The Enterprise Bill

United Kingdom

The Enterprise Bill reforms corporate insolvency in a way which is intended to facilitate the rescue of viable companies, or where this is not practicable, to effect returns to creditors. This note will concentrate on the corporate insolvency reforms.

The Bill also changes the bankruptcy regime by reducing the number of restrictions that are automatically imposed on undischarged bankrupts, providing for the automatic discharge of nearly all bankrupts after a maximum of 12 months and introducing provisions to protect the public from bankrupts whose conduct has been found culpable. No further detail on this aspect will be given in this note.

The Bill is still at the amendment stage, having been introduced to the House of Commons on 26 March 2002, and amended on 16 May 2002. References to clause numbers in this note refer to the 16 May version. Estimates of when the insolvency sections are likely to become law vary: the most conservative currently stands at next Spring (2003). The text of the Bill can be obtained from: www.publications.parliament.uk/pa/cm200102/cmbills/138/2002138.htm .

1. Overview

Only a slim part of the Enterprise Bill (Part 10)relates to insolvency; the rest of it deals with Competition and Consumer issues. The Bill stems from the Government’s wish to promote the “enterprise culture and to simplify the rules of insolvency.

The last big reform of insolvency law was in 1986. The reforms introduced now by the Enterprise Bill centre on the Treasury’s concern to restrict the number of banks appointing Administrative receivers, in the belief, probably mistaken, that this was damaging the economy. The administration procedure has been streamlined with the intention of making it the most frequently used rescue device. It introduces a mechanism to protect a proportion of funds for return to unsecured creditors.

A substantial issue for banks will be the new prohibition on banks from appointing an administrative receiver under their floating charge. There are certain exceptions in which administrative receivers will continue to be appointed, such as agreements which form a capital market arrangement involving a debt of at least £50m, certain projects involving step-in rights, and floating charges executed before the Bill becomes law, which claim the right to appoint an administrative receiver.

For the main part, however, a “qualifying floating charge holder will no longer be able to appoint an administrative receiver and by doing so, block the making of an administration order.

2. Administration

The Administrator will technically remain a court-appointed officer, even though it will now be possible to appoint him through a new out-of-court procedure. The reason for this is to enable the Administrator to be recognised across the EU in line with the spirit of the EU Insolvency Regulations which came into force on 31 May. The Administrator must be a qualified insolvency practitioner.

The maximum length of an administration will be 3 months. It will be possible to extend this period by consent, but this will increase the costs. Experience to date of Administrations such as Maxwell or Polly Peck has shown that it is rare for a substantial administration or administrative receivership to be concluded in this short time.

The purpose of the administration is to rescue the company. Note that this means rescuing the corporate shell and not the business, which a receiver might previously have been able to sell off profitably to the benefit of the creditors and employees. This approach appears perverse, requiring the Administrator to pursue company rescue at the expense of transferring a profitable part of the business.

To emphasise the aim of company rescue, the Bill replaces the four existing statutory purposes (s8 (3) Insolvency Act 1986) with a single, overarching purpose which will apply to all cases of administration. The Administrator will be required to carry out his or her functions with the objective of rescuing the company when it is reasonably practicable. (See the detailed example of this in the Explanatory Notes to the Bill).

Whether a company rescue is a reasonably practicable option is a matter of commercial judgement. It is envisaged, the Explanatory Notes assure us, that the courts will not seek to criticise the exercise of such judgment unless there is bad faith or the decision could not have been taken by a reasonable Administrator.

Company rescue means continuing the company as a going concern. It is most likely to involve the creditors agreeing to a CVA or Scheme of Arrangement under s425 Companies Act 1985.

If a rescue proves to be impracticable, the Administrator must perform his functions with the objective of achieving a better result for the company’s creditors as a whole than on a winding up. In such a case, the company’s individual’s businesses might be broken up and sold as a going concern, and assets sold not on a going concern basis.

And if this second objective cannot be reached, then where the company is not viable and has no business that could be sold as a going concern, the Administrator is to sell the company’s remaining assets to make a distribution to one or more secured or preferential creditors.

In each case, the Administrator is obliged to act in the interests of the creditors as a whole or without “unnecessarily harming the interests of the creditors as a whole. The Bill has in mind the situation where there are insufficient funds to pay the unsecured creditors, but quite what the phrase “unnecessarily harming means is unclear; it is not defined.

Routes into Administration

The Bill continues the current procedure under s.8 Insolvency Act 1986 to appoint administrators by court order. Those currently entitled to use this method will continue to be able to. Because the process would benefit from not relying on obtaining a court order of appointment, the Bill sets out a new method by which holders of floating charges and companies or their directors can directly appoint an Administrator.

2.1 Appointment by Court

An administration order by the court can be applied for by a floating charge holder, a company or its directors, or one or more creditors of a company. The Court will only make an order if it is satisfied the company is unable to pay its debts (or likely to become so) and that the order is likely to achieve an objective or the purpose of the administration.

Once the application has been made, notice must be given to anyone able to appoint an administrative receiver or Administrator. The application cannot be withdrawn without the permission of the court.

2.2 Out-of-Court Routes into Administration

This is the innovation of the Bill designed to make the administration procedure easier and more frequently used. A floating charge holder may use this method if they hold “a qualifying floating charge. A floating charge will be a qualifying charge if the security agreement contains a statement to this effect or purports to enable the holder of the floating charge to appoint an Administrator or administrative receiver. The drafting of the security agreement is therefore of paramount importance. Existing standard documentation should be reviewed to ensure the wording is adequate.

A more familiar requirement of course is that the floating charge must relate to the whole or substantially the whole of the company’s property or do so when taken together with other charges or security.

The preconditions for a floating charge holder to appoint an Administrator of their own choosing are:-

1. the relevant floating charge is enforceable (meaning the holder is entitled to call in his security);

2. he has given notice to any floating charge holder with priority over his own;

3. the company is neither in liquidation nor has a provisional liquidator been appointed; and

4. neither an administrative receiver nor Administrator is already in office

Note that a floating charge holder can apply to court for an administration order without needing to demonstrate the company is unable to pay its debts, or likely to become so.

A winding up order on the company will prevent an out of court appointment, but a floating charge holder (not the company or its directors) can still apply for administration through the court. If the administration order is made, the court will then discharge the winding up order The liquidator could present an application for administration.

Filing Requirements

The floating charge holder must file a notice of appointment with the court – remember the Administrator is an officer of the Court. The notice must identify the Administrator and include a statement of his consent to act. The floating charge holder must file with this a statutory declaration that they have a qualifying floating charge – if the holder here makes a false statement which the holder does not reasonably believe to be true, he will be committing an offence.

2.3 Route used by Company or Directors

A company or its directors can appoint an Administrator out of court if:-.

1. the company has not been in administration nor subject to a moratorium in respect of a failed CVA in the previous 12 months;

2. the company is, or is likely to be, unable to pay its debts;

3. there is no outstanding winding up petition in respect of the company;

4. the company is not in liquidation; and

5. there is no Administrator or administrative receiver in office

The company or the directors must file a “notice of intention to appoint at court with a statutory declaration and send a copy to the floating chargeholder. As soon as this is done, an interim moratorium commences. Five business days’ notice have to be given, and during this period, the floating charge holder may either agree with the appointment or appoint their own.

Note that the moratorium becomes effective on filing: the aim of the Bill is to encourage rescue, which contrasts with the current approach to stop the directors from trading whilst insolvent, and generally to regard insolvency as a problem. There is no power of veto in favour of a bank or other secured creditor with a floating charge. The directors are encouraged to remain in control.

If the floating charge holder either consents or does not respond, the company or its directors must make their appointment within ten days of filing the “notice of intention to appoint.

The notice of appointment must be filed within the 10 day period or else the interim moratorium will cease and an Administrator cannot be appointed. The Administrator takes office once the notice of appointment is filed.

An application for administration will fail if an administrative receiver is in office, unless the receiver consents or the court thinks the receiver’s security may be set aside.

A pre-existing winding up petition does not prevent the floating charge holder from using the out-of-court route into administration and any winding up petition will be suspended but not dismissed. Contrast the position if the court route is used, where the court has to dismiss any outstanding petition.

Process of Administration

The Bill attaches as Annexes clear flow-charts setting out the following steps.

Once appointed, the Administrator sends a notice of appointment to the company and its creditors as soon as reasonably practicable and to the Registrar of Companies within 7 days of appointment. The company must provide a statement of affairs verified by a statement of truth within 10 days of receiving the notice.

The Administrator is required to make a statement 28 days from appointment, setting out his proposals for achieving the purpose of the administration. (The 28 day period can be extended by court permission of creditor’s event)

The proposals have to be sent to the Registrar, the creditors and every member of the company (the latter can be done by publishing a notice).

If the business of the company had to be sold quickly to maximise its economic value, the Administrator will report these facts in the proposal.

The Administrator also has to call an initial creditor’s meeting to consider the statement, unless he thinks the assets of the company, except for those flowing from the abolition of Crown Preference, are insufficient to enable a distribution to be made to the unsecured creditors.

The statement must be prepared and sent to all known creditors even if the Administrator is entitled not to call the meeting. Where the value of the secured liabilities is greater than the value of the secured assets, the secured creditors will bear the costs of this process. Further, creditors whose claims comprise 10% of the debts of the company can demand the meeting even if it is unlikely there would be any distribution to unsecured creditors. The meeting must be held within 6 weeks of the administration commencing.

At the initial creditor’s meeting the Administrator will present a copy of his or her proposals. The creditors have to decide whether to accept proposals to rescue the company as a going concern and to accept an arrangement under which they will agree to accept less than full payment of their debts. This will normally be done through a CVA, or a Scheme of Arrangement under s425 Companies Act 1985. The agreement of 75% of the creditors (by value) is required. How this will operate in practice under the tight deadlines imposed by the proposals is open to question – are the creditors less likely to agree under such pressure?

The creditors can decide to reject the Administrator’s proposals, in which case the court may provide that the Administrator’s appointment will cease to have effect, adjourn the hearing with the Administrator conditionally or unconditionally and make an interim order or any other order.

If the proposals are accepted by the creditors, the Administrator cannot subsequently make any substantial revisions to the proposals without the creditors’ agreement.

The time provisions imposed on the Administrator and the creditors lead some commentators to suggest that the first outstanding objective may actually be too difficult to strive for in practice. Perhaps the second objective, “where it is not reasonably practicable to rescue the company, [to achieve] a better result for the company’s creditors as a whole than would be likely if the company were wound up (without first being in administration) will prove most popular.

3. The exceptions

The cases in which an Administrative Receiver may continue to be appointed are set out in detail at Schedule 18 of the Bill. The nature of the exceptions to the prohibition on appointing an administrative receiver may mean that structures will be deliberately created to fall within the exceptions. A commentator has pointed out that there is no policy reason for having exceptions for certain types of transactions but not others.

4. Liquidators Brining Proceedings and Recovery of Costs

The Liquidator is required, at section 247 of the Bill to seek the sanction of the creditors or the court before bringing proceedings for recovery of monies in relation to fraudulent trading, wrongful trading, avoidance of preferences and transactions at an undervalue. This forms part of a wider legislative picture designed to address the problems encountered by liquidators from the decision in “Floor 14 in recovering their costs of legal action in relation to antecedent recoveries. A draft statutory instrument is understood to be being worked on at present, which is likely to provide the Liquidator with an indemnity out of the assets of the company in liquidation for the costs incurred if he turns out to be unsuccessful.

5. Unsecured Creditors

There will now be a prescribed percentage of assets available for unsecured creditors. This proposal was first made almost 20 years ago in the Cork Committee’s Report. The prescribed percentage of the assets to be available for unsecured creditors is left to be included in a statutory instrument for later publication; rumour places the figure currently at 10%. The fund that will be made available to the unsecured creditors comes only out of the assets of the company which are not caught by a fixed charge. It will still be subject to the prior claim of the remaining preferential creditors and the costs of the Insolvency Practitioner. The change will only affect the holders of floating charges entered into after the coming into force of the new law and so it will be some time before the benefit is felt by the unsecured creditors.

6. Abolition of preferential PAYE, NIC and VAT claims

Crown preference will be removed. Certain preferential claims such as some employee claims and the expenses of the administration will be given priority to the claims of the floating charge holder. Provision is made for a fund in the floating charge recoveries for preferences and unsecured creditors. This is precisely because the government does not want the benefit of the abolition of the status of certain crown debts to go to the floating charge holder. The fund is likely to amount to 10% (“a prescribed percentage) of the company’s net property: which is the property available for distribution once the fixed charge liabilities and preferential debts have been discharged and the costs of realising the company’s property deducted. Hence it is intended to cover the floating charge realisations. If the costs of distributing the fund are disproportionate to the benefits, no distribution need be made.

7. Some difficulties

Some problems arise with the current drafting in attempting to protect the unsecured creditors:

7.1 There is no proof of debt mechanism or procedure for making distributions to unsecured creditors, so it is not clear how an Administrator or receiver can make the fund available for unsecured creditors. How does he know to whom to pay the money? A suggestion has been made that the money should be handed to the liquidator to make the distributions.

7.2 The fund has to be set aside in all cases where there is a floating charge and so this means the administrative receiver appointed in the case of a floating charge in a capital markets or project finance transaction will have to create the fund. This will have an impact in assessing the credit-worthiness and rating of a company.

7.3 The discretion of the office holder not to make a distribution to unsecured creditors applies only if the “net property is below the prescribed minimum. It does not seem to take into account the number of unsecured creditors which, if there is a large number of small claims, will affect the costs of distribution.

The abolition of preferential creditors may be of more significance to unsecured creditors than the ring fence device. Banks with charges over book debts will no longer be quite so concerned whether those charges are fixed or floating. The categories of preferential creditors who would rank ahead of them if their charge was merely floating have been much reduced. Some issues for banks remain, however: there are some preferential claims left, although the amounts involved for employees and pensions will be far less than the government claims for various taxes, and finally, liquidators will still be entitled to cover their expenses out of the monies under the floating charge.

For further information, please contact Ruth Pedley at [email protected] or on +44 (0)20 7367 2098.