The Rescue Culture

The rescue culture is fundamental to the 1986 Insolvency Act (UK) and drawn upon recommendations made by Kenneth Cork who argued that “a concern for the livelihood and well being of those dependent upon an enterprise which may well be the livelihood of a whole town or even a region is legitimate factor to which a modern insolvency law must have regard”.

Introduction

It has now been more than twenty years since the philosophy in corporate insolvency law practice has moved from a focus on ex post responses (reactionary) to one where the actors manage risks ex ante (anticipatory)1. As Fletcher points out "From a purely political point of view reform of this area of law has consistently been allocated a low property. Insolvency Law has traditionally been perceived as arid, obscure and remote, there are 'no votes in it'"2 Previously corporate insolvency was mainly considered as a punitive offence driven by three distinct forces:

• • An urge to punish bankrupts;
  • Organise administration of debtor's assets (the one who goes bankrupt) so that competing creditors are treated fairly and efficiently;
  • The hope that the bankrupt will be allowed to rehabilitate himself.

A revision of insolvency roles took place with the advent of the Cork committee. At present, participants in corporate and insolvency processes have become more encouraged and inclined to see corporate disasters as matters to be anticipated and prevented rather than to be responded to after the event.

Background Of Insolvency Law In UK

In England, before the enactment of 1883 Act, the insolvency law was mostly regarded as a criminal or quasi-criminal offence with remedies available to creditors that covered seizure of debtor's goods, his arrest or imprisonment. During the mid 1550's the law on insolvency recognised the rights of creditors that could be gathered together and enforced as one against the debtor. The focus was on punitive approaches, much dependent on the debtor's conduct; insolvency procedures were aimed at the debtor who went bankrupt. The punishment for corporate failure was draconian in nature and until 18th century fraudulent debtors, who became insolvent even faced death penalties. The then bankruptcy law only applied to traders. Nontraders who fell into debt were imprisoned, if they failed to pay off their debts to the creditors. It was not until 1861 that both traders and non-traders came under the same system and only in 1869 were the powers of courts to imprison debtors reduced. With the expansion of trade and commerce in the Victorian era, major reforms took place in the insolvency laws. It was felt that severe punishments in case of business failure were becoming barrier to commerce. This lead to the formulation of the Bankruptcy Act 1883 to incorporate changes in law so to accommodate the growing public discontentment with the administration of bankrupt estates, which were privately run and open to considerable abuse. Soon after further changes were made and in the1914 Act which came into force and remained unchanged until 1976. The 1883 Act and the 1914 Act, imposed restrictions on the bankrupt to ensure his cooperation in the administration of his estate as well as to prevent him from engaging in activities that required a degree of trust. In other words it implied that the debtor, as soon as he becomes bankrupt, was not someone in whom society at large could place its trust or confidence. With the enactment of the Insolvency Act 1976 a new kind of discharge and review procedure was introduced. According to Section 7 of the Act, the court was entitled to make an order at the end of the bankrupt's public examination, and if it thought was appropriate, the bankrupt would be discharged after five years. Otherwise, section 8 applied which required the receiver to make an application for the discharge of the bankrupt within a specified time. It was found that the old legislations paid less attention to the rescue of companies or business in particular and mostly aimed at punishing the debtor for his misconduct. It is noteworthy to mention here that some visions of insolvency process and laws are very unsympathetic to the whole idea of corporate rescue. According to Finch, “The credit wealth maximisation vision, sees insolvency as a process of collecting debts for creditors and as a response to the common pool problem, is in tension with the notion that keeping firms in operation is an independent goal of insolvency law.6 In some circumstances, maximising the potential returns to creditors may result in some sort of rescue activity but this will not always be the case and a failed rescue may reduce creditors' returns materially. The beginning of rescue culture took off when the preservation of companies became a desirable outcome alongside the maximisation of realisations for secured creditors. The business rescues were done mainly through receivership under the powers contained in a floating charge usually granted to banks. The floating charge holder's right to appoint a receiver was contractual. Since then the law has developed beyond comprehensible bounds. The report presented by the Cork committee initiated a stricter control against errant directors It was further argued that creditor wealth maximisation was too narrow and in looking at insolvency process, attention should be paid to interests beyond those creditors:

• To social and distributional goals
• To public and private interests
• To values such as expertise, fairness and accountability

8 A Review of Company Rescue and Business Reconstruction Mechanisms, Department of Trade and Industry and HM Treasury, May 2000. giving emphasis on rehabilitation of insolvent companies. In short to “facilitate rescues rather than just process failures.”9

The Nature Of Rescue Culture

Kharbanda and Stallworthy, define rescue culture as the process of “strategies for rescuing companies in distress.”10 According to Rajak rescue involves “a more advantageous realisation of assets than would be available on liquidation”11 and Finch states that “the drastic actions that rescue necessarily involves will almost inevitably entail changes in the management, financing, staffing or the modus operandi of the company.” The central idea behind rescue is to take a remedial action at the time of corporate crisis. Whether or not the rescue is a success is a different issue. The success of rescue may differ from person to person e.g. the shareholder's perspective may differ from that of others (managers or creditors). According to Finch, “a distinction can also be made between the company and business. Even where a company is liquidated, successful steps may be taken to retain aspect of the business as operational enterprises, to sustain the employment of groups of workers and to ensure the survival of some economic activity.” At the other side of the spectrum the rightists have their own view on the rescue culture as opined by Baird, “A debtor in bankruptcy should have the same legal obligations as everyone else.”14 Such a view is also held by Jackson who believes that "bankruptcy, at first glance, may be thought of as a procedure geared principally towards relieving an overburdened debtor from 'oppressive' debt. Yet this discharged centred view of bankruptcy is correct neither firm a historical perspective nor form a realistic appraisal…”15 The one who took the middle path such as Rasmussen asserted on Contractarianism - which reaches beyond the veil of simply seeing the creditors contractual rights as paramount but also the contractual rights between the employees, mangers, members of the community and beyond. Thus we see the term rescue culture is a multifaceted one which has different aspects dependent on whole host of concepts. This not only depends on personal viewpoints but also on jurisdictions where it is applied.17 In the last decade or so, many countries have made various modifications and changes in their respective insolvency law to reduce the number of companies liquidated and safeguard the interests of the debtor. The Cork Report In 1977, the then Labour government commissioned a major review of the law relating to insolvency, bankruptcy, liquidations and receivership. The Cork Report19, which was published in 1982, was quite inclusive in its scope and had a far reaching impact. Basically, it laid out the foundation for the rescue culture. In his report Cork said, “A good, modern system of insolvency law should provide a means for preserving viable commercial enterprises capable of making a useful contribution to the economic life of the country: “We believe that a concern for the livelihood and well being of those dependent upon an enterprise which may well be the life blood of a whole town or even a region is a legitimate factor to which a modern law of insolvency must have regard” Sir Kenneth Cork and his review committee examined the basic objectives of insolvency law, and stated that: "It is a basic objective of the law to support the maintenance of commercial morality and encourage the fulfilment of financial obligations. Insolvency must not be an easy solution for those who can bear with equanimity the stigma of their own failure…" The Report further discussed the social and financial implications of insolvency, and drew a distinction between the consumer insolvent and the commercial insolvent, stating that the insolvency of a businessperson had much wider implications. The Cork Report also identified two major objectives of insolvency law:

• • Insolvency laws were treated by the trading community as an instrument in the
  • process of debt recovery and constitute in many cases, the sanction of last
  • resort for the enforcement of obligations;
  • Insolvency laws were the means by which the demands of commercial
  • morality can be met, through the investigation and the disciplinary measures
  • and restrictions imposed on the bankrupt.

The Cork report also discussed the penal side of bankruptcy, suggesting the ‘stigma' associated with it was stimulated in the 19th century by a desire to uphold acceptable standards of conduct in the commercial community. The chain reaction that could be caused by the collapse of a business and the dislocation that followed was regarded as serious enough to require a degree of severity as a means of deterring other traders. According to Cork, the bankruptcy laws were in large measure used as a medium for carrying out these disciplinary functions. The discharge period was seen as a period to allow for the rehabilitation of the bankrupt. On this point, the Report supported an automatic review of the bankrupt's position after five years, which would result in the discharge of the bankrupt unless the Official Receiver or the trustee put forward a strong objection. Nevertheless, the Report recommended that a bankrupt should still be free to apply for a discharge before this time, but not within 12 months of adjudication. In these cases the onus was on the bankrupt to prove that his discharge was warranted. In its response to the Report23, the Government stated that it preferred to adopt an automatic discharge regime rather than retaining the then current system of applications after five years, citing considerable resource savings for both the Insolvency Service and the courts. A bankruptcy period of three years was preferred because: " …in a modern society the emphasis should be on the rehabilitation of debtors and that a three year period of restriction is sufficient for those who have failed financially." The Cork Report also recommended the introduction of new procedures for the administration of the affairs of insolvent debtors with a view to reserving bankruptcy to more serious cases where there was misconduct. The Report proposed a process of liquidation of assets to deal with less serious cases. Under this system the disabilities that applied to this category of debtor would have been less severe than for a bankrupt and it was proposed that the process would be completed and the debtor discharged within one year. This recommendation was not taken forward. At that time it was felt that the level of inquiry required to determine the appropriate procedure for each debtor would place considerable additional demands on Official Receivers' resources at a time when the government was seeking to effect a substantial reduction in the size of the Civil Service. This aside, the Government also felt that if the existing procedures were suitably modified, it would allow the debtor "sufficient opportunity" to avoid bankruptcy if he or she was prepared to take active steps to that end. Strengthening Rescue Culture: Period since the Cork Report As Finch views, rescue culture has been strengthened and 25endorsed by judiciary and bankers and politicians since the Cork Report. In Powdrill v. Watson, Lord Browne- Wilkinson stated in the House of Lords: The rescue culture which seeks to preserve viable business, was, and is, fundamental to much of the Act of 1986. Its significance in the present case is that, given the importance attached to receivers and administrators being able to continue to run a business, it is unlikely that Parliament would have intended to produce a regime as to employees' rights which render any attempt at such rescue either extremely hazardous or impossible. The British Banker's Association also endorsed a rescue culture in its 1997 paper, Banks and Businesses Working Together.27 The Blair government also shifted its stance towards more US-style philosophy that was more encouraging of rescue. Legislative Actions: The 1986 Insolvency Act. The Insolvency Act 1986 was designed to ensure that an independent and impartial examination took place into the causes of each bankruptcy, as well as the conduct of each bankrupt. It recognised that bankruptcy should be regarded as a public matter, affecting the community at large. The changes introduced by the Act included:28

• Abolishing the concept of an act of bankruptcy;
• Introducing an automatic discharge for first time bankrupts after three years;
• Introducing a number of measures designed to streamline and simplify the process;
• Provision for the protection for a limited period of the rights of occupation of the bankrupt's spouse in the matrimonial home;
• Allowing the bankrupt to keep a greater range of personal assets than permitted by the 1914 Act.

It can be said the government took into consideration much of the proposals of the Cork Committee (although not word by word) and incorporated them in the Insolvency Act 1986. The Act focused on establishing legal procedures that would have a two fold impact- attempt to make a smooth the progress of the new concept of rescue culture and provide stringent provisions that would preclude malpractice form being common place. The creation of the administration procedure in the Insolvency Act 1986 was carried out in an attempt to fill the vacuum in those cases where companies had not granted floating charge to a lender and whose business therefore could not be rescued by the conventional means of receivership. This aside, the Act also created an alternative rescue mechanism for companies, the Company Voluntary Arrangement procedure, which formalised the ability of a company to come to a contractual arrangement with the creditors. Thus the process of rescue as introduced under the Act can be summarised as being either the appointment of administrator30 by the court, the approval of a company voluntary arrangement, or the sanctioning of a scheme of arrangement under section 425 of the Companies Act, all with the aim of ensuring the survival of the company as a going concern.

Rescue Culture: Present Scenario

On the legislative front, the Enterprise Act 2002 made significant changes by introducing a number of reforms that were designed to assist the troubled companies. The Act removed the Crown's preferential rights as secured creditors (over tax debts) and reduced the role of administrative receivership subject to exceptions in The Insolvency Act 1986.31 With respect to receivership, it provided that the administrators should act in the interest of the company's creditors as a whole32. This aside, it also set out inclusive procedures and enforcement provisions that ensured that the interests of creditors as whole would be taken into account and protected when the administrator took decisions about the company's prospects Another remedy available to companies is a Scheme of Arrangement under section of the Companies Act 1985. Such schemes can be complex and are mainly reserved for larger companies. Here, it is pertinent to mention that the government is trying to augment the “London Approach.”34 It has been suggested in the Insolvency bill that Section 425 procedure could be augmented by the option of a moratorium, not dissimilar in its operation to that proposed in relation to CVAs for smaller companies. Notable changes were made through the passing of section 417 of the Companies Act 2006. This section was introduced in the wake of the short-lived notion of the Operating and Financial Review.36 As per this section the director's report should include a business review that informs the members and help them to assess how directors have performed to promote the success of the company.37 The section 417 reports will be used by leading companies as an instrument to convince their stakeholders about the effectiveness of risk identification methods towards their achievement of corporate objectives. In the wake of Enron/WorldCom international accounting debacles38 with the enactment of the Companies Act 2004, a higher level of pre insolvency scrutiny of corporate management was introduced through directorial disclosures to auditors. Further Section 9 of the act inserted Section 234 ZA into the Companies Act 1985 to demand that directors state in their report that there is no relevant audit information that they know of and which they know auditors are unaware of Conclusion: Over the last decade there has been a series of developments in the UK insolvency law that points towards a shift from ‘debt collection' to ‘risk management approaches'. Such a shift may be explained by citing new governmental concerns to maximise 34 A Review of Company Rescue and Business Reconstruction Mechanisms, Department of Trade and Industry and HM Treasury: Under the “London approach” the financial creditors of a multi banked company agree to a voluntary standstill as between themselves to enable trade and other creditors to be paid in full in the ordinary course of trading. This approach requires unanimity amongst financial creditors, something which has proved increasingly difficult to sustain in recent years Lessons from America' [2003] Ins.Law.214; D.Kershaw, ‘Waiting for Enron: The Unstable Equilibrium of Auditor Independence Regulation' (2006) 33 Journal of Law and Society. Rescue opportunities.40 As far as bank strategies are concerned, insolvency law has moved from a reactive towards an anticipatory philosophy has been in the approaches that the banks have adopted when lending to potentially troubled companies.41 There is now greater initiative to confront corporate troubles and to effect turnarounds before there is any need for formal actions. A key aspect of rescue process is that it provides for intervention at an early stage in the proceedings and action of a speedy nature to achieve the end goals of restoration of the company either in full or in part where it is more likely to be reorganised.

Bibliography:

• • Baird, D.G., (1986) "The Uneasy Case for Corporate Reorganisations" 15 Journal of Legal Studies
  • Baird, D.G., (1987) "Loss Distribution, forum Shopping and Bankruptcy: a Replay to Warren 54 University of Chicago Law Review
  • V.Finch, Corporate Insolvency Law, 2nd Ed (2009)
  • Professor Ian F. Fletcher"The Genesis of Modern Insolvency Law - An Odyssey of Law Reform
  • Bankruptcy: An Historical Perspective (The 1883 and 1914 Acts), The Insolvency Service Publication
  • Kharbanda and Stallworthy, Takeovers, Acquisitions and Mergers, Strategies for Rescuing Companies in Distress (1988)
  • Harry Rajak, Insolvency Law Theory and Practice, Sweet and Maxwell
  • Douglas G Baird "A World Without Bankruptcy" 50 Law and Contemporary Problems (1987)
  • Thomas H Jackson "Bankruptcy, non bankruptcy entitlement and the creditor's bargain" The Yale Law Journal (1982)
  • R. Rasmussen "An Essay on Optimal Bankruptcy Rules and Social Justice" (1994) U Illinois Law Review 1
  • Department of Trade and Industry/ The Insolvency Service, "A Review of Company Rescue and Business Reconstruction Mechanisms" London 1999
  • Insolvency Law and Practice. Report of the Insolvency Law Review Commitee, 1982
  • Hunter, ‘Nature and Functions of a Rescue Culture'
  • S.Griffin, ‘Corporate Collapse and The Reform of Boardroom Structures- Lessons from America' [2003] Ins.Law.214
  • D.Kershaw, ‘Waiting for Enron: The Unstable Equilibrium of Auditor Independence Regulation' (2006) 33 Journal of Law and Society
  • J.Franks and O. Sussman, ‘The Cycle of Corporate Distress, Rescue and Dissolution: A study of Small and Medium Size UK companies,'IFA working Paper 306 (2000)