Company Rescue and Business Reconstruction - DTI/Treasury Review

United Kingdom

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 as part of that aim to 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 certain of the recommendations, set out later, early action would be very advantageous; however, other suggestions require further consultation, debate and thought to avoid a serious risk of their imposition having unforeseen effects in the economy.

The cornerstone of insolvency principle is that the assets of an insolvent debtor are realised and distributed equally amongst creditors. There are areas of the economy, such as the insurance industry, where the speed of recycling of assets back into 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 certain changes that will potentially slow down the process.

The Government Review 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 concern businesses and maximum economic value. The main thrust of the Review Group's perspective on the UK's insolvency law regime is that there ought to be the imposition of a more collective approach to the way in which companies in difficulties are dealt with.

Their 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.

Whilst the collective approach is more inclusive to new areas of finance introduced over the last few years such as asset finance, factoring and, in particular, 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 this will establish (or re-establish) the prime issue that administration is a collective insolvency procedure, rather than being a procedure that gives way to the interested secured creditor. Research carried out by Professor Harry Rajak shows that in approximately 50 percent of all administrations a floating charge was in existence yet the floating charge-holder did not exercise its veto. The Review Group take this as evidence that many secured creditors are content to allow administrations to proceed at the moment. It seems inequitable to deprive the holder of the floating charge of the veto right on the basis of evidence that they have agreed not to exercise it in many cases in the past. In practice, the veto right, while often not used, is a control mechanism that enables the bank to influence the process leading up to an administration. That influence will include the possibility of funding, the identity of the administrator and the shape of any potential proposals and will be exerted by, in most cases, bankers with experience of intensive care. The decision making process is careful and responsible because it is in the bank's best interest to do so.

In addition to this, the incidence of hostile non-consensual appointment of receivers has reduced considerably 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, observably, more often now resolved in favour of the directors inviting the bank to appoint so as to protect their own positions. My fear is that in introducing a right for banks to give reasons at the time of the application for the administration as to why they do not agree with the identity of the proposed administrator or the proposal is too late in the process and may lead to significantly more court time being taken up with such applications. Further research in this area should be undertaken before this recommendation is implemented.

There are some very positive suggestions that ought to be introduced as quickly as possible. The Review Group suggested that the revenue departments develop a commercial approach to proposals under CVAs, with a centralised function within the Crown to deal with companies in difficulties. That function ought to deal with businesses individually and proposals for the settlement of tax debt will be judged on individual merits, leading to a more flexible approach. Attempts to improve the level of awareness of directors of the insolvency process so as to encourage them to take advice early on potential problems, is also admirable. This is to be welcomed because many of the rescue procedures that the Review Group wish to encourage will only be effective if brought into play in time. As the Group points out, there is no purpose in seeking to rescue an enterprise that has definitely failed but, in practice, there are matters that can be addressed and dealt with if caught early enough. Classically, in the world of multi-bank work-outs where the rule is "no surprises", it is essential that all stakeholder creditors, not just banks, are brought in to agree to any creditor proposals that are required to assist the company.

These are the best examples of consensual creditor-driven rehabilitation procedures without the need of formal court protection, where debtor and creditor work together for their mutual advantage and the Review Group could have concentrated more on encouraging such arrangements.

The Review 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 and particularly when the company disagrees with the conclusion of the investigating accountants that a receivership is necessary. The research that the Review Group draws on was conducted by Alan Katz and Michael Munford of Lancaster University. That found no significant difference in the accountants' recommendations to The Royal Bank of Scotland, who already adopt this policy, and to the other banks who do not; therefore it is difficult to see why there needs to be a change in ethical guidance, except, perhaps, to meet a problem of perception.

Whilst some of the Review Group's recommendations are admirable and whose 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.

Executive summary

The Review Group has made 16 specific recommendations across five broad areas which are, in summary, as follows:

The development of the rescue culture and collective insolvency procedures

  • Floating charge holders should lose the power to veto administration orders.

  • The insolvency profession should consider changing their practice so as to retain existing management (in appropriate circumstances) in administrations more often and so reducing costs.

  • A possible moratorium for the section 425 CA 1985 scheme of arrangement procedure should be considered.

  • An Advisory Committee should be established to review and monitor the insolvency laws and a programme of research should be initiated into the impact of CVAs, administrations and administrative receiverships, supported by the government, banks and the profession.

The Crown as preferential creditor

  • The Revenue and Customs should develop a more commercial approach to CVAs and use their discretion rather than insisting on being paid in full.

  • The Revenue and Customs should establish a central specialist unit to deal with CVA proposals and have clear terms of reference to ensure that "commercially sound" solutions are reached, using private sector skills where possible.

  • Revenue departments should consider providing insolvency warnings to companies in difficulties. Financial health checks could be developed by the Insolvency Service to encourage small firms to raise the standard of their financial and business management.

Directors: their education and conduct

  • The Insolvency Service should consider ways of speeding up the process of deciding whether to bring proceedings against the directors of an insolvent company so that if a decision not to proceed has been made a director can be told and R3 should demonstrate that its change of name from the Society of Practitioners of Insolvency to the Association of Business Professions should be matched by a real change of approach to the problems of companies in distress.

Reporting accountants perceived conflicts in becoming administrative receivers

  • The perception of accountants' conflict of interest in accepting appointments on cases where they have also been reporting accountants should be dealt with by the Banks accepting, in their Statement of Principles, that if the company disagrees with the accountants' conclusions another firm should be appointed. Likewise, the accountants should change their ethical rules. The new Insolvency Practices Council should provide the public interest input on this point.

Financing of Business Rescues

  • The law on CVAs and administrations should be changed so that a lender's fixed charge on debtors should not apply to debts created during the insolvency process to enable funding of the process with sale proceeds.

  • The law be changed so that a landlord's right of peaceable re-entry should no longer be exercisable in an administration or CVA - this will occur when the Insolvency Act 2000 becomes law.

If you would like further information, please contact banking partner Stephen Foster by e-mail at stephen.foster@cms-cmck.com or by telephone on +44 (0)20 7367 2812.