Insolvancy Law Essays

Promoting the ‘rescue culture’ has become an all important feature of Government policy towards insolvancy law. However, this is without adequate consideration being given to the extent to which the moratoria available in both CVAs and Administrations may harm the pre-existing contractual rights of creditors. Discuss

Structure: Issues, Legal
rules and application

• • Rescue culture
    under insolvency law
  • what is C V A
    and moratoria available under it
  • what is
    Administrations and moratoria
  • contractual
    rights of creditors, how they are protected

Introduction

The ultimate enforcement option of forcing the
company into an administrative receivership was the most sought after tool any
creditor with a security over a company’s business and assets could have. This
was the position until recently where the administrative receiver mainly was
answerable to the debenture holder who appointed him. This was almost a proof
of the UK’s pro-creditor approach to insolvency situation. The Banks used to
appoint receivers rather than support any sort of collective rescue plan for
the company and reaslise those assets which could satisfy only their debt. There
has been a major impact on how financial failure of a business is dealt with in
the UK after the introduction of the Enterprise Act 2002. The rescue culture
is reinforced by reforming the administration procedure

The Enterprise Act 2002 has attempted to restore
the balance between the secured and unsecured creditors by heavily restricting
the administrative receivership as an enforcement option and abolishing its use
completely in most cases where secured lending after the Act becomes effective.
The effective date when the Act becomes fully operational is 15 September 2003.
Although the Act restricts or prohibits the floating charge holder from
appointing an administrative receiver it does not prevent the appointment of
fixed charge receiver. However, there is condition attached to such an
appointment that they must vacate the office in case where an administrator is
appointed. If a creditor holds a security which was in existence before the
effective date then such a creditor could still retain their priority status
and can appoint administrative receiver if he needs to enforce its security.
Not only that, but the Act also gives right to secured creditors with a
qualifying floating charge a new right whereby they are able to appoint an
administrator without having to go to court. Some commentators have said that
this could be perceived by the banks as loss of control and may consider
levying extra charges on company’s borrowing making it more expensive and
difficult to obtain. Current practice is to consider rescing the company rather
than enforcing security . The receiver tries to obtain best price on a sale and
takes reasonable care while he is running the business and considers the
fundamental issues which affect all creditors.

Analysis of new regime

The insolvency
regime that was in place beforehand didn’t offer enough clearness and
accountability to the variety of stakeholders, especially to the creditors who
have an interest in the affairs of the company. The Administration procedure is
used to give a company a breathing space so as to assemble a plan of rescue or
to give better returns for creditors. The formalities have been cut down and Company
Voluntary Arrangements have been made more accessible to the companies.

The
preferential treatment of some of the creditors was very attractive under the
old regime and especially administrative receivership was used whenever secured
creditors wanted to call off the debt. Under new administration procedures
there are new rules regarding the distribution to all creditors which is
examined in more detail below. The Act makes the new collective rescue
procedures available to secured creditors more easily than before as these
procedures are designed to be inexpensive and simple.

Only small
companies
are entitled to apply for a CVA moratorium but only if there are no formal
insolvency proceedings already in place which lasts for twenty-eight days. During
this time the proposals are considered by the creditors.

The statutory purpose of the Administration is to
rescue the company as a going concern while achieve a better realisation of
assets for the benefit of its creditors and to reaslise property to distribute
amongst its secured and/or preferential creditors. If the purpose of the
administration changes during its course, as these are ranked according to
priority, then the administrator can vary it without having to apply to the
court.

Administration

The legal purpose of an
administration is the rescue of the company as a going concern. This course of
action is available by court order if the court takes the view that the
business of the company or at least a section of it should be saved. The court
could also be of the view to a more beneficial realisation of assets than could
be achieved if that company was wound up, or with a view to obtaining approval
for a voluntary arrangement with the creditors of the company.

The company can present the
administration order petition, or its directors, or by a creditor on the
grounds
that the company is not capable of paying of its debts or is likely to become not
capable of paying its debts. As a result of the petition being presented a
‘moratorium’ is imposed on the company’s debts and the creditors are not
allowed to impose any security over the property of the company, but they can assign
an administrative receiver, repossess goods and start or continue proceedings
or levy distress against the property of the company. For the duration of this
time the company is unable to be wound up.

Notification to
everyone who is entitled to appoint an administrative receiver of the company
must be done by the company directors or who is entitled to appoint an
administrator of the company. The administrator would sell property to pay off
secured and preferential creditors. This would not damage the creditors’, as a
whole, contractual rights unnecessarily. In WBSL Realisations 1992 Ltd Administrators could pay
creditors on the basis of a notional winding up. The allocation was done on the
basis of special circumstances of the preferential
creditors of PLC and on a pro rata basis to the unsecured creditors. A qualifying
Floating Charge (QFC) holder can appoint an administrator by giving two
business days’ notice at the court without having to prove insolvency of the
company. QFC holder must prove that his security is valid and enforceable. As
soon as he has done that an interim moratorium up to five days will start until
he files a consent form from the proposed administrator.

Company
Voluntary Arrangements

A major difficulty
in bringing about corporate voluntary arrangements has been the complexity
involved in holding off individual creditors whilst a rescue strategy is applied.
By applying for an administration order a moratorium could be achieved. The
problems posed by the often overwhelming difficulty in obtaining a moratorium
have been sorted out by the Insolvency Act 2000. It includes provisions that allow
an insolvency practitioner to put a moratorium into place for a short while
without resorting to the court.
The moratorium comes into effect the instant all the applicable documentation is
filed at the court. This stops creditors from filing for a winding up petition during
the period of moratorium. The floating charge cannot crystalise during the
moratorium as it occurs regardless of the Bank’s wishes.

Frequently in
practice security holders such as Banks have to be pursued so that they hold
back and don’t enforce their security. Throughout the moratorium the company can
dispose of property, which is the subject of security such as fixed or floating
charge, and property in the possession of the company under a hire-purchase
agreement.

The arrangement
becomes binding on all creditors entitled to attend and vote at the meeting unless there is an appeal
within 28 days on the basis of either procedural irregularity or unfair
prejudice.
If the C V A is appropriate then it will give higher returns to the
creditors than would have been received if the company had gone into
liquidation or receivership. C V As allow secured creditors such as, the
holders of a fixed or floating charges, to leave the agreement without the need
to enforce its security by appointing an Administrative Receiver. The creditors
therefore maximise their interests and as well as this allows the company to
continue trading.

This essentially
preserves the creditors’ contractual right to take the required action in order
to recover the debt. In Tager v Westpac Banking Corporation [1998]
BCC 73, Judge John Weeks QC, sitting in the Chancery Division said that
the court has jurisdiction to extend the 28 day period for challenging the
decision of a creditors’ meeting to consider a debtor’s voluntary arrangement.

The Equal
treatment of all the creditors

The pari passu rule
is said to be ‘the foremost principle in the law of insolvency around the
world’. It is believed to be ‘all-pervasive’, and its effect is to ‘strike down
all agreements which have as their object or result the unfair preference of a
particular creditor by removal from the estate on winding up of an asset that
would otherwise have been available for the general body of creditors.’ Insolvency
regimes have a main aim to get equal distribution for creditors unless a
different class of preferential creditor is created. This priority to one class
of creditor is usually acquired by putting to one side some of the available
assets of the company. These are otherwise available for the general body of
creditors. By controlling in this way, this class of creditors can keep the
assets beyond the reach of general body of creditors and it could result in an
adverse effect in rescuing the company.

The underlying principle behind
this is the existence of the different types of secured creditors who take
priority and hence their claims fall beyond its ambit. Even unsecured claims do
not have application of pari passu principle. With the new insolvency regime,
the priority of preferential creditors like the Crown has been eliminated but
there is still questions regarding secured creditors.

Currently the law
today allows a company to be able to grant security over all of its assets. Yet
if the company imposes restriction on these secured creditors then it is likely
that the credit facilities will become more expensive regardless of any rescue
procedure in place. There is the possibility that it will become more difficult
to obtain finance, which is less flexible. This could result in more personal
guarantees and securities being demanded by the secured lenders from directors
of the company in order to lessen their exposure. On the other hand when the
company comes into financial difficulties then secured creditors would want
their position protected, which could be detrimental to the unsecured
creditors.

Administration of
a company will benefit the unsecured creditors. The new provisions allow the
administrator to be given new powers to make distributions to secured and
preferential creditors. An administrator can create a Special Fund and this has
been introduced exclusively for the benefit of unsecured creditors. The share
of the assets has to be ring fenced for the unsecured creditors to preserve
their contractual rights under the new regime. The amount being ring fenced for
the unsecured creditors will depend upon the size of the company and the amount
of creditors involved. However it is likely that 10% of the assets may be ring
fenced for this purpose.

The Insolvency Act
2000, has made several significant changes, particularly to company voluntary
arrangements and directors’ disqualification. This is in an effort to strike a
balance between enterprise and abuse of limited liability.

The new legislation’s main thrust
is to limit the use of administrative receiverships and extend and streamline
the administration procedure. The holder of a floating charge is unable
generally to appoint an administrative receiver. However a floating charge
holder, or the company or the directors can get an administrator appointed
through a court order. The main function of the administration is to rescue the
company as a going concern.

The majority of
creditors’ informed and involved in the process of managing company’s affairs.
The new changes have been welcomed by the creditors due to the fact that the
interests of all creditors have to be accounted for. However, under C V A the
existing management stays in control and would want to increase the value of
shareholders. On the other hand, under administration, the office holder is
effectively running the company and has a statutory duty to consider the
interests of all the creditors and not just one group of creditors. It is
difficult to reconcile the pari passu principle and the propriety rights of
creditors.

Company Voluntary Arrangement Moratorium

The 1986 Act
introduced the company voluntary arrangement procedure as a means of rescuing
companies. Yet, the recession of the early 1990s showed that it was not appropriate
for a small company in financial difficulty. This was because there was no
moratorium on creditors’ action, before an arrangement could be agreed. So
creditors were able to resort to their own recovery action for the debts
against the company.

That rendered any
proposed voluntary arrangement unworkable and the rescue attempts to collapse.
There was a need to prevent other creditors’ rights to take action during the
period when the voluntary arrangements were being considered in order for the
company’s management to come up with a rescue plan for the creditors to
consider.

Holding off
individual creditors whilst a rescue strategy is put into place has been a
major problem. A moratorium could be achieved by an application for an
administration order
. Under the Insolvency Act 2000 a small company’s
management has an option of a short moratorium without recourse to the court so
long as the appropriate criteria are satisfied. This will stop creditors from
taking enforcement action, initially for a period of up to 28 days while the
proposed voluntary arrangement is put to creditors.

Also the
management of the company especially the owners were very reluctant to use the
administration procedure as they knew they would be displaced by the
administrative receiver if the bank exercised its effective veto or by the
administrator if the court appointed one. Cost issues needed to be considered
as well.

Conclusion

When
the company runs into financial trouble unless the lenders are willing to fund
the company during the administration process to give it an opportunity to sort
out its affairs, the administration is not going to work. The fixed charge
holders still have a right to appoint a receiver and would be considered as
more feasible option in certain circumstances. The only way the lenders can be
kept happy is to offer asset based lending or some kind of debt-purchase
lending which would give them flexible exit route and cost of borrowing to a
minimum.

The new changes in the Enterprise Act are
based on the principle of equity and efficiency. These are the collective
insolvency proceedings in which all creditors take part and fixed and floating
charge holders are not the only ones who have a say in it. Under these
collective proceedings a duty is owed to all classes of creditors and an office
holder has to account for his dealings with a company’s assets to all
creditors.

The new Act tries
to strike a balance by introducing collective insolvency proceedings which
would give all creditors an opportunity to participate. To a certain extent
unsecured creditors now have a greater say in the whole process. They can also
influence its outcome and ensure that secured creditors are not put at risk in
any way. However, under these changes, creditors will not be able to enforce
action for an initial period of 28 days.

The
government has an intention to introduce legislation to provide for a
moratorium to be part of the company voluntary arrangement procedure which was
missing from C V As before.

As there are no
precedents as yet the Insolvency Practitioners will have to run to the court
for guidance under the new proposals which could increase the cost of
administration and less money available for the creditors as a consequence.

Bibliography

• • www.insolvency.gov.uk/consultation
  • Department of
    Trade and Industry web site, s247(3) Companies Act 1985