24 March 2003
Insurance insolvencies have been prominent in the news recently, with big names such as Independent Insurance, HIH and Equitable Life all encountering financial difficulties. The way in which English law handles such matters has long been trusted and admired, but is nevertheless about to undergo a fundamental change.
The Treasury has recently concluded a consultation exercise on the implementation into UK law of the Insurers Reorganisation and Winding-Up Directive (2001/17/EC), and it is proposed that the regulations implementing the directive will be brought into force on 19 April 2003. They will have a dramatic effect on all reorganisations and insolvencies of insurance companies, and will be of relevance to all practitioners who work in the insolvency and insurance fields, as well as anyone who may have a policy with or claim against an insolvent insurer.
Traditionally, when an insurance undertaking became insolvent, the insolvent entity would be placed into provisional liquidation, thereby allowing time for a scheme of arrangement to be proposed under Section 425 of the Companies Act 1985. Schemes of arrangement offer many advantages in terms of flexibility and return to creditors. The range of options available to insolvent insurers has also been widened by the Financial Services and Markets Act 2000, which allows administration orders to be made over insurance companies. The first of these administrations was made over Folksam International Insurance Company (UK) in July 2002.
However, the implementation of the directive will require many of the current principles and practices to be rethought. In many ways, the directive has a similar effect to the EU Regulation on Insolvency Proceedings, which became part of UK law on 31 May 2002. The purpose is that, in future, all European insurance insolvencies should be the subject of a single set of proceedings in the jurisdiction where the insurer is authorised. The aim of the directive, in short, is to reduce costs and to aid policyholder protection.
Scope of the directive
The directive will apply to 'direct' insurers. In the UK this will mean all life, non-life and composite insurers authorised by the Financial Services Authority (FSA). It will not apply to pure reinsurers, but to companies that write a mixture of direct and reinsurance business.
The directive will govern almost all winding-up proceedings or reorganisation measures affecting an insurer. 'Reorganisation measures' is widely defined, and includes all current UK court-driven insolvency procedures, company voluntary arrangements (CVAs) and reductions of value under Section 377 of the Financial Services and Markets Act 2000. As the draft regulations stand, the directive will also apply to receiverships and schemes of arrangement under Section 425 of the Companies Act 1985. However, this has been strongly opposed by the Association of Business Recovery Professionals (R3).
R3's view is that making such schemes subject to the directive would restrict the flexibility that they offer. Also, schemes are often used in run-off situations for solvent insurance companies, in which cases the directive will have no relevance. A point that cannot be far from the thoughts of the UK insurance insolvency industry is that if the directive were to be applied to schemes, it would no longer be possible to implement schemes for branches of non-UK insurers, or books of business written by such insurers, in this country without the authorisation of the competent authority in that insurer's home state.
R3 also argues that the directive should not apply to administrative receiverships, on the basis that they do not involve the court and that court-appointed receivers generally hold or preserve assets pending resolution of a particular dispute or realise assets on behalf of a judgment creditor. Neither of these appointments, says R3, is intended to "preserve or restore the financial situation", nor are they collective proceedings.
The response of the Association of British Insurers has been quite different: it argues that, considering the broad intention of the directive, Section 425 schemes, administrative receiverships and CVAs should fall within the ambit of the directive. Amid such opposing views, the question of how these procedures will be treated will remain uncertain until the Treasury's regulations are published.
Goodbye to Pari Passu?
Perhaps the most dramatic change introduced by the directive will be the new order of creditor priority that it creates. The directive places direct insurance creditors in a class of their own, so they will be paid after the insurer's preferential debts (presently various tax and employee claims) but before the non-insurance unsecured creditors. Where the assets of the insurer available for the payment of ordinary creditors are insufficient to meet the preferential debts and the insurance debts, those debts have priority over the claims of floating chargeholders and must be paid accordingly out of any property subject to that charge.
The position of insurance creditors will be further improved when the preferential status of crown debts is abolished by the Enterprise Act 2002, the relevant provisions of which are expected to be implemented this year. The creation of priority status for direct insurance creditors represents a departure from the pari passu approach, which applies to non-insurance insolvency.
The new order of priority imposed by the directive will also have a significant effect on reinsurance. The terminology employed adopts the European definition of an 'insurer', which does not include pure reinsurers. Claims under contracts of reinsurance are not, therefore, treated as 'insurance debts', on the basis that they do not arise from direct insurance as envisaged by the directive; and it will follow that insurers with claims against a reinsurer that also carries out direct insurance business (and to which the directive therefore applies) will find that their claims rank below those of the direct insurance creditors and any floating charge holder.
This will obviously have a profound impact on the security provided by reinsurance, and it remains to be seen how the problem will be dealt with. It has been suggested that insurers writing both direct and reinsurance business will have to reorganise their structure so as to keep the two separate to avoid the problem arising. In light of the wording of the directive, there is little that the UK authorities can do to mitigate the problem, so it therefore falls to the market to be solved.
Law and jurisdiction
As already mentioned, only the competent authorities of the member state in which an insurer is authorised will have jurisdiction to order winding-up proceedings, or to approve reorganisation measures in respect of that insurer or any of its branches in other member states. European branches of insurers with head offices outside the EU are covered by the directive, and will be subject to the relevant authorities in the member state where the branch is located. In order that the office-holder appointed in the winding-up proceedings or reorganisation measures should be able to carry out their functions effectively, the directive provides that their powers are exercisable in any member state without any need to seek recognition.
The applicable law in any particular case will, in general, be the law of the member state which has jurisdiction to open proceedings. The directive does not, therefore, seek to create a unified approach to insurance insolvency across the EU, but to provide for a single jurisdiction and set of proceedings in any one case.
The principal exception to the jurisdiction rule applies to secured creditors. The opening of winding-up proceedings or commencement of reorganisation measures will not therefore affect the proprietary rights of creditors in respect of property belonging to the insolvent insurer which is situated in a member state other than that hosting the winding-up or reorganisation. Such proprietary rights will still be governed by the law of the member state where the property is located, or the law governing the rights themselves. In effect, this will mean that UK creditors with fixed or floating charges or retention of title claims against an insurer registered in another member state will still be able to exercise their rights against any property in the UK, notwithstanding that the insurer is being wound-up or reorganised abroad.
The treatment of set-off is slightly different. Article 22 of the directive states that the right of a creditor to set off its claim against a claim made against it by an insolvent insurer will not be affected by the opening of winding-up proceedings or reorganisation measures "where such set-off is permitted by the law applicable to the insurance undertaking's claim". It follows that it will not be possible for all set-off issues to be dealt with in the same way across the insolvent estate, as the availability of set-off will depend on the law relating to each contract.
The implementation of the directive will represent a considerable shake-up of insurance insolvency practice, at a time when such insolvencies are on the increase. There are many provisions of the directive which, for reasons of space, cannot be discussed in this article, such as the requirements for notification of creditors. The result of all these changes is likely to be an increase in the burden on those who administer the insolvent insurers. Whether in the longer term the directive will reduce the cost of such insolvencies and increase the returns to insurance creditors remains to be seen. Much will depend on the Treasury's response to the consultation process. The profession will await the new regulations with interest.
Mark Fennessy is a corporate recovery and insolvency partner and Jamie Leader a barrister at Clyde & Co