Formal Corporate Rescue

Chapter One: Introduction

Recently, the environment in which corporate insolvencies are resolved has changed. In the past fifteen years corporate insolvency law in the UK has been radically reshaped mainly by means of the Enterprise Act.[1] As a result corporate rescue has become increasingly a fashionable topic, which has long been a subject of global interest. It has been commanding very significant legislative, academic and professional attention.

Generally, insolvency is defined as the inability to pay debts as they mature, or as obligations become due and payable.[2] In such situations a person may still have an excess of assets over liabilities, but will still be considered insolvent if is not able to convert the assets into cash in order to meet financial obligations.

According to Finch[3] rescue procedures in corporate insolvency involve going beyond the normal managerial responses to corporate troubles. Corporate rescue is seen as “a major intervention that is necessary to avert eventual failure of the company”.[4] It aims at providing an alternative to liquidation proceedings for financially ailing but economically viable companies; it helps companies in difficulty take a breath by freezing the enforcement of creditors’ claims for a prescribed period as well as to enable such companies to recover from the temporary cash flow difficulties.[5]

When an attempt to rescue is not successful, the business of the insolvent company can be sold as a going concern. Through this method, the creditors’ claims are more likely to be satisfied to a greater extent than would be possible in an immediate liquidation where the assets of the debtors are usually disposed for the purpose of a quick realisation to creditors. Outside insolvency professionals may be involved in the rescue activity and take control over the assets and management of the company, or the existing management of the company may remain in control of the company. This can be either unsupervised or subject to supervision which will be undertaken by an outside insolvency professional who can be appointed by the entitled creditor or the court under the terms of relevant legislation.[6]

Corporate rescue has become so popular that even unregulated investors, such as private equity investors and hedge funds, have increased their role as purchasers and creditors of troubled firms, and derivatives and other financial products have permitted these sophisticated investors to “participate out” their risks[7]. Most importantly, there has been an enormous growth in merger and acquisition activity associated with troubled firms. All of these changes have put pressure on the traditional approaches to corporate insolvency.

Background to corporate rescue

The UK government has long been concerned with the innovation and formulation of a modern and efficient corporate rescue system. The introduction of formal corporate rescue procedures in the UK can be traced back as far as 1870,[8] but a sophisticated system of corporate rescue procedures did not develop until much later. The main reason for such a significant reform was the economic disaster in the 1970’s.

Because of the weak bankruptcy and rescue law system, it was impossible for the corporate sector to rehabilitate in the face of a high volume of enterprise distress and long term economic recession. Many countries that had been seriously affected by the impact of the crisis started reconsidering and improving their domestic corporate rescue regimes, especially through informal workouts. A typical model of the informal rescue arrangements was the “London Approach” which was first created and promoted by the Bank of England in the mid 1970’s.[9] This procedure has played a significant role in contributing to corporate recovery outside formal insolvency proceedings.

The informal rescue procedures were simple but unfortunately lacked protection for the company. The government, realising the need for more sophisticated rescue procedures, appointed the Cork Committee to review and make recommendations to both corporate and personal insolvency laws. The committee’s report advised the provision of “means for the preservation of the viable commercial enterprise capable of making a useful contribution to the economic life of the country”.[10] The report also observed;

“We believe that a concern for the livelihood and wellbeing of those dependent upon an enterprise which may well be the lifeblood of a whole town or even a region is a legitimate factor to which a modern law of insolvency must have regard. The chain reaction consequences upon any given failure can potentially be so disastrous to creditors, employees and the community that it must not be overlooked”.[11]

With this aim in mind the Cork Committee set out a number of recommendations based on two proposed new procedures. These were the company voluntary arrangement and the administration order.

In the 1980’s the recommendations of the Cork committee were implemented in the legislation. The company voluntary arrangement and the administration procedures were first introduced under the Insolvency Act 1985 and later on under the Insolvency Act 1986 where it accommodated the existing administrative receivership, the scheme of arrangement procedures as well as the London approach.

Even though the legislature adopted the Cork Committee’s recommendations, some departures were made from what had been originally recommended. This is because the initial format of these procedures was not fully conducive to an effective corporate rescue. Over the following years very few administration orders were made and only a low number of company voluntary arrangements were agreed each year. As a result a series of legislative amendments followed.

Research aims and the need for this analysis

Since the Insolvency Act of 1986[12], the focus of reforms in corporate insolvency law has increasingly been on the avoidance of corporate failure and improvement of the rescue culture. An example of this is through the Insolvency Act 2000[13] where a statutory moratorium has been introduced which makes the Companies Voluntary Acts more attractive to small eligible companies that require salvage.

Apart from that, the Enterprise Act 2002[14] has brought some great reforms with its main focus being on formulating a more rescue oriented and efficient administration regime that promotes “fairness, efficiency and accountability by the abolition of administrative receivership”.[15]

The provisions of the Enterprise Act 2002 on corporate insolvency came to force on the 15th September 2003. These provisions brought about major changes to the corporate insolvency regime that was introduced by the Insolvency Act 1986. As mentioned before, even though there had been previous amendments to the 1986 Act, like the provisions of the Insolvency Act 2000, the Enterprise Act 2002 has clearly provided for the most fundamental revision of both corporate and personal insolvency for over 20 years.

In July 2001, the Government published its White Paper, “Productivity and Enterprise: Insolvency – A Second Chance”.[16] This paper proposed measures to modernise both personal and corporate insolvency law. While some of the most radical measures were reserved for personal insolvency, on the corporate side the focus was on promoting the rescue of viable companies and their businesses, thereby encouraging productivity and enterprise, increasing accountability and returns to creditors.

This dissertation is formulated upon a thorough exploration of the legislative changes in corporate insolvency law over the past years in relation to corporate rescue. It will be looking at the theoretical and practical issues of the current corporate rescue laws in the UK.

It is of no question that the appropriate solution to the financial difficulties of a company depends on the circumstances of the case; that is the nature of the problems, their severity and the means available for resolving them. The most commonly used corporate insolvency procedures are voluntary and compulsory liquidation. These provide for an orderly winding up of the affairs of financially distressed companies and are both generally terminal for the company involved.

These liquidation procedures were left relatively untouched by the Enterprise Act which instead concentrated on two alternative corporate insolvency proceedings, namely administration and administrative receivership. In support of the White Paper’s call to promote rescue and collective insolvency procedures, the Enterprise Act streamlined the procedure of administration and removed (in most instances) the right to appoint an administrative receiver. In addition, to provide a more equitable outcome for creditors the Enterprise Act also abolished the Crown’s preferential status in all insolvencies and introduced a mechanism (the “prescribed part”) in corporate insolvencies for the benefit of that abolition to flow to ordinary unsecured creditors, in cases with floating charges.

The key objective of this research is to analyse the current UK corporate rescue laws with particular emphasis on the administration and how it came about to be the main rescue procedure in corporate insolvency law. The dissertation furthermore, pays specific attention to the administration procedure to see if it is appropriate for the current economic regime. There is also an overview of the other rescue procedures as well in order to examine the weaknesses and inadequacies of the rescue regimes.

Due to the high profile instances of companies that have been in need of rescue in the recent years administration represents the second most important corporate insolvency regime (the first being liquidation). It should be noted that even though liquidation is a procedure in corporate insolvency law, this dissertation is dealing specifically with the rescue procedures in corporate insolvency. For this reason even though liquidation might be mentioned here and there in this research, it will not be part of the insolvency procedures to be explored.

How are these aims being achieved?

Research Methodology

This is an empirical researched dissertation and has been conducted through library based research. It primarily relies on a comprehensive review of existing literature, legislation, case decisions and official documents (governmental documentation). The dissertation also relies on insolvency scholarship mixed with journalism in order to get a clear update picture of the current economic regime.

The dissertation title indicates that this research is constructed upon the analysis of the insolvency procedures with relation to corporate rescue. Through the title of the dissertation two important methodological questions are required to be addressed before commencing with the analysis.

Is it appropriate to carry out a research on a topic relating to the legislative changes in corporate insolvency procedures?

In order to answer this question we need to establish if it is appropriate to conduct a research on corporate insolvency law procedures in the first place. It is well known that corporate insolvency and more specifically, the corporate rescue laws are an important part of the bankruptcy laws of any country. This is because they are “a defining characteristic of a market economy”.[17]

The market economy encourages using the resources available as well as competitive methods in order for the companies to achieve the maximum of economic value. This being the case it is completely normal to see companies getting into financial trouble (falling into insolvency) when business has not been going well.

Therefore, corporate failure is a common problem that any “market economy country” will encounter. Because of this, corporate rescue laws are created and developed in order to rescue the businesses that are in financial distress but viable economically. Corporate rescue is not only a legal procedure that helps in bankruptcy law, but is also a very important part of the economy. A research on this is highly appropriate because understanding corporate rescue will be of both academic value and practical significance because the current regime we exist in is market based economic regime.

It can be argued that the Enterprise Act 2002 aimed at a paradigm shift that is to make the UK the best place in the world to do business. The statute can be viewed in the context of the late 1990s economic boom that was fuelled by the technology and Internet sectors.[18] At the same time however, the government feared a return of the economic downturn and recession of the early 1990s.[19]

By analysing the legislative changes that have occurred in corporate insolvency law one can understand how administration procedure came to be the main rescue procedure in the UK. Through this analysis one can also draw a conclusion as to whether or not this rescue procedure has succeeded in the current economic regime (in dealing with the economic crisis that had been feared and had given rise to the idea of corporate rescue in the first place).

Why does this dissertation choose the United Kingdom as a research object?

The UK has had long history of bankruptcy law among western industrialized countries since a statute of Henry VIII was enacted in 1542.[20] In addition, it should be noted that the schemes of arrangement approach which is the first rescue oriented regime, was introduced by the Victorian legislation in 1870, and it had great influence on the insolvency law reforms of other industrialized nations.[21]

The UK has structured a relatively advanced corporate rescue system which is being referred to by other countries worldwide. It is of great importance to do this analysis especially since the UK has undergone two dramatic reforms to its rescue regimes in the new millennium under the Insolvency Act 2000 and Enterprise Act 2002. Therefore doing an extensive research on rescue laws in relation to the present economic regime will have some value theoretically and practically. The research will enrich the corporate rescue theory not only for the UK but also other countries that look towards the United Kingdom (for example the developing countries). In addition, this dissertation will open a window for insolvency professionals, who can, with their experience build up on the ideas on whether the current rescue procedures in corporate insolvency are indeed the proper way to go in this current economic regime.

The UK government has been a pioneer, using corporate rescue practice to promote its insolvency law reforms towards a modern corporate rescue culture. The widespread acceptance and reference of the UK rescue regimes in other jurisdictions clearly shows that UK is the perfect country with which to base this research on when taking into account the central rules and policies in rescue regimes.

Outline of the dissertation

This dissertation makes extensive reviews of the corporate insolvency laws and reforms to rescue regimes. It explores how the UK has shaped its own rescue laws for their respective systems on the basis of differing circumstances and how they have balanced the bargaining power of every interested group in a rescue activity. Although the dissertation is aimed specifically at the impact of the legislative changes in the corporate insolvency laws and although it focuses on the administration procedure, the dissertation also touches on the other rescue procedures in corporate insolvency law. The dissertation takes this approach so as to explain how the administration procedure came about to be one the most important procedures in corporate insolvency law.

In order to realise the research aims this dissertation has five chapters. Chapter two, which may be described as the literature review, explores the historical developments that have occurred in corporate rescue laws in the UK. It explains the corporate rescue legal framework before the reforms of the 1980’s, the rescue procedures in the Insolvency Act 1986, the reforms that took place in the Insolvency Act 2000 and how it changed the Company Voluntary Arrangements as well as an introduction of the Enterprise Act 2002 and the new administration procedure.

Chapter three is a follow up on chapter two. Here the administration procedure is discussed in more detail and the position of law is brought forward. In this chapter the Enterprise Act among other legislations are discussed and specific attention is paid to how the administration of companies takes place in order to get a practical sense of the issue.

Chapter four is a combination of the law and practice. In a way it is a chapter that exposes the gaps found in the laws governing corporate rescue in the economic situation which the UK is facing at present. In this chapter the criticisms from the literature review are brought forward. The challenges posed by the current economic crisis and the efficiency of the insolvency law also are explained in this chapter as well as the further need for reforms. Again in this chapter there is still the argument about the advantages of administration over the other rescue procedures but clear criticism is still made if it is the best procedure in dealing with the economic crisis. The Enterprise Act is also discussed in order to see if it has indeed managed to promote efficiency and transparency in so far as insolvency proceedings are concerned.

Chapter five is a specific chapter dedicated to the conclusions and recommendations that result from the dissertation. In this chapter there are general observations made as well as suggesting further reforms on the law governing insolvency in terms of the administration procedure.

Chapter two: Historical developments of corporate rescue laws in the UK

The corporate rescue legal framework prior to the reforms in the 1980s

As briefly mentioned before in chapter one; the dramatic changes to the UK insolvency law did not take place until the 1980s. This is when the Insolvency Act 1986 was enacted under the recommendation of the Cork Committee.[22] The Cork Committee, which was established in 1977, made a very comprehensive review of the existing insolvency law and as a result recommended two corporate rescue regimes; these are company voluntary acts and administration and represented the first formal procedures of rescue culture in the UK[23]

Before the legal reforms that were recommended by the Cork Committee there were some limited aspects in certain laws that somehow managed to provide solutions to the insolvent companies. An example of this was the schemes of arrangement which was created by the Company Law legislation in the late 19th century. The scheme of arrangement method was used to provide ground for the company in trouble along with its creditors for debt restructuring. Since there was no available insolvency law framework at that time this method was seen as an alternative to liquidation. Through this method the troubled company could reach a certain agreement with its creditors (company debt restructuring). Unfortunately this method was widely criticised as complicated and expensive. [24]

Apart from the schemes of arrangement, the administrative receiverships also seemed to have some rescue oriented aspects although they were quite limited. The rescue procedure in the administrative receiverships was specifically in the cases where the claim of the floating charge holder was under secured. Here the receiver and manager continued trading in order to restore the company in trouble instead of just doing a quick sale in order to realise the claim of the floating charge holder.[25]

The different social and economic conditions that took place in the UK after World War II are what encouraged the corporate insolvency reforms. For example, the oil crisis and the economic recession which occurred in the 1970s made the government take a look at the existing insolvency law. The insolvency law was seen to be ineffective when the crisis occurred because many companies had been liquidated and would have been restored had there been an effective corporate rescue law procedure in place.

Following the reaction from the economic crisis in the 1970s, the “London approach” was formed in 1977 under the bank of England. This became a well established voluntary procedure (informal rescue procedure) and proceeded under the consensual support of banks. The London approach is one the major informal rescue arrangements and is seen as the opposite to schemes of arrangement. It is an informal well functioning rescue solution to corporate failure and has managed to remain so even in the modern UK corporate rescue legal framework. [26]

Schemes of arrangement

The scheme of arrangement procedure is not a specialist insolvency procedure as such but has still been used to carry out many company restructurings. The procedure can be found in Part 26 of the Companies Act 2006 and has a very lengthy history which can be traced as far back as the late 19th century.[27]

The scheme of arrangement provided a rescue procedure apart from the traditional winding up proceedings (liquidation) before company voluntary agreements (hereafter referred to as CVAs) and administration became available. The procedure can be used to buy out minority shareholders but can also be used to facilitate the reorganisation/restructuring of large companies facing financial trouble for example, Cape plc and British Energy plc.[28]

The scheme of arrangement has also played an important part in the restructuring of insurance companies.[29] The case of Re Hawk Insurance Co. Ltd[30] explains how the approval of a scheme of arrangement is a three stage process. Firstly, is the application to the court for an order that a meeting should be summoned (this gives the opportunity for those affected to be present at the meeting). Secondly, the scheme proposals are brought up at the meeting to obtain approval (this ensures that the proposals are accepted by the majority). Thirdly, if the scheme proposals are approved by the majority, there must be a further application to the court for its sanction (The court’s job here is to make sure the opponents interests receive impartial consideration). In the case of Re British Aviation Insurance Co Ltd, [31] it is seen that the creditors’ decisions always prevail. Lewison J pointed out in this case that it doesn’t matter if the opposing creditors have reasonable objections to the scheme. Even if a creditor is equally reasonable in voting for or against the scheme the creditor democracy prevails.

One advantage of schemes of arrangement procedure is that there is no statutory requirement that the company needs to be insolvent or likely to be insolvent. Because of this the procedure can take place at quite an early stage.

It has been a continuous concern however that in the scheme of arrangement procedure the court’s level of involvement quite high making the procedure expensive. From the case of Re Hawk Insurance Company Ltd and the case of Re British Aviation Insurance Company Ltd mentioned above we can see that the court has a wide discretion to refuse to sanction an arrangement if it believes that some interested party is not being treated fairly and reasonably. This can happen even if the scheme has been approved by the meetings of creditors and members in every class.[32] Furthermore, if the court feels that fraud has been established in the scheme of arrangement then it is entitled to nullify the scheme that had already been sanctioned earlier.[33]

The procedure has also been repeatedly criticised for its complex voting structure. The members and creditors included in the scheme are actually divided into classes and the voting takes place within each class (The procedure is collective and all the interested parties are taken into account by the court).[34]

Because of the disadvantages the scheme of arrangement procedure had especially in rescuing small companies,[35] The Cork Committee still saw the need for further insolvency reforms and the introduction of other corporate rescue procedures.

Administrative receiverships

Administrative receivership was essentially a creditor- oriented procedure which originated as a remedy to protect a person’s interests in property (developed to protect the interests of the floating charge holder). It is a process of enforcing the debt by a secured creditor with a floating charge over the company’s assets. The administrative receivership procedure was introduced in the late 19th century and from that time became a very large part of the UK financial structure.[36]

The technique of the administrative receivership procedure is that the floating charge holder appoints “an administrative receiver” to take over the assets and business affairs (finances) of the company in trouble. The aim here is to trade the company out of financial difficulty in order to benefit all stakeholders. Since it is not always the case that the company can traded out of financial difficulty, the administrative receiver may attempt a quick realisation of assets. It is important to note here that the administrative receiver owes a primary duty to his appointer (that is the floating charge holder) so he needs to ensure that the charge holder obtains a better return.[37]

In the past two decades, the administrative receivership procedure was highly criticised and a lot of issues were brought up as to whether receivership was a “rescue” procedure as such. The Cork Committee contributed tremendously to these thoughts:

“Such receivers and managers are normally given extensive powers to manage and carry on the business of the company. In some cases, they have been able to restore an ailing enterprise to profitability, and return it to the former owners. In others, they have been able to dispose of the whole or part of the business as a going concern. In either case, the preservation of the profitable parts of the enterprise has been of advantage to the employees, the commercial community, and the general public.”[38]

One of the main concerns that were brought up concerning the administrative receivership procedure was that the receiver could be appointed at any time,[39] and he owes his duties to his appointer. Because of this the receiver discharges his duties without considering the interests of the general body of creditors. It is only where a rescue attempt is encouraged that the administrative receiver operates for the benefit of all the stakeholders if the charge holder is under secured. This means that the administrative receiver does not have sufficient incentives to maximize the realisation of the assets as long as the value of the remaining assets could satisfy the repayment to the secured lender.[40]

Furthermore, another concern with the administrative receivership procedure is that the administrative receiver is not accountable to other creditors apart from the floating charge holder. It has been a continuous complaint from unsecured creditors that receivers looked out for the interests of the bank that appointed them and not the interests of the business or the other creditors.[41] The interests of the unsecured creditors are at the mercy of the action of the floating charge holder.[42] This is unfair to the ordinary creditors who are in a weak bargaining position and as a result may end up being prejudiced.[43]

The weaknesses recognised by the Cork Committee in the administrative receivership procedure directly resulted in the innovations of Company Voluntary Arrangements (CVAs) and Administration Orders which could be used in circumstances where there was an absence of a floating charge. The Cork Report recommended that reforms be made to deflect the administrative receiver’s primary duties away from the floating charge holder to the general body of creditors. It was also recommended that the administrative receiver be made more accountable at times when the legislation failed to adopt this approach.[44]

The “London Approach”

The London Approach procedure is defined as:

“…a non statutory and informal framework introduced with the support of the Bank of England for dealing with temporary support operations mounted by banks and other lenders to a company or group in financial difficulties, pending a possible restructuring”.[45]

The London Approach procedure can be traced back to the economic recession in the 1970s. The recession had a very bad impact on the companies at that time (especially multibank based companies) and the general banking sector in the UK.[46] Since there was no formal rescue procedure at that time The Bank of England became involved in achieving an approach to the rehabilitation of a distressed company. This to a large extent relied on the cooperation, understanding, consensus and continuing support amongst the bank creditors.[47]

Since the procedure started, The London Approach has succeeded in rescuing a great number of companies facing financial difficulty out of court even though the companies have a large number of bank creditors. The success of the London Approach has not only created a flexible and cooperative informal rescue arrangement for corporate recovery, but it has also provided a useful pattern that has been learned and imitated in many other developing countries despite their cultural and legal differences.[48]

The London approach is seen as a set of principles rather than rules. It offers a flexible pattern of debt restructuring and relies on negotiation with banks and their collective financial support.[49] The London approach provides a ground where informal restructuring can take place without any bad publicity impacting on the company on its financial status (when a large publicly held company falls into financial difficulties, the disclosure of its financial status brings fear to the creditors and may as a result cause difficulties in the rescue attempt).[50]

In the London approach procedure there is a standstill which covers all the debts (the standstill is a voluntary rather than a statutory process). The standstill restricts the lenders from taking individual action for debt enforcement or improving their positions relative to other creditors in terms of debt repayment or by way of security. It must take place over a relatively short period of time and should be under agreed limits that are measured by months.[51]

The advantage of a standstill is that it enables a team of investigating accountants to gather information on the company’s affairs. The information gathered then helps the lenders to decide collectively on whether or not restructuring can be done. During the negotiation, a lead bank is identified to act as a mediator, which plays the key role of resolution of any disagreement amongst banks, since there is no legal arbitration process for their disputes. After a successful negotiation, all the lenders will reach consensus on a new financing agreement, which typically requires the lenders to advance loans pro rata for continued trading of the company experiencing financial trouble.

In addition, it is commonly proposed that all the lenders will share the costs and expenses for the expertise and negotiation on an equitable basis. The proposal of restructuring may include a variety of measures to reorganize the debt structure of the ailing company, such as the reduction of claims pro rata or a debt equity s