Stephen Foster is a banking partner at CMS Cameron McKenna.
The consultation period for the joint DTI/HM Treasury Review Group on Company Rescue and Business Reconstruction Mechanisms, which wishes to lend greater support to a culture of enterprise and thus improve the legal and commercial infrastructure in the UK, ended earlier this month. The Government is broadly content with the recommendations and there are several areas in which it would like to see early action.
On some of the recommendations, early action would be very advantageous; however, other suggestions require further consultation, debate and thought to avoid a serious risk of their imposition prompting unforeseen effects in the economy.
The cornerstone of insolvency principle is that the assets of an insolvent debtor are realised and distributed equally among creditors. There are areas of the economy, such as the insurance industry, where the speed of recycling of assets back into the economy via the insolvency process is crucial. Court-driven procedures do lead to argument and delay and the thrust of reform should be to avoid the courts, but the review group has recommended changes that will potentially slow down the process.
The group recognised that the developing principle of corporate rescue should not be used to prop up unviable businesses but to promote the rescue of a company, to preserve going concerns and achieve maximum economic value. The main thrust of the group's perspective is that there ought to be the imposition of a more collective approach to the way in which companies in difficulties are dealt with.
The concentration on formal collective insolvency procedures has led to one of the more controversial proposals within the review, which is to abolish the ability of the holder of a floating charge to veto the proposal for an administration by a company. However, the secured creditor is to be given the right to make representations to the court as to the identity of the proposed administrator in lieu of its right of veto. While the collective approach is more inclusive to new areas of finance introduced over the last few years, such as asset finance, factoring and high-yield bonds, this change of emphasis should not be used to justify the removal of the secured lender's right of veto.
The reason for this recommendation is that it will establish (or re-establish) the prime issue that administration is a collective insolvency procedure, rather than one which gives way to the interested secured creditor. Research carried out by Professor Harry Rajak shows that in around 50 per cent of all administrations a floating charge was in existence, yet the floating charge holder did not exercise its veto. The review group takes this as evidence that many secured creditors are content to allow administrations to proceed. It seems inequitable to deprive the floating charge holder of the veto right on the basis of evidence that they have agreed not to exercise it in many past cases. In practice, this right, while often not used, is a control mechanism enabling the bank to influence the process leading up to an administration, which will include the possibility of funding, the identity of the administrator and the shape of any potential proposals, and which will in most cases be exerted by bankers with experience of intensive care.
Additionally, the incidence of the hostile non-consensual appointment of receivers has reduced con
siderably since the last recession. Many bankers in this area will confirm that they have not carried out hostile appointments for many years – the balance between the risks on the directors, whose decision it is to invite the bank to appoint receivers, and the bank's interests is now more often resolved in favour of the directors inviting the bank to appoint so as to protect their own positions. One fear is that in introducing a right for banks to give reasons at the time of the application as to why they do not agree with the identity of the proposed administrator, or the proposal is too late in the process, may lead to significantly more court time being taken up with such applications. Further research into this area should be undertaken before implementation.
There are, though, some very positive suggestions. The group suggested that the revenue departments develop a commercial approach to proposals under corporate voluntary arrangements (CVAs), with a centralised function within the Crown to deal with companies in difficulties. It ought to deal with businesses individually and proposals for the settlement of tax debt will be judged on similarly. Improving directors' awareness of the insolvency process to encourage them to take advice early on is also admirable. Indeed, many of the rescue procedures that the group wishes to encourage will be effective only if brought into play in time. There is no point in seeking to rescue an enterprise that has definitely failed, but there are matters that can be addressed and dealt with if caught early enough. Classically, in the world of multi-bank workouts where the rule is “no surprises”, it is essential that all stakeholder creditors, and not just banks, are brought in to agree to any creditor proposals required.
These are the best examples of consensual creditor-driven rehabilitation procedures without the need of formal court protection, where debtor and creditor work together to their mutual advantage. The review group could have concentrated more on encouraging such arrangements. The group also suggests that insolvency practitioner accountants ought not to accept appointments as administrative receivers after having also carried out a report as an investigating accountant, particularly when the company disagrees with the investigating accountant that a receivership is necessary. The research that the group draws on was conducted by Alan Katz and Michael Munford of Lancaster University. It found no significant difference in the accountants' recommendations to the Royal Bank of Scotland, which already adopts this policy, and to the other banks which do not. So it is hard to see why there needs to be a change in ethical guidance, except perhaps to meet a problem of perception.
While some of the review group's recommendations are admirable, and early introduction would assist businesses in financial difficulties, careful consideration of some proposals is still required. Insolvency reform must be given a high priority by the Government post-election to provide businesses in trouble with an improved chance of survival. In short, time is of the essence. n