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On 1 November 2005, the Company Law Reform Bill was introduced to the House of Lords some seven years after the Department of Trade and Industry started its wide-ranging review of company law. The bill proposes substantial changes to existing company law with the intention of making it more flexible and easier to understand. The Government has also taken this opportunity to address two issues of insolvency law and practice currently causing grief, of differing degrees, to the profession.
Before the House of Lords' decision in Re Leyland Daf in March 2004, life for liquidators had been fairly straightforward. For 30 years it had been agreed that, where companies had granted debentures containing floating charges, all of the expenses they incurred as part of the liquidation process were payable out of floating charge assets in priority to the floating charge holder. However, the Lords' landmark decision changed all that.
The Lords decided that there were, in fact, two separate funds of assets: those subject to the floating charge and available to the floating charge holder, and those free assets of a company (if any) available for the general creditors. Unfortunately for liquidators, the Lords decided that each fund should bear its own costs - therefore, liquidators could only recover certain limited expenses from floating charge assets, ie those expenses they incurred in preserving, realising and distributing floating charge assets. For their other expenses, liquidators had three choices:
(i) to look to the company's free assets, if there were any;
(ii) to try to reach a deal with the floating charge holder; or
(iii) simply and least palatably, to go without payment.
During Re Leyland Daf, counsel for the liquidator sought to argue that the Enterprise Act 2002, introduced shortly before the case was heard, had been drafted by the Government on the agreement that a liquidator's expenses were payable out of floating charge assets (ie the earlier authority of Re Barleycorn Enterprises was a correct statement of the law). In particular, paragraph 99(3) of Schedule B1 to the Insolvency Act 1986 replicates that approach in the administration context, stating that an administrator's remuneration and expenses are payable out of floating charge assets.
This argument was correct. The Government has confirmed that there should not be an anomaly between the recovery of expenses in an administration and liquidation, as this raises concerns about whether companies are going into the most appropriate form of insolvency procedure. The result is clause 868 of the bill which effectively proposes a reversal of the decision in Re Leyland Daf.
The effect of clause 868 is to introduce a new section, 174A, into the Insolvency Act 1986, stating that liquidation expenses are payable out of floating charge assets ahead of the floating charge holder. However, a key point to note is that a liquidator will only be able to deduct those expenses that have been approved by the floating charge holder. Secondary legislation is going to be introduced to detail how this will work in practice.
Although the provision is not to be retrospective and there will remain some difficult issues to resolve, it will nevertheless be welcomed by insolvency practitioners and should see the end of the artificial use of administration rather than liquidation where there is a shortfall to the floating charge holder. Bankers may be less pleased, but under the new regime they will have control over the level of liquidators' fees.
Substantial property transactions
The bill also introduces a change to Section 320 of the Companies Act 1985 from an insolvency point of view. In short, the provisions of Section 320 currently mean that a company cannot agree with a director of the company (or a party with whom they are connected) to sell or purchase an asset (other than cash) that has a substantial value unless the arrangement has been approved by the company's shareholders. The consequence of failure to comply is to render the transaction voidable at the option of the company.
While a statutory exemption means Section 320 does not apply to any such transaction where the company is in compulsory or creditors' voluntary liquidation, it does not extend to receivership or administration (confirmed by the decision in Demite v Protech Health (1998)). Clause 176 of the bill now proposes an extension of this exception to cover a company that is in administration, but in line with the Government's current unfavourable approach to non-collective insolvency procedures, Section 320 will continue to apply to administrative receiverships.
This section has in practice been more of a minor irritation than a serious headache for administrators and receivers. Although commonly faced when an administration or receivership is used, often through a prepackaged process, to sell a business to an entity connected with previous management, several techniques have been used to circumvent the section. One route is for the directors to avoid involvement with the transaction, whether by resigning as a director pre-sale or for them to delay acquiring an interest in the purchaser until the sale is complete.
The change will be welcomed as there is little logic in giving shareholders a power of veto, albeit usually ineffective in practice, in a matter where creditors' interests should prevail. Both changes, particularly the demise of Leyland Daf, will make life easier for insolvency practitioners and lawyers alike.
Tom Withyman is a partner and Tim Pritchard a solicitor at Lawrence Graham