At the beginning of 1999, the U.K. government appointed a review team to examine aspects of company and insolvency law and practice "relating to the opportunities for, and means by which, businesses can resolve short- to medium-term financial difficulties, so as to preserve maximum economic value."

Ministers agreed that the principal areas of focus should be:

1. the further development of the "rescue culture,"
2. reassessment of the relative rights and remedies of secured and unsecured creditors in insolvencies to include the Crown as a preferential creditor, and
3. consideration of the duties of directors of companies experiencing financial difficulties.

The report was published in September 1999. In the Queen's speech in November 1999, the government indicated that, subject to the availability of parliamentary time, it would introduce legislation "to assist the rescue of viable businesses in short-term difficulties, and improve the procedures for disqualifying unfit company directors." The major reforms expected in the bill were twofold. First, in the U.K., we have had since 1986 a mechanism by which a company can enter into a consensual arrangement with its creditors that, if supported by 75 percent of unsecured creditors (voting in person or by proxy), will bind all unsecured creditors. Unfortunately, it has not been as widely used or as successful as the corresponding provisions applicable to personal insolvency. This is ascribed to the fact that there is no procedure to prevent execution by creditors while the arrangement (known as a company voluntary arrangement [CVA] under Part I of the Insolvency Act 1986) is constructed and placed before creditors. It was expected that the government would introduce a moratorium into the CVA procedure for this purpose.

Second, and some would say more importantly, there is a proposal to ensure that banks and other holders of security with power to appoint receivers give a warning to a company prior to appointment. The current position, which is probably unique to the U.K., can see directors divested of control of their companies literally within hours of receipt by them of a formal demand for repayment from the bank.

The Insolvency Bill was introduced in the House of Lords on Feb. 3, 2000. The most significant provisions in the bill enable eligible companies in financial difficulty to make voluntary arrangements with their creditors by providing the option of a moratorium to give the company's management time to put a rescue plan to creditors. The purpose of the moratorium is to prevent a creditor from taking legal action against the assets of the company while the voluntary arrangement is prepared and submitted to creditors.

To be eligible, a company must satisfy two or more of the conditions for being a small company specified in §247(3) of the Companies Act 1985. However, insurance companies, under the Insurance Companies Act 1982, authorized institutions under the Banking Act 1987, and companies that are subject to formal insolvency proceedings, or where in the previous 12 months a moratorium failed, are ineligible.

The directors of an eligible company may apply to the court for a moratorium. The bill places a duty upon the directors to provide information to a nominated insolvency practitioner (known as the nominee). They must submit to the nominee:

• details of the proposed voluntary arrangement,
• a statement of affairs detailing the company's assets, debts and other liabilities and such other information as may be prescribed, and
• any other necessary information requested by the nominee to allow him to indicate to the directors whether the proposed arrangement is feasible.

The nominee should then issue a statement, in the prescribed form, to the directors indicating whether or not in his view:

• the proposed voluntary arrangement has a reasonable chance of being approved and implemented,
• the company has sufficient funds available for clearing the proposed moratorium to enable it to carry on its business, and
• meetings of creditors and members should be summoned to consider the proposed arrangement.

To obtain a moratorium, the directors must file certain documents in court. However, unlike a moratorium pursuant to an Administration Order, no court hearing is required to effect the moratorium. The moratorium comes into force when the documents required to be submitted to the court are filed. It lasts generally until the meetings of creditors and shareholders have been held or after 28 days, whichever is sooner, but can last significantly longer in certain circumstances. During the moratorium, the nominee must monitor the company's affairs so as to form an opinion as to whether the proposed voluntary arrangement continues to be feasible and whether the company is likely to have the funds during the remainder of the moratorium to enable it to carry on its business. If the nominee withdraws his consent, the moratorium comes to an end.

It is clear that these new provisions are intended to give companies the time and opportunity to put a rescue plan to creditors. The provisions are designed to reduce the number of businesses and companies that are liquidated.

The second expected major reform outlined above was included in the draft legislation and then removed. The position remains that banks and other holders of security with power to appoint receivers do not have to give any more notice to a company prior to appointment than they have in the past.

As expected, there has been a change to the procedure for disqualifying persons who are unfit to be company directors. The bill provides for the secretary of state to be able to accept an undertaking not to act as a company director from a person against whom he could otherwise take proceedings for disqualification on the grounds of unfitness.

Will the U.K. embrace a rescue culture? The political justification for a rescue culture is said to be the amelioration of the consequences of the unfettered operation of the market, for example, where the pursuit by creditors of their own individual interests leads to the liquidation of businesses and companies, especially (although not exclusively) in circumstances where there are substantial implications for employment. Obviously, secured creditors will not welcome the developments in the new legislation, as the moratorium can be put in place without them being given an opportunity to object. The decision as to whether a moratorium is put in place is with the nominee. There is no court hearing to decide. If the court is happy that the documentation for filing is in order, the moratorium will be put in place; the bill implies that the paperwork will be processed by the court without consideration of its contents. Therefore, it will be left to insolvency practitioners acting as nominees to promote a rescue culture for small companies.

If the rescue of companies is to become the dominant ideology, consideration must be given to the following submissions:

1. One of the key attractions of being a secured creditor is the effective veto over company rescue procedures.
2. Companies attempting to use CVAs or the administration procedure (which is akin to the new provisions) may find it difficult to obtain new financing for their proposed "rescues."
3. The proliferation of lease financing, debt factoring and retention of title clauses that increase the number of parties capable of placing difficulties in the way of a rescue or reconstruction.
4. The reluctance of directors and managers to consider alerting interested parties, such as banks, or to take professional advice from, say, insolvency practitioners at any early stage of distress. This may be due to a lack of understanding of options that are available other than receivership or liquidation, a desire to maintain their own positions (and income) for as long as possible, or even a reluctance to accept how bad the position really is.
5. Directors and managers may also be reluctant to alert creditors (particularly secured creditors) at an early stage because this might result in them using their early knowledge to take action that might hinder rather than help any rescue. For example, a creditor might enforce its security at an early stage knowing that it will get full recovery of its debt, whereas a rescue might result in higher recovery rates in general and be a more efficient outcome, but introduces a risk that the secured creditor will recover less.

The report, prior to the bill, acknowledged that the 1986 reforms moved the U.K. closer toward a "rescue culture," but noted that the overall progress in that direction has been less than had been hoped for. The Insolvency Bill was an opportunity to push the ideology further; has this opportunity been taken? Unfortunately not. Many of the suggested reforms have been left as recommendations. The introduction of the option of a moratorium is a small step toward reducing the powers of secured creditors to veto rescue procedures. However, the option of a moratorium is only open to "small companies," and only to those that can persuade a nominee to issue a statement in their favor. It is also disappointing that the requirement to give notice to a company before appointing a receiver was removed from the bill.

A key issue that the bill fails to address is the financing of rescue procedures. The report highlighted this issue as central to the prospects of success to the rescue or reconstruction of a company whose business is fundamentally sound but suffering from short-term difficulties. The report conceded that raising finance in such circumstances is a problem, and a number of ideas were put forward that may facilitate the raising of financing in such circumstances. They included (1) disallowing the possibility of banks retaining the proceeds of the companies' book debts, (2) allowing companies to raise funds by a sale or mortgage of assets covered by a floating charge up to a limit of, say, 10 or 20 percent, and (3) more generally allowing "super-priority financing" where financing is raised during a rescue/reconstruction procedure, and the resulting creditor is given priority in respect of any funds realized.

All that the bill contains on this issue is that the nominee must include in his statement that "the company is likely to have sufficient funds available to it during the proposed moratorium to enable it to carry on its business." Unfortunately, there are no provisions to facilitate the raising of such financing.

It is clear and has been for some considerable time that culturally U.K. businesses, debtors and creditors alike have difficulties with the "debtor-in-possession" concept. Since business practice and business thinking does not currently focus on rescue, this is a pervasive problem and it will take more than the proposed legislation to effect a change in ideology. The U.K.'s insolvency professionals have recently "re-badged" their organization to remove from its name the word "insolvency," and although this is encouraging, it may take some considerable time before their innovative ideas find acceptance in the marketplace.

Author's Note: The insolvency bill received the Royal Assent on Nov. 30 to become the Insolvency Act 2000. It is in substantially the same terms as descibed above and is available from The Stationery Office for £7-50 (www.legislation.hmso.gov.uk/acts/acts2000/20000039.htm).

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Journal Date:  Thursday, March 1, 2001 © American Bankruptcy Institute. All rights reserved. ABI is a (501)(c)(3) non-profit business (52-1295453)