Money matters

Enhancing the rescue culture, saving viable businesses, reducing the number of liquidations – these were all seen as aims underpinning the corporate insolvency provisions of the Enterprise Act 2002, due to come into force later this spring.

The act has generally been well received and there is a willingness among the insolvency and lending communities to see it work in order to assist the so-called ‘rescue culture’ in the UK.

However, the act misses an important opportunity. It lacks a key component – the provision for financing companies that continue to trade in new-style administrations. Due to this glaring omission, the act cannot aspire to be a true means of promoting and assisting company rescues. It is incomplete, so a major step remains if we are to create an effective ‘rescue culture’ for businesses in trouble.

The essence of the debate

The act lays out a modified insolvency regime for the UK and contains a range of provisions to streamline and improve the process of administration. The changes introduced are essentially designed to support and rescue viable businesses facing insolvency, but it does not tackle the financing issues involved. It does not include provisions allowing businesses to seek finance to keep going while a rescue package is developed. It does not give them breathing space to seek the money that might support their recovery.

This has not been an issue under the receivership-dominated model of corporate insolvency. Receivers, and often administrators, could usually rely on bank support to finance ongoing trading; but under the new regime, in which banks will no longer have the same power to veto an administration, bank finance is not necessarily going to be available. Financing options for administrators will be less certain. A lack of clear channels for fundraising is likely to undermine an administrator’s ability to undertake a successful rescue in cases where ongoing trading, beyond the short term, is required.

The missing piece in the jigsaw

The new insolvency regime could provide less support to help troubled businesses recover than was available before. The central issue on financing has been ignored by the act. Why?

There is no clear answer, but it is not because the issue has not been previously identified. The Government’s own working group on this issue, the Company Rescue Review Group, published a report in May 2000 that proved to be the blueprint for the corporate insolvency provisions of the act. The report stated: “The Review Group believes that the issues of financing are central to any discussion of the rescue culture in the UK.”

The report went on to suggest there was a case for introducing a form of “super-priority financing” in insolvencies, similar to that provided for in the US Chapter 11 model. Also known as debtor in possession (DIP) financing, this allows lenders to provide funding for companies in a formal insolvency process and be first in line to be paid back. In other words, priority is given to a lender who takes the risk of putting cash into a business in order to keep it going while a rescue is being worked out. The Review Group strongly recommended that the issue be explored further within the framework of a complete review of company rescue mechanisms in the UK. It stated: “The Review Group believes that there is a case for a more radical approach to company rescues giving the courts (or supporting tribunals) discretion to agree to super-priority finance within tight criteria. This would be a major change, and there would need to be detailed consideration and wide consultation… We recommend that a debate on this proposal should begin as soon as possible.”

Yet, when the Enterprise Bill was introduced in March 2002, it did not contain any provision for financing in the new administration regime. An amendment tabled in the House of Lords to deal with the issue was rejected. When asked why it had not done anything about the issue of financing, the Government’s less than satisfactory response was essentially that the decision to lend to a company in insolvency should be left to the commercial judgement of the lending market, based, among other things, on whether free assets were available to use as security.

This approach appears to misunderstand the position that many companies are in when facing insolvency. Characteristically, all available assets would have been pledged to secured lenders long ago. A super-priority arrangement recognises this and provides for the company to continue to borrow, and therefore operate, during a rescue phase. It could help to create an insolvency regime that is genuinely rescue-orientated.

The reality is that much of the international community considers the UK’s insolvency system to still be essentially a liquidation-dominated regime. Many small and medium-sized businesses in particular see the system in the same way, and therefore something to be avoided at all costs, very often until it is too late. Certainly, the original Review Group recognised this, if not the Government.

The road ahead

The Government has admitted that financing is a difficult and complex issue. This is undeniably true. It was too complex, in fact, to be dealt with in the context of the political realities of the Enterprise Bill, which required the bill to be passed within a tight timetable with little amendment. The Government’s assurance that it would keep the matter under review provides some comfort. There are certainly many professionals and businesspeople familiar with this area who would welcome the chance for a real debate.

This debate must take place, because we still need a formal means for companies in administration to seek the financing that would help them carry on. We must continue to seek the “detailed consideration and wide consultation” on financing arrangements that the Review Group recommended. We must continue to lobby the Government to engage with this fundamental issue.

By not answering the clear need for support on financing arrangements, the act misses the chance to seriously enhance the power of the administration regime in the UK. Opportunities for major reforms of insolvency law do not arise often. By the time this issue is properly considered by the Government, and perhaps put into legislation, it is almost certain that another wave of company failures will have been and gone, and we will still be some time away from a genuine corporate rescue system.

Nick Brainsby is a corporate services associate at Beachcroft Wansbroughs