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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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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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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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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The Chancellor has announced (notably without using the n-word) that Northern Rock is to be nationalised.

What does this mean?

• The shares pass into public ownership
• The government has at last called the bluff of the hedge fund shareholders
• Ron Sandler becomes Executive Chairman
• Focus should now be brought to restructuring the business to create - in several months' time - something saleable

It will be difficult for the government to avoid the charge of dither and delay. As reported in our previous post, the Treasury Select Committee has made clear that early decisive action was the missing ingredient in this restructuring.

Although the company should now be able to concentrate on turning itself around, the government - as the new owner - should steer clear of micromanagement. Mr Sandler and his team should be left to manage the business, and the government should concentrate on the politics (and the arguments with shareholders about compensation).

At least the risk of formal insolvency has receded almost entirely - it's just not necessary with the Treasury as both senior lender and shareholder. The balance sheet has been restructured through a form of debt-for-equity deal. One could also describe nationalisation in this case as a form of administration or receivership but without the stigma of insolvency and with only shareholders being crammed down. Indeed, had the government not guaranteed all the depositors, Northern Rock would have been in a similar position to other companies with administration being the mechanism used to restructure the balance sheet.

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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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Reorganisation, creditor empowerment and faster proceedings are the highlights of the new Czech Bankruptcy Act, in force from 1 January 2008.

A local perspective is given in Czech Business Weekly, emphasising strict deadlines on courts, debtors and creditors - the court has two hours to publish a petition for insolvency and has to declare bankruptcy or otherwise within 10 days. This should reduce the length of the average Czech insolvency proceeding from its current 5 years.

There has been a shift in philospophy as regards creditors:

"The new law grants power to creditors, and the administrator in bankruptcy is more the 'executor' of the will of creditors in insolvency proceedings."

The new reorganisation procedure, which has shades of the US Chapter 11, is limited to businesses with turnover above CZK100m (c. EUR3.3m) or more than 100 employees. A stay provides 120 days for the submission of a reorganisation plan. Further details are available in a Clifford Chance briefing paper here.

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. . . at KFC Uerdingen.

The insolvent club is auctioning the opportunity for 19 January, to include a friendly against Rot Weiss Oberhausen. At the time of writing the ebay bids are up to EUR 2,100 here, with 5 days of bidding to go.

The club has until the end of January to stave off bankruptcy proceedings.

Read more of the story at Deutsche Welle here.

An interesting tactic, but I'm not sure it would have helped at Luton Town!

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The register will be launched in September 2007 at the Regional Court in Brno and the Supreme Court in Olomouc before testing is rolled out to other courts. It will contain on-line details of bankruptcy administrators, debtors and their electronic files, according to epractice.eu.

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Credit crunch - market volatility - insolvency - where next?

Nouriel Roubini is a professor of economics at New York University and he is not optimistic about what will happen in the US: The Forthcoming Fed Rate Cuts May Not Prevent a US Hard Landing .

If there is a hard landing in the US, then Europe and the UK will feel the bump.

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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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David Wood's new blog, Insolvency Consultant and Bankruptcy Trustee, offers a Canadian perspective on the insolvency and restructuring world. Visit it and see what you think! David's firm, Boale, Wood & Company, is an insolvency boutique based in Vancouver.

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GILD , the Global Insolvency Law Database, is a resource dedicated to all aspects of credit and debt, including debtor and creditor rights, the creation and enforcement of security interests, corporate restructuring, bankruptcy, reorganization and liquidation.

At the heart of the World Bank's Insolvency Initiative, GILD is designed to promote understanding and awareness of best practices by presenting information on the latest developments and systems adopted or proposed in countries and regions throughout the world. GILD contains reports on cutting edge innovations, the World Bank Principles and Guidelines for Effective Insolvency and Creditor Rights Systems, explanatory overviews by experts in the field, and excerpts from relevant legislation.

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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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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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