When the changes to insolvency and competition law regimes, now encompassed in the Enterprise Act, were first announced by Gordon Brown in June 2001, much was made of the entrepreneurial regime in the US – specifically, how the UK economy could reach US levels of productivity if certain key US features were adopted. The Enterprise Act echoed the longstanding recognition in the US that cartels are, in Brown’s words, “simply a sophisticated form of theft”, and that bankruptcy in the US does not have the same stigma as it has in Europe. It was these two themes that drove the reforms of the Enterprise Act 2002, the insolvency sections of which came into force in September this year.
In terms of the reform of corporate insolvency and restructurings, the Enterprise Act fell short of implementing a full Chapter 11-style process. The resultant statutory framework has missed some opportunities, but has avoided potential problems associated with Chapter 11.
Perhaps one of the greatest missed opportunities was not to introduce the concept of a debtor in possession (DIP) priority financing arrangement. In the US, there is an established industry of DIP lenders who, because of the super-priority status granted to them in a Chapter 11 process, will make funding available to support a company through its restructuring. A US company in financial difficulties is not, therefore, dependent on attempting to persuade its existing banks to make more money available. If the business is worth saving there will be any number of DIP lenders queuing up, not least because in certain circumstances a DIP lender is able to bid its debt when the business is eventually sold.
Another missed opportunity was the failure to introduce the key concept behind the US Chapter 11 process, namely that the debtor stays in possession. While the Enterprise Act has put all the emphasis now on the administration process – although administrative receivership still exists in substance if not in name – it did not go so far as leaving management and the directors in possession of the company with the benefit of a statutory moratorium on creditor action and enforcement of security.
The changes introduced by the Insolvency Act 2000, which introduced a statutory moratorium to protect companies seeking a company voluntary arrangement, got close, but in reality remain of little practical value given that the moratorium protection is available to only small companies – a company that has a turnover of not more than £2.8m and/or a balance sheet total of not more than £1.4m and no more than 50 employees. The abolition of this restriction could have changed the insolvency and restructuring landscape significantly. Instead, we have been left with an interesting statutory framework that has little or no practical application in the context of a complex, high-value, out-of-court restructuring.
Others may point to the Enterprise Act having missed the opportunity to introduce similar provisions as apply in the US to executory contracts. The ability of a Chapter 11 debtor to pick and choose which unexpired leases and executory contracts to assume or reject is perhaps one of the most valuable provisions of the Bankruptcy Code. This not only gives the directors of the Chapter 11 debtor the ability to disclaim what UK insolvency lawyers would call unprofitable or onerous contracts, but also gives them the right to compel the counterparty’s continuance of contracts that are classified as ‘executory’, provided the Chapter 11 debtor cures past defaults and demonstrates its financial capability to perform its side of the contract in the future. All this is further enhanced by two other elements of the Chapter 11 process. First, the Bankruptcy Code renders unenforcable any provision purportedly terminating a lease or executory contract by reason of the debtor’s financial condition or the commencement of a Chapter 11 case. Second, most leases and contracts can be assigned, on a non-recourse basis, to third parties, notwithstanding the existence of anti-assignment provisions in the relevant contract or lease. There must be many UK administrators trying to hold together and sell a business as a going concern who would welcome this range of powers in the context of a UK administration process, and many directors in consensual restructurings would also welcome such powers.
It would be wrong, however, to seek to endorse every aspect of the Chapter 11 process. The Enterprise Act may well have avoided some of the pitfalls associated with the US bankruptcy process. The directors, or, in a significant restructuring or workout scenario, a chief restructuring officer from one of the turnaround firms in the US, do not have unlimited discretion in the management of the business. There are substantial financial reporting requirements to creditors and other ‘parties in interest’. This imposes a significant administrative burden on the management of a Chapter 11 debtor because parties in interest will often include some or all of the following: the US trustee; various creditors/committees; secured creditors; a Chapter 11 trustee – distinct from the US trustee – if one has been appointed; an examiner, if one has been appointed by the bankruptcy court; and various other parties including lessors, utilities, personal injury claimants and counterparties to contracts. All of these entities generally become involved in a Chapter 11 case and all have the ability to appear before the court on any motions in connection with the Chapter 11 process. All parties have the right to be consulted during the Chapter 11 process. Against this background, it is a relief that most of the provisions in the Enterprise Bill, which sought to hand greater powers to creditors’ committees, were dropped by the time the act came into force.
Developing market practices in the UK have left us with a consensual restructuring regime that adheres to many of the principles of a Chapter 11 process, but without some of the disadvantages. This is mainly as a result of market practice, rather than anything introduced by the Enterprise Act. As a result of the large influx of US capital into Europe during the past decade, the capital structure of many companies in consensual restructuring will be complex enough for administration to be seen as a last resort and destructure for value, even under the Enterprise Act regime. Instead, a consensual out-of-court restructuring process will be pursued, with investors from the US having a seat at most restructuring tables. They, in turn, will expect to see familiar restructuring techniques employed, particularly as regards standstill, intercreditor agreements and new money priority. This will often mean that the restructuring will stay out of court. The directors will stay in possession of the company, sometimes with ‘new blood’ being injected in the form of an equivalent to a chief restructuring officer as in the US. The only court action is likely to be at the conclusion of the restructuring, with a scheme of arrangement under section 425 of the Companies Act 1985, to cram down and bind in various classes of creditors. This again introduces a concept well-known to US investors, as the cram down provisions in a Chapter 11 are frequently used to force through the restructuring plan, even if one or more of the impaired classes reject it. The requisite majorities of classes of creditors approving a cram down as part of a Chapter 11 are almost identical to the majorities required in a Companies Act scheme of arrangement.
In conclusion, UK restructuring and insolvency practice has moved some way towards the US style of restructurings. This is largely as a result of market practice rather than as a consequence of the changes introduced by the Enterprise Act 2002.
John Houghton is a partner in the insolvency practice in the London office of Latham & Watkins