10 July 2011
Administration is the UK’s principal business rescue tool. In the first quarter of this year alone 782 companies entered into administration.
However, from a high-water mark in 2008 the use of administration appears to be declining.
Taking into account the difficulties the UK economy has faced in recent times along with unprecedented levels of corporate debt, this appears surprising. Both proponents and opponents of the current system are pressing for urgent reform, united only in the belief that, as it stands, the process does not work. Regrettably, it appears that unless action is taken the process itself is in danger of terminal decline.
Much of the current debate on administration focuses wrongly on the use and perceived abuse of pre-pack administration. It has long been a judicially approved practice for an insolvency practitioner, in appropriate circumstances, to negotiate the sale of an insolvent company’s business or its assets prior to the commencement of the insolvency process.
The reasons for a pre-pack are compelling. As a consequence of a business entering into an insolvency process, key suppliers may withhold services, demand ransom payments or seek to vary terms; staff can be poached by rivals and the business may become fundamentally destabilised and lose enterprise value. At a time when the business is already in financial difficulties administration is likely to leave it facing severe cash calls. For smaller businesses that are unlikely to receive funding from banks and other key stakeholders this can be fatal.
Opponents of the pre-pack claim it disenfranchises creditors from the insolvency process, excludes possible purchasers and could see the return of a business to a failed management. While all these arguments need to be considered, if the aim of the process is to rescue the business a pre-pack may be necessary.
Where existing stakeholders are unwilling to provide a cash injection to ensure the business continues to trade, a pre-pack allows a new owner to be lined up who can inject much-needed funds. At other times there is a justifiable fear that to publicise the company’s insolvency and invite offers would expose it to public scrutiny that may result in the steps by suppliers, creditors or rival businesses outlined above.
It should also be borne in mind that existing managers or stakeholders are often willing to purchase the business in excess of valuations due to their knowledge of and connection with it, resulting in a better overall return to creditors.
The SRA’s Statement of Insolvency Practice 16 has provided professional guidance on how pre-pack sales should be conducted, which quite rightly leads to the administrator sharing with the creditors the reasoning and justification for the initiation of the pre-pack process. The problem with this is, of course, that the requisite statement is provided after the sale has been completed, providing, to all intents and purposes, a fait accompli.
On 31 March, business, innovation and skills minister Ed Davey announced measures intended to improve transparency and confidence in pre-pack administrations in a written statement to Parliament. These include a requirement on insolvency practitioners to announce their intentions to sell in advance to creditors where there is no opening market of the assets or business.
It is suggested that three business days’ notice will be required before the sale can be completed. This will enable creditors to consider and make representations, possibly make higher offers and, if necessary, apply for an injunction to restrain the proposed sale taking place. This reform would clearly lead to legally led challenges to proposed pre-pack sales and see certain opportunistic creditors apply leverage to ensure they have a seat at any negotiating table.
In the meantime case law has been developing, with decisions on rates, rent and, recently, pension liabilities shifting an ever increasing burden of costs onto companies in administration. Prior to taking on any appointment, administrators must ensure that costs and expenses - whether voluntarily or involuntarily incurred by the company in administration and which could be seen as furthering the purposes of the administration - will be paid.
As an administrator has no ability to disclaim onerous contracts the administrator can be left to meet significant liabilities, making a trading administration highly unattractive. In April, in a move to partly tackle this problem, insolvency trade body R3 introduced a campaign called Holding Rescue to Ransom to call on the Government to amend insolvency legislation to prevent suppliers withholding services or varying terms and demanding ransom payments, or utility companies putting companies on more expensive tariffs as a result of entering into formal insolvency. Effective reform in this area could mean that the need for pre-packs is lessened.
Are we to embrace a flexible, pro-rescue culture, allowing administrators to act in avoiding costs and expenses, where this does not further business rescue? Or are we to uphold the rights of suppliers and creditors in ensuring certainty in recovery and return, even if that results in more business failures? What is clear is that purposeful reform is required to arrest what could be a terminal decline.
Vernon Dennis is a partner and head of corporate recovery at Howard Kennedy
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