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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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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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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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 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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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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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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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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"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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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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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 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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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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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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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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