accounting exercise, and generally accepted accounting principles do not apply.

Sir Andrew Morritt (C) may have made it more difficult to establish that a company has failed the balance sheet test, but it is clear that each case should be decided on its legal (rather than accounting) merits.

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Guarantee-stripping - the compromise of a landlord's claim against the guarantor of a tenant debtor - also known as the Powerhouse principle, has been endorsed by the High Court as a valid legal mechanism within a CVA, as long as the compromise is not unfairly prejudicial.

In a judgement that was highly critical of Peter Hollis and Nick O'Reilly, then of Vantis PLC, who proposed a CVA as administrators of Sixty UK Limited, the "Miss Sixty" retailer, Henderson J found that a landlord could have been crammed down in this way, but was in fact unfairly prejudiced (Mourant & Co Limited Trustees and another v Sixty UK Limited (in administration) and others). The CVA was set aside.

The judgement concludes:

I am conscious, of course, that I have not heard the administrators' side of the story, because of their decision not to participate in the trial. Nevertheless, I am satisfied that there is a prima facie case of misconduct on their part which ought to be considered by the professional bodies to which they are answerable. I therefore propose to direct that copies of my judgment should be sent to the appropriate bodies by which they are licensed to act as insolvency practitioners.

Such judicial criticism of IPs occurs rarely and is sad to see, not least because of its effect on the whole profession. Speedy, clear and fair action by the regulators concerned will no doubt ensue.

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Commercial landlords and insolvency practitioners are all alive to the effects of the decision of HHJ Purle QC in Goldacre (Offices) Ltd v Nortel Networks UK Ltd [2009] EWHC 3389 (Ch) (07 December 2009), that rent is an administration expense when it falls due during the administration.

Gabriel Moss QC has however written a fascinating analysis in Insolvency Intelligence ((2010) 23 (5) Insolv. Int. 76), concluding that Goldacre failed to follow the Court of Appeal's approach to administration expenses in Re Atlantic Computer Systems plc, which he says was unaffected by the House of Lords decision in Re Toshoku Finance (UK) plc (in liquidation). Accordingly, he argues, the court retains a discretion whether or not to treat rent, a pre-administration liability arising at the time the lease was executed, as if it were an administration expense.

Goldacre's consequences were not an obvious triumph for the rescue culture and perhaps were due to a logical flaw. Can we now return to the common sense of the courts' discretion?

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The previous Government's support in giving businesses time to pay their their debts to HMRC via the Business Payment Support Service (BPSS) has been widely acknowledged as having provided a lifeline to many businesses. Continued support was assured in their March 2010 Budget although from the increasing number of referrals we have seen in recent weeks there are clear signs that HMRC are taking a stricter view when dealing with outstanding debt. This experience has been supported by information released by HMRC showing there has indeed been an increase in the number of applications being rejected with the rate having risen in the three months to 31 March 2010 compared to 5.3% in the first quarter of last year.

Whilst no formal comment on the continuance of the BPSS has been made by the new Coalition Government, pressure on it to cut the national deficit will inevitably lead to greater scrutiny of all applications made under the scheme. Rejection rates are likely to continue to increase as HMRC will at best apply more stringent criteria when assessing which applications for time to pay arrangements to support. As for existing arrangements in place, breaches of such agreements are likely to lead to support being withdrawn.

As long as the BPSS remains in place it will remain a valuable source of funds for companies able to demonstrate the existence of a viable business. However, businesses that are relying upon rolling over their deferrals are taking immense risk. Alternative funding options need to be explored and be put in place before any deferral period ends. We are seeing an increasing number of businesses following this course. As is always the case the sooner matters are addressed the more likely a distressed situation can be avoided. 

Peter Godfrey-Evans is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Peter you can call him on 01908 605552. 

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Portsmouth FC's administrators' proposals to creditors make fascinating reading. Their accessibility highlights the Football Association's football creditors rule, which requires players, clubs and agents to be paid often very large sums in full, while non-football creditors including charities such as St John Ambulance, ordinary business suppliers and HM Revenue & Customs, receive only pence in the £ through a Company Voluntary Arrangement (CVA).

HMRC lost its legal argument against the football creditors rule in 2004 in the High Court and the Court of Appeal in the Wimbledon FC case. There, HMRC was a preferential creditor, but analogous arguments applied. The problem was that it was not the company but the buyer of the business who paid the football creditors. The courts found, perhaps surprisingly, that the amount paid by the buyer to the company was not reduced by the amount the buyer paid to the football creditors. In effect, payment to the football creditors was an entirely separate issue from the insolvency and distribution of the company's assets. The payment was a condition required by the football authorities to allow the purchaser to have the club continue to play in the Football League.

More recently in the Lehmans and Woolworths insolvencies, the courts have considered the deprivation principle ("an anti avoidance principle designed to prevent parties agreeing in advance provisions which better [a] party's position in the event of insolvency" according to the Woolworths judgement). One could imagine HMRC running an argument that the football creditors rule puts the football authorities in a better position than they would otherwise have been (namely that the participants in the football authorities' league competitions, and their associates, are protected financially when a club becomes insolvent).

Of course, in cases such as Portsmouth, where HMRC may be a sufficiently large creditor to vote down the CVA and force the club into liquidation, the point may not be argued in court. It will however be of great concern to Pompey fans, who want to see the club's business continue beyond the FA Cup Final. Many commentators (from CRITique via The Lawyer and accountingweb to The Daily Mail and The Telegraph) are now questioning whether the football creditors rule can survive, especially as its abolition has been proposed by the All Party Parliamentary Group on Football and questioned in parliament.

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Credit Today reports "OFT weighs up insolvency regulation" on the Office of Fair Trading study of the corporate insolvency market.

The OFT is considering whether to recommend that the number of Recognised Professional Bodies (regulators) be reduced to 2 or 3 - or even one. A key issue appears to be the encouragement of trust in the profession and transparency.

There is a lack of understanding about insolvency amongst creditors, according to the OFT. I think that is hardly surprising. The profession and the regulators have a lot to do to educate ordinary businesses and consumers. Insolvency is a complex technical and legal subject and not all practitioners are as user-friendly as they might be!

A tentative thought from the OFT is, interestingly, that secured creditor involvement appears to "regulate" IPs outside the formal system. If so, shouldn't banks' panels be expanded to encompass more IPs?

Insolvency practitioners are highly qualified professionals, and they are highly regulated. That they are trustworthy and properly represent creditors' interests should be made self-evident through effective regulation.

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Some landlords struggle with their position in administrations (especially pre-packs) and CVAs, as illustrated by the naturally landlord-centric perspective of insolvency given by the British Property Federation.

Landlords are so used to their powers of distraint and forfeiture maintaining their income streams from financially distressed tenants that they can fail to appreciate that formal insolvency will recognise them as mere unsecured creditors (albeit with a property that may or may not have value to the business) alongside all other suppliers.

I've talked about the issues of CVAs and Landlords before on this blog and commented on tenant insolvency under the InsolvencyNews item Rent deadline threatens retailers.

There is clearly much ground to be covered in convincing all landlords that it is not the insolvency procedure that causes them loss, but the underlying insolvency and the mismatch between their income expectations and the revenue that the property is able to generate.

Particularly in multi-site businesses there is no rationale for an insolvent business to continue to occupy uneconomic premises. All creditors should recognise that, whatever their particular concern, the business should, and the insolvency practitioner will, maximise overall value - even if some individual creditors, such as landlords with leases that have no value to the business, cannot continue to supply to the continuing or successor business.

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You will be delighted to know that The Insolvency (Amendment) Rules 2010 are not the only piece of insolvency legislation coming into effect on 6 April 2010.

The main insolvency rules changes are joined by The Insolvency (Amendment) (No. 2) Rules 2010, which correct a number of errors in the first attempt!

Succinctly and memorably named, The Legislative Reform (Insolvency) (Miscellaneous Provisions) Order 2010 makes the changes to The Insolvency Act 1986 required to give proper effect to the rule changes.

The new statutory forms required by all this legislation are listed on and should be available from the Companies House website.

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"CVAs allow troubled companies to escape their full obligations", say landlords and other critics, according to Accountancy Age.

Such a perspective ought not to be surprising because the whole point of a CVA is to relieve the company of obligations it cannot meet - on fair terms.

The principles are that a company and its creditors are free to agree whatever they like in a CVA, provided, broadly, that 75% of those creditors who vote do in fact support the proposals and that no creditors are unfairly prejudiced.

Landlords in particular should recognise that accepting a compromise on future income and/or outstanding debt can be preferable to the loss of value to creditors on liquidation, with the consequential absence of future income (voids) and outstanding debt (unpaid rent).

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The Insolvency (Amendment) Rules 2010 effect a number of changes to insolvency procedure from 6 April 2010. One such change, subject to certain safeguards, is to bring administrators' pre-appointment costs into the expenses of the administration, which are payable by the administrator out of the assets under his control.

But what exactly are "administrators' pre-appointment costs" - or, in the language of rule 2.33 (2A), "unpaid pre-administration costs"?

John Tribe  has kindly brought to my attention the recently handed down decision of HHJ Purle QC in Johnson Machine and Tool Co Ltd & Anor [2010] EWHC 582 (Ch) (18 March 2010), which clarifies the law as it stands prior to 6 April 2010 but also sheds light on the potential interpretation of the new law.

The significant pre-appointment costs that pre-packs can involve and the ill-informed and over emotive concern often voiced about the procedure make this issue all the more pertinent. What commentator could resist the double whammy of pre-packs and insolvency practitioners' fees?

The Johnson Machine decision

The Johnson Machine judgment covers two cases, both of which involved court appointed administrators who undertook pre-pack sales of the business and assets to parties connected with the company's directors.

It cites Kayley Vending Ltd [2009] EWHC 904 (Ch) (15 May 2009) and Re SE Services Ltd (9 August 2006) (unreported - although a note of the judgement is reported in the Kayley Vending judgement), emphasising that administrators' pre-appointment costs are payable only at the discretion of the court under para 13(1)(f), Schedule B1, Insolvency Act 1986.

Judge Purle strengthens that emphasis by also analysing the position in out-of-court administrations and observing that pre-appointment costs cannot be approved by creditors as part of the administration proposals, which para 49(1), Schedule B1 specifies are "for achieving the purpose of the administration". He says:

"This has nothing to do with pre-appointment costs."

Referring to rule 2.106 and rule 2.67(1), he goes on to exclude pre-appointment costs from administrators' remuneration and expenses, concluding:

"It does not seem to me, therefore, that it lies within the power of the creditors to approve any payment to the administrators in respect of pre-appointment costs which would not otherwise count as an administration expense."

I confess, with the greatest respect to the learned judge, to finding not wholly convincing the reasons given for his exercise of discretion against allowing the pre-appointment costs.

Where the purpose of the administration is a better result for creditors than liquidation, surely the pre-appointment arrangements for a pre-pack are for achieving that purpose?

The test advanced by HHJ Norris QC in Re SE Services Ltd and approved in the Kayley Vending and Johnson Machine cases is particularly vexing.

Why should creditors be deprived of a benefit (through the prospective administrators not undertaking pre-appointment work for which they will not be paid) merely because the directors are perceived to derive a greater benefit? This has nothing to do with pre-appointment costs.

The Insolvency (Amendment) Rules 2010

Be all that as it may, the law changes from 6 April 2010 with Rule 2.33 (2A):

(a) “pre-administration costs” are—

(i) fees charged, and

(ii) expenses incurred,

by the administrator, or another person qualified to act as an insolvency practitioner, before the company entered administration but with a view to its doing so; and

(b) “unpaid pre-administration costs” are pre-administration costs which had not been paid when the company entered administration.

The key point is that to be allowable as an administration expense, the costs must be incurred with a view to the company entering administration.

In the Johnson Machine case, Judge Purle effectively identified three categories of pre-administration costs:

1. insolvency or other advice that may or may not lead to administration, liquidation or some other process;
2. formalities required to be completed by the proposed administrator, such as considering and completing form 2.2B and preparing a witness statement in support of an application for a court appointment; and
3. considering and arranging a pre-pack.

You may have been expecting all these costs to be covered by the new rule 2.67(1)(h), provided that they had been duly approved by the committee, the creditors or the court.

Whilst I believe that categories (2) and (3) are covered, the line of cases referred to above means that category (1), insolvency advice, is not.

Whether any of the judiciary might be inclined to continue to apply the test from the SE Services case and would therefore consider the extent of benefit to the directors, or in some other way exclude pre-pack costs, is not entirely free from doubt.

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The Insolvency (Amendment) Rules 2010 were published by HMSO on 11 March 2010, having been laid before Parliament on 10 March 2010. They come into force on 6 April 2010.

We first reported the New Insolvency Rules (then known as the draft Insolvency (Amendment) (No. 3) Rules 2009) in November 2009 prior to final revision by the Insolvency Rules Committee and to final government approval.

Key points (extracted from the official Explanatory Memorandum) are:

• communications passing between insolvency office-holders and those involved in the insolvency process may be by electronic means, provided there is consent between the sender and the recipient that communication may be effected in that way;
• new authentication provisions are provided, to replace the existing requirement that all insolvency documents must be physically signed;
• meetings that are required to be held within insolvency processes may be held other than at a physical venue;
• insolvency office-holders are being provided with the option of publishing documents and reports on a website as an alternative to sending such information to creditors by post or e-mail;
• the requirement for insolvency documents to be sworn before a solicitor or commissioner for oaths is being replaced with a requirement that such documents be instead verified by less burdensome statements of truth and witness statements in accordance with the Civil Procedure Rules;
• significant amendments are being made to the bases of remuneration and the mechanism by which administrators, liquidators and trustees in bankruptcy have their remuneration and expenses approved or challenged within the insolvency process;
• an express legislative mechanism is being introduced to enable administrators and other insolvency practitioners to seek recovery of unpaid pre-appointment costs as an expense of the administration;
• new provisions concerning the content of notices of insolvency events that are advertised in the London Gazette and by other means are being introduced to require certain basic details to be provided in every notice;
• the current requirement for documents in many insolvency proceedings to be filed with the court will be reduced;
• provision is being made to provide greater protection to individual debtors by making it explicit that the court may consider limiting disclosure of their address or whereabouts in circumstances where it is satisfied that such disclosure might reasonably be expected to lead to violence against the debtor or a member of their family; and
• amendments are being made to the 1986 Rules to reflect the fact that the Registrar of Companies will use a power he has within section 1068 of the Companies Act 2006 to impose requirements as to the form, authentication and manner of delivery of documents required or authorised to be delivered to the Registrar.

The essence of the changes in the bases of remuneration is that, for new insolvency cases beginning on or after 6 April 2010, insolvency office holders will be able to be paid on any one or more of the three bases: time-costs, fixed fees and percentage of asset value.

The revised wording makes clear that it is the basis of the remuneration, rather than the quantum, that is fixed by the creditors' committee, the creditors or the court (except when the court is dealing with a claim that the remuneration or expenses of the administrator are excessive).

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"Pre-packs are not the problem; the problem is the insolvency."

So said Lord Drayson, The Minister of State, Department for Business, Innovation and Skills, in a House of Lords debate on Thursday 11 March 2010. He was responding to a question, prompted by the Wind Hellas case and concern about insolvency tourism, asking what action the Government will take:

"to prevent foreign companies using "pre-pack" insolvency laws to avoid debts." 

Lord Drayson also said:

"Independent studies by the World Bank have shown that the United Kingdom's insolvency framework is highly regarded - above above that of the United States, Germany and France - particularly on the basis of its protection to creditors, the costs of proceedings and the speed with which the process is able to be carried out."

and:

"The important advantage of a pre-pack, particularly in people-type businesses such as an advertising agency or a football club, is that in a difficult insolvency situation it enables the value of the business and, most particularly, the jobs to be retained. Up to 91 per cent of pre-packs lead to a situation where all the jobs in that business are preserved."

Perhaps with the Government making these points clearly it will become more widely accepted that pre-packs are a useful mechanism for preserving value when a company has become insolvent and that the UK's flexible and constructive insolvency regime is well suited to the rescue of business.

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The restructuring of Wind Hellas, a Greek telecoms company, has prompted the Sunday Times to repeat a claim by Bertrand des Pallières, of hedge fund SPQR Capital, that Britain is becoming a bankruptcy brothel.

In this high profile example of aggrieved creditors misconstruing that it is the procedure involved rather than the underlying business failure that causes loss in insolvencies, jurisdiction shopping and bankruptcy tourism have been joined by a more colourful phrase!

Not only was the Centre of Main Interests (COMI) of the relevant Wind Hellas company moved to England from Luxembourg (ie 1300 miles away from Greece rather than 1000), but it was then put through a pre-pack administration (with all the unfortunate connotations that unfortunate phrase has come to bear).

The administrators will have acted in the best interests of the creditors generally, otherwise their regulator and the courts would have been active, especially with aggrieved creditors on the scene, yet still the Sunday Times and the Mail on Sunday chose to suggest that the losses were somehow linked to the insolvency mechanism used.

This may be something of a storm in a teacup in the Wind Hellas administration, but it is regrettable that such shrieking hinders genuine business reconstruction by casting doubt on the flexible, highly-regulated UK insolvency regime, which operates subject to the scrutiny of a highly regarded and equitable court system.

Of course, a Luxembourg insolvency might have suited a particular aggrieved creditor, but the well-established COMI principle allows companies to move between jurisdictions. It’s the debtor’s choice.

In cross-border cases there will often be those who would have preferred a different insolvency regime, but while the UK continues to offer the most varied and flexible system and the experienced and regulated practitioners to make best use of it, debtors – and creditors generally – will benefit.

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Portsmouth Football Club’s insolvency has valuable lessons for other troubled businesses. Why did this premiership club that has been established for over 112 years go bust?

Putting aside the football legislation and emotional embroilment of Pompey’s fans, there were several business factors that led to Portsmouth FC becoming the first premiership club to go into administration.

• Overdue payments to HMRC

Portsmouth failed to pay its scheduled payments as they fell due. This allowed HMRC to provide the courts with evidence that the company was technically insolvent. Not every case will result in a creditor taking action against an overdue unpaid bill, but directors should remain aware of the potential consequences. 43% of successful winding-up petitions are presented by HMRC, but they will support what they believe to be a viable business, so it is vital directors act early.

• Cash flow

It is reported by the BBC that due to Portsmouth’s insufficient ground capacity, the club relied heavily on TV payments to meet its monthly outgoings. When the premier league withheld its TV payments in January 2010, the strain on the company’s cash flow was evident with players not been paid on time and management searching for new sources of finance. Accountancy Age reported that the club was looking to receive a cash injection before 17 February from an associate, but this never came. Cash flow is a key component in operating a successful business, and during a recession its importance cannot be understated. If you are regularly unable to pay suppliers or employees, then without restructuring your business and finances, the outcome will normally be insolvency. There are various cash management strategies that can be implemented (for example, re-negotiating supplier terms or selling non-core assets) to give a company some breathing space.

• Management and infrastructure

In the last 12 months, Portsmouth has had 4 different owners and sold several key players, such as Jermain Defoe and Peter Crouch. Management failed to recognise that stability and long term planning is vital for the future success of a company. Without key employees or coherent management strategies, it will be difficult to overcome any external pressures. Now, more than ever, owners/directors should be keeping a close eye on the company’s accounts and the monthly management reports. Spot potential problems and resolve them quickly and swiftly. If ever unsure, directors should seek advice promptly before it is too late.

Should these recent events be a stark warning to all that HMRC are starting to play hard ball? Will 2010 bring a influx of winding up petitions being presented against companies? Should the Portsmouth situation start to ring alarm bells for other companies in similar situations? The answers are most likely to be yes in all cases.

On 2 March, the Financial Times reported that following HMRC request the High Court has ordered a hearing to be held to consider whether the administrators appointment was valid. So with HMRC continuing to add pressure, there is still a danger that Portsmouth could be wound up.
 

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Statistics released in February 2010 have revealed that the number of compulsory liquidations, following the issue of a winding up petition, is increasing.

Previous recessions have shown that, as the economy moves into recovery, the number of businesses facing corporate insolvency increases. The incidences of winding up petitions being issued are, therefore, likely to increase. A new aspect for this post recession period is that many businesses are coming to the end of their 'time to pay' arrangements with HMRC having failed to meet their payments schedule. With HMRC taking a stricter line, failure is likely to result in termination of the arrangement and their instigating a winding up petition.

In the event of a winding up petition being served it is imperative that directors comply with their responsibilities and seek professional advice on the options available for the business as soon as possible.

If your business has or is likely to be served with a winding up petition then you can contact us for an initial free consultation on 0845 603 6253 to speak with one of our Licensed Insolvency Practitioners or alternatively you can email us.

Mercer & Hole's Restructuring & Insolvency team have considerable experience of dealing with a wide variety of insolvency issues. The team specialise in rescuing businesses through operational turnaround and financial restructuring, and through the constructive use of formal insolvency procedures.

Steve Smith is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Steve you can call him on 01727 869141. Email Steve Smith

 

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The headlines from the statistics released last week by the Insolvency Service focus on the record increase in personal insolvencies. There has been an increase of 24.9% on the same quarter last year and 2009 as a whole is 25.9% up on the previous year.

As far as corporate insolvencies are concerned there are marked differences across the different types of insolvency procedure. For liquidations there has been a 23% increase in cases on 2008 whilst the numbers for administrations, after eliminating anomolies, shows just a 1.7% increase for the year. By comparison to the changes on the same quarter last year liquidations have a 1% fall but administrations a drop of some 34%. A closer examination of the numbers show that across all forms of corporate insolvencies the numbers increased throughout 2009 with liquidations and administrations peaking in the second quarter of 2009. The notable exception was company voluntary arrangements, which are continuing to rise. The reduction in liquidations and administrations is likely to be as a result of the reticence of the banks and HMRC to initiate formal insolvency proceedings during this period with the latter promoting their Business Payment Support Service (so called 'time to pay' arrangements) . There is also a greater willingness to support CVAs to maximise the chance of recovery from creditors.

The key question is what is going to happen in the coming months? History dictates that now that we are technically out of recession we can expect the number of insolvencies to climb in the months ahead. Following the recession of the late eighties and early nineties, the level of liquidations did not peak until 1992. This time around the recession has hit harder and whilst I think there can be little doubt that corporate insolvencies will begin to climb again in the near future and will take a long time to fall back to pre-recession levels, the timescale and the level to which they will rise is more difficult to determine.

Peter Godfrey-Evans is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Peter you can call him on 01908 605552. 

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The Government’s Insolvency Service says:

“We maintain the view that in the right circumstances pre-packs can be a useful tool”.

This echoes our previous commentary on pre-packs noting that insolvency procedures operate in interests of creditors, and that creditors lose not because of the insolvency mechanism used, but because the company failed in the first place.

At a recent R3 Breakfast Briefing to insolvency practitioners, Mike Chapman, the Head of Insolvency Practitioner Regulation at The Insolvency Service, confirmed that the Service has been tackling ignorance about the position of unsecured creditors in insolvency legislation generally, but he added that it was difficult to engage effectively with creditors and that he would welcome suggestions about how best this might be achieved.

The focus of the briefing was Statement of Insolvency Practice 16 (“SIP16”), which requires administrators to report fully to creditors immediately on the execution of a pre-pack sale.

The Insolvency Service position is very clear on the SIP16 requirements being principles based:

“It is important that [creditors] are provided with a detailed explanation and justification of why a pre-packaged sale was undertaken, so that they can be satisfied that the administrator has acted with due regard for their interests.”

A checklist approach to covering all the points mentioned in SIP16 may be found to be non-compliant if it is not clear to creditors why the pre-packaged sale was undertaken.

That is, of course, the point. Transparency means enabling creditors to understand why a particular course was followed and it is transparency that will enable creditors to have confidence in insolvency practitioners’ activities on their behalf.

Chris Laughton is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Chris you can call him on 020 7353 1597.

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Not only is rent an administration expense, but it is payable on the terms of the lease. Having the company occupy only part of the premises on a quarter day will in most cases trigger an administration expense liability for the whole of the next quarter's rent, payable immediately.

This results from the decision in Goldacre (Offices) Ltd v Nortel Networks UK Ltd [2009] EWHC 3389 (Ch) (07 December 2009), where HHJ Purle QC applied the Lundy Granite or liquidation expense principle to administrations in light of the similarlity of wording between Insolvency Rules 4.218 and 2.67.

In February 2009 we postulated, following Innovate Logistics Ltd v Sunberry Properties Ltd [2008] EWCA Civ 1321 (18 November 2008), that the administrator and the landlord would have to consider the balancing exercise that the court would undertake between the financial loss to the landlord and the financial loss to the creditors generally. The pendulum has now swung firmly in favour of landlords.

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Prior to the Pre Budget Report (PBR) in December, there was speculation that the Business Payments Support Service (BPSS), which provides assistance by agreeing to deferred payments for those businesses facing difficulties, was to be closed. The Pre Budget Report however confirmed the BPSS is to remain in place and more recently, there has been an announcement that the scheme is to be fully extended to partnerships.

The availability of the BPSS for partnerships will be particularly helpful for larger professional partnerships where individual partners have to date been dealt with individually and by different tax offices, leading to the potential for inconsistent treatment. The ability to deal with a single office will be a considerable benefit.

HMRC have reiterated the basic principles underlying the circumstances in which support will be given, the key one being that in their opinion they must be satisfied that the business remains viable. In addition, to obtain support the business must be in genuine difficulty, unable to pay their tax on time and likely to be able to pay their tax given more time.

In the PBR it was announced that in the future, probably from April 2010, HMRC will require an Independent Business Review to be carried out where the debt exceeds £1 million; details of exactly what is to be required have yet to be determined.

Notwithstanding these developments there is a general feeling which is echoed by comments in the press that HMRC are taking a much stricter line when dealing with time to pay applications and more are being refused. Contrary to the guidance given in their manuals, HMRC appear to be demanding more information to support any agreements. In addition, any breaches of agreements previously made are likely to lead to enforcement action being taken by HMRC.

Whilst the above may appear to provide mixed messages, the bottom line appears to be that HMRC will support what they believe to be viable businesses. Applications must be well prepared and realistic, and failure to meet previously agreed schedules is likely to result in termination and institution of recovery proceedings. Should you require assistance in making such applications, or require help approaching HMRC, then please do not hesitate to contact me.

Peter Godfrey-Evans is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Peter you can call him on 01908 605552. 

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Stitching up creditors; insolvency practitioners earning huge fees; rescuing businesses; clearing up a mess: these are examples of what insolvency means to people.

You may have thoughts of your own (please comment below), but some of my observations are:

• Directors or debtors don’t usually cause loss to creditors on purpose, although creditors often lose and directors/debtors can certainly be at fault.
• Insolvency practitioners are highly trained, qualified, skilled and regulated specialists, who are paid the same as other specialist accountants and lawyers. Their fees are approved by creditors.
• Most troubled businesses can be rescued if good advice and remedial action are taken soon enough. If left too late, that remedy may involve insolvency proceedings where creditors are not paid in full.
• There are always losers in a formal insolvency, which is why action should be taken early enough to avoid it. When that doesn’t happen, problems turn into a mess and people lose – sometimes a lot.

The theme is that whether you’re a creditor or a debtor it pays to seek advice early – from someone who really knows what they’re talking about.

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How often has the cost of redundancies been the principal obstacle to restructuring a business?

Few employers are aware of the financial assistance offered by the Insolvency Service’s Redundancy Payments Office ('RPO') to meet the cost of redundancies.

Qualifying criteria

Applicants will need to show that: 

• the business lacks the funds to meet the statutory redundancy payments;
• providing help will:
  • save a significant number of jobs;
  • secure the solvency of the business for the foreseeable future;
• the business will be able to repay the money within an agreed period of time. 

Minimum information requirements 

The RPO require: 

• an explanation of why redundancies are necessary and funds are not available to meet the payments, supported by:
  • latest management accounts including a profit and loss account and balance sheet;
  • last set of audited accounts;
  • a detailed monthly cash flow forecast detailing the proposed repayments to the RPO and, if showing a deficit in excess of any finance facilities, how the business intends to manage the deficit;
• evidence that other sources of finance have been explored; including approaches to directors and shareholders;
• evidence that the business has already exhausted other measures to raise the finance e.g. sale of assets, renegotiating terms with creditors, improved debt collection;
• copies of the last three months bank statements;
• full details, with supporting evidence, of the employees concerned. 

A lifeline for businesses

If an application is successful, the RPO offer an interest free loan which may be repayable over two years. 

Clearly businesses with significant numbers of long serving staff could see a dramatic improvement in their cash flow which, as part of a well thought-out restructuring plan, may prove to be the lifeline needed to turn the business around. 

Should you require our assistance with the evaluation and collation of information in making an application for funding from the RPO then do not hesitate to contact us. 

Caroline Stark is a senior manager at Mercer & Hole.  The views given in this blog are personal to the author, if you would like to discuss the contents of this blog in with Caroline you can call her on 01727 869141. 

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Modernisation and consolidation are the focus of The Insolvency (Amendment) (No. 3) Rules 2009, which are published in draft form by the Insolvency Service and are due to come into force on 6 April 2010.

Fortunately they are accompanied by a consolidated version of the Insolvency Rules 1986 showing tracked changes introduced by the "Modernisation Draft Rules". Also useful - and readable, at only 19 pages - is the Stakeholder Commentary.

There's a fair amount of detailed change for insolvency professionals to assimilate, but a few tasters from the Stakeholder Commentary are:

• The remuneration of office-holders may be set as a fixed amount instead of, or in addition to, a percentage of the value of property dealt with or a time charge. Remuneration may consist of a combination of any two, or all three, of these bases.
• Provision is made for an administrator or other qualified insolvency practitioner to be able to recover remuneration charged and expenses incurred before the formal start of the administration, of particular importance in what have become known as “pre-pack administrations”.
• One of the key facets of the modernisation reforms is to facilitate the delivery of documents electronically. With this in mind the amending Rules make a number of provisions facilitating the sending of documents by electronic means. The general principle found in Rules 12A.7 and 12A.10 is that documents may be delivered by electronic means provided that the recipient has consented and provides an electronic address.

The Insolvency Service notes:

• The Rules amendments have been prepared with the benefit of extensive stakeholder input and they are not issued now for further consultation, which would delay the delivery timetable. Instead, we are seeking comments concerning any errors or drafting difficulties that may be found within the draft Rules. Please note that the draft Rules being published here are currently under review with the Insolvency Rules Committee and therefore may be subject to some further revision.
• Any enquiries regarding the above should be directed towards Neil Ogilvie, Policy Unit, Area 5.7, 21 Bloomsbury Street, London WC1B 3QW; e-mail Neil.Ogilvie@insolvency.gsi.gov.uk

Chris Laughton is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Chris you can call him on 020 7353 1597.

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As you are probably aware, the HMRC Business Payment Support Service is responsible for running the Time to Pay Scheme to assist businesses with temporary cash flow difficulties. It is rumoured that the fast track service may be closed by the end of this year, although there is no suggestion that the Time To Pay scheme is due to be scrapped altogether.

On speaking direct to the BPSS they have advised that their service was only a temporary line and they were unable to advise for how much longer they would remain open.

If I receive any further information on this matter I will advise accordingly.

Steve Smith is a Restructuring & Insolvency partner at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this post with Steve you can call him on 01727 869141.

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Under s212 of the Insolvency Act 1986, Liquidators have the power to pursue compensation from directors who breach their fiduciary duties to the Company.

In the recent case of E D Games Limited [2009] EWHC 223 (Ch), the liquidators brought such a claim against the director. It resulted from his failure to submit VAT returns or pay VAT or any tax for a period of 22 months before the company went into liquidation. The liquidators claimed that the funds that should have been paid to HMRC in respect of VAT were used to fund the continued trading of the company beyond the point it would have otherwise ceased to trade. The continued trading generated a further loss to the company.

The director tried to claim that any losses were not the company's but the creditors' and he could not be held personally liable. The High Court held, however, that the liquidators' claim did support a basis from which, at least in principle, it could be shown that the director's breach of duty caused loss to the company and was, therefore, recoverable under s212.

The scope of this case is not limited to HMRC and the principle could apply to any creditor. It further supports the necessity of directors seeking advice as soon as possible from a licensed insolvency practitioner if they believe their company is in financial difficulty, in order to limit the risk of personal liability.

Caroline Stark is a senior manager at Mercer & Hole. The views given in this blog are personal to the author, if you would like to discuss the contents of this blog with Caroline you can call her on 01727 869141. 

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With effect from 1 October 2009, the maximum amount of a week’s pay for the purposes of calculating payments under the insolvency (and other) provisions of the Employment Rights Act 1996 is increased from £350 to £380.

The new rate also applies to the calculation of entitlement to redundancy payments.

The regular annual increase in February has been suspended for 2010, so the next increase in a week’s pay is now due in February 2011.

Caroline Stark is a senior manager at Mercer & Hole. The views given in this blog are personal to the author.

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The 35 year long liquidation of Apal is finally completed, a tour operator that went bust in 1974 after the collapse of the Israel-British Bank. The case involved complex loans and lengthy legal actions outside the UK. 

The creditors, totalling more than 500, comprised holiday makers, airlines and hotels. They were paid a total of 74p in the pound; the first of seven dividends was paid in the 1970s and the final dividend was paid in August 2009.

As the recent cases of Lehman Brothers, Bernard Madoff and Allan Stamford undoubtedly involve many complex issues, will any of these last longer than the 35 years of Apal?

Caroline Stark is a senior manager at Mercer & Hole. The views given in this blog are personal to the author.

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What is a statutory demand?

A statutory demand is a formal written request from a creditor for the payment of an unsecured debt due to it within a period of 21 days from the date of service of the demand. 

If you are a creditor, this can be a useful tool for you to pursue your debtors for their outstanding balances. However, if a statutory demand is served on your company for an unpaid debt, it can have significant implications for both the company and you personally if you are a director and/or shareholder. Similar provisions apply for personal debt which could lead to personal bankruptcy.

What are the implications of a statutory demand?

Provided the debt is greater than £750 (or, if the debt is disputed, the undisputed element of the debt is greater than £750), if the debt is not paid within 21 days, then the creditor may present a petition to Court to wind-up the company.

Under UK insolvency legislation, where a statutory demand has been served on a company, failure by that company to pay a debt which is not disputed is evidence of insolvency and the Court will issue a winding-up order for the compulsory liquidation of the company. The company’s business and assets will initially be taken under the control of the Official Receiver and your powers as director of the company will be suspended.

As director, your conduct and management of the company will be considered to establish whether you are fit to act as a director in the future. The liquidator will also consider historical events, including any disposals of company assets or distributions to shareholders, to establish whether any of these events should be overturned and the assets/funds returned to the company for the benefit of its creditors. The liquidator will also consider whether, as a director, you continued to trade the company at a time when it was insolvent to the detriment of the company’s creditors. Actions can be brought against you personally for all of these events and can result in the liquidator seeking a recovery from your personal assets.

My company has received a statutory demand, how do I deal with it?

If your company is served with a statutory demand, you must act promptly to avoid the creditor being able to petition for the company’s liquidation. Further proceedings can be prevented by the following actions:

• pay the full amount immediately or reduce the debt to below £750 within 21 days
• negotiate with the creditor to reach agreement over a settlement figure, or agree payment instalments
• apply to the Court to have the statutory demand set aside.

You should take all threats of a statutory demand seriously as you cannot be certain of the creditor’s intentions and whether they will ultimately petition for the liquidation of your company. 

Can I have a statutory demand set aside?

You can apply to have a statutory demand set aside when there is a genuine dispute about whether the debt exists. Further information is available from the Insolvency Service website at www.insolvency.gov.uk.

If you or your company are currently suffering financial difficulties, by contacting an Insolvency Practitioner at early stage you can receive advice regarding the options available to you which could assist in the turnaround of your business, and the avoidance of formal insolvency proceedings.

Please contact one of our Restructuring & Insolvency partners if you require any further information or assistance in connection with this or any other insolvency matter.

 

Deborah Hart is a manager at Mercer & Hole. The views given in this blog are personal to the author.

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As the UK economy begins, in late 2009, to recover from the harshest recession in 75 years, insolvency is becoming somewhat more prevalent than has been the long term experience of most of us. The few high profile administrations such as Lehman and Woolworths are likely to be followed by many ordinary smaller businesses encountering formal insolvency procedures. Formal insolvencies tend to lag on economic recovery because of reluctance to invoke them and the time it can sometimes take to do so.

Now is therefore an ideal time to remind you about corporate insolvency and this is the first of a series of posts to do so.

Definitions

The word insolvency can be used either in a general sense to identify a company’s illiquidity or over-indebtedness (technical insolvency), or more specifically to identify a company subject to a formal insolvency procedure (formal insolvency).

Technical insolvency is most simply identified using the terms of s123 Insolvency Act 1986 ("IA86"):

• ‘the company is unable to pay its debts as they fall due’ (illiquid – the cashflow test); or
• ‘the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities’ (over-indebted – the balance sheet test).

Classic evidence of the cashflow test being failed includes creditors having issued writs or statutory demands and late payment of PAYE and VAT.

Realisation that the balance sheet test includes contingent and prospective liabilities often puzzles directors because so many companies do fail that test, but it is the case that prospective and contingent liabilities are taken into account when assessing a company’s technical insolvency.

Of course, failure of one of the two tests does not immediately lead to adverse practical consequences or penalties. This is in contrast to some jurisdictions, such as Germany, where it is a criminal offence for directors not to instigate formal insolvency proceedings within three weeks of failing similar illiquidity and over- indebtedness tests. In the UK it is more helpful to consider the concept of the ‘zone of insolvency’.

A distressed company may move into insolvency but with a ‘reasonable prospect of avoiding insolvent liquidation’.

This paraphrase of part of s214 IA86 (the section that deals with wrongful trading) allows for the taking of a somewhat longer view than under the German system. It is not, however, a view without risk. Even if there had been a long period during which there was a reasonable prospect of avoiding insolvent liquidation, followed by a calamity that caused liquidation, the company will have been technically insolvent from the moment it failed either the cashflow test or the balance sheet test.

One consequence of technical insolvency is that it determines whether transactions entered into by the company are at risk of being overturned under insolvency legislation relating to antecedent transactions such as transactions at an undervalue (s238 IA86) and preferences (s239). In order for an administrator or a liquidator to be able realistically to take court action to overturn a transaction at an undervalue or a preference, the company must have been in the zone of insolvency at the time of the transaction.

However, the section that more clearly focuses directors’ minds on the zone of insolvency is s214. Wrongful trading – incurring losses when a director ‘knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation’ can lead to the court declaring that the director is personally liable for the amount the court orders to be paid. That amount is likely to reflect the losses suffered by creditors during the period of wrongful trading.

The practicalities of technical insolvency are that:

•  it can lead to formal insolvency;
• it introduces additional risks, notably for the directors personally, at a time when the company is already stressed; and
• the onset of technical insolvency is an ideal time – perhaps even the best time – for a company to take specialist insolvency advice.

Case Study

In July 2007 I was consulted by an AIM listed company whose directors where concerned about its financial position. Since then I have advised the board many times about the risks they face and whether they have a reasonable prospect of avoiding insolvent liquidation. At times there has been a gap of several months between consultations and at times we have spoken every few days. The company remains in the zone of insolvency but it currently has a reasonable prospect of avoiding insolvent liquidation and it is less illiquid and less over-indebted than when I was first consulted. It has achieved this through enhancing its profitability and attracting investment. As a start-up company in a relatively new sector it has already become a market leader although it has yet to break even. If it were to stumble and fall into formal insolvency, it seems to me unlikely that the directors would be at significant risk of a wrongful trading action. Also, for the last two years they have been aware that any transactions at an undervalue or preferences could be overturned in the event of formal insolvency – but I am not aware of there having been any such transactions!

Look out for Part 2, which will explain how best to avoid formal insolvency despite failing the technical insolvency tests.

Chris Laughton is a partner at Mercer & Hole. The views given in this blog are personal to the author.

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There has been a marked rise in the number of Director Disqualification Proceedings being issued by the Insolvency Service. In the year to 31 March 2009 the total number of companies targeted was 1,079 by comparison to 820 in the previous year, an increase of some 31%. Whilst these numbers relate to companies, the number of directors being targeted is significantly greater at 1,852*.

Given the recent increase in the number of companies entering into liquidation and administration, these numbers can only be expected to increase in the coming months ahead.

Companies are targeted where there is evidence that one or more of the directors have been involved in activities which suggest those involved are not fit to continue to act as a director.

The Insolvency Service considers the specific involvement of each director when considering prosecutions. Directors who fail to react to misconduct by fellow directors and those who take no part in the management of the company are also liable to prosecution. A successful prosecution can result in individuals being barred from acting as a director for a period from two to fifteen years.

Historically the most common reason for disqualification proceedings being brought relates to directors who use PAYE/NI contributions deducted from employee wages and VAT to fund their business. Many companies have taken advantage of the HMRC deferred payment arrangements; a scheme initiated by the Government in November 2008. Company failures, before completing a deferred settlement plan, are bound to result in the director’s conduct coming under greater scrutiny, resulting inevitably in an increase in the potential for director disqualification.

Other areas which commonly lead to disqualification proceedings include the failure to keep proper accounting records and entering into transactions which are to the detriment of the company.

The recession and cash flow pressures will undoubtedly force further companies into insolvency so it is important that the actions and decisions of management are fully documented where the decision is to continue to trade and, if there is no reasonable prospect of a turnaround or recovery, the directors of insolvent companies should take immediate advice on the cessation of operations.

* Research by Wedlake Bell, 2009

Peter Godfrey-Evans is a partner at Mercer & Hole. The views given in this blog are personal to the author.

 

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Speaking on corporate insolvency at the Chartered Institute of Taxation autumn conference yesterday, I uncovered some interesting points about HM Revenue & Customs’ current attitude to distressed businesses and insolvency.

·        most tax advisors are finding that HMRC is less willing now than over the last 9 – 12 months to facilitate business cashflow problems by agreeing to defer tax payments;
 

·        one senior tax advisor suggested that although there has been no recent policy or strategy change, HMRC is worried that it may have been encouraging wrongful trading in companies that end up going into liquidation despite its forbearance;
 

·        HMRC’s underlying position remains that, despite supporting the rescue culture, its role is to collect taxes and it is reluctant to agree to insolvency solutions involving creditors (including HMRC) writing off significant debt; and
 

·        an insolvency practitioner (who I hope could withstand regulatory scrutiny and who is not from Mercer & Hole!) had suggested to one tax advisor that HMRC would not bother to pursue a £60k tax debt being left unpaid when a company’s business and assets were sold back to the director-shareholders through a pre-pack administration with all the trade creditors being paid in full.
 

What is your experience of HMRC supporting business rescue, either outside or within formal insolvency procedures?

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The controversy surrounding Sir Allen Stanford has reached the Royal Courts of Justice. Both the Antiguan liquidator of Stanford International Bank Limited and the US receiver appointed over its assets sought recognition in the UK under The Cross Border Insolvency Regulations 2006. Both sought to be recognised as the foreign representative in foreign main proceedings.

Lewison J noted on 3 July 2009 that “the apparent lack of co-operation between them has resulted in an expensive application at the creditors’ expense.”

The judgement makes clear that The Cross Border Insolvency Regulations 2006, which were of course founded on the UNCITRAL Model Law, are closely tied to the EC Insolvency Regulation, particularly in relation to COMI.

“In my judgement it is a reasonable inference that the intention of the framers of the model law was that COMI in the Model Law would bear the same meanings as in the Regulation since it “corresponds” to the formulation in the EC Regulation.”

The judgement also considered Eurofood on the basis that Lewison J did not need to decide whether he was strictly bound to follow it but the parties agreed that he should do so. He went on to analyse application of the Head Office functions test and the presumption in favour of COMI coinciding with a company’s registered office, disapproving of his own previous judgement in Lennox Holdings, and concluding that the decision in ReCi4net.com Inc, to the effect that the location of the registered office is no more than a factor to be considered was also no longer be followed.

Interestingly, in relation to the presumption, Lewison J distinguishes between the US implementation of the law as Chapter 15 and The Cross Border Insolvency Regulations 2006. In Chapter 15 the registered office is presumed to be the debtors’ COMI in the absence of evidence to the contrary, whereas in The Cross Border Insolvency Regulations 2006, the debtor’s registered office is presumed to be the COMI is absence of proof to the contrary. 

Lewison J notes

“this change of language of the enactment, as it seems to me, may well explain   why the jurisprudence of the American courts has diverged from that of the ECJ”.

As a final point, having decided that the COMI of Stanford International Bank Limited was in Antigua, Lewison J decided that the powers and duties conferred or imposed on the receiver did not amount to a ‘foreign proceeding’ and that the receivership cannot be recognised under The Cross-Border insolvency Regulations 2006.

All in all an innings defeat of the US Receiver by the Antiguan liquidators!

The full judgement is available at http://www.bailii.org/ew/cases/EWHC/Ch/2009/1441.html. 

 Chris Laughton is a partner at Mercer & Hole. The views given in this blog are personal to the author.

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Whether the terms of a CVA are fair and sensible has a bearing on their meaning, according to the Court of Appeal in Re Energy Holdings (No 3) Ltd (in liquidation) [2009] EWCA Civ 173 CA.

The EH3 proposals included the following term at para 23.5:

"Claim Forms must be lodged with the CVA Supervisors of the relevant CVA Company on or before the Claims Date. If a Claim Form is lodged after the Claims Date, a CVA Claim will not rank for Distributions unless the CVA Supervisors of the relevant CVA Company or the Court determines either that the failure to lodge the Claim Form earlier did not result from a wilful default or lack of reasonable diligence on the part of the CVA Creditor, or that the CVA Creditor:

(a) did not have notice of the Creditors' Meeting of the relevant CVA Company; and

(b) within 28 days of becoming aware that the Creditors' Meeting of the relevant CVA Company had taken place it lodged its Claim Form with the CVA Supervisors."

At first sight you may very well think that a creditor who did not have notice and did not make a claim within 28 days of becoming aware of the creditors' meeting cannot be entitled to a distribution.

However, this construction creates an anomaly in that a creditor with notice has 45 days to claim (para 4.2), but a creditor who has no notice and becomes aware of the meeting the day after it took place would have to submit his claim within 29 days of the meeting.

The judgement examines the CVA terms' construction in detail and supports the view of the creditor in question, Gold Fields Mining LLC ("GFM"), with Mummery LJ concluding:

"In sum, the Supervisors' suggested construction of paragraph 23.5 as imposing an absolute bar on claim forms lodged by a creditor without notice more than 28 days after becoming aware of the creditors' meeting is (a) conceded not to be absolute in practice and (b) makes less than absolute sense. Like the Chancellor I prefer GFM's construction: it fits more comfortably into the scheme, structure and language of the paragraph and it makes good sense."

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When is an administrator not an administrator?

The facts:

An administrator appointed by a qualifying floating charge holder discovers that the purportedly qualifying floating charge is "invalid" under s245 Insolvency Act 1986, in that the consideration for the charge was given by the creditor before the charge was created, at which time the company was unable to pay its debts within the meaning of s123.

The questions:

(a) Is the administrator's appointment therefore invalid and (b) what should he do?

The issues:

(a) Since s245(2) is triggered retrospectively by the definitions of "relevant time" (s245(3)) and "onset of insolvency" (s245(5)), and the onset of insolvency in this case is the appointment of the administrator, there is a "scintalla of time" argument that the charge does not become invalid until the administrator is appointed, by which time he has been appointed under a (then) valid charge, his appointment was therefore valid and it remains unaffected by the charge's subsequent invalidity.

Alternatively, and on the face of it more pragmatically, there could never be a valid administration appointment within the 12 month (or two year) relevant time period because that was the clear intention of the legislation, an appointment by a floating charge holder that was not a "qualifying" floating charge holder by reason of the charge's invalidity is itself invalid, and an invalid appointment is sufficient to trigger the relevant time and to give the administrator the locus to apply for directions.

(b) Should the administrator plough on, seek directions or just walk away from the nullity?

Some answers:

1. the administrator's appointment is invalid and he should seek directions, which might include a declaration from the court declaring the appointment to be invalid and an order that the administrator be indemnified by the appointor. This is arguably the safest route for the administrator and a proper course to bring the matter to the court's attention. Since the whole matter is uncertain, it must be right for the (purported) administrator as (or in case he is) an officer of the court to bring the matter to the court's attention in this way. A separate administration application can then be made, possibly retrospectively to the time of the original, invalid appointment; or  
2. on the scintilla of time argument, the administrator's appointment was valid at the time he was appointed and he should just carry on. This might avoid a creditor or the directors having to make a fresh administration application, but there is a risk that someone might view the position differently and challenge the administrator's actions. If the court is not wholly persuaded by the scintilla of time argument, such a challenge might find favour with the court, with adverse cost and liability implications for the administrator; or
3. the whole appointment was a nullity and the purported administrator is not in a position to do anything, even make an application to the court, as the company is not subject to any insolvency proceedings.

Observations:

I have recently followed answer (1) in an unreported case, but I am aware of other cases where different Counsel advised along the lines of each of answers (2) and (3).

What is your view? Is it useful to have a precedent of seeking directions or is it preferable to retain the flexibility of being able to plough on in cases where there is little prospect of challenge? Is there a real prospect of the court declining to entertain a directions application from an administrator in these circumstances?

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1. Cash Control is Key

• Make sure you are aware of all aspects of your current financial position. Sticking your head in the sand and hoping it will all fix itself is never going to be constructive.
• Budget, forecast and review frequently; the sooner you know something is not quite right, the sooner you can take corrective action and minimise the harm to your business.
• Ensure you have an effective credit control process which closely manages debtors and receivables. Remember that you can always renegotiate credit terms if necessary.

2. Proper Preparation Prevents Poor Performance

• Research your market thoroughly so you know your place in relation to your competitors, pricing, marketing and objectives.
• Plan both short-term and long-term achievable objectives. Remember to monitor your progress in relation to your plan, updating it if necessary and providing feedback to staff and other stakeholders if appropriate.
• Think to the future and ensure that any retention of title clauses in your terms of trading are sufficiently drafted to secure your proprietary interest and protect yourself if a debtor becomes insolvent. 

3. Think Outside the Box

• In uncertain times the rules have to be adapted to achieve the best results and slightly less conventional methods of raising finance, such as asset-based lending, may offer viable solutions. Ensure you’ve considered all the options and evaluate which best suits your goals.
• It’s very easy to get caught up thinking about the welfare and activities of your own company but don’t forget to consider the wider environment and potential risks from external sources such as suppliers.

4. Be Proactive 

• If your cash flow becomes problematic, speak to creditors early and try and initiate informalarrangements to defer payment temporarily.
• If a debtor enters insolvency proceedings, make a claim as soon as possible and inform the appointed insolvency practitioner so that you are kept informed and can participate in the process where possible.
• If you think you’re at risk of becoming insolvent, contact an insolvency practitioner as soon as possible so you can take advice on saving the business, minimising liabilities and maximising returns to creditors.

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A landlord has no automatic right to be paid rent as an administration expense and, as regards rent falling due after the date of the administration order, the landlord is an unsecured creditor of the tenant company.

In case there had been any doubt after the Trident Fashions case, where business rates were found to be an administration expense and some commentators suggested, by analogy, that rent would be treated similarly, Innovate Logistics Ltd v Sunberry Properties Ltd [2008] EWCA Civ 1321 (18 November 2008) clarifies the position.

It does not mean that a company can occupy premises rent free after administration, but the court will exercise its discretion in considering whether to allow the landlord to override the statutory administration moratorium according to the guidance in Re Atlantic Computer Systems plc.

That guidance illustrates that significant financial loss to the landlord in the event of the landlord not being able to enforce his proprietory rights could be outweighed by loss to the creditors in the event that occupation of the premises came to an end.

Accordingly, in practice, the administrator and the landlord will need to consider the balancing exercise the court would undertake, and some payment - perhaps even the full amount of the rent due - may have to be made, effectively as a ransom payment in respect of the landlord's unsecured claim.

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You may remember an earlier post Liquidation and bankruptcy petition dangers, where I highlighted a legal decision emphasising that a petition is not to be used to pressurise a debtor into paying one creditor.

Ruth has asked about how to deal with this situation in practice:

Can I get an emergency injunction to prevent a supplier who is abusing process petitioning for my bankruptcy over a disputed debt? I sent them a cheque with a letter stating it was in full and final settlement of the debt and the supplier banked the cheque. Now they are saying I still owe the balance and have taken out a bankruptcy petition. I don't want it to get publiciced or it will damage my reputation. Can I stop them with an injunction?

Unlike company winding-up petitions, bankruptcy petitions are not normally advertised, but what are your suggestions or observations? Please comment below.

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Pre-pack administrations, where the business of an insolvent company is sold as soon as the administrators are appointed, often to the company's management or shareholders, are under scrutiny.

• The Business and Enterprise Select Committee (Chairman - Peter Luff MP) examined the issue when Stephen Speed, the head of the government's Insolvency Service, appeared to be questioned on 27 January (video here - see 38mins 50secs).
• BBC Radio 4's File on Four recently illustrated creditors' concerns about companies in the printing and retail industries where pre-packs had occurred (transcript here).
• BBC 2's Newsnight is shortly also to explore the sales of assets to failed companies' directors or their associates through pre-pack administrations.
• Press articles frequently refer to the effect of insolvencies on creditors and report surprise that businesses can be allowed apparently to continue after dumping creditors.

Two separate issues should not be confused.

Firstly, creditors suffer financial loss in an insolvency because the company has failed. The pain may feel worse if the management thought to be responsible for the loss appears somehow to benefit. But the fact remains that it is the company failure that causes the loss.

Secondly, insolvency procedures operate in the interests of creditors. Of course they must work properly to produce the best result, but that is why insolvency practitioners are highly trained, licensed, strictly regulated and, as officers of the courts, obliged to act properly. Insolvency is a complex process where a highly specialised area of law confronts commercial reality. Explanation is therefore crucial and the regulators emphasise transparency, for example in Statement of Insolvency Practice ("SIP") 16  "Pre-packaged Sales in Administrations", which came into effect for adminstrators appointed after 1 January 2009.

Until the recession, few people in business felt the need to think about insolvency, but understanding the insolvency process and its safeguards may help creditors appreciate that the procedures and the practitioners really do act in the interests of the creditors.

How can it be right that the directors appoint the administrator to sell the assets back to them?

The administrator acts for and has his remuneration fixed by the creditors. Of course he may have been introduced by the directors, but they have a legal obligation to call in an insolvency practitioner as soon as it becomes necessary.

Why were the assets sold so cheaply?

The administrator's job is to get the best result for the creditors (if the company can't be saved). One of his skills is selling distressed businesses and assets. Sometimes there may have been no obvious marketing, in which case the administrator will have commissioned an independent valuation and taken specialist professional advice to get the best deal.

At the time of the pre-pack sale (or shortly afterwards when they find out about it), creditors may not know enough about the precise circumstances to make a fully informed judgement, which is why the administrator is required by SIP 16 to explain the sale to creditors as soon as practicable. Ideally they should learn about it from the administrator immediately, with a full explanation so that even if not pleased about their losses, they are at least satisfied that the insolvency procedure is achieving the best recovery.

What if I'm not convinced it was the best deal?

Remember that it must be the best result for all creditors, including some who may have different interests; but, if you're not satisfied, engage in the process.

Talk to the administrator - if you know something he doesn't, he'll want to hear from you.

Raise your concerns at the creditors' meeting - other creditors may share your views or could have a different perspective.

To be involved in monitoring the administration and assisting the administrator to get the best result for creditors, get yourself elected onto the creditors' committee, but be aware that your duties there will be to act in the interests of all creditors rather than just yourself or an interest group.

It may be possible to nominate another insolvency practitioner to be liquidator once the administration ends, for an independent professional review of the administration. If not, and you still have concerns, you should consider seeking specific advice from an insolvency practitioner or insolvency lawyer on other remedies such as applying to court.

If you think the administrator has done something wrong you may want to complain to his regulator (the administrator has to tell you who that is - there are several), but that is more likely to lead to sanctions against the administrator than to things being put right in your particular case.

Why should the directors get away with it?

Buying a business from an administrator isn't itself a bad thing. But if you know of impropriety that went on before the administration, tell the administrator. He can then take any necessary action for the benefit of the creditors.

Are pre-packs a good thing?

Independent research into pre-packs by Dr Sandra Frisby of Nottingham University has established that in over 90% of pre-packs all the jobs in the business are saved, compared to only about 60% in other insolvency business sales.

There is no evidence that returns to unsecured creditors are better in pre-packs than in those administrations where the administrator secures funding to allow the company to continue to trade for a period while he markets and sells the business. Pre-packs can, however, reduce the risk of value destruction as a result of the insolvency process; they often realise more than simple liquidation; and they almost invariably cost less than a period of trading followed by a business sale.

The crucial point though is that in any particular case, the insolvency practitioner has to get the best result for the creditors as a whole. There is no evidence that this is not happening in the vast majority of cases. If the administrator has chosen to use a pre-pack it is because he believes that it is in the best interests of the creditors as a whole that he should do so.

Once the administrator has been appointed, the creditors' money has already been lost; and if the alternative is worse, using a pre-pack is undoubtedly a good thing.

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While the recession will undoubtedly hurt a good many people, those (albeit relatively few) private investors and buyers of businesses who have ready cash to invest stand to make handsome profits as they take advantage of increased opportunities to buy 'undervalued' businesses.

For them, choices as to which investment to make, how to make that investment, and timing will be key. Of these three key decisions, the 'how' requires closest professional support, and this article considers some of the issues shrewd investors should consider.

Buying an insolvent business is very different from buying a solvent one

• Insolvent and unprofitable businesses often have significant hidden costs that can come back, often several years later, to haunt the buyer. The list of such potential costs is long, but typically includes unrecorded customer disputes; underutilised assets to which excessive liabilities are attached; unprofitable products or services where there are significant discontinuation costs; unrecognised tax liabilities, such as on misreported director drawings; and contingent exposure under property leases. The full list goes on and on!
• Investors are generally unable to call on indemnities for such costs from the owners or management of the business or any insolvency practitioner dealing with the company.
• Restoring a business to profitability often has significant cost implications. If it didn't, the current owners of the business would probably have already done it.

This means that buyers of, or investors in, insolvent businesses should: 

Assess the level of risk in their investment

It is essential that a thorough due diligence is done, whichever acquisition route is followed - Investors truly have to fully understand the business, not just the potential for greater upsides but also the potential for significant downsides. Investors should not rely on assurances or warranties given by the directors or owners of the business - it is in their interests to say what they think the investor wants to hear in order to get the deal through. In practice directors almost always understate the issues investors may have with the business.
 

Make sure that the risk involved is reflected in the price paid and in the way that the purchase is structured

Investors should always allow themselves some considerable margin for error - in practice nothing works out as well as they would hope when it comes to buying an underperforming business. As the issue of of the structure of the deal is so important, the remainder of this article will focus on some of the key issues we see time and time again.

Structure of the investment

Ask yourself these questions:

1. Should I be buying the shares in the company or the business and assets?

There is nothing to stop investors buying the shares of an insolvent company, the investor will simply have to restore it to solvency by pumping more cash in, typically by increasing the share capital. However the main drawback to any such 'share deal' is that not only does the investor take on the known insolvent position of the business and thus all of its recorded debts, they also take on any unrecorded and unascertained debts. At the time of the deal most investors simply have no real idea what hidden liabilities may or may not lie in the business.

If a business and asset purchase is the route to be taken, the investor takes on only those liabilities that they agree to take on or by law have to take on. It is not unusual for a purchaser to take on debts owed to key suppliers in order to maintain important trading relationships. Other liabilities, such as certain employee liabilities under TUPE, cannot be avoided by law: the investor has to take them on. Such a 'business and asset deal' can give the investor more certainty as to what they are taking on than a share deal - but this is no reason to limit the due diligence exercise, investors should still search out potential liabilities they may be forced to take on at a later date for commercial if not legal reasons.

There can sometimes be advantages to buying the company's shares. For example there is a much easier transition to the new management - all pre-existing contracts, such as with suppliers, customers, finance companies, etc remain in place. Yet again, investors should review all such contracts as part of their due diligence, as some may contain termination provisions, or require pre-existing guarantees to be replaced should there be a change of ownership. Again, it is a case of the investor understanding exactly what they are taking on.

Serial investors often have a model route for buying into businesses. These models do not always fit the specific circumstances of the target business: it is important that both sides recognise that fit is important.

2. Do I really want all of the business?

Often purchasers want to cherry pick, taking the best bits of the business while leaving someone else, either the existing management or an insolvency practitioner, to clear up the parts they do not want.

There are several issues here. Leaving the clearing up of the unwanted remnants of the business can be a diversion of precious management time post acquisition. Management have difficulty valuing the 'best bits' and often wish to distance themselves from the sale process in order to avoid any accusations of having somehow benefited unfairly from the sale - management may prefer the deal to be completed by an insolvency practitioner because he, unlike the directors, has no long term interest in the outcome, and he will, in employing his own valuer to value the business, be able better to explain the rationale for the deal to suppliers and other creditors. Completing a sale through an insolvency practitioner can not only protect the directors from criticism that in some way they failed to comply with their duties, including those under the Insolvency Act 1986 and Companies Act 2006, but can also simplify the overall scheme. And, as you will see later on in this article, it can also save the investor money.

3. Should I defer some or all of the purchase consideration?

Deferring part of the price paid, particularly if the sum is dependent on trading results achieved post acquisition, will reduces investors' risk. As typically vendors look to maximise what they receive in certain cash on day one, the vendor's and purchaser's preferred outcomes can be poles apart.

Another option is to introduce cash into the business on a secured basis, rather than as share capital or unsecured loan. There are several implications of this should the company go into formal insolvency sometime later on: make sure that you discuss your options with the appropriate professionals beforehand.

If the business is insolvent and in need of a cash injection, the investor is often helping the vendor 'avoid' potential exposure to the bank under personal guarantees. Most investors like to see some input from the vendor post acquisition if only in making introductions to customers and suppliers. Under these circumstances, it is not unreasonable for you to defer some, if not much, of the purchase price as arguably the shares have little or no value at the time when you release your cash and deferring payment will secure the vendor's cooperation.

4. Have I explored the tax consequences?

If an investor buys the shares in the company and it has tax losses, the losses can be used going forward, against profits of the same business. If the assets are bought instead, the benefit of such tax losses are often lost.

Take advice from a tax specialist as this is very much a simplification of a much more complicated situation.

5. What are the true costs of this purchase?

Putting the company into a formal insolvency process and buying the business and assets from an insolvency practitioner can enable potential investors to reduce the working capital requirement of the business and thus the amount of cash they need to invest. In the right circumstances a 'Pre-pack', where the insolvency practitioner completes a sale of the business and assets immediately after his appointment, may be the best way to put the business on a soundest possible footing going forward, but here too there are further issues, with pre-packs coming under ever greater scrutiny.

Stop, think and plan

In summary, shrewd investors considering buying an underperforming or insolvent business, will stop, think, and then re-assess exactly what they intend doing and how before committing. That way they will maximise the profits from, and reduce their risk on, the increasing number of opportunities they will surely get as the Recession bites deeper.

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For most businesses, the next year or so will be a time of battening down the hatches as they see their profits squeezed, their cash flows under increasing pressure, and the banks not as 'profligate' as they were before.   The companies that manage to trade through this period will find most of the answers lying within, rather than outside, the business.  For them, cash will be 'King', all thoughts of growing market share or maintaining profitability will be sidelined as the focus is placed firmly on a survival of the (cash) fittest.  

• Cut out all non-essential expenditure.  Do it now, do not defer it for another day.  Be brutal, assume that the sector will not recover quickly, if at all.  If you have cut too deeply, you can probably repair things later on.  If you do not cut deeply enough, you could die 'a death of a thousand cuts' , others  on whom you may need to rely later for support will view your management skills as weak.
• Recognise where your commercial muscle lies, and then fully utilise it.  This can be on the supply side (typically) or sales side (less often).  Use your muscle to obtain longer payment terms from your suppliers.  They will not want to see you reduce your spend or go out of business.  Use your muscle to secure earlier payment from your customers.  They may need your prompt service or wish to see you reduce your prices to help them survive.  Be flexible, do what is necessary in the short to medium term.
• Reduce your fixed costs (those that you have to pay regardless of how busy you are) and increase the proportion of variable costs that you have.  Examples of this include taking on temporary rather than permanent staff.  Changing your cost base to one that is more resilient to unforeseen changes in activity levels will increase the chances of you surviving the battle of the fittest. 
• Keep on good terms with your bank and HM Revenue & Customs.  The bank's view is often that as the largest single investor in your business, you should have more regard to their interests than others'.  HMRC's view is that, as an 'involuntary' creditor, any ' investment' in your business is probably too much.  Don't rely on getting better terms from either, expect both to cut a hard bargain.  But be fair with them and recognise their views, and they will probably be fair with you.
• Cut your own outgoings.  You will not encourage others to work with you and support you if they do not see you hurting too.                     

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A new special insolvency procedure for investment firms that hold client assets or client money is to be introduced in response to issues arising in the administration of the UK subsidiary of Lehman Brothers.

A review of the insolvency arrangements for these investment firms will by the summer of 2009 consider:

• the precise definition of the firms to which the new procedure should apply;
• the treatment of unencumbered client money and client assets;
• the treatment of client money and client assets which have been posted as collateral;
• arrangements to enable a temporary continuation of brokerage activities (including the matching of unsettled trades); and
• how the insolvency procedure would work and what the objectives for the new procedure should be.

Following the review, there will be full formal consultation on the draft secondary legislation, in line with normal legislative procedure.

 

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Credit is hard to find and, with global recession looming, businesses face many new challenges. The solution is to develop sensible, cost effective and tax efficient restructuring plans.

Cash flow and business viability are key and should be uppermost in your mind when considering restructuring options and strategy. Falling turnover, pressure on margins and limited cash resources require a tightening of belts and a speedy withdrawal from those business ventures that have a long lead time to profitability, or otherwise drain the business of cash. Identifying such parts of the business is usually quite easy, but downsizing or eliminating them can be extremely challenging.

A good restructuring plan begins with an in-depth review of the business operations and an understanding of what drives costs, profits and cash flow. After analysing the business model and its structure you should consider the restructuring options available, taking into account relevant commercial and legal constraints effecting the business operations and its cash resource.

Restructuring a business is likely to involve the removal of financial burdens that may include the cost of premises, employees, unprofitable contracts, or loss-making subsidiary companies or operations. The legal mechanisms for dealing with these will be different in each case and may involve compromising debt through a company voluntary arrangement or via an administration, or even liquidation. The need for an insolvency process will depend upon whether the company, group or business requires protection from its creditors while a restructuring plan is put in place.

The main focus is to establish a restructuring plan that saves jobs, goodwill and business infrastructure, retaining value to the business wherever commercially and sensibly possible. Business restructuring can be painful, impacting upon the many stakeholders who have supported the business over the years, but this pain should be short-lived. Restructuring an operation into a viable, more streamlined and profitable business will provide opportunities for most of those stakeholders already involved; without restructuring they would get nothing.

None of this can you do alone. You need an adviser with experience and expertise in developing the most appropriate restructuring plan for a business facing either a need to downsize or financial distress. They will analyse and consider restructuring and refinancing options, with or without an insolvency process, introducing funders and investors where necessary.

When we at Mercer & Hole are asked to advise in these circumstances, we analyse with clients the requirements and consequences of a restructuring plan and endeavour to ensure that its implementation is as effective and painless as commercially possible.

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It depends on:

• how early you react to deal with the problem;
• whether any part of the business is able to continue as a going concern; and
• what workforce is required for that business (remembering that a purchaser may have some positions already covered).

The result can vary:

• no material change if insolvency can be averted quickly;
• some redundancies as part of an operational turnaround, again whilst avoiding formal insolvency; or
• if an insolvency procedure is necessary:
  • some or all of the workforce may be made redundant (leading to enhanced pre-insolvency claims);
  • pre-insolvency claims may receive anything between the modest state-guaranteed limits and full payment; and
  • wages and salaries for employment during insolvency should be paid in full.

This is a highly complex area of insolvency law and practice. Further background reading is available here from Business Link and here from The Insolvency Service.

There is no substitute for consulting a specialist, whose advice will be tailored to your specific circumstances. Most licensed insolvency practitioners, including those at Mercer & Hole, will consider the position with you at an initial meeting without charge.

 

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Q: I want to buy a business that’s about to go bust. Do I have to pay the claims of its employees?

A: It depends on:

• what you buy (assets alone or a business);
• the type of insolvency procedure (was it “instituted with a view to the liquidation of the assets of the transferor”?).

The Transfer of Undertakings (Protection of Employees) Regulations 2006 (TUPE) generally mean that:

• employment obligations move to the purchaser when a business is transferred; and
• rights and obligations relating to employees who were dismissed in connection with the transfer are also transferred to the purchaser (unless the dismissal was for an economic, technical or organisational reason).

However, in an insolvency “instituted with a view to the liquidation of the assets of the transferor” these obligations do not automatically transfer to the purchaser.

A challenge is that most businesses are transferred using administration and the obligations probably do then transfer to the purchaser.

Other pitfalls are that even if you purport to buy assets alone and there are elements of business continuation (intellectual property transfer, some employees rehired, same product/customers etc), the Employment Tribunal may find that it was a business transfer.

Liquidation may not help business continuity, but it can help avoid employment liabilities for a purchaser.

Two conclusions:

• be prepared to factor the cost of employment liabilities into your price calculation; and
• make sure there’s an experienced insolvency adviser on your team early.

 

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The credit crunch is hitting mainland Europe, raising insolvency rates, according to Legal Week's recent article NautaDutilh launches 20-strong Benelux team.

Most UK insolvency practitioners felt the economy starting to bite in midsummer and all the signs here are that, despite the oil price receding, corporate insolvency will loom for many this autumn.

For some thoughts on avoiding insolvency, try our earlier post Find a Business Angel.

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The number of companies facing insolvent liquidation rose by 15% during the second quarter of 2008, as compared to the same period last year, as the credit crunch continues to impact upon the UK economy.

Figures from The Insolvency Service published on 1 August 2008 revealed that there were 3,560 compulsory liquidations and creditors' voluntary liquidations (CVLs) in England and Wales during the second quarter of 2008. This was made up of 1,324 compulsory liquidations, an increase of 19.8% on the previous quarter, and 2,236 CVLs, an increase of 7.3%.

Further evidence of an economic slowdown was highlighted by 1,246 other corporate insolvencies, comprising 177 receiverships, 938 administrations and 131 company voluntary arrangements, an increase of 63% compared to the same period last year.

These numbers support the findings of a recent survey (July 2008) undertaken by R3, the trade body for insolvency practitioners, which showed that 90% of respondents believed that a rise in business insolvencies would hit the UK in 12 months’ time, indicating that the worse is still to come.

The Insolvency Service figures support this survey and highlight retail, construction, property, leisure and manufacturing among the worst affected sectors as consumers rein in spending in the face of rising inflation rates and a deteriorating property market.

Offering his reaction to the latest statistics, Steve Smith, Head of Insolvency at Mercer & Hole comments: “These are very worrying figures and do not bode well for the UK corporate sector - particularly for small to medium-sized businesses which suffer most in a downturn. Of particular note is the rise in compulsory liquidation numbers which suggests that creditors are now seeking to recover their debts more aggressively as other forms of recovery become less effective.” 

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The number of individuals becoming insolvent fell 8.3% to 24,553 in the second quarter, surprising analysts who expected to see an increase as evidence that higher living costs were impacting upon people's finances.

Individual insolvencies were made up of 15,297 bankruptcies (down 6% on the same quarter a year ago) and 9,256 Individual Voluntary Arrangements (IVAs) (down 12%). Interestingly there was a pronounced shift towards debtors' petitioning for their own bankruptcy as, in the second quarter of 2008, 84% of bankruptcy orders were made on a debtor’s petition.

Nevertheless, we must look at these statistics with an element of caution as they may have been skewed by a rise in the number of people entering into informal debt management plans to try and head off insolvency.

Indeed, the decline in individual insolvencies is generally perceived to be a result of a reduction in the number of people entering into IVAs as lenders are more reluctant to accept IVAs and are imposing stricter terms. This has been fuelled by reports over the past year of banks raising their hurdle rates - the amount of money they are willing to accept from borrowers to settle their debts.

Steve Smith, Head of Insolvency at Mercer & Hole, comments: “Although the 'trickle down' effect of the credit crunch hasn’t truly hit personal insolvency figures, over the next 12 months the situation seems certain to deteriorate as consumers in the UK rein in their lifestyle borrowings. The downturn in the housing market, soaring commodity prices and the credit crunch will continue to take their toll.”

 

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The credit crunch has made it more important than ever for business owners to address
viability and solvency issues early. Delays in taking remedial steps now will only result in
more pain and fewer options, and will give you less time to act later on. 

Directors and managers concerned about their business should carry out an ongoing and in-depth assessment of the company, asking themselves the following five key questions:

1. Where can I improve cash generation or legitimately defer outgoings in order to
   improve the retention of cash in the company? 
2. Where are the main risks in the business? What would I do if I lost that valuable
   customer, or the bank were to withdraw its support? 
3. Are there any costs which can be moved from being ‘fixed’ to ‘variable’? 
4. Are there any areas of business that should be pruned back or sold? Is that
   person, department, service or product adding real value at this point in time? Can
   I afford to take a long term view without increasing risk? 
5. What can I do to cut my drawings from the business?

You need to be brutally honest with yourself. If you are at all unhappy with the
answers to these questions, you should re-assess all of your available options, which could
include restructuring the business using formal or informal routes. Now is not a good time to
defer that re-assessment.

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Under our previous post Permacell Finance: judgements affecting charge holders, commentators debated the then recent High Court case of Day v Haine, in which Sir Donald Rattee held that a protective award (for the employer's failure to consult on redundancies pursuant to s189 Trade Union and Labour Relations (Consolidation) Act 1992) made after the date of liquidation is not a provable debt.

The Court of Appeal has now reversed that decision - Haine v Secretary of State for Business Enterprise & Regulatory Reform & Anor [2008] EWCA Civ 626 (11 June 2008).

The Court of Appeal's approach was that this is not essentially an insolvency issue, but rather a matter of employment law in the particular context of an EU Directive. The focus of this purposive judgement appears to be on protection of the workforce through the discouragement of failure to consult by the levy of a financial penalty on the company; and there is sympathy for the Secretary of State

"to whom are transferred the workforce's rights under the 1992 Act [and who] has no means of recouping his expenditure from the employer by proving in the company's liquidation."

What is not explicitly recognised is that any such expenditure by the Secretary of State is limited by s186 Employment Rights Act 1996, whereby each employee's maximum entitlement from the Secretary of State for all employment debts is (currently) £330 per week for eight weeks.

Is it right that the financial penalty should fall largely on creditors (and partly on the Secretary of State) in an insolvency? How will that discourage directors of going concerns who might be tempted to avoid consultation?

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The time limits within which transactions at an undervalue can be upset under sections 238 and 339 of the Insolvency Act 1986 are reasonably well understood: 2 years for companies and 5 years for individuals.

Section 423, which deals with transactions at an undervalue that were intended to defraud creditors, is less straightforward. It requires proof of intention - a much more difficult hurdle than simple proof of facts - to upset a transaction successfully. And although there is no statutory time limit, historically the courts were reluctant to extend its reach too far. The recent case Sands v Clitheroe [2006] BPIR 1000 revisits these issues and great care is now required to avoid falling foul of s423.

The facts in the Sands case were that Mr Clitheroe, a practicing solicitor, gifted his interest in his home to his wife. At the time he was solvent and a partner in a fairly secure practice, but he effected the transfer in order to protect the family home in the event of the financial collapse of the partnership. After being made bankrupt 15 years later, and despite all of his creditors being "new", the court upset the transaction.

The court decided that where the intent of the transaction had been to put assets beyond creditors' reach, even though the debtor was not engaging in "risky business" and none of the bankruptcy debts existed at the time, the transaction fell within Section 423, for which there is no time limit. Notably, Section 423 applies equally to companies as to individuals.

The case shows that if a transaction is for full value or the reasons for the transaction are other than to put assets beyond the reach of creditors, it will be safe from attack under Section 423, regardless of how long ago the transaction occurred. It is, therefore, imperative that the reasons for a transaction are fully documented rather than leaving a court to assume it was to avoid creditors. The case also highlights that, where there could be a dispute as to value, it would be wise to retain evidence of the basis of valuation well beyond the appropriate statute of limitations period.

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The Court of Appeal case Oates v Stimson [2006] EWCA Civ 548 highlights the need for advisers when ascertaining parties' interests to consider not only the legal and beneficial ownership of a property but also the potential for a constructive trust to exist.

The case concerned how the equity should be split between two legal owners of a house. The parties had previously reached an oral agreement for Mr Oates to sell his interest to Mr Stimson, whereby the latter met all the outgoings and paid for certain improvements over an eight year period, despite not formalising the sale.

Although the Law of Property (Miscellaneous Provisions) Act 1989 requires a sale of an interest in land to be in writing, the Court of Appeal decided that the conduct of the parties had created a
constructive trust, "rendering it unconscionable not to permit him to enforce the oral agreement".

Therefore, if a debtor falls on hard times and the spouse continues to pay all the property outgoings over time, you need to look deeper than mere legal and assumed beneficial ownership when exploring their respective positions. Is there an earlier oral agreement and a course of conduct between them that affects their interests, and thus their available solutions?

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A unanimous appeal verdict but a divergence of reasoning characterise the Law Lords' speeches in McGrath and another v Riddell and others [2008] UKHL 21.

The significant point of the judgement is not the result of English assets being remitted to Australia, but the absence of majority support for the proposition that it is English common law or judicial principles, rather than section 426 Insolvency Act 1986, that allow the result.

Commentators suggesting that the judgement paves the way for foreign liquidators to seize English assets in cross-border insolvency disputes (eg Norton Rose, who acted for the Australian liquidators, and Accountancy Age) may therefore have overstepped the mark.

In the liquidations of four HIH insurance group companies, the Australian court sought the assistance of the English High Court through s426 Insolvency Act 1986 in directing that the English provisional liquidators, who had been appointed over the companies' English assets - mostly reinsurance claims, should remit the assets to the Australian liquidators for distribution rather than distributing them through an English liquidation.

Under the Australian regime an insurance company's assets are applied first to Australian debts and reinsurance proceeds are applied to the reinsured liabilities, whereas under the English regime at the time of the provisional liquidators' appointment (which was therefore applicable in this case although insurance insolvency priorities have since been changed) such assets would be distributed pari passu among insurance, reinsurance and other unsecured creditors.

The appeal was allowed and the assets are to be remitted, but there was disagreement in the judgements over how the decision could be reached.

Lord Hoffmann (with Lord Walker agreeing) analysed the doctrine of ancillary liquidation, noting that:

"the judicial practice to which I have referred . . . is inconsistent with the broad proposition that creditors cannot be deprived of their statutory rights under the English scheme of liquidation."

He went on to say that allowing the appeal and directing remittal of the assets to Australia was exercising a power established under English common law, and he concluded:

"this is a case in which it is appropriate to give the principle of universalism full reign."

Lord Phillips declined to support this view, saying:

"I do not propose to stray from the firm area of common ground [allowing the appeal on the basis of s426] onto the controversial area of whether, in the absence of statutory jurisdiction, the same result could have been reached under a discretion available under the common law."

Lord Scott was very clear in his opposing view:

"The proposition that the assistance and directions sought . . . could be given under an inhernet power of the court . . . is unacceptable . . . [and] would constitute the usurpation by the judiciary of a role expressly conferred by Parliament on the Secretary of State."

"It would, in my opinion, as I hope I have made apparent, have been sufficient [to justify a refusal] if the country of the principal winding up had not been a "relevant country or territory" for section 426 purposes."

"I would allow this appeal but repeat that I would do so on the footing that the power to accede to the Australian liquidators' request derives from section 426 and not from any inherent jurisdiction of the court."

Lord Neuberger similarly disagreed with Lord Hoffmann:

"I take the view that it would not have been open to an English court to make the order sought by the Australian liquidators in the absence of section 426(4) and (5) of the 1986 Act."

Under s426 it has always been open to the English courts to choose to apply the law of a "relevant country or territory" designated as such by the Secretary of State. This judgement clarifies the exercise of the court's discretion under s426 but it does not extend the geographical boundaries.

It has been suggested that this judgement will make it easier for foreign office-holders to obtain the assistance of the English courts under The Cross-Border Insolvency Regulations 2006. I would observe that the cross-border regulations restrict the court's discretion rather more than does s426, for example in Article 21(2):

"Upon recognition of a foreign proceeding, whether main or non-main, the court may, at the request of the foreign representative, entrust the distribution of all or part of the debtor's assets located in Great Britain to the foreign representative or another person designated by the court, provided that the court is satisfied that the interests of creditors in Great Britain are adequately protected."

and Article 22(1):

"In granting or denying relief under article 19 or 21, or in modifying or terminating relief under paragraph 3 of this article or paragraph 6 of article 20, the court must be satisfied that the interests of the creditors (including any secured creditors or parties to hire-purchase agreements) and other interested persons, including if appropriate the debtor, are adequately protected."

How do you see universalism developing in the response of English courts to requests from foreign liquidators and courts for assistance and directions?

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As the major (English) trading creditor of the London branch of a troubled bank registered and with its principal operations and headquarters in Switzerland but with other branches in a variety of largely offshore jurisdictions, what insolvency process would you seek to have employed in which jurisdiction in order best to protect your interests? The majority of the bank's assets are in England and you fear that without proper control being exercised they might be dissipated in the impending collapse.

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Experian reports a rise in UK corporate insolvency: up 8.5% in Q1 2008 compared to Q1 2007, in line with our last forecast here.

Business sectors identified as suffering include agriculture, banking, food retail and clothing (although some of the sample sizes are small), but 10% of the quarter's failures are in building and construction.

Regionally, the East Midlands is hardest hit with insolvencies up 53.6%.

Creditors' voluntary liquidations increased by 14.1% but compulsory liquidations fell by 2.2%, perhaps reinforcing concerns about confidence as debtors go for CVLs whilst fewer creditors are pursuing compulsory winding-up. The popularity of the procedures amenable to corporate rescue - administrations and company voluntary arrangements - continues with growth of 23.7% and 37.6% respectively.

My own experience is that more businesses are considering an insolvency procedure than either 3 or 12 months ago. Certainly, businesses cannot borrow their way out of trouble at the moment and the signs are that advice about facing insolvency is being sought earlier - offering more prospect of a constructive solution.

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Some say we are on the brink of a major slow down. Clearly the economy is not as strong as it has been, but surely the real questions are:

• just how sharp is the ‘adjustment’ likely to be;
• how long will it last; and
• where will it be felt most?

Let’s look back over some recent figures and at the same time consider what the future may hold:

• Currently GDP is growing at 2.9% pa and is expected to fall to under 2% over the next few months. Research has shown a 1% drop in GDP growth could lead to a 10% increase in corporate insolvencies (see our previous post). The economy has been incredibly resilient throughout the last decade, but the credit crunch has ended that period of stability.
• Whilst inflation is presently running just above the government’s target at just 2.2%, the Bank of England is forecasting a rise to over 3% in the near future giving rise to further pressures on disposable income. 
• House prices are weakening generally across the country, although less so in London. The recent reduction in loan to value ratios and income multiples on offer will restrict mortgage funding and reduce both demand and consumer confidence.
• Total personal debt levels, at £1.4 trillion, are huge and growing at £1 million every 5 minutes, more than three times the rate of inflation. The growth in personal debt may be slowing, but record numbers of personal insolvencies and a significant number of borrowers defaulting support the trend towards less excessive consumer spending.

In summary, the main aspects of the economy are less volatile than, say, the 1980s to early '90s when huge swings could be expected. The economy has certainly become more unstable during the last 6 months, but overall, I expect the ‘adjustment’ to be relatively shallow and short-lived, with the pain being suffered more in particular regions or sectors :

• Retailers who enjoy a strong market position and are well organised and managed are likely to fare better than their weaker competitors. Suppliers of ‘growth support services’ into retailers, such as shopfitters, can expect a further deterioration in both sales volumes and margins, causing viability and solvency issues (see previous post).
• Pubs and restaurants have already seen their takings fall as a result of consumers’ reduced free cash, the smoking ban, and cheap supermarket alcohol. Fixed costs remain high, and leisure outlets with poor procedures and low staff morale are at risk.
• Confidence is low in the construction industry, despite the Olympics Effect and government housing requirements. Many construction related companies will not be able to cope with any further reduction in prices or any deferral of work or payment by the major employers(see previous post).

The slow down in these parts of the economy will no doubt create added opportunities for Insolvency Practitioners to bring their turnaround skills to bear to rescue ailing but viable businesses, as well as to assist in close down scenarios. As always, early attention to potential problems increases the likelihood that a turnaround will be achievable.

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An interesting case passed through the Court of Appeal a few weeks ago, which counsel for the bank concerned said could impact on a good number of cases where banks have acquiesced in allowing borrowers to remain in their homes.

In the National Westminster Bank v Ashe case, a trustee in bankruptcy took action to defeat Nat West's second charge over a property on the basis that the bank's debt, and its rights of repossession, had both become statute barred under the Limitation Act 1980. The fact that the case was taken by a trustee in bankruptcy is not relevant, the principles apply to any case where a lender defers taking recovery action.

In the Nat West case, the bank had to concede that its right to sue the debtor for repayment of the debt was statute barred - the debtor had made no payments, nor had he acknowledged the existence of the debt, for well over twelve years. The main argument on which the bank relied related to a technicality in the Limitation Act: it argued that the debtor had not been in 'adverse possession'  for the purposes of the Act (ie the debtor could not benefit from expiry of the limitation period), which if the court had agreed would mean that the bank could still take possession. In this case the bank had, through a fairly standard 'all monies' legal charge, acquired an immediate right of repossession when the charge was signed, but it simply failed to follow it through.

The Judges were not particularly sympathetic with the bank. They chose instead to uphold the principles of the Limitation Act in preventing stale claims being brought, protecting settled interests from being disturbed, and bringing finality to disputes. In essence, the Judges told the bank it should have taken more substantial steps, sooner, to get its money back because, after all, it was a large bank with access to specialist legal advice. The Judges decided that the debtor had been in 'adverse possession' with the result that the right of possession was not enforceable and the bank lost its money.

Does this case open, as counsel for the bank suggested, the floodgates for thousands of debtors to avoid paying old secured debts which they have ignored?

We do not think so. First off, not all mortgages contain a right of repossession at the date of the mortgage, indeed many mortgages limit the lender's right of repossession; and secondly, instances where a charge holder has been paid nothing on his debt and received no contact from the debtor  acknowledging either the debt or the title for over twelve years are probably few and far between. It will mean, however, that the banks will be dusting off their security documentation and applying more pressure, and earlier, on debtors to acknowledge the debt and title so as not to trip up limitation issues.

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The European High Yield Association has announced refinements to its proposals to the Treasury on insolvency law reform.

Its original submission in April 2007 identified perceived shortcomings of the Enterprise Act reforms:

". . . the administration procedure has not been widely used in distressed situations and, more generally, statutory processes have been avoided.

We believe this occurs for the following reasons:

• despite the best efforts of those in government and elsewhere, administrations and Company Voluntary Arrangements (CVAs) are still perceived in the UK as reflecting corporate failure rather than rescue, which depresses confidence in the business and enterprise value;
• the ability of suppliers and customers to abandon their contracts with the distressed company if it makes a formal insolvency filing discourages filing, and where filing does ultimately occur, the ability to cancel contracts destroys the value of the business; and
• difficulties in obtaining funding in administration impair the company's ability to trade through the proceeding."

The first point above is uncontroversial; a direct remedy to the second by a simple extension of the administration and small CVA moratoria enjoys the support of the City of London Law Society (here), amongst others; and the third point refers to DIP funding (although some might argue that administration is inimical to the concept of debtor in posession).

Under a heading "Facilitating 'out-of-court' restructurings in the UK" then come three suggestions leading to "a call for a court supervised restructuring process":

• An all-encompassing stay on actions should be available to prevent value destruction as this is currently seen as an inevitable consequence of filing for insolvency in the UK. In other jurisdictions, notably the US and France, contractual termination provisions are not enforceable. The current stay deployed by English law does not go far enough in protecting failing businesses and allows customers and suppliers to terminate contractual relations just when their continued commitment is most crucial to the rescue.
• A framework should be created for fast judicial resolution of valuation disputes in restructurings, short of administration proceedings. This will enable practise and precedent to develop in restructuring valuations, thus providing stakeholders with relative certainty of outcome, whilst avoiding the value loss that arises through administration.
• Creditors or shareholders with no economic interest in the revalued enterprise should not be able to block restructurings or force full insolvency proceedings. A mechanism is needed to deal fully with 'out of the money' claims in restructurings.

It is these lightly sketched but far-reaching proposals that are now refined and extended - and will be considered in a subsequent post.

 

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Directors' duties

Directors' duties can be onerous at the best of times. The general duties have been codified in the Companies Act 2006 and are summarised simply in the following Ministerial statement:

1. Act in the company’s best interests taking everything you think relevant into account.
2. Obey the company’s constitution and decisions taken under it.
3. Be honest and remember that the company’s property belongs to it and not to you or its shareholders.
4. Be diligent, careful and well informed about the company’s affairs. If you have any special skills or experience use them.
5. Make sure the company keeps records of your decisions.
6. Remember that you remain responsible for the work you give to others.
7. Avoid situations where your interests conflict with those of the company. When in doubt disclose potential conflicts quickly.
8. Seek external advice where necessary, particularly if the company is in financial difficulty.

Troubled companies

But things get more difficult if the company has financial problems.

Directors must recognise that when a company’s assets exceed its liabilities or it cannot pay its debts as they fall due, their primary duty ceases to be to the shareholders and the interests of creditors become paramount.

Failure to carry out his duties with the appropriate degree of skill and care may render a director liable for wrongful trading if he knew or ought to have known that the company could not avoid insolvent liquidation. The guilty director may then be liable to compensate creditors for the losses caused by his conduct. He may also be disqualified from acting as a director for up to 15 years. 

Practical steps

What can you do as a director to protect yourself when your company is in financial difficulties?

1. Hold regular full board meetings and keep comprehensive minutes of commercial decisions and the reasons for them - indeed, keep notes of all significant discussions about the company's affairs.
2. Make sure that you have full financial information and are aware of the extent of creditor pressure, court or recovery action by creditors and disputes.
3. Make sure that the decisions you take are taken in the interests of creditors.
4. Seek specialist advice. You are not expected to know all the answers about how to deal with financial distress.
5. If you know or suspect that there is no reasonable prospect of the company avoiding insolvent liquidation, discuss the situation at a full board meeting with a view to taking specialist advice and initiating a formal insolvency procedure.
6. Take independent advice if fellow directors do not share your concerns about the company’s solvency.
7. Do not take further credit.
8. Take steps to minimise losses to all creditors equally.

Points 7 and 8 can be particularly challenging in the real world and will be much easier to deal with if you have the benefit of specialist insolvency advice.

Seek advice early as this not only protects you as a director, it widens the options for rescue and turnaround action.

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We reported just over a year ago (here) on Euler Hermes' 2006-2007 Insolvency Outlook, which suggested a 3% increase in business insolvencies in 2007.

Their latest report, issued in November 2007, forecasts under the headline

 "United Kingdom - A rise in insolvencies in sight"

an 8% increase in insolvencies in 2008. Interestingly, it relates that increase to GDP growth of 2%.

Three months on, forecasts are for rather lower GDP growth. The Bank of England Inflation Report published on 13 February suggests (here) a decline to well below 2% GDP growth during 2008, particularly when the Governor's introductory remark is taken into account:

"the potential for further falls in asset prices and tightening of credit conditions means that the balance of risks around the central projection is on the downside, particularly over the next eighteen months."

Euler Hermes' previous report (linked here) noted the strong negative correlation between insolvency and GDP growth, and the elasticity - a 1% fall in GDP growth gives a 10% rise in insolvencies.

With the lower GDP growth now forecast by the Bank of England, the prospects are for a somewhat larger increase in insolvencies than Euler Hermes' November forecast of 8%.

PS Does anyone know why there was an anomaly in the q4 2006 administration statistic? From the Insolvency Service figures there appear to be perhaps 700 extra appointments that quarter, mainly in London.

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Shopfitter JDS Group Limited was not saved by a critical mass of 350 staff and £30m turnover as it went into administration on 12 February, suggesting that retail problems (see our previous post - Retail insolvencies as the credit crunch hits the high street), or their underlying causes, may be knocking-on into the construction sector.

Certainly, the construction industry is not confident at the moment - less so than retailers according to the ICAEW Business Confidence Monitor (here).

The ICAEW also notes:

"In line with the expected slowdown in predicted capital spending growth, a greater
proportion of firms report increased challenge in raising capital currently compared with 12 months ago. This is particularly the case for those in the Property, Communications and Construction sectors."

JDS is just the first sizeable specialist contractor facing insolvency. Building.co.uk reports More specialists face the axe amid insolvency fears, suggesting that smaller specialist contractors will be the losers.

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We reported in our earlier blog 'Retail Insolvency News', that the New Year is a time when retail insolvencies tend to come to the fore. 

Some British retailers, hit by poor Christmas trading, may struggle to pay their December rent bills, forcing them into insolvency or a debt restructuring in the New Year.  Experts are predicting that the most likely to run into trouble are 'big ticket' retailers selling discretionary products.  

So noted Credit Today recently.  As one of those whose view they sought I think there are systemic risks and that big-ticket, discretionary-spend retailers are in the front line.

But so far 2008's prominent retail insolvencies have been in shoes (Stead & Simpson and Dolcis), books (The Works) and fashion (Elvi and Base Menswear).

The common thread is undistinguished chains at the low end of the middle market being most  at risk, with the credit crunch affecting future levels of retail spending and spending on non-essential delayable purchases. Differentiation and a nose for fickle customer demand remain the key factors for survival.

The Financial Times observes (here) that the tally of retail failures is lower than it might have been. Restructuring takes longer because of the more complex stakeholder structures found now compared to 5 years ago, and some of the weaker players saw the New Year's problems coming. Together these factors encouraged some retailers to start taking advice and acting early enough to avoid administration.

 

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The cash flow or commercial insolvency test contains a flexible and fact sensitive futurity requirement in the phrase “as they fall due”, according to Briggs J in Cheyne Finance Plc (in receivership) [2007] EWHC 2402 (Ch).

Cheyne was a structured investment vehicle (“SIV”). It was one of the first SIVs to go into receivership as a result of the credit crunch. The receivers sought the court's directions as they had to identify whether an “Insolvency Event”, which was defined by reference to the cash flow test in s123 Insolvency Act 1986, had occurred.

s123(1)(e) provides that a company is deemed unable to pay its debts:

“if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due”

The wider implications of the Cheyne decision, which is the first time the court has considered this section, are that technical insolvency may be triggered earlier in some cases than might have been expected.

The judge gave the following example:

“The company has £1,000 ready cash and a very valuable but very illiquid asset worth £250,000 which cannot be sold for 2 years. It has present debts of £500, but a future debt of £100,000 due in 6 months. On any commercial view the company clearly cannot pay its debts as they fall due, but it is, or would be balance sheet solvent”.

In other words, if the company can continue to pay its present debts, but it cannot pay a known future debt, it is insolvent. 

Consider a company with positive net assets but limited cash, say £100,000, which it is burning at a rate of £50,000 per month. In one month’s time it has to pay a wages bill of £60,000. Provided that on the balance of probability it will continue to burn cash at £50,000 per month, it is insolvent now, not just in a month’s time when it no longer has the cash to pay its present debts.

This decision seems especially relevant during the current credit crunch when companies may have positive net assets but insufficient liquidity. It emphasises the need to take specialist advice early.

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We reported in September 2007 (here) the consultation paper issued by the Insolvency Service setting out its proposals to modernise and streamline the law governing insolvency procedures.

You may recall the disenfranchising proposal requiring creditors to “opt in” if they wish to receive information on or to participate in the insolvency process.

The Insolvency Service now reports (here) that the consultation was completed in December 2007. Responses are being reviewed and necessary changes to primary legislation will be taken forward in late 2008, with a view to implementation on 1 October 2009.

Another modernisation project relates to the Insolvency Rules. The Insolvency Rules Committee is expected to complete its work on the revisions in late 2008 and the changes are planned to come into force on 1 October 2009.

Companies House expects revisions to the insolvency forms to require procedural changes, which will also be implemented by October 2009.

Further consultation is planned in relation to the Insolvent Partnerships Order and the Administration of Insolvent Estates of Deceased Persons Order and those and other insolvency related statutory instruments are also to be revised ready for implementation by 1 October 2009.

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An industry news snippet for those who missed it: Tenon's recent acquisition of Haines Watts BRI's insolvency practice was done through an administration pre-pack (PwC were the administrators).

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A members' voluntary liquidation ("MVL") can be a tax efficient exit option for the shareholders of a solvent company.

Under current legislation shareholders receiving a distribution through an MVL or, where appropriate, using Extra Statutory Concession C16, may benefit from the business asset taper relief provisions.

The government has recently announced (http://www.hmrc.gov.uk/cgt/disposal.htm) that as from 6 April 2008 all capital gains will be taxed at a flat rate of 18% irrespective of the marginal income tax rate of the taxpayer concerned; and also that the current systems of taper relief and of indexation allowance will be abolished. Alongside these reforms the government will introduce a tax relief for entrepreneurs that will deliver a 10% tax rate for up to the first £1 million of lifetime capital gains.

MVL 

An MVL is a statutory procedure for realising assets, agreeing and settling liabilities and distributing surplus funds to shareholders. The majority of MVLs arise as a result of:

• Tax planning - Taking advantage of changes in tax legislation when it may be appropriate to withdraw capital, or alternatively divide the business interest between shareholder groups
  and mitigate or defer tax liabilities (S.110 reorganisations).
• Retirement planning - Shareholders who are considering retirement and wish to realise the value of their investment. A liquidator has the power to accept or reject claims of creditors and can disclaim onerous assets, such as leases, if appropriate.
• Group reorganisations - The removal of dormant, non-trading or redundant companies in order to reduce costs, group restructuring or the release of capital for use elsewhere within the group.
• End of specific purpose - The orderly closure of a company which has achieved the specific purpose for which it was incorporated.

Tax planning

An MVL is not simply a case of passing a resolution and completing the winding up. It is important that the process is planned and the company suitably organised in order to minimise tax liabilities and maximise any commercial advantages. For example, consideration should be given to either making a pre-liquidation "income" distribution or a post-liquidation "capital" distribution.

Pre-appointment planning is particularly important at present, as those anticipating paying CGT
at a certain rate, whether 10% or 40% or some rate between, may find a different rate applying to their capital gain after 6 April 2008. Individuals who do not benefit from the current business asset taper relief provisions are likely to be better off under the new rules unless they have substantial indexation allowance. Other tax related matters to consider prior to liquidation:

• A new 12 month accounting period for corporation tax purposes begins at the date a company resolves to wind up.
• The surrender of trading losses by way of group relief.
• The realisation of capital gains and their offset.
• The tax consequences of moving assets between group companies.

Other issues

• The Companies Act 2006 (http://www.dti.gov.uk/bbf/co-act-2006/index.html) introduces changes to company law that will directly affect directors and shareholders. From 1 October 2008 the time limit for making an application to Court for the restoration of a liquidated company to the register after dissolution will be six years. The time limit is currently two years. The six year time limit will also apply to companies struck off and dissolved by application of the directors (presently 20 years). It remains essential, therefore, that thorough due diligence is undertaken to identify and deal with all actual and contingent liabilities and onerous contracts to avoid any future action against the company and its directors.
• When a company is struck off owning property, that property vests in the Crown as 'bona vacantia'. As share capital and non-distributable reserves (including the share premium) cannot be repaid otherwise than by liquidation or the buy back of shares, or Court Order, the equivalent assets will pass to the Crown. The Office of the Treasury Solicitor has confirmed
  that where a company has been struck off by application of the directors it will waive the right to recover any unauthorised distribution of less than £4,000.
  

An MVL can be a tax efficient and cost effective way of bringing a company to a formal end. An alternative may be to make an application to Companies House for striking-off.

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In 2003 the Enterprise Act made several major changes to insolvency law, including dropping the preferential status of the main government departments and the creation, through Section 176A of the Insolvency Act 1986, of a 'prescribed part'. This was done in an attempt to improve the chances of unsecured creditors receiving some return in 'larger' liquidations. It has taken until now to answer the question of whether a floating charge holder who experiences a shortfall on their secured debt, which would fall to be unsecured, can share in the 'prescribed part', discussed in a previous post here.

In a judgement handed down by the Birmingham High Court recently in the Permacell Finesse case, HHJ Purle QC decided that floating charge holders should not have a further crack of the whip by sharing in the prescribed part.

The Judge made his views abundantly clear, saying:

'The prohibition on distributing the prescribed part to a floating charge holder is in my judgment absolute'.

The Judge seems to have given effect to what he believes was parliament's intention at the time, namely to give banks and other floating charge holders the benefit of increased realisations through the abolition of Crown preference without having a detrimental effect on the unsecured creditors' distribution prospects.

The case will probably come as no surprise to bankers and other institutional floating charge holders as it is a case of quid pro quo.

However, the decision presumably comes as another blow to the charge holder in Permacell, coming soon after the Employment Appeals Tribunal made a 'protective award' of 90 days pay to employees because the employees were not properly consulted about their proposed redundancies under the Trade Union and Labour Relations (Consolidation) Act 1992.

The Act requires that employees be consulted even in an insolvency situation where there can be only one outcome. And claims under a protective award rank preferentially, i.e. before the floating charge. Follow this link to the EAT decision: Evans & Others -v- Permacell Finesse Limited (In Administration).

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Here's a view on the UK's economic outlook from Howard Reed, Chief Economist at the Institute for Public Policy Research, published in the New Statesman: Was Northern Rock the worst of it?

Despite huge stock market falls in the last two days, the balance of comment still appears to be that the underlying UK economy is in reasonable shape and whilst we can expect further tightening a recession is not on the cards.

Reports following analysis of January's Monetary Policy Committee minutes at Bloomberg and Channel 4 News illustrate current thinking (although the latter notes that George Soros, billionaire investor, disagrees. . . ).

No recession, I agree, but we certainly haven't seen the worst of the turbulence. In the business world I think there are many who have not yet come to terms with either the dramatic change in lenders' appetites or the effect the turbulence has had on consumer sentiment.

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Creditors who petition the court for the winding-up of a company or the bankruptcy of an individual as a debt-collecting remedy are not free from risk.

HHJ Peter Coulson QC sets out in Jacob v Vockrodt [2007] EWHC 2403 (QB) when petitioning is an abuse of process that could involve the tort of malicious presentation of a bankruptcy petition.

The key parts of the judgement on abuse of process are:

Mr. Davies relied on the well-known passage in the judgment of Harman J in Re a Company [1983] BCLC 492 in which he said:

"First, it is trite law that the Companies Court is not and should not be used as (despite the methods in fact often adopted) a debt-collecting court. The proper remedy for debt collecting is an execution upon a judgment, a distress, a garnishee order or some such procedure. On a petition in the Companies Court, in contrast with an ordinary action there is not a true lis between the petitioner and the company which they can deal with as they will. The true position is that a creditor petitioning the Companies Court is invoking a class right (see Re Crigglestone v. Coal Co. [1986] 2 Ch 327) and his petition must be governed by whether he is truly invoking that right on behalf of himself and all others of his class rateably, or whether he has some private purpose in view. It has long been an order that a petition presented for the purpose of putting pressure on the company is not properly presented: see Re a Company [1894] 2 Ch. 349 and, in a slightly different context, Re Bellador Silk Ltd. [1965] 1 All ER 667."

It is, of course, right that a bankruptcy petition must not be utilised where the petitioner knows that the debt is the subject of a bona fide dispute, but chooses to proceed with the petition in any event, so as to put illegitimate pressure on the other party to pay the debt. But the authorities cited above cannot be taken as authority for any wider principle or proposition. In my judgment, the correct approach to the facts, in a situation where the petition has failed and it is subsequently suggested that the presentation was malicious, was that applied in Partizan Ltd v OJ Kilkenny & Co Ltd [1998] 1 BCLC 157 by Rimer J, when he concluded at page 173:

"It follows that I am not satisfied that, when it presented the petition, Kilkenny was moved by notice or considerations different in any way from those which ordinarily motivate creditors who petition to wind up a company on the grounds that a debt claimed to be due to them (not being one which is regarded by the petitioner as disputed on substantial grounds) is unpaid despite demand; namely, at least an element of hope that, if the company can pay the debt despite its previous failure to do so, it will pay it and, if it cannot do so, a hope and expectation that it will be placed in liquidation so that there can be an orderly realisation of its assets for the benefit of its creditors generally."

What the cases show (and the point I take Rimer J to be addressing by the phrase in brackets in the quotation from his judgment set out above), is that the presentation of a petition is an abuse of process only if the petitioner knows or believes that the debt is in truth the subject of a substantial dispute.

Take care when petitioning if there is a substantial dispute!

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Three interesting procedural points relating to the bankruptcy of individuals arose in Law Society v Dixit Shah [2007] EWHC 2841 (Ch), where recovery was sought from bankrupt solicitors' professional indemnity insurers.

1. Discharge of a bankrupt merely extinguishes a creditor's remedy of enforcement, not the underlying cause of action.
2. The court can accept or reject a proof of debt (under its general jurisdiction from Section 363 of the Insolvency Acy 1986) without the trustee having considered the matter first.
3. A proof may be admitted or rejected for reasons other than determining a right to vote or participate in a dividend, where the proof of debt procedure is directed to satisfying the claim of a legitimate creditor (here, through the Third Party (Rights against Insurers) Act 1930) without any possible harm to any other creditor.

Floyd J appeared determined to ensure that legal technicalities should not prevent the third party claimants being able to recover from the insurers. Read the judgment (link above) for more detail.

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For those of you who are not accountants - or don't read Accountancy Age - the quotes below are from its article "Retailers protected from impact of Trident ruling" published on 10 January 2008.

We reported the UK government's decision to exempt companies in administration from empty property rates in an earlier post.

President of R3 Patricia Godfrey says the decision couldn’t have been better timed for retailers: ‘With the effects of the credit crunch increasingly likely to be felt in the New Year, this move will help administrators save business and jobs.’

Mercer & Hole business recovery partner Chris Laughton agrees, highlighting the credit crunch as likely to lead to more retail insolvencies. Removing the preferential treatment on business rates for unoccupied properties would save businesses.

‘The decision will help what will be a higher number of retail insolvencies than last year,’ Laughton says.

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The Northern Rock crisis has prompted Alistair Darling, Chancellor of the Exchequer, to announce proposals for a special insolvency regime for banks in the UK. Following the publication of a consultation paper in October 2007, “Banking reform – protecting depositors”, and consideration of its results, the Chancellor revealed in an interview with the Financial Times, reported here on 3 January, some hints about his intentions.

Details are patchy – perhaps deliberately – with the Chancellor planning to release more information to the Treasury Select Committee on Thursday 10 January.

It seems that the FSA (Financial Services Authority) would have a role to step in at the beginning of one or more “trigger events” such as the provision of emergency funding by the Bank of England.

A debatable observation from the Chancellor was that “Insolvency laws make it actually quite difficult to move quickly if you need to take action”. He also appeared to criticise the US system, where he said a healthy bank could find itself being restructured, while he suggested that there may be ideas worth following in the Canadian and Belgian systems.

What special insolvency regime does your experience suggest will work for banks?

 

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"Retail insolvencies start the year" was one of Insolvency Blog's first posts of 2007.

It's hardly surprising to see retail administrations at this time of year - over-leveraged and under-performing retailers have minimum borrowings after the Christmas sales peak and secured creditors will naturally choose that point to stop the losses.

. . . constructive use of formal insolvency . . . can often add value when a business is saleable and the right restructuring team is brought in early enough.

Paul's comment on the retail sector was:

I think the consumer has the last word on who survives - if they wish for identikit high streets, or doughnut towns, or McDonalds bacon sandwiches, so be it.

History seems to be repeating itself. The Sunday Telegraph notes here this week that:

• Insolvency experts are on standby amid fears several high street retailers could collapse in January
  
• Consumers turn to sub-prime lenders as credit squeeze bites
  
• Footwear and clothing retailers have been particularly badly hit by the downturn in consumer confidence
  

Consumer confidence will be the biggest factor in retail business distress for the next few months, and with the weak housing market and a generally cooling economy there is cause for concern.

But the way to address business stress is, as it was a year ago:

• take advice early
• ask a situational expert
• don't panic!

Happy New Year!

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Companies in administration are to get a permanent exemption from empty property rates, Local Government Minister, John Healey, announced on 17 December. His decision on companies in administration was a consistent view put to the Department for Communities and Local Government in consultation and brings such businesses into line with those in liquidation and individuals subject to bankruptcy proceedings who already enjoy exemptions:

"We are committed to the promotion of a rescue culture which provides opportunities for insolvent companies that have viable underlying businesses to be rescued wherever possible. A permanent exemption will remove any potential for decisions about whether to enter administration to be distorted by differences in rates liability."

The department is now drafting the relevant secondary legislation to give effect to the reforms on empty property relief including introducing the new six month exemption from empty property rates for vacant industrial and warehouse properties, as announced in the 2007 Budget. The aim is to lay this secondary legislation before Parliament so that all aspects of the new reforms to empty property relief can come into effect on 1 April 2008.

R3, the Association of Business Recovery Professionals, notes here that the decision will overturn the controversial decision in the Trident Fashions case - Exeter City Council v Bairstow & Ors [2007] EWHC 400 (Ch) (02 March 2007). Commenting on the Government's move, the President of R3, Patricia Godfrey, said:

"This decision couldn't have come at a better time. With the effects of the credit crunch increasingly likely to be felt in the New Year, this move will help administrators save business and jobs."

The effects of the Trident decision and how it might be mitigated are discussed in our previous post here.

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According to the Yorkshire Post's article "6pm update: Bates free to stay at Elland Road - Yorkshire Post", Ken Bates, Mark Taylor and Shaun Harvey have been "allowed to continue to remain directors of the club after their involvement in a previous Leeds United-related liquidation left them in breach of insolvency rules".

We gave the background to this story in a previous post. The detail of the recent judgment is not clear from the press report, which suggests that the judge gave retrospective leave for the three men to act as directors of the club. Does anyone have a copy of the judgement so we can see what really happened?

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In a post on an academic US blog about credit and bankruptcy, Credit Slips: Corporate Bankruptcy Costs and Recoveries in the UK, John Armour points out the results of his research into whether creditor control is better concentrated in the hands of a single creditor (receivership) or creditors generally (administration).

He concludes that there is no net difference as a result of two opposing factors:

there are higher gross realisations in administrations - due, Armour suggests, to higher accountability to junior creditors incentivising administrators to maximise realisations;

but dispersed creditor governance allows administrators to charge retail fee rates rather than the lower wholesale rates negotiated by secured creditors.

Intuitively, the explanation of higher administration realisations works at the margins. An administrator has a statutory priority of objectives and "getting the bank out" is last (as opposed to being the sole objective in receiverships).

But the retail/wholesale fees rationale is less persuasive. Bank panel firms are not always able simply to abandon wholesale rates once the bank is repaid. The fact is that administrations, with their heavier burden of broad obligations to creditors, including significant additional statutory reporting and compliance requirements, and a primary duty to have the company and its business continue as a going concern if possible, are simply more complex and costly procedures than receiverships.

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As revealed in Insolvency reform - Bank Law Blog, the Insolvency Service has issued a consultation paper setting out its proposals to modernise and streamline the law governing insolvency procedure.

The broad aims are to bring insolvency law up to date with our current ability to communicate electronically, to move some decision-making process to insolvency practitioners and to remove some unnecessary burdens from insolvency practitioners. Replies to the consultation must be with the Insolvency Service by 10 December 2007.

The document's full title is:

"A consultation document on changes to the Insolvency Act 1986 and the Company Directors Disqualification Act 1986 to be made by a Legislative Reform Order for the modernisation and streamlining of insolvency procedures".

It is:

 "A Consultation Paper issued by The Insolvency Service on behalf of the Minister of State for Employment Relations and Postal Affairs"

and it is available for download (from the Insolvency Service website) here.

There are eight proposals, detailed below:

1. To modernise and make more flexible the means of communication, and the exchange of information, between insolvency office-holders and creditors (and others who send or receive information) in insolvency cases by:

1.Introducing a provision requiring creditors to “opt-in” if they wish to receive information issued by the insolvency office-holder during the conduct of the proceedings and/or who wish to participate in the insolvency process.
2.Updating insolvency legislation to make it explicit that communication can be effected electronically where the legislation requires it to be “in writing”.
3.Enabling insolvency office-holders to provide information by sending a link to a website on which information is posted.
4.Providing a legislative framework that will allow insolvency office-holders to hold meetings required to be held as part of their conduct of insolvency cases through media other than meetings held at a physical venue.

2. To remove a requirement that is imposed upon liquidators and trustees in bankruptcy requiring them to obtain sanction for certain actions they propose to take as part of their conduct of the case.

3. Moving to allow discretionary advertising of the appointment of a voluntary liquidator and to remove restrictions on the form any such advertisement can take.

4. Removing a requirement imposed upon liquidators to summon annual meetings of members and/or creditors for the purpose of laying an account of their acts and dealings and of the conduct of the winding up during the preceding year.

5. Removing the requirement for any document in insolvency proceedings to be sworn by affidavit and to replace it with a less burdensome requirement for such documents to be verified by a statement of truth in accordance with the Civil Procedure Rules 1998.

6. To remove the requirement for an insolvency practitioner, acting as liquidator, to submit a report to the Secretary of State on the conduct of the directors of a company if he has already submitted such a report as administrator of the same company.

7. To remove a requirement that exists for the Insolvency Services Account (“ISA”) kept by the Secretary of State to be held with the Bank of England.

8. To remove the power of the court to order that a person owing monies to a company in liquidation pay those monies into an account, in the liquidator’s name, at the Bank of England.

As an IP, I have to say that on first reading the proposals make good sense.

Comment below, or respond directly to the Insolvency Service on Annex B of the document.

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Recent trade press reports Pre-pack administrations boosted by court decision - Accountancy Age and Pre-pack administration survives HMRC claim - Creditman refer to this case decided in March 2007.

The trigger was a press release by R3 (the Association of Business Recovery Professionals) quoting Dr Sandra Frisby, Baker & McKenzie Lecturer in Company and Commercial Law at Nottingham University, whose recent research into pre-packs (sponsored by R3) shows a significant increase in the use of pre-packs since the Enterprise Act 2002.

The judge rejected a claim by HMRC against the sale of DKLL Solicitors when DKLL made an application to the court to be placed into administration. This was to allow an immediate sale of the business to another (newly-formed) firm of solicitors, Drummonds Kirkwood LLP.

The judge said:

"I am particularly influenced by the fact that the proposed sale appears to be the only way of saving the jobs of the 50 odd employees of the partnership. The proposed sale is also likely to result in the affairs of the partnership's clients being dealt with, with the minimum of disruption."

Notably, the judge did not declare the pre-pack strategy unlawful, thus validating it as a legal rescue tool. Also importantly, the judge gave weight to the expertise and experience of impartial insolvency practitioners.

The judgement is available in full here.

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The credit crunch of August-September 2007 has disturbed the economic equilibrium - and may continue for a while yet. Debates about illiquidity or insolvency abound, but are we really facing a swing from boom to bust?

The underlying UK economy is strong, but we now have corporate transactions stalling through lack of funding, hedge fund failures, a sub-prime lender in administration and the Northern Rock bailout. What many considered a strange US phenomenon (had many people heard of sub-prime before this summer?) has become a real domestic issue. No wonder business and consumer sentiment is waning:

• the ICAEW UK Business Confidence Monitor (BCM) has moderated in Q3 2007 from a Q2 peak of +11.5 to a relatively weak +4.8;
• the BDO Optimism Index shows a sharp fall in August, from 101.9 to 101.2, confirming the impact of the US sub-prime crisis on UK businesses. This drop takes the Index to its lowest score since November 2005 and whilst business optimism has been decreasing slowly since July 2006, it appears that the impact of the turbulent financial markets has accelerated this trend; and
• the Nationwide Consumer Confidence Index fell back in August reflecting the impact of five interest rate rises over the past year. The main Index fell by two points, but it was not alone. All indices fell in August, the first time since December 2006 that all four measures of confidence showed a downturn in the same month.

For a reminder of how the credit crunch derived from the US sub-prime contagion via risk reappraisal amongst lenders and hedge funds, how CDOs, CLOs and SIV-lites were ideal vectors to spread the disease around the world, and the impact on bank lending, read "While you were away - fear and loathing in the markets" from The Times.

Other recent indications of the state and direction of the economy are:

• US business bankruptcies are on the rise, reports Bob Eisenbach, quoting Euler Hermes, who continued to forecast a small rise in the UK. After we reported Euler's November '06 forecast in a previous post, Geoff Swire commented when the UK's June insolvency figures became available that the forecast had been pessimistic. I suspect it was a timing issue and that corporate insolvency statistics in Q3 will rise in the UK, albeit by less than in the US.
• The world has changed dramatically: Germany’s Chamber of Industry has been flooded with distress calls from family Mittlestand firms unable to roll over credit lines and in Canada and Australia, junior mining finance has dried up almost entirely, according to Ambrose Evans-Pritchard on his Telegraph blog post "Brace yourself for the insolvency crunch".
• If the liquidity crisis continues it will will become an insolvency crisis and the banking industry will be hardest hit, according to Panmure Gordon.
• Insolvency firms are likely to be busy dismantling failed investment vehicles, with the most likely suspects being the quantitative hedge funds and funds focused on CDOs that have fallen foul of market conditions, writes Antonia Rawlinson "Uncertain times call for certain measures" in The Lawyer.
• "The M&A boom is over and law firms must adapt" agrees James Rossiter in The Times - restructuring is now the hottest game in town.

So what does all this mean? Yes the capital markets are in turmoil, banks are lending much more cautiously and some high risk investment vehicles are failing, but essentially this is only a liquidity problem. Its effect though is that stressed businesses will no longer be able to borrow their way out of trouble as they have become hard-wired to do over the last 3 years.

Crisis cash management and operational and corporate restructuring will come back into vogue as refinancing becomes passé. Only if stressed businesses fail to seek appropriate and timely assistance will the business insolvency statistics really start to rise.

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Was the Bank of England's bail-out of Nothern Rock, Britain's 5th largest mortgage lender justified on the grounds that it met Mervyn King's parameters explained recently in a letter to the Treasury Select Committee?

". . .central banks, in their traditional lender of last resort (LOLR) role, can lend
“against good collateral at a penalty rate” to an individual bank facing temporary
liquidity problems, but that is otherwise regarded as solvent."

Professor Willem Buiter of the LSE, formerly a member of the MPC, believes the Bank is proven to be a paper tiger. Firstly his blog notes (here) Northern Rock's "extremely agressive and high risk" business strategy and that its share price was declining steeply well before the credit crunch in recognition of an absence of long term viability.

Adam Applegarth, Northern Rock's chief executive is quoted by the Times on 15 September 2007acknowledging a flawed model (here): “Is the model flawed looking foward? Of course it is. Is it flawed looking back? I think the answer is no because of the markets that we were operating in prior to August 9".

Mervyn King's letter also stated:

"The moral hazard of an increase in risk-taking resulting from the provision of LOLR lending is reduced by making liquidity available only at a penalty rate. Such operations in this country are covered by the tripartite arrangements set out in the MOU between the Treasury, Financial Services Authority and the Bank of England."

Professor Buiter quotes the Memorandum of Understanding:

"Such a support operation is expected to happen very rarely and would normally only be undertaken in the case of a genuine threat to the stability of the financial system to avoid a serious disturbance to the UK economy.”

and argues that if Northern Rock were to fail it would neither threaten the stability of the UK financial system nor seriously disturb the economy.

According to the Times article, two white knights have walked away from rescuing Northern Rock.

But despite reports of savers queing to withdraw £1bn today, the BBC's story "What if Northern Rock goes bust?" shouldn't become reality. The Old Lady of Threadneedle Street has stepped in as Lender of Last Resort.

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Late July 2007's market shocks, when the Dow, FTSE and other indices slipped 5% or so on the back of the US sub-prime collapse spreading to prime homeloans and - some feared - into the corporate bond and credit markets, suggested that the wall of cash fuelling the recent credit boom was subsiding.

Such an outcome was not entirely unforseen, as reported here by Reuters in early June in an article highlighting a dramatic switch in worldwide corporate insolvency levels, from a 17% reduction in 2006 to 7% growth in 2007.

The last few days have seen faltering LBOs and a reluctance amongst banks to participate in recently planned syndications. The covenant-lite loan is said to be history and rising interest rates and oil prices encouraged market jitters.

Alongside this, investment banks, turnaround boutiques, lawyers and accountants are busy hiring restructuring talent and experience.

Will there be an insolvency boom? Not in my judgement. But there will be enough of an uptick to keep the skilled, flexible and client-oriented restructuring professional busy.

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Leeds United's administration has insolvency interest not only because of potential breaches of s216 Insolvency Act 1986 (see our earlier post), but also because of the administrators' concerns about personal liability for wrongful dismissal of players.

Administrators have been concerned about the adoption of employment contracts since the well known Paramount case (Powdrill v Watson [1994] 2 All ER 513 (CA)) (summarised at para 15 here),  where the administrators had to pay pre-appointment employment liabilities as an administration expense and all manner of upheaval was caused to the estates of earlier administrations due to the retrospective effect of the decision.

The legislature moved immediately to restore the rescue culture and amend the offending s19 Insolvency Act 1986, introducing the Insolvency Act 1994, so that s19 applied only to employment liabilities arising after the date of administration.

One of the problems with Paramount was that although the administrators wrote to the employees within 14 days stating that they were not adopting the contracts of employment, the court found that the administrators had in fact adopted the contracts by their conduct in continuing the staff's employment and paying them in accordance with the contracts.

Paramount was distinguished in Re Antal International Limited ([2003] EWHC 1339 (Ch)), a case where I was the administrator. In that case, although I did not know that the employees in question were employees of the company until more than 14 days after my appointment, I then simply dismissed them and was found not to have adopted their contracts. (Why didn't I know about them? Well, they were employed in the group's Paris office, which the directors had told me and the accounts showed was a subsidiary that was not in administration, but which proved to be a branch. "Simply" is perhaps the wrong word for me to use to describe the dismissals, since the employment contracts were subject to French law.)

With the advent of the Enterprise Act 2002, the administration regime was changed and para 99, Schedule B1, Insolvency Act 1986 replaced parts of s19.

It was held in Re Allders Department Stores Ltd. & Ors [2005] EWHC 172 (Ch) (16 February 2005) that redundancy payments and unfair dismissal payments were not "wages and salaries" and therefore were not afforded priority by para 99, Schedule B1.

Then in Krasner v McMath [2005] EWCA Civ 1072 (10 August 2005), overturning the first instance decision of Peter Smith J and upholding those of Etherton J in Ferrotech Ltd and Granville Technology Group Ltd, the Court of Appeal held (with some criticism of the drafting of para 99, which was inexplicably changed from s19) that neither protective awards nor payments in lieu were afforded priority.

In Re Leeds United Association Football Club Ltd [2007] EWHC 1761 (Ch) (25 July 2007), Pumfrey  J  held that damages for wrongful dismissal were not payable in priority to other expenses pursuant to para 99(4) to (6) of Sch B1 to the Insolvency Act 1986.

The current position appears therefore now clearly to be that only straightforward (post-appointment) wages and salaries are payable as an administration expense where employment contracts are adopted by administrators.

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We mention in a previous post and, briefly, in comments (here) the decision in the Trident Fashions case, Exeter City Council v Bairstow & Ors [2007] EWHC 400 (Ch) (02 March 2007), that the administrators were found liable to pay rates as an administration expense. The decision applies to administration cases generally and, in addition to causing consternation with its retrospective effect, it has significantly increased the cost of administration where there are substantial property assets.

The impact can sometimes be mitigated by applying to the court under para 79(1), Schedule B1, Insolvency Act 1986, for an order that the administrators be discharged with effect from the passing of a resolution to put the company into creditors' voluntary liquidation. Such was the decision in Re TM Kingdom Limited, as reported here by Theo Anderton and in the Law Society of Scotland's Journal here by Alistair Burrow. Sylvia Yendall notes here that it was also held in Re OM Recoveries Limited that an administrator may apply to court under para 79(1) when he considers it necessary or desirable.

Advantages of liquidation in thses circumstances are that unoccupied property rates are not a liquidation expense and a liquidator is able to disclaim onerous property.

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How do the anti-phoenix provisions of s216 Insolvency Act 1986 work in real life?

• Ken Bates was a director of the old Leeds United Football Club Limited (company number 05334247) ("Oldco") from 17 January 2005 until 7 March 2006. Oldco went into compulsory liquidation on 6 March 2006.
• He was also a director of The Leeds United Association Football Club Limited ("AFC") from 20 January 2005 until 4 May 2007. AFC went into administration on 4 May 2007.
• Since 21 January 2005 he has been a director of:
  • Leeds United Stadium Limited ("Stadium");
  • Leeds United Retail Limited ("Retail"); and
  • Leeds United Investments Limited ("Investments") .
• Stadium and Retail went into compulsory liquidation on 27 June 2007.

So far, so good:

• When Oldco went into liquidation Mr Bates had been a director of the other Leeds United companies for more than 12 months.
• Under the "third exception" in r4.230 Insolvency Rules 1986 he therefore did not have to apply to court for permission to continue to Act as a director of those companies.

But:

• Investments was dormant at some time during the 12-month period before Oldco's liquidation. It filed dormant company accounts for the years ended 30 June 2005 and 30 June 2006.
• The third exception does not apply to a company that has been dormant at any time during the 12-month period.

So:

• Unless Mr Bates applied by 13 March 2006 for leave to act as a director of Investments, and was given leave before 17 April 2006, making use of the "second exception" in r4.229, he was in breach of s216.
• He could therefore be subject to criminal penalties. Although Investments may be dormant he could also be liable personally for any debts it may incurs during the 5 years to 6 March 2011.

Chapter 2 - Summer 2007

Shortly before AFC went into administration on 4 May 2007, Mr Bates became a director of  Leeds United 2007 Limited (1 May 2007) and Leeds United Football Club Limited (company number 05765697) ("Newco") (3 May 2007).

The Guardian reports here that:

• KPMG, AFC's administrators, think an application to court was made;
• HM Revenue & Customs, a creditor challenging the Company Voluntary Arrangement proposed by AFC's administrators, thinks that Mr Bates does not have the court's permission to act as a director of Newco;
• the Insolvency Service has no notice of any such application; and
• Mr Bates made no comment.

Unless Mr Bates obtained leave of the court to act as a director of the two companies before he began to act, he would be in breach of s216.

The "first exception" under r4.228, notifying creditors when a new company acquires the business from an administrator or other appointed insolvency practitioner, could not apply in this case as Mr Bates was already a director of Newco. This difficulty is explained in our previous post here.

The law may be changing to overcome that difficulty (from 6 August 2007, as explained in previous posts, here and here), but that change will not be retrospective and will not help in this case.

A real challenge for Mr Bates is that if he did not have permission, it is too late, he is in breach and may well be liable for Newco's debts up to 6 March 2011.

As an aside, Mark Taylor, Mr Bates' solicitor, became a director of Newco on 4 April 2006, two months before Oldco went into liquidation. He was also a director of Olcdco  and was caught in the trap highlighted in our previous post, arising from the decision in Churchill & Anor v First Independent Factors & Finance Ltd [2006] EWCA Civ 1623 (30 November 2006). He cannot have applied to court successfully unless the court took the highly unusual step of granting retrospective permission.

What went wrong?

They used the wrong company to buy the business (and may have failed to make an application).

Leaving aside the 2006 problem of Investments, Messrs Bates and Taylor should have obtained permission from the court before becoming directors of the company they used to buy the business from the administrators. There was plenty of time to have done so between 1 May 2007 (if not before) and 10 July 2007 when Newco bought AFC's business from the administrators.

So did Ken Bates break the law?

I don't know, but he has to have made some timely and successful court applications to have avoided breaching s216!

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Question: I am the director of an insolvent company and want to use a similar name in my new business. Can it be done and what are the pitfalls?

Answer: Yes it can be done. The main pitfalls are the penalties if you get the details wrong - imprisonment or a fine, or both, and personal liability for the debts of your new company!

 

Q: So how can I use the name I want without risk?

A: Either:

1. you buy the business from the insolvency practitioner appointed to the insolvent company and send certain information to its creditors;
2. you apply to court for permission to use the new name; or
3. the new company has been known by the new name for 12 months before the old company went into formal insolvency.

 

Q: So as long as I give notice or get permission there will be no problem?

A: As you might expect, the law is not entirely straightforward:

• the points above apply from 6 August 2007 (until then problems with the wording of the law and a Court of Appeal decision made it much more difficult - our technical posts explain this here);
• there are strict time limits for giving notice and making court applications; and
• making a court application costs money and the court may say no!

 

Q: So what should I do?

A: This is a tricky and specialised area where you should take advice from an independent insolvency practitioner or a specialist insolvency lawyer.

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As anticipated in our earlier posts on phoenix companies here and here, the amendment to the Insolvency Rules to remedy the problem caused by the Court of Appeal decision in Churchill v First Independent Factors has now been published.

The relevant statutory instrument is The Insolvency (Amendment) Rules 2007, SI 2007/1974, which comes into force on 6 August 2007.

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A share of the assets subject to a floating charge is reserved for distribution to unsecured creditors in priority to the chargeholder in an administration, liquidation or receivership (s176A Insolvency Act 1986 - see below).

This share is known as the "prescribed part" or sometimes the "ring-fenced fund" and was designed to prevent floating charge holders from benefitting from the abolition of government preferential creditors by the Enterprise Act 2002. The share is quantified in accordance with the Insolvency Act 1986 (Prescribed Part) Order 2003.

The requirement to make this distribution to unsecured creditors is disapplied if, inter alia, the administrator, liquidator or receiver either

• "thinks that the cost of making a distribution to unsecured creditors would be disproportionate to the benefits" (s176A(3)(b)); or
• applies to the court for an order on such grounds and the court so orders (s176A(5)).

The first known case of the court making an order under s176A(5) is Re Hydroserve Ltd [2007] All ER (D) 184 (Jun) Chancery Division Rimer J 19 June 2007, the facts of which are reported by Bank Law Blog here and by Law-Now here.

In summary, the court agreed that it was disproportionate to distribute a net £2,000 amongst 122 creditors at a cost of £3,000.

There is nothing startling in this decision but it makes clear that costs need not be wasted on trvial distributions.

s176A Insolvency Act

Property subject to floating charge

176A Share of assets for unsecured creditors

(1) This section applies where a floating charge relates to property of a company—

(a) which has gone into liquidation,

(b) which is in administration,

(c) of which there is a provisional liquidator, or

(d) of which there is a receiver.

(2) The liquidator, administrator or receiver—

(a) shall make a prescribed part of the company’s net property available for the satisfaction of unsecured debts, and

(b) shall not distribute that part to the proprietor of a floating charge except in so far as it exceeds the amount required for the satisfaction of unsecured debts.

(3) Subsection (2) shall not apply to a company if—

(a) the company’s net property is less than the prescribed minimum, and

(b) the liquidator, administrator or receiver thinks that the cost of making a distribution to unsecured creditors would be disproportionate to the benefits.

(4) Subsection (2) shall also not apply to a company if or in so far as it is disapplied by—

(a) a voluntary arrangement in respect of the company, or

(b) a compromise or arrangement agreed under section 425 of the Companies Act (compromise with creditors and members).

(5) Subsection (2) shall also not apply to a company if—

(a) the liquidator, administrator or receiver applies to the court for an order under this subsection on the ground that the cost of making a distribution to unsecured creditors would be disproportionate to the benefits, and

(b) the court orders that subsection (2) shall not apply.

(6) In subsections (2) and (3) a company’s net property is the amount of its property which would, but for this section, be available for satisfaction of claims of holders of debentures secured by, or holders of, any floating charge created by the company.

(7) An order under subsection (2) prescribing part of a company’s net property may, in particular, provide for its calculation—

(a) as a percentage of the company’s net property, or
(b) as an aggregate of different percentages of different parts of the company’s net property.

(8) An order under this section—

(a) must be made by statutory instrument, and
(b) shall be subject to annulment pursuant to a resolution of either House of Parliament.

(9) In this section— “floating charge” means a charge which is a floating charge on its creation and which is created after the first order under subsection (2)(a) comes into force, and “prescribed” means prescribed by order by the Secretary of State.

(10) An order under this section may include transitional or incidental provision.

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Section 216 of the Insolvency Act 1986 restricts the use by a Phoenix company or successor business of a similar name or trading style to that of a company in insolvent liquidation as reported in an earlier post.

Any director of the insolvent company who is involved in managing the successor, unless he has leave of the court and subject to the exceptions in rules 4.228 to 4.230 Insolvency Rules 1986, is both liable to criminal prosecution and personally liable (under s217) for the debts of the successor.

The first exception - when notice is given to creditors (rule 4.228) was found wanting by the Court of Appeal in Churchill & Churchill v First Independent Factors and Finance Ltd ([2006] EWCA Civ 1623).

The draft Insolvency (Amendment) Rules 2007 have therefore been produced to substitute a new version of rule 4.228 with effect from 23 July 2007.

The new rule will enable a director - as had been intended but not achieved by the original rule - to give notice to creditors and so avoid contravening s216 if the insolvent company's business is acquired from an insolvency practitioner.

Most insolvency MBOs will therefore be able to avoid an application to court, provided the notice is given either:

• before the director becomes involved with management of the successor; or
• before the successor uses a prohibited name.

Circumstances in which an application may still be required include:

• where the director is involved with management of a business or a company using a prohibited name and there is no acquisition of the whole (or substantially the whole) of the insolvent company's business; and
• where the director is already a director of a company with a prohibited name, but that company has not been known by that name for 12 months prior to the date of liquidation or has been dormant during that period.

The complexities of these requirements mean that to be sure of avoiding the criminal and civil consequences of contravening s216, directors of insolvent companies who anticipate involvement with a similarly named business take specific professional advice about this issue.
 

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Yesterday's judgement in the Powerhouse company voluntary arrangement (CVA) dispute has been hailed as a victory for landlords, but in reality will lead to landlords seeking greater security from tenants.

Reported in The Times and Citywire, the High Court decision (Etherton J) in fact held that parent company guarantees can effectively be avoided through a CVA, provided the value of the guarantee is recognised in the proposal. In other words, guaranteed creditors must get a better deal than ordinary unsecured creditors.

Whilst the landlords' advisers, Addleshaw Goddard and Lovells, are keen to emphasise the judge's ruling against "guarantee stripping", a well-crafted and balanced CVA remains a powerful tool for managing minority creditors' claims.

Who do you think actually got the better deal here, the landlords or the beleaguered insolvency practitioners trying to find an equitable solution for all stakeholders? Will the commercial property market suffer, or is this another attack (like the Trident case on administrators' liability for business rates) on the proper and efficient use of insolvency procedures as rescue tools? Let us have your comments.

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Schefenacker reports that its bondholders have agreed today, at a company voluntary arrangement meeting, to take:

• EUR 7.5 million cash;
• 5% of the equity; and
• warrants that could raise the equity to 15%.

The shareholder, Dr Alfred Schefenacker, retains 25% of the equity but has contributed:

• EUR 20 million of new money;
• his personal equity in the Engelmann subsidiary; and
• the cancellation of EUR 100 million of shareholder loans.

Senior creditors now hold 70% of the equity.

The success of the migration now depends on the operational restructuring that Stephen Taylor has been managing during the last few months of stakeholder negotiations - he claims "a solid first quarter performance".

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The Court of Appeal's judgement given by Lord Justice Neuberger in Re: Lune Metal Products Limited (in administration), [2006] EWCA Civ 1720, is a delightful model of clarity of thought and expression and is worth reading for that alone.

The point of the case is short. The administrators in a pre-Enterprise Act administration may obtain the court's sanction to make a distribution to creditors only if the distribution is a condition of their discharge.

I am grateful for my attention being drawn to the case by Upload-Finance.

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When an insolvency practitioner applies to the court for directions, the estate may be at risk of an adverse costs order.

Mike Pavitt and Nick Keitley's article on the Beam Tube Products case (Fanshawe & Adshead v Amav Industries Limited and others: All ER (D) 246 (Feb); (2006) EWHC 486 (Ch)), which followed Spectrum Plus, carries a footnote illustrating that risk.

The joint administrative receivers applied for directions about the proper characterisation of purported fixed charges. The court accepted the joint administrative receivers' views that:

• a floating charge over the proceeds of book debts was inconsistent with the charge over the book debts being fixed; and
• a purported fixed charge over plant, machinery and equipment was too wide and was properly characterised as floating.

The respondent debenture holder, whose arguments were unsuccessful, was awarded his costs as an expense of the receivership.

This is not a unique case. Insolvency officeholders should be aware of the risk of adverse costs on a directions application and should consider insuring that risk. (See an earlier post on insolvency litigation insurance here.)

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The UNCITRAL Model Law on Cross-Border Insolvency should enhance cross-border assistance for non-EU officeholders and creditors in British insolvency proceedings.

Introduced in England and Wales, and Scotland, on 4 April 2006 it was first applied in the English High Court on 23 November 2006 in Re Rajapakse (unreported) when a US Chapter 7 Trustee sought the court's assistance to recover assets in England.

Cooperation in cross-border insolvency proceedings within the EU is governed by the European Insolvency Regulation.

Chapter 15 of the US Bankruptcy Code similarly introduces the UNCITRAL Model Law into US law.

Richard Howard's post Global Bankruptcy Mutual Assistance addresses the question in relation to Great Britain by outlining the core provisions of The Cross-Border Insolvency Regulations 2006.

We address foreign creditors' rights in the UK in a previous post here, and you can find out more about the UNCITRAL Model law here.

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This post was prompted by the following question on LawGuru.com:

Can someone outside of the European Union start Bankruptcy Proceedings in Great Britain or make a claim in existing British Bankruptcy Proceeedings against an Individual or a Company?

The short answer is "Yes, and yes"!

Foreign creditors are fully recognised in the UK jurisdictions of England and Wales, Scotland and Northern Ireland and, whilst they may benefit from local professional assistance, they can certainly present insolvency petitions and claim in UK insolvencies.

These existing rights were confirmed in England and Wales and in Scotland by The Cross-Border Insolvency Regulations 2006 (and Northern Ireland is planning to introduce similar regulations during 2007):

Article 13. Access of foreign creditors to a proceeding under British insolvency law 1. Subject to paragraph 2 of this article, foreign creditors have the same rights regarding the commencement of, and participation in, a proceeding under British insolvency law as creditors in Great Britain. 2. Paragraph 1 of this article does not affect the ranking of claims in a proceeding under British insolvency law, except that the claim of a foreign creditor shall not be given a lower priority than that of general unsecured claims solely because the holder of such a claim is a foreign creditor.

3. A claim may not be challenged solely on the grounds that it is a claim by a foreign tax or social security authority but such a claim may be challengedó

(a) on the ground that it is in whole or in part a penalty, or

(b) on any other ground that a claim might be rejected in a proceeding under British insolvency law.

The regulations are the British enactment of the UNCITRAL Model Law on Cross-Border Insolvency.

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The Insolvency Practitioners and Insolvency Services Account (Fees) (Amendment) Order 2007 (S.I. 2007/133), which comes into force on 1 April 2007, makes amendments to the Insolvency Practitioners and Insolvency Services Account (Fees) Order 2003 (S.I. 2003/3363). It increases the fee to be paid in relation to the authorisation of insolvency practitioners and provides for a fee of £10 to be charged in respect of those transfers which are made electronically by way of the Clearing House Automated Payments System (CHAPs) in respect of funds held in the Insolvency Services Account.

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A version of this article first appeared in Financier Worldwide Global Restructuring & Insolvency Review 2003

The 21st century has seen the firm establishment of a rescue culture in the UK, exemplified by the growing influence of the Society of Turnaround Professionals and the now familiar corporate insolvency provisions of the Enterprise Act 2002.

The legislative developments have served to lower entry barriers to insolvency proceedings in terms of cost and perception, the latter through reducing the "stigma of bankruptcy". In particular, the statutory objectives of administration, which is firmly established as the jurisdictionís principal non-terminal corporate insolvency procedure, are defined with "rescuing the company as a going concern" as the first priority.

Solutions like those in the case studies below are now easier to implement (if not necessarily to conceive or manage), making it all the more vital to consult an experienced and rescue-oriented insolvency practitioner at an early stage.

In Case Study 1, early realisation that the groupís cost reductions had lagged the industry-wide market collapse was a key factor, enabling the (nevertheless rapid) formulation and execution of a refinancing and balance sheet restructuring plan. Had this company not been caught in time it would have hit the buffers really hard ñ speed of reaction was of the essence.

Case Study 1

Antal International Limited ñ £20m turnover global recruitment business

Problem:

• Dramatic market contraction 2001

Solution:

• Bank debt replaced by invoice financing.


• Invoice financiers would only fund with administrators controlling company.


• Administration (August 2002) allowed more cost cutting and "breathing space".


• Subsequent Company Voluntary Arrangement (October 2002) eliminated excess creditors and restored profitability and cash generation.

Other Features:

• Paramount distinguished (administrator did not automatically adopt employment contracts after 14 days).


• European Insolvency Regulations tested in action.

Case Study 2 was a relatively healthy core business being turned around successfully. However, the reverse premium that would have been required to effect a trade sale of the two most seriously underperforming subsidiaries would have brought it down. Selling the subsidiary businesses and assets as going concerns through a formal insolvency process was anathema to the incumbent management, but we showed them the value of an insolvency tool in the right hands. Here it both avoided a potentially terminal cash drain and protected the core business from the likely counter-claims of group-wide customers if the subsidiariesí businesses had not continued.

Case Study 2

£10m turnover engineering business
Problem:

• Restructured 2000


• Ongoing turnaround


• 2 subsidiaries draining cash.

Solution:

• Subsidiariesí administrative receivership (October 2002).


• Going concern sales of their businesses and assets.


• Remaining group freed of cost, risk and contingent liabilities.

Other Features:

• Group pension fund issues required preparation for parent company administration to precipitate commercial settlement on the steps of the Court.

Case Study 3 is the most innovative. The cash-rich quoted shell with a positive balance sheet had contingent liabilities that the Court was persuaded (unlike in Colt Telecom) were more likely than not to render the company unable to pay its debts as they fell due. However, the very use of a formal insolvency procedure prompted the crystallisation of many of those contingencies, yielding significant benefits to shareholders. The administration exit was the return of control to its directors, when the company's shares were relisted at 6 times the price at which they had been suspended.

Case Study 3

PNC Telecom plc ñ £60m turnover AIM-listed former mobile retail and fixed line telephone company.
Problem:

• Contingencies remaining after sale of operating businesses/subsidiaries precluded use of the shell as a vehicle for a reverse takeover or distribution to shareholders via a membersí voluntary liquidation.

Solution:

• Administration order (June 2003) prompted landlords to accept replacement obligations from the business purchaser and enabled litigation contingencies to be reduced.

Other Features:

• s236 Insolvency Act applications allowed the administrator to obtain information about the companyís affairs more quickly and cheaply than could the turnaround managers.

In each of these cases a turnaround manager not well-versed in the benefits of formal insolvency procedures might have continued to "think positive", avoiding insolvency at the risk of missing the opportunity of a successful rescue. I believe that a balanced mix of turnaround and insolvency skills and an ability to innovate are most likely to deliver optimal solutions to the stakeholders of companies in financial distress.

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We looked at The Purple Book, the Pensions Regulator's ("TPR") and the Pension Protection Fund's ("PPF") view of pensions and insolvency risk, in an earlier post. Further analysis reveals a strikingly high risk of insolvency for the sponsors of a number of schemes.

Of the defined benefit schemes examined by TPR and the PPF at 31 March 2006, the 82 schemes (1.4%) whose sponsors are most likely to become insolvent within 12 months have an average insolvency probability of 35.7%.

24 of those companies can be expected to have failed already and 5 more are expected to fail in the next two months.

75 of those 82 schemes are underfunded and they represent 41% of the combined insolvency and underfunding risk identified amongst underfunded schemes. They have an average insolvency probability of 37% and combined risk of £226m (£3m per scheme).

The trustees and the management of sponsors of these schemes risk severe criticism or potential personal liability if they do not take insolvency advice from a suitable professional. Many have, but now may not be too late for the rest to act.

Having a significant pension fund deficit is not necessarily terminal to a company whose business is viable, but the earlier all options are explored the more likely it is that a solution will be found.

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Insolvency litigation funding is a maturing industry, certainly if you believe the press reports about Insolvency Management Ltd funding a $173m claim by the liquidator against the auditors of Stone & Rolls.

The details and merits of the claim need not concern us. What is important is that an "after-the-event" insurer will provide cover sufficient to enable a liquidator to issue such proceedings.

Litigation is not something a liquidator can pursue lightly. Even directions hearings can lead to adverse costs orders.

But the point has not been lost on the insolvency regulators that arguably liquidators have to explore - even in cases where there are very limited other assets to cover the costs - litigation funding and costs insurance whenever a reasonable antecedent transaction or other recovery claim arises.

Although such funding and cover has been available for some years (see "Funding insolvency litigation", Recovery, Summer 2002, p30), only now has it developed into a practical and actively used solution (see also "Using Litigation Funding - a practitioner's experience", Insolvency Practitioner, Summer 2005, p4).

The cases will not be a flood, but I see the development of such funding as good for creditors and good for the insolvency profession.

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The Pensions Regulator ("TPR") and the Pension Protection Fund ("PPF") issued The Purple Book in November 2006, revealing, in addition to much wider pension risk issues, the PPF's perspective of insolvency risk, largely on the basis of Dun & Bradstreet's methodology and data.

Key relevant messages include:

• insolvency risk is higher in companies with poorly funded or small pension schemes or in traditional industries;
• 0.7% of active companies go into insolvent liquidation each year, but the risk of insolvency is dramatically higher for the 5% of companies with the lowest Dun & Bradstreet failure score (ie those scoring 1 - 5).

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With both Greeting Card Group and Music Zone going into administration this week (reported in Financial Director), are we seeing a retail-led continuation of the last quarter's surge in UK corporate insolvency rates?

It's hardly surprising to see retail administrations at this time of year - over-leveraged and under-performing retailers have minimum borrowings after the Christmas sales peak and secured creditors will naturally choose that point to stop the losses.

Retail has been a risky sector for some while, and although some brands are reporting a strong Christmas season, the continuing consumer debt problem (£1.3 trillion total and over 100,000 personal insolvencies in 2006) cannot help.

But constructive use of formal insolvency - such as the pre-pack administration used to rescue Little Chef this week - can often add value when a business is saleable and the right restructuring team is brought in early enough.

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In November 2006 Euler Hermes, the credit insurer, reported:

Economic outlook: global insolvency to increase in 2007

The forecast suggests a peak growth rate of 10% for the USA, as highlighted by Bob Eisenbach at In The (Red), and a global average increase in business insolvency rates of 3%.

The UK forecast is also 3%, but with this week's figures from Experian showing 10.7% UK corporate insolvency growth in 2006, posted here, that 3% forecast may be light.

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The 21st century has seen the firm establishment of a rescue culture in the UK, exemplified by the successful establishment of the Society of Turnaround Professionals and the coming into force of the corporate insolvency provisions of the Enterprise Act 2002 in September 2003.

The legislative changes have served to lower entry barriers to insolvency proceedings in terms of cost and perception, the latter through reducing the "stigma of bankruptcy". In particular, the statutory objectives of administration, which has been re-established as the jurisdictionís principal non-terminal insolvency procedure, are now defined with "rescuing the company as a going concern" as the first priority. Solutions like those in the case studies below will now be easier to implement (if not necessarily to conceive or manage), making it all the more vital to consult an experienced and rescue-oriented insolvency practitioner at an early stage. Each case study is factual and I was the administrator and/or the company's advisor.

In Case Study 1, early realisation that the groupís cost reductions had lagged the industry-wide market collapse was a key factor, enabling the (nevertheless rapid) formulation and execution of a refinancing and balance sheet restructuring plan. Had this company not been caught in time it would have hit the buffers really hard ñ speed of reaction was of the essence.

Case Study 2 was a relatively healthy core business being turned around successfully. However, the reverse premium that would have been required to effect a trade sale of the two most seriously underperforming subsidiaries would have brought it down. Selling the subsidiary businesses and assets as going concerns through a formal insolvency process was anathema to the incumbent management, but we showed them the value of an insolvency tool in the right hands. Here it both avoided a potentially terminal cash drain and protected the core business from the likely counter-claims of group-wide customers if the subsidiariesí businesses had not continued.

Case Study 3 is the most innovative. The cash-rich quoted shell with a positive balance sheet had contingent liabilities that the Court was persuaded (unlike in Colt Telecom) were more likely than not to render the company unable to pay its debts as they fell due. However, the very use of a formal insolvency procedure prompted the crystallisation of many of those contingencies such that there was a value to shareholders - the shares were relisted on return of the company to the directors at six time the price at which they were suspended on administration.

In each of these cases a turnaround manager not well-versed in the benefits of formal insolvency procedures might have continued to "think positive", avoiding insolvency at the risk of missing the opportunity of a successful rescue. I believe that a balanced mix of turnaround and insolvency skills and an ability to innovate are most likely to deliver optimal solutions to the stakeholders of companies in financial distress.

• Case Study 1

Antal International Limited ñ £20m turnover global recruitment business
Problem: Dramatic market contraction
Solution: Bank debt replaced by invoice financing. Invoice financiers would only fund with administrators controlling company. Administration allowed more cost cutting and "breathing space". Subsequent Company Voluntary Arrangement eliminated excess creditors and restored profitability and cash generation.
Other Features: Paramount distinguished (administrator did not automatically adopt employment contracts after 14 days). European Insolvency Regulations tested in action.

• Case Study 2

£10m turnover engineering business
Problem: Restructured, ongoing turnaround, 2 subsidiaries draining cash.
Solution: Subsidiariesí administrative receivership. Going concern sales of their businesses and assets. Remaining group freed of cost, risk and contingent liabilities.
Other Features: Group pension fund issues required preparation for parent company administration to precipitate commercial settlement on the steps of the Court.

• Case Study 3

PNC Telecom plc ñ £60m turnover AIM-listed former mobile retail and fixed line telephone company.
Problem: Contingencies remaining after sale of operating businesses/subsidiaries precluded use of the shell as a vehicle for a reverse takeover or distribution to shareholders via a membersí voluntary liquidation.
Solution: Administration order prompted landlords to accept replacement obligations from the business purchaser and enabled litigation contingencies to be reduced. Administration ended after 7 months and company relisted at 6 times the price at which the shares were suspended on the date of administration.
Other Features: s236 Insolvency Act applications allowed the administrator to obtain information about the companyís affairs more quickly and cheaply than could the turnaround managers.

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Experian report a surge in formal insolvencies in the UK in Q4 2006 (see their statistics here: "Corporate failures storm to highest level for more than a decade").

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Section 216 of the Insolvency Act 1986 restricts the use by a Phoenix company or successor business of a similar name or trading style to that of a company in insolvent liquidation.

That is well known, as are the exceptions ñ or are they?

The Exceptions

S216 works by making any director of the insolvent company who is involved in managing the successor, unless he has leave of the court and subject to the exceptions in rules 4.228 to 4.230 Insolvency Rules 1986, both liable to criminal prosecution and personally liable (under s217) for the debts of the successor.

• The first exception, giving notice to creditors (rule 4.228), will rarely be available, contrary to widely adopted practice, because the notice must be given before the relevant director is involved with the successor, as the Court of Appeal made clear recentlyin Churchill & Churchill v First Independent Factors and Finance Ltd ([2006] EWCA Civ 1623).


• The second exception, a six week grace period following an application for leave made to the court no later than 7 days after the date of liquidation (rule 4.229), may be more common but requires an application anyway.


• The third exception, when the successor company has been known by the prohibited name for 12 months prior to the liquidation (rule 4.230), will also not assist most directors who wish to acquire and continue a business from an insolvent company.

Consequences

The first exception does not work in the way many people have thought. Notice to creditors is ineffective if the director is already a director, shadow director or de facto director of the successor business (but the notice cannot be given until the transaction has occurred).

What s216 therefore requires in most cases is an application to court for permission to be involved with a similarly named business, as a recent article ìRe-use of company names: the efficacy of the notice procedure called into questionî points out (Recovery, Summer 2006, p25).

Unless the application is made before the end of the first week of liquidation, making use of the second exception, there may be a period of several weeks during which the business cannot be transferred, pending the hearing.

Since the criminal and civil liabilities that result from breaching s216 are strict and automatic, and the court will actively consider whether approval is appropriate, and the court is unlikely to give retrospective permission (following Arden LJ in ESS Production Ltd v Sully [2005] EWCA Civ 554), a director would be ill-advised to rely on seeking permission after the event.

Sales by administrators

There are most likely to be unforeseen difficulties when the business was sold to the director by an administrator, administrative receiver or voluntary arrangement supervisor some time before the company went into liquidation. S216 will apply if the vendor company goes into insolvent liquidation at any time during the 12 months after it stopped being known by the prohibited name being used by the purchaser.

The only way for a director to avoid liability in these circumstances is to apply to court under s216. The application should be made before liquidation ñ although there is some doubt as to whether this would be valid ñ or within 7 days afterwards (making use of the six week period within which the application can be heard without liability attaching from the date of liquidation, provided the application is successful).

Addressing the problem

The situation is clearly unsatisfactory as MBO directors cannot wholly avoid the risk of liability and the Insolvency Service is therefore considering an urgent, albeit not retrospective, rule change.

In the meantime, directors involved in purchasing a business from an administrator may seek to agree with the officeholder that he avoids using insolvent liquidation as an exit mechanism. They are also likely to want him to avoid the vendor company being known by the prohibited name from the date of sale.

For those who have already breached s216 following an insolvency sale, in the mistaken belief that notice to creditors when the director was already involved with the successor was adequate, an application under s216 now would at least offer the prospect of relief from personal liability for the successor companyís future debts. Otherwise the director, whilst he remains involved in management of the successor company, will continue to be personally liable for all the successor companyís debts for up to 5 years after the liquidation of the vendor company.

Phoenixes beware!

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The Trident Fashions case brought by Exeter City Council on whether business rates have to be paid in priority to an administrator's remuneration returns to the High Court in February, according to Accountancy Age.

Retail insolvencies may be made more difficult if the council wins, which could lead to more out-of-court restructurings or more pre-pack business and asset sales.

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LONDON (Reuters) - Some retailers, hit by poor Christmas trading, may struggle to pay their December rent bills, forcing them into insolvency or a debt restructuring in the New Year. . . click here for the full article.

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