Paying by the rules

Jermaine Beckford

Research published by the Centre for the International Business of Sport at Coventry University in 2008 revealed that clubs in the top four tiers of English football between the 2001-02 and 2005-06 seasons made an aggregated loss of more than £1bn. In addition, 56 clubs in the English leagues went bankrupt between the Insolvency Act’s introduction in 1986 and June 2008.

While no club has ever become insolvent while in the Premier League (established in 1992), there has been a pattern of clubs becoming insolvent shortly after being ­relegated from it, including Bradford City in 2001 and Leeds United in 2004, indicating that clubs often spend beyond their means in order to retain their positions in the top flight.

Football has overstretched itself and is now starting to suffer. In 2008 FA chairman Lord Triesman estimated that the debt figure across English football stood at £3bn. Buyouts of clubs in recent years have often been heavily leveraged and many are now struggling to meet interest payments to lenders. Additionally, very few clubs break even as a result of player wage costs.

For clubs that enter administration the consequence is a 10-point deduction from their league table position (nine points for Premier League clubs). This is to penalise clubs that do not and cannot pay their creditors because of financial mismanagement. However, it applies irrespective of whether some unforeseen catastrophe is the cause, or whether the administration is the result of poor management.

A points deduction is likely to result in the club being relegated, which will dissuade commercial investment and damage its future prospects. Many therefore question whether this blanket deduction is fair and reasonable.

The football creditors rule

In an insolvency scenario the ‘football creditors’ rule provides that football creditors have to be paid in full, irrespective of the position of any other unsecured creditors
of the club, before the club is eligible to ­participate again in league football.

The Football League and FA argue that the rule maintains competition. It is also argued that football clubs are a community of businesses that can only survive as a ­collective, so that allowing one club to escape its liabilities to other clubs should not be allowed.

Nevertheless, there has been severe criticism that the rule operates unfairly (and some argue illegally) because it supersedes the order in which creditors are ranked by insolvency legislation. Critics ask: why should a club, or one of its players, either of which is an unsecured creditor of another club in administration, be more deserving of being paid than the club caterer or HM Revenue & Customs (HMRC)?

Certain examples illustrate the rule’s potentially distasteful effect. At Bradford City, which collapsed in 2002, 36 workers in club shops were sacked, while money was also owed to local authorities and to St John Ambulance. However, the highly paid players, including Benito Carbone (on £40,000 a week), had to be paid in full.

The Inland Revenue (now HMRC), in Inland Revenue Commissioners v ­Wimbledon FC (2004), has challenged the operation of the football creditors rule in the Court of Appeal, but lost the case.

Leeds United

The penalty for entering administration has the ability to work harshly when it is read in conjunction with the football creditors rule. The Football League requires clubs coming out of insolvency to agree a company voluntary arrangement (CVA), a settlement that requires approval by 75 per cent of creditors.

In the case of Leeds United’s 2007 CVA proposal, HMRC was in line to receive around only £77,000 of the more than £7m tax bill it was owed, while Leeds’ football creditors would receive full repayment.

HMRC refuses to agree to be paid only a proportion of the tax it is owed, while under the football creditors rule players’ wages and any money owed to other clubs are being paid in full. As a result HMRC tends to vote against CVAs proposed in relation to clubs.

HMRC therefore challenged the Leeds CVA (which had the requisite majority agreement), which led to the administrators collapsing it and being forced to complete a private sale. Due to this legal challenge Leeds incurred the automatic 10-point penalty when the club went into ­administration, then accepted a further 15-point deduction in League One when it failed to achieve a CVA (HMRC did not eventually follow through with its challenge to the CVA).

As the recession continues to bite it seems almost certain that more clubs will collapse under the weight of their debts. Since HMRC will almost always be a significant creditor clubs will require its support to exit from administration via the CVA mechanism required by league rules. Yet HMRC has made its opposition to the distortion of statutory insolvency rules that the football creditor rule creates clear and will likely continue to vote against CVAs that abide by it, with clubs potentially being penalised with further point deductions.

Consequently the football industry is facing a period of uncertainty and instability that is likely to shape it for years to come.

Adam Plainer is a partner and London head of business restructuring and ­reorganisation at Jones Day