Going for broke
20 October 2003
The introduction of the relevant provisions of the Enterprise Act 2002 (the act) on 15 September 2003 heralded major insolvency reform in England and Wales. Although the act also implements many changes to the competition regime, the new provisions on corporate insolvency will have the greatest impact on the business world and its professional advisers.
The aim of the act is to modernise the approach to corporate insolvency, facilitating the rescue of viable companies, or at the very least achieving a better result for the company's creditors as a whole. The act aims to achieve this by:
Restricting the appointment of administrative receivers
Prior to 15 September, lenders holding floating charges over the assets of a company had the power to appoint an administrative receiver to enforce security. An administrative receiver's principal duty is towards their appointer. They therefore remain largely unaccountable to any other creditor.
From 15 September, lenders will no longer have the power to appoint an administrative receiver over new securities taken out from this date (with a few significant but confined exceptions); thus, the theory goes, the process will move towards a more beneficial and equitable outcome for creditors as a whole.
Abolishing Crown preference
In respect of companies that go into administrative receivership, administration or liquidation on or after 15 September, the Crown will no longer enjoy preferential rights to recover unpaid monies, but will instead take its place among other unsecured creditors.
Prescribing part of floating charge assets for unsecured creditors
The abolition of the Crown preference will ultimately benefit other floating charge holders, and the act seeks to redress this balance by prescribing part of the company's net property for unsecured creditors via a formula set out in the act. This may ensure that an unsecured creditor recovers something, whereas in the past they may not have.
Enhancing the liquidator's powers Sources: administrations, DETI; administrative receiverships, The Belfast GazetteThe act seeks to remove the barriers to bringing voidable transaction and wrongful trading type proceedings to allow them to have the effect for which they were intended.
Reformation of the administration procedure
The act attempts to make the administration procedure more accessible, efficacious and receptive to creditors as a whole. More importantly, the introduction of these reforms is designed to encourage a rescue-based insolvency environment.
Parallel legislation for Northern Ireland is in the pipeline. The Department of Enterprise, Trade and Investment (Deti) has issued a consultation document entitled 'Productivity and Enterprise. Insolvency - A Second Chance', which is based on the act and the reforms outlined above. The closing date for responses has now passed.
According to the consultation document: "The package of reforms in the corporate sector is designed to create a fairer system in which there is a duty of care to all creditors and all creditors are able to participate. It should also help to maximise economic value by aligning incentives properly and will ensure that companies in financial difficulty do not go to the wall unnecessarily."
The reforms in Northern Ireland are based on a two-pronged approach:first, restriction of the right to appoint an administrative receiver. The Government is in favour of collective insolvency proceedings where a duty is owed to all creditors; and second, streamlining of the administration procedure. The Insolvency Service aims to introduce these reforms into the legislative programme as an Order in Council in mid-2004. However, as major subordinate legislation will have to be brought into force to implement these changes, it will probably be 2005 before Northern Ireland will feel the impact of this reform. If the Northern Ireland Assembly resumes during this period, the procedure will have to be reviewed in order for the reforms to be introduced as an Assembly bill. Although this could delay the process, it should not hamper the introduction of the legislation significantly. The reforms seem to have been well received. Reg Nesbitt, director of the Insolvency Service in Northern Ireland, said: "Responses to the consultation document have indicated that, in general, the need for change in the approach to corporate and individual insolvency is welcomed."
Impact on Northern Ireland
Although the legislation implementing corporate insolvency reform is not yet in force in Northern Ireland, practitioners should be aware of the provisions of the act if they are dealing with companies registered outside the jurisdiction, or where, for example, the use of group debentures are necessitated. Similarly, mainland-based practitioners dealing with a UK-wide security transaction should be aware that, at least until 2005, the rights and remedies of a secured creditor will be significantly different in Northern Ireland to those on the mainland. At present, lenders in Northern Ireland will still be able to appoint administrative receivers if they hold a floating charge. This is a significant power and there may well be an increase in the appointments of administrative receivers as the lenders seek to minimise their risk prior to the new legislation coming into force. The aim of the proposed legislation is to make administration the rescue device of choice. The reforms seek to confer benefits on the directors and shareholders of small companies by improving the chances of the source of their livelihood being preserved in the event of the company encountering financial difficulties. It should also benefit the employees of such businesses by assisting in the preservation of their jobs. This may work in England and Wales; however, administrations in Northern Ireland form a very small percentage of corporate insolvencies owing to the fact that the average size of companies is smaller and thus require a different approach. Northern Ireland also has a much smaller private sector as a whole in comparison with England. The administration procedure was introduced by the Insolvency (Northern Ireland) Order 1989 and was designed to provide companies in financial difficulty with a period of respite in which to put together a rescue package, or alternatively to achieve a more effective realisation of the company's assets than would be possible in a liquidation. However, the administration procedure has never been taken up in Northern Ireland at the levels anticipated, largely due to the fact that a fixed or floating charge holder can disrupt the procedure by appointing an administrative receiver before an administration order is granted by the High Court (see table). While supporters of the new regime point to the fact that the appointment of an administrative receiver can represent precipitate behaviour on the lender's part, causing companies to fail unnecessarily, the possible economic knock-on effect of the new law is still a source of concern for those familiar with both issues of finance-raising and enforcement of security. As Tom Keenan, a partner in Deloitte & Touche's Belfast office, points out: "A streamlined system of administration would be welcome, as it will facilitate company rescues by providing 'without court order' routes into administration for floating charge holders, companies and their directors. However, despite many arguing that the existing administrative receivership route offers debenture holders, such as banks, too much power, in my experience it's a tool that debenture holders use with great reluctance, when all other options have been exhausted. I hope the proposed changes will not make it harder to raise bank finance, because the security available to banks would be reduced." It will be interesting to monitor how lenders react to the new legislation once it is in force. At worst, it could affect a lender's decision to lend, particularly to smaller businesses, as they seek to minimise their risk. Leeanne Whaley is a solicitor in Carson McDowell's corporate department