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The European, Middle Eastern and African Restructuring Review 2017

England & Wales: Overview

English insolvency law – the current position and where it may be heading

This year marks the 30th anniversary of the Insolvency Act 1986 (the Act). This anniversary presents a good opportunity to consider both the current state of English corporate insolvency law and how it may develop over the next few years in order to maintain its reputation for efficiency and effectiveness, and to address the potential impact of Brexit.

A summary of English corporate insolvency procedures

The Act contains four main corporate insolvency procedures, namely administration, company voluntary arrangements (CVAs), receivership and liquidation. While not technically an insolvency procedure, schemes of arrangement (schemes) are also used by companies facing financial difficulties, particularly in larger, more complex, debt restructurings. The key aspects of these procedures are described below:

  • The primary statutory objective of administration is to preserve, as a going concern, a company that is, or is likely to become, insolvent. In reality, it is often the company’s business (which, if not sold immediately, generally continues to trade while the administrators consider their options), rather than the company itself, which survives the process. Insolvency Service statistics suggest that, during 2016, administration accounted for approximately 10 per cent of UK corporate insolvencies, with high-profile administrations during the year including British Home Stores and Austin Reed.1
  • CVAs and schemes both provide statutory mechanisms by which a restructuring plan can be imposed on dissenting creditors. Both may be used on a stand-alone basis, together (as occurred in Fitness First, where a scheme was used to restructure secured financial indebtedness and a CVA was used to implement an operational restructuring involving unsecured lease liabilities) or in conjunction with administration. The CVA is generally perceived as being the more straight-forward of the two procedures, with simpler voting mechanics and less court involvement, but it cannot, unlike a scheme, be used to ‘cram down’ secured liabilities.
  • Receivership is an enforcement right given to a secured creditor under the terms of a debenture or similar security document, allowing the sale of the secured assets, with realisations being applied against the secured liabilities. Companies typically go into liquidation following the appointment of a receiver. Legislative changes since the Act came into force have generally discouraged the appointment of receivers.
  • A company ceases trading when it goes into liquidation. A liquidator is appointed to (i) collect in the company’s assets; (ii) distribute the resulting realisations to the company’s creditors so as to satisfy, as far as possible, its liabilities; and (iii) investigate whether transactions entered into by the company before it went into liquidation should be set aside. Once the liquidation process (which, in 2016, accounted for approximately 85 per cent of UK corporate insolvencies) has been completed, the company is dissolved and ceases to exist.

While these are the main corporate insolvency procedures, there are a number of specific insolvency regimes that only apply to certain types of company or industry. Most notably, the Banking Act 2009, which implemented the EU Bank Recovery and Resolution Directive, contains a special resolution regime for failing UK banks. Other specific insolvency regimes may apply to companies operating in the transport sector and supplying water, gas and electricity, the common thread between such regimes being a policy objective to prioritise continuity of essential supplies and services to the relevant company’s customers.

The procedures in more detail – administration

Initiating the process

Administration may be initiated either by a notice filed at court by the company, its directors or a secured lender holding a qualifying floating charge (QFC), or a court order following an application made by the company, its directors or any creditor. One or more licensed insolvency practitioners, who are often chosen by a secured lender holding a QFC, act as administrator.

What is administration intended to achieve?

The administrator has the following statutory objective:

  • to rescue the company as a going concern;
  • (if the first objective is not possible), to achieve a better result for the company’s creditors as a whole than would be likely if the company were put into liquidation; or
  • (if the second objective is not possible), to realise the company’s property in order to make a distribution to one or more of its secured or preferential creditors.

One of the recurring observations made about the administration procedure is that it does not, in practice, work particularly well as a tool for achieving the survival of a company as an ongoing legal entity. In many cases, a conclusion is rapidly reached that the company cannot be rescued as a going concern and that the administration process should, therefore, instead focus on maximising recoveries. This is often achieved through a rapid sale of the company’s business, the terms of which may have been agreed prior to the formal appointment of the administrator (such pre-agreed sales being referred to as ‘pre-pack’ sales).

Powers and duties of the administrator

Unlike Chapter 11 proceedings in the United States, to which it is sometimes compared, administration is not a ‘debtor in possession’ procedure – the administrator takes over the management of the company and controls both the business and the restructuring process. 

The administrator, who owes his or her duties to the company and its creditors as a whole, has the power, on behalf of the company, to do anything that is ‘necessary or expedient’ for the management of the company’s business and property, including borrowing money and disposing of the company’s assets.

The administrator also reports on the conduct of the company’s directors and reviews potentially voidable transactions entered into by the company, in order to decide whether the court should be asked to set them aside.

The administration moratorium

The administration process includes a statutory moratorium that prevents creditors from taking certain enforcement actions without first obtaining the consent of either the administrator or the court. The moratorium, which lasts for the duration of the administration, extends to enforcing security and commencing or continuing legal proceedings, but it does not prevent creditors from terminating contracts (even where the right to terminate arises as a result of the company going into administration) or from exercising rights of set-off.

Cramdown

There is, unusually for a statutory rescue process, no cramdown mechanism in the administration regime. If, therefore, a rescue plan needs to be imposed on dissenting creditors, it is necessary to use either a CVA or a scheme (discussed below) to do so.

The end of the process

Administration terminates automatically after a year, unless the company’s creditors agree to extend it by up to 12 months. Thereafter, the administration can only continue with court consent. Such consent is likely to be granted in complex cases, such as the Lehman Brothers International (Europe) and Nortel administrations, where it is clear that every effort is being made to progress the administration in a timely manner.

If the company cannot be preserved as a going concern, administrators can distribute any proceeds that they have realised, whether from a sale of the business or otherwise, to the company’s creditors, but they usually decide to transfer such proceeds to a liquidator, who would then deal with the distribution process.

The procedures in more detail – CVAs and schemes

What can be proposed?

There are few restrictions on what can be proposed under a CVA or a scheme, both of which can be used to amend the maturity and other terms and conditions of loans or notes, to write off all or part of a debt or (with the consent of the shareholder) to convert all or part of the debt into equity.

Any CVA proposal does, however, need to be reviewed before it is sent to creditors by an insolvency practitioner who acts as a gatekeeper, scrutinising the proposed CVA and ensuring that it is not manifestly unfair. There is no requirement for an initial review of a scheme proposal, as the court will consider its fairness at the final scheme sanction hearing.

How do schemes vary from CVAs?

While there are many similarities between schemes and CVAs in terms of what can be proposed, the probable timetable and the fact that (unless used in conjunction with an administration) the debtor’s management remain in control, there are five key differences to consider when deciding whether to use a scheme or a CVA:

  • Secured liabilities – Only schemes can be used to impose restructuring solutions on secured creditors without their individual consent. Schemes, rather than CVAs, are therefore used in more complex financial restructurings involving one or more tiers of secured debt.
  • Jurisdictional issues – A CVA can, in practice, only be used if the debtor company has its ‘centre of main interests’ – effectively its central management function – in the United Kingdom. This is not the case with a scheme, where the debtor company only needs to demonstrate a ‘sufficient connection’ with the United Kingdom, a test that may be satisfied if the liabilities being restructured are governed by English law. It is for this reason that a number of foreign companies, including Global Garden Products Italy SpA, CBR Fashion GmbH, Gulf Keystone Petroleum Limited and Metinvest BV have, during 2016, used schemes to restructure their English law liabilities.
  • Voting – The voting mechanics in a CVA are, as discussed below, more straightforward, as all creditors vote in the same class and there is no need to obtain the support of a majority in number of those voting.
  • Court involvement – While schemes are a court-driven process, there is no court involvement in a CVA unless a creditor exercises a (limited) statutory right to object to its terms.
  • Perception – While a CVA is an insolvency process under the Act, a scheme is not, as the relevant law is found in Part 26 (sections 895–901) of the Companies Act 2006.

Voting – CVAs

A CVA will be binding if approved by 75 per cent or more in value of the unsecured creditors voting at the creditors’ meeting called to consider the proposed CVA. It is an unusual feature of a CVA that all unsecured creditors can vote on the proposal, whether or not their rights are being altered.

There is no requirement that a majority in number should approve the CVA but there is a restriction on CVA proposals being forced through by connected parties (such as group companies), as a CVA cannot be approved if more than 50 per cent of the unconnected creditors voting at the creditors’ meeting vote against it.

Voting – schemes

Unlike a CVA, creditors may, in a scheme, be divided into different classes for voting purposes if there are significant differences in their existing rights or if they are being offered different rights under the scheme. Each class must approve the scheme, such approval requiring a majority in number, representing 75 per cent or more in value, of the creditors in each class voting at the relevant creditors’ meeting. If the scheme receives such approval, it then has to be sanctioned by the court before it becomes binding.

Court involvement – CVAs

The court will only become involved in a CVA if an aggrieved creditor challenges its validity on the basis that there was either a material irregularity in the conduct of the meeting, or unfair prejudice (which may arise if a creditor receives less under the CVA than they would have received in a liquidation or if they are offered a worse deal than other creditors in the same position).

Court involvement – schemes

There are two court hearings in relation to a scheme, a ‘convening hearing’ at which the court agrees to initiate the process, and, should the scheme proposal receive the requisite level of creditor approval, a sanction or ‘fairness’ hearing, at which the court needs to be satisfied that:

  • the relevant statutory requirements were complied with, the voting classes were correctly identified and each class was fairly represented at the creditors’ meetings; and
  • it would be reasonable to approve the scheme, the test being whether an intelligent and honest creditor, acting in respect of their own interests, would reasonably have approved the proposed scheme. The court would generally be reluctant to refuse its sanction on this basis unless either the scheme was being pushed through by those with special interests or there was an obvious inherent unfairness in what was proposed.

The procedure in more detail – receivership

The different types of receiver

There are, broadly speaking, two different types of receiver. An ‘administrative receiver’, who has wider powers and duties and normally takes over the running of the company’s business, can only be appointed by the holder of a floating charge created over the whole, or substantially the whole, of a company’s property and then only if such security (assuming that it was created after 15 September 2003) falls within one of the limited exceptions set out in sections 72A-GA of the Act.

Any other receiver is generally known as a ‘fixed charge’ or ‘Law of Property Act’ (LPA) receiver. Such receivers, who do not need to be licensed insolvency practitioners, are mostly used to sell land or other specific assets that are subject to a fixed charge.

The key distinction between an administrative receiver and a fixed charge or LPA receiver is that the latter has to stop acting if an administrator is appointed. The appointment of an administrative receiver, on the other hand, would prevent the subsequent appointment of an administrator.

The impact of receivership has diminished significantly as a result of recent legislative changes, as many lenders who previously had the power to appoint an administrative receiver now only have a choice between appointing an administrator and appointing a fixed charge or LPA receiver.

Initiating the process

The process for appointing either an administrative or a fixed charge or LPA receiver is broadly the same. The security document will set out the circumstances in which an appointment can be made and the process that needs to be followed (normally the service of a demand for payment followed by a written notice appointing one or more persons to be receiver of all or any part of the secured assets). There is no court involvement. In practice, an appointment is often made almost immediately after a default, with the company inviting the secured creditor to appoint a receiver where administration is not seen by the company’s directors as a viable option.

The powers and duties of a receiver

An administrative receiver is given, in addition to any contractual powers contained in the security document, the very wide statutory powers listed in Schedule 1 to the Act, including the power to manage the company’s business. Their powers may, however, not be significantly greater than those of a fixed charge or LPA receiver, as the latter are normally granted extensive powers pursuant to the security document under which they were appointed, including the power to use, sell or otherwise dispose of the secured assets, whether by public auction, private contract or otherwise. 

A receiver’s primary duty is to realise the secured assets and to pay the proceeds to the secured creditor, up to the amount of the secured debt, with any remaining balance being paid to the company, its liquidator or any subsequent ranking security holder. The receiver does, however, also owe duties to the company, in particular a duty to obtain the best price reasonably obtainable at the relevant time when selling any asset.

Impact of receivership on other creditors

There is no moratorium in receivership, so creditors can enforce any rights that are consistent with the priority of the security, including exercising rights of set-off and forfeiture, collecting goods that are subject to valid retention of title claims and terminating contracts.

The procedures in more detail – liquidation

There are two types of liquidation – voluntary (which is started by a shareholder resolution) and compulsory (which is started by a court order). Voluntary liquidation is normally the simpler and less expensive procedure and is, therefore, the preferred option (assuming that the company’s shareholders are willing to pass the necessary resolution) where the company is likely to have sufficient assets available to pay the liquidator’s fees and expenses. Approximately 80 per cent of all insolvent liquidations during 2016 were, according to Insolvency Service figures, voluntary liquidations.

Initiating the process – voluntary liquidation

A voluntary liquidation may be either:

  • a members’ voluntary liquidation (MVL). This is effectively a solvent liquidation, as it involves the company’s directors swearing a statutory declaration of solvency before the winding-up resolution is passed. MVLs are often used to remove dormant companies as part of a group reorganisation. As the expectation is that the company’s creditors will be repaid in full, it is the shareholders who control the process and appoint the liquidator; or
  • a creditors’ voluntary liquidation. This is also commenced by a shareholder resolution but is used by insolvent companies (or where directors are unwilling to make the statutory declaration of solvency). The company’s creditors control the process and appoint the liquidator.

Initiating the process – compulsory liquidation

A compulsory liquidation is commenced by the filing at court (usually by a creditor) of a winding-up petition. The petitioner must demonstrate that the company is ‘unable to pay its debts’. Section 123 of the Act provides that a company will be deemed to be unable to pay its debts if:

  • it is currently insolvent on a cashflow basis, as evidenced by either the existence of an unsatisfied judgment or its failure to pay a debt of at least £750 within 21 days of receiving a ‘statutory demand’ (a written demand for payment in a prescribed statutory form); or
  • it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities. This longer term assessment of the company’s anticipated future cashflow position is sometimes referred to as the ‘balance sheet insolvency test’.

Powers and duties of the liquidator

While there are different ways in which to initiate the liquidation procedure, the process, once commenced, is very similar. The liquidator who owes his or her duties to the company and its creditors as a whole takes control of the company’s assets. Those assets are then disposed of for the best price reasonably obtainable, with the net realisations being distributed (in cash or in specie) to satisfy, as far as possible, the company’s liabilities in the order set out below.

The liquidator also reports on the conduct of the company’s directors and reviews certain transactions entered into by the company that may have prejudiced the company’s creditors, in order to decide whether an application should be made to court to have them set aside.

The distribution process

Unsecured creditors must prove for their debts. There are detailed rules regarding proofs of debt, the valuation of debts, the ability to prove for interest on any debt, the exercise of rights of set-off and the disclaimer by the liquidator of certain liabilities (a mechanism for converting those liabilities, typically arising under unprofitable contracts, into provable claims in the liquidation).

Those debts that are accepted as being valid are repaid in accordance with a statutory order of priority, which, broadly speaking, runs in the following descending order:

  • fixed charge holders receive the proceeds from the disposal of fixed charged assets;
  • expenses of the liquidation are then paid (which include liabilities incurred under contracts entered into by the liquidator);
  • preferential debts (mainly limited amounts due to employees) are paid next;
  • the ‘prescribed part’ is set aside to pay unsecured creditors a maximum aggregate amount of £600,000 out of realisations from floating charge assets;
  • floating chargeholders receive the proceeds of floating charge assets (less the ‘prescribed part’);
  • unsecured creditors, who rank equally between themselves (unless they are subject to a binding subordination agreement) are then paid; and
  • any surplus is paid to shareholders in accordance with the company’s articles of association or other relevant constitutional documents.

Recent developments in insolvency legislation

There have been a number of recent statutory amendments to insolvency legislation, primarily as a result of policy initiatives to (i) tighten up on ‘pre-pack’ sales by insolvency officeholders; (ii) make it easier to pursue ‘rogue directors’; and (iii) simplify existing insolvency procedures, following the UK government’s ‘Red Tape Challenge’, which was aimed at cutting unnecessary costs and bureaucracy.

Pre-pack sales

Such sales, where the company’s business is sold almost immediately after the appointment of an administrator, receiver or liquidator, often to a former director or a secured creditor, have generated a considerable amount of negative publicity, mostly because, given its nature, the sale process is not always transparent.

To address this issue, the Graham Report made a number of recommendations, including establishing (albeit on a voluntary basis) a ‘pre-pack pool’ to vet proposed pre-pack sales and tightening up the reporting requirements in SIP 16, in order to require insolvency officeholders to explain to creditors why they felt that it was appropriate to enter into a pre-pack sale. Practitioners have now started using the pre-pack pool procedure to obtain pool ‘approval’ prior to implementation. The government has also reserved the power to further regulate, or even ban, pre-pack sales to connected parties if the measures adopted so far do not increase creditor confidence in the process.

Penalising delinquent directors

In April 2014, Vince Cable, the then Business Secretary, issued a press release headed ‘Cable takes aim at dodgy directors’ in which he was quoted as saying that ‘rogue directors can cause a huge amount of harm . . . It is only right that we should put the toughest possible sanctions in place . . .’

One of the key tools for holding such directors to account under UK insolvency legislation is the wrongful trading regime. It therefore came as no surprise that, following this announcement, the Small Business, Enterprise and Employment Act 2015 introduced a number of changes that were intended to make it easier to pursue wrongful trading claims against delinquent directors. These included allowing administrators, as well as liquidators, to bring such claims (thus removing the need to wait until the company went into liquidation before an action could be commenced) and, most significantly, allowing liquidators and administrators to assign such claims to third parties who were willing to fund and pursue such claims.

There has also been a clear effort to prevent delinquent directors from becoming involved in the management of other companies, as evidenced by recent Insolvency Service statistics detailing enforcement outcomes achieved in the year to March 2016, which showed that the number of director disqualifications was at its highest since 2010.

Simplifying the process and modernising the Insolvency Rules: The potential simplifications identified as part of the ‘Red Tape Challenge’ included:

  • removing the requirement to hold physical meetings, so that alternative methods, such as virtual meetings, electronic voting, meetings by correspondence or deemed consent could be used instead;
  • allowing creditors with no further interest in the insolvency to opt out of receiving routine correspondence and reports from the office-holder; and
  • allowing liquidators to pay dividends to creditors owed less than £1,000 without requiring them to first submit a proof of debt.

These changes, which may alter the amount of creditor involvement in the insolvency process, are generally seen as tidying up the legislation rather than implementing any substantive changes. The desire to modernise and simplify is also clearly apparent in the new Insolvency (England & Wales) Rules 2016, which primarily govern procedural matters and come into force on 6 April 2017.

Potential developments – the possibility of more substantive changes

It is important that United Kingdom’s insolvency legislation maintains a market-leading position and remains able to address the challenges posed by increasingly complex financial products and changing stakeholder dynamics. This is particularly the case where other jurisdictions, such as the Netherlands, are currently modernising and reforming their insolvency legislation, a process that is likely to be encouraged by the European Commission’s proposal for a Directive on ‘preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures’, which was published in November 2016.

With this in mind, the Insolvency Service initiated a consultation in May 2016, setting out the following four proposals, which, if implemented, could have a significant impact on UK insolvency legislation:

  • the creation of a new three-month moratorium for financially distressed (but ultimately viable) companies, during which creditors would be prevented from taking hostile action;
  • an extension of the existing continuity of supply legislation (which currently covers utilities and IT suppliers) to all those identified as being ‘essential suppliers’, requiring such suppliers to continue to supply to a financially distressed company on existing terms and not use termination clauses or demand ‘ransom’ payments;
  • the introduction of a new stand-alone debtor in possession restructuring procedure for UK companies, which would allow ‘out the money’ classes of creditors to have their rights altered without their consent; and
  • new provisions allowing companies to raise rescue finance and provide security that, in certain circumstances, could override existing negative pledge clauses.

It appears from the Insolvency Service summary of responses to this consultation that the proposals relating to new rescue finance will not proceed, as responses ‘indicated that a lack of finance rarely prevents the rescue of viable businesses; the existing framework does permit rescue financing, and there is currently a market for rescue finance’. The other three proposals, all of which require further, more detailed consideration, may, however, proceed, with SMEs probably being the main beneficiaries of any changes.

Arguably the most significant of the surviving proposals is the suggested introduction of a procedure that would allow the cramdown of ‘out the money’ classes of creditors, as the current lack of a statutory mechanism permitting the cramdown or elimination of equity and out of the money liabilities (with the result that creditors who no longer have an economic interest in a business could still, under the current legislation, potentially block a viable restructuring plan) is often cited as weakness in the existing UK insolvency legislation.

The potential impact of Brexit

As UK domestic insolvency legislation is not derived from EU law, the effect of Brexit on the insolvency of entities domiciled and trading only in the UK would be extremely limited. While there are a limited number of statutory provisions that refer to EC Regulation No. 1346/2000 on Insolvency Proceedings 2000 (the EIR),2 such provisions would continue to work, post Brexit, as they do today.

There are a number of pieces of EU legislation that have a direct impact on domestic insolvencies, particularly the Settlement Finality Directive and the Financial Collateral Arrangements Directive, but these two Directives have already been incorporated into UK domestic legislation. They may, therefore, depending on the exact mechanics adopted in the proposed ‘Great Repeal Act’, remain in force post Brexit, particularly as much of their content comes not from the European Commission or Parliament, but from sources such as the OECD and the Basel Committee.

Brexit will, however, create uncertainty in relation to insolvencies involving UK companies that have businesses or significant assets located in other EU member states, as insolvency proceedings commenced in EU member states (other than Denmark) are currently subject to the EIR, which contains a framework of rules governing (i) where insolvency proceedings may be opened; (ii) the laws applicable to certain matters arising in such proceedings; and (iii) the recognition of proceedings in other member states. Recognition under the EIR is currently reciprocal and automatic in nature.

Unless otherwise agreed, the EIR would cease to apply in the UK once the UK leaves the EU, with the result that insolvency proceedings relating to UK companies would no longer benefit from automatic recognition in the EU. This introduces an element of asymmetry, as while insolvency officials in other member states would no longer benefit from automatic recognition in the UK pursuant to the EIR, they could still benefit from the (more limited) recognition provisions contained in the UNCITRAL Model Law on Insolvency, which the UK has implemented in the form of the Cross-Border Insolvency Regulations 2006.

UK officeholders would not be in this relatively happy position, as, across Europe, only Greece, Poland, Romania and Slovenia have currently implemented the UNCITRAL Model Law. In any other member state, a UK officeholder seeking recognition would, as was the case before the EIR came into force, have to seek recognition under the local domestic law of the relevant country. This may well be a difficult process, particularly post Brexit, but at least such officeholder would, today, typically be an administrator or liquidator acting in relation to a collective insolvency process and owing duties to all creditors, whether domestic or foreign. This contrasts sharply with the particularly problematic position at the end of the last century, before the EIR came into force, when it was often a receiver appointed by a secured creditor, with a view to obtaining payment for just that creditor, who was seeking recognition under the insolvency laws of another jurisdiction.

Conclusion

UK insolvency legislation, which is generally well regarded, has evolved significantly since the Act came into force, with initiatives to prioritise corporate rescue, improve the efficiency of insolvency procedures and make it easier to hold directors to account. This process of evolution is likely to continue over the next few years, potentially at an accelerated rate, as the UK insolvency regime seeks to retain its reputation for comparative efficiency and effectiveness at a time of widespread insolvency reform across Europe and beyond.

Notes

  1. Data taken from Insolvency Service insolvency statistics for July–September 2016 (Q3 2016).
  2. Such as the definitions of ‘company’ contained in section 1(4) and paragraph 111(1A) of Schedule B1 to the Act, which were introduced in order to allow companies in other EU member states to use the CVA and administration procedures.