also provides an opportunity to acquire a fresh injection of funds from other sources (such as shareholders or other banks) and allows such wellpositioned creditors to extract enhanced or new security, or priority, as the price for supplying further funds to the company. A bank, for instance, may improve its position by taking a floating charge as security and, even if an informal rescue ultimately fails, the bank will often have improved its security position and may then be able to appoint an administrator of its choosing out of court.50

A disadvantage of informal rescue, however, is its potential to prejudice the interests of less-well-placed creditors. Informality may be attractive to directors, but, from the point of view of certain creditors, a deficiency of informality may be the absence of investigative powers and the lack of an inquiry into the role of directors in bringing a company to the brink of disaster. A fundamental weakness of informal rescue is, furthermore, that the agreement of all parties whose rights are affected will generally be required if the rescue is to succeed. Informal rescues demand that parties with contractual rights agree to compromise, waive or defer debts, or alter priorities. Dissenting creditors, accordingly, have the power to halt informal rescues by triggering formal insolvency procedures, including liquidation. This renders the informal rescue a fragile device that is dependent on a high degree of co-operation from a range of parties.51 In contrast, a formal procedure such as administration involves a moratorium on the enforcement of a wide range of creditors’ rights and so creates a more sustainable space within which a rescue can be organised.

The new focus on rescue

Since the late 1990s, corporate insolvency law and processes have changed in a way that places a new emphasis on rescue and on early actions to respond to corporate troubles. It can be argued that a fundamental

50I.e. if holding a ‘qualifying floating charge’: see Insolvency Act 1986 Sch. B1, para. 14. The administrator may then even be implementing a ‘pre-packaged’ administration: see further ch. 10 below.

51Brown, Corporate Rescue, p. 13. In an informal bank rescue, for example, the negotiations between the banks are intensive and, as will be seen in ch. 7 below, negotiation and resolution may become even more difficult if there is a multiplicity of interests to be catered for in the form of hedge funds, distressed debt traders, etc. Even within the grouping of banks different rights and obligations need to be ironed out: ‘Some banks may start out as secured, while others start out as unsecured.’ Segal, ‘Rehabilitation and Approaches’, p. 133.

philosophical change has now occurred so that the law, in combination with corporate and creditor practice, has moved from a focus on ex post responses to corporate crises to one that increasingly involves influencing the ways that corporate actors manage the risks of insolvency ex ante. This movement, it can be said, is consistent with those increasing appetites to audit and to risk manage that are to be observed more generally across public and private sector activities. It can, in addition, be contended that, in parallel with such a philosophical shift, a revision of insolvency roles has taken place so that participants in corporate and insolvency processes have become more encouraged and inclined to see corporate disasters as matters to be anticipated and prevented rather than to be responded to after the event.52

The philosophical change

From at least the times of the Cork Report, commentators on insolvency processes have stressed that the furtherance of rescue demands that interventions from outside troubled companies should take place at the earliest opportunity.53 Now, however, we may be seeing the start of a shift that institutionalises anticipatory approaches to corporate troubles. That shift can be seen in legislation, corporate reporting requirements and bank strategies.

On the legislative front, the Enterprise Act 2002 effected a significant change of stance by introducing a number of reforms that were designed to assist troubled companies and to do so by fostering a rescue culture.54 As will be detailed in chapter 9 below, it replaced the regime of administrative receivership with provisions that gave pride of place to the new

52This section builds on V. Finch, ‘The Recasting of Insolvency Law’ (2005) 68 MLR 713. On the case for considering the roles of different institutions in insolvency law and procedures see J. Westbrook, ‘The Globalisation of Insolvency Reform’ (1999) NZLR 401, 413. See also ch. 5 above.

53See e.g. the Cork Report, ch. 9; Sir Kenneth Cork, Cork on Cork: Sir Kenneth Cork Takes Stock (Macmillan, London, 1988) ch. 10.

54On the rise of the ‘rescue culture’ in the UK see Hunter, ‘Nature and Functions of a Rescue Culture’; Belcher, Corporate Rescue; Carruthers and Halliday, Rescuing Business. On the primacy of rescue objectives under the Enterprise Act 2002 see S. Frisby, ‘In Search of a Rescue Regime: The Enterprise Act 2002’ (2004) 67 MLR 247; and the Secretary of State for Trade and Industry’s statement at HC Debates, col. 53, 10 April 2002 (P. Hewitt). On the link between new worldwide concerns with rescue and a growing awareness that global financial waves can distress even fundamentally sound enterprises see Westbrook, ‘Globalisation of Insolvency Reform’, p. 403.

administration procedure and it also ring-fenced a set portion of funds for the benefit of unsecured creditors.55

The Enterprise Act did more, however, than further rescue. It arguably encouraged those involved with potentially troubled companies to think about insolvency risks in advance of the final crisis – to manage such risks ex ante rather than ex post.56

The timescales set up by the Enterprise Act have this effect. The administrator must present proposals to creditors within eight weeks of his appointment and must commence a creditors’ meeting within ten weeks of the administration’s start.57 This means that the party that is going to appoint an administrator – which will usually be the bank that holds a qualifying floating charge58 – will have to be in a position to inform the administrator about the company, its businesses, prospects and risks at the very earliest stages of the administration process. This is not least because the notice appointing an administrator must be accompanied by a statement by the administrator that, inter alia, he consents to the appointment and that ‘in his opinion the purpose of the administration is reasonably likely to be achieved’.59 When, accordingly, a bank is faced with a troubled debtor company and approaches a potential administrator, it is likely to be made very clear to the bank that such a statement will not be forthcoming unless the administrator is supplied

55On the new administration procedure as a rescue procedure see ch. 9 below. See also I. Fletcher, ‘UK Corporate Rescue: Recent Developments – Changes to Administrative Receivership, Administration and Company Voluntary Arrangements – the Insolvency Act 2000, the White Paper 2001 and the Enterprise Act 2002’ (2004) 5 EBOR 119; V. Finch, ‘Re-invigorating Corporate Rescue’ [2003] JBL 527; Finch, ‘Control and Coordination in Corporate Rescue’. But on the same procedure as a route to winding up see A. Keay, ‘What Future for Liquidation in the Light of the Enterprise Act Reforms?’ [2005] JBL 143; L. Linklater, ‘New Style Administration: A Substitute for Liquidation?’ (2005) 26 Co. Law. 129. On reforms dealing with administrative receivership and the ring-fenced fund see Insolvency Act 1986 ss. 72A, 72B–72G; Insolvency Act 1986 Sch. B1; Insolvency Act 1986 s. 176A; Insolvency Act 1986 (Prescribed Part) Order 2003 (SI 2003/2097).

56On the rise of the pre-packaged administration – the ‘pre-pack’ as an aspect of the movement towards anticipatory action – see ch. 10 below and V. Finch, ‘Pre-packaged Administrations: Bargains in the Shadow of Insolvency or Shadowy Bargains?’ [2006] JBL 568.

57See the Insolvency Act 1986 Sch. B1, para. 52. Para. 52(1) sets out exceptions from these requirements.

58That is per Sch. B1, para. 14. After the Enterprise Act 2002 reforms there are three methods by which a ‘new’ administrator can be appointed: see Sch. B1, paras. 12, 14–15, 22.

59Para. 18.

with all of the information that is needed in order to evaluate the prospects of achieving the purpose of the administration.60

For the bank this is no small matter. If it has loaned funds to a number of companies and a proportion of these are liable to encounter some financial difficulties at some time in their corporate lives, it will have an incentive to institute monitoring procedures that, in an ongoing manner, will place it in a position that allows it potentially to instruct an administrator at very short notice. Those monitoring procedures are likely to involve analysing and updating information that is supplied by the debtor company in compliance with lending conditions that require the company to keep the bank appraised of the former’s financial position, its prospects and business risks.61 The bank, moreover, is liable to demand that the debtor company should identify any business risks that are potentially threatening to the company and to state what is being done to manage those risks. The overall effect can be expected to be a driving forward of both a new awareness of insolvency risks and a new rigour in dealing with these before the company’s position becomes terminal.

It might be responded that too much is being made of a modest reform here and that the banks monitored their debtors long before the Enterprise Act 2002 came onto the scene.62 That, however, would be to understate the effect of the Enterprise Act. The imposition of new timeframes for action in that Act means, as indicated, that incentives to monitor are given a new urgency. The Enterprise Act, moreover, did not merely institute new time pressures. Under the former regime of administrative receivership, the bank that loaned funds under the security of a floating charge operated in something of a comfort zone. It knew that if the company entered troubled waters it could enforce its security quickly by appointing an administrative receiver who would act entirely in the interests of the bank so as to realise assets, if necessary, and settle the debt. The ‘new’ administration procedure, established by the

60The Enterprise Act 2002 replaced the alternative purposes of the old administration regime under the Insolvency Act 1986 (former) Part II with a hierarchy of objectives: all ‘new’ administrations (whether instituted by court order or out of court) have the same statutory objectives. See para. 3(1) of Sch. B1, Insolvency Act 1986.

61See J. Day and P. Taylor, ‘The Role of Debt Contracts in UK Corporate Governance’ (1998) 2 Journal of Management and Governance 171; G. Triantis, ‘Financial Slack Policy and the Law of Secured Transactions’ (2000) 29 Journal of Legal Studies 35.

62On bank monitoring see chs. 7 and 8 below; and J. Armour and S. Frisby, ‘Rethinking Receivership’ (2001) 21 OJLS 73.

Enterprise Act, replaced administrative receivership as the process for enforcing floating charges.63 It still placed the banks in a strong position relative to unsecured creditors64 but it brought changes that the banks would not necessarily have welcomed. First, in contrast with receivership, it provided that administrators should act in the interests of the company’s creditors as a whole65 and, second, it set down inclusive procedures and enforcement provisions that ensured that the interests of creditors as a whole would be taken into account and protected when the administrator took decisions or made judgements about the company’s prospects.66

For the banks, these changes brought significant new challenges. The bank’s interests fell to be protected in the face of inclusive procedures that gave all of the company’s creditors a voice. These procedures were, as a result, potentially drawn out in operation and were also capable of leading to legal attacks on a number of fronts.67 The administrator’s statutory objectives were set out in a complex series of contingently phrased subsections that did little to assuage bankers’ fears that administrators would be too bogged-down in procedural constraints and

63The replacement is subject to six exceptions: see Insolvency Act 1986 ss. 72B–G. See further ch. 8 below.

64Though see Enterprise Act 2002 s. 252 which inserted a new s. 176A into the Insolvency Act 1986 to ring-fence, for the benefit of unsecured creditors, a prescribed proportion of funds otherwise available for distribution to the holders of floating charges. See also Insolvency Act 1986 (Prescribed Part) Order 2003 (SI 2003/2097). On whether, on the wording of s. 176A, a floating charge holder with an unsecured balance is entitled to participate in the prescribed part see G. McPhie, ‘New Legislation’ (2004) Recovery (Autumn) 24. The Insolvency Service is of the view that the floating charge holder is not so entitled, as is His Honour Judge Purle QC in Permacell Finesse Ltd (in liquidation) [2008] BCC 208 and as is Patten J in Re Airbase (UK) Ltd, Thorniley v. Revenue and Customs Commissioner [2008] BCC 213 (Ch): see A. Walters, ‘Statutory Redistribution of Floating Charge Assets: Victory (Again) to Revenue and Customs’ (2008) 29 Co. Law. 129.

65Insolvency Act 1986 Sch. B1, para. 3(2).

66On inclusiveness and challenges to the administrator see Insolvency Act 1986 Sch. B1, paras. 49–58, 74–5.

67The administrator is subject to a duty (under Sch. B1, para. 4) to perform his functions as quickly and efficiently as is reasonably practicable. Under para. 74(1) a creditor or member can challenge the administrator by claiming that he is acting or has acted or proposes to act so as to unfairly harm their interests. Para. 74(2) allows the same parties to mount a challenge on the grounds that the administrator is not performing his functions as quickly or as efficiently as is reasonably practicable. Para. 75 allows misfeasance actions to be brought (by, inter alia, a creditor) against administrators and the company does not have to be in liquidation for such an action to be commenced.

litigation to be able to protect the banks’ interests effectively.68 These challenges arguably created new needs for the banks to work harder to maximise their potential control of the new administration process and to do so by engaging in anticipatory actions – notably by collecting more, better and earlier information on the company’s state of affairs and its prospects. The banks had gained incentives to follow the rugby-playing advice to ‘get your retaliation in first’. In this way the insolvency process was shifted in its focal concern – away from debt collecting and towards the management of insolvency risks.

In reply to the above argument it might be contended that the Enterprise Act 2002 may encourage the banks to take steps other than to increase their ex ante monitoring of companies. Thus, it might be forecast that, daunted by the uncertainties and complexities of the 2002 Act, the banks may be induced to shift their lending practices away from using floating charge securities and towards more lending via fixed asset security.69 The result of this, it might be suggested, would be a fragmentation of security as the floating charge loses dominance in favour of a mixture of lending arrangements. The overall effect, it could be contended, would be a diminution in incentives to monitor the activities of the debtor company.70 This would happen, the argument runs, because it is the concentration of a company’s borrowing in a single credit arrangement that makes it worthwhile for the creditor to monitor the company’s behaviour – a scenario that was arguably fostered by the floating charge under pre-Enterprise Act arrangements.

Turning to corporate reporting requirements, it can be argued that concerns to monitor companies ahead of troubles have been reinforced by other changes in corporate procedure, notably in reporting requirements through the passing of section 417 of the Companies Act 2006. This section was promulgated in the wake of the short-lived notion of the

70On ‘creditor concentration’ and its encouragement of monitoring see Armour and Frisby, ‘Rethinking Receivership’; Armour ‘Should We Redistribute in Insolvency?’. On limitations of the ‘concentrated creditor theory’ see ch. 8 below.

Operating and Financial Review (OFR)71 and demands that (unless the company is subject to the small companies’ regime) the directors’ report includes a ‘business review’ that informs members and helps them to assess how the directors have performed their duty to promote the success of the company. The review must contain a fair account of the company’s business and a description of the principal risks facing it. It must offer an analysis of development and performance but (in requirements going beyond the former provisions of the Companies Act 1985) must, in the case of quoted companies, report on the main trends and factors likely to affect the business’s future development and performance.72 Information about the company’s supply chain and arrangements that are essential to the business must be included.73

The importance of the new reporting requirements, in insolvency terms, lies in their potential effect in furthering processes in which company directors not only manage serious risks but also disclose to stakeholders how they are managing such risks. This emphasis on managing and controlling risk, the foundations of which were established by the Turnbull Report,74 goes a significant step further than the Cadbury Code on Corporate Governance of 1992,75 which established the principle that senior managers are responsible for the maintenance of an internal control system.

It can be anticipated that companies may set out to comply with the new requirements and to identify risks and describe risk management systems in different ways. One group will ‘box-tick’ and confine itself to

71In November 2005 the Chancellor, Gordon Brown, announced the repeal of the OFR less than a year after the OFR Regulations had been laid: see the Companies Act 1985 (Operating and Financial Review and Directors’ Report etc.) Regulations 2005 (SI 2005/1011). On the background to the OFR see Company Law Review Steering Group

(CLRSG), Modern Company Law for a Competitive Economy: Final Report (DTI, London, 20 01) ch. 5; White Paper, Modernising Comp a ny Law (Cm 5 553 , 20 02).

72Companies Act 2006 s. 417(5).

73Ibid. s. 417(5)(c).

74See Internal Control: Guidance for Directors on the Combined Code (ICAEW, London, 1999).

75Report of the Committee on the Financial Aspects of Corporate Governance (December 1992). Other guidelines also demand that boards identify risks to the company’s value and state how these are managed: see the Association of British Insurers’ (ABI) Disclosure Guidelines on Social Responsibility, Investing in Social Responsibility: Risks and Opportunities (London, 2001), Appendix 1 (dealing with risks from social, ethical and environmental considerations). See J. Parkinson, ‘Disclosure and Corporate Social and Environmental Performance: Competitiveness and Enterprise in a Broader Social Framework’, [2003] 3 JCLS 3, 6–11.

‘boilerplate’ reviews that offer a broad-brush identification of the main risks and uncertainties facing the company and its subsidiaries. A second group will go further and seek to identify the main risks faced and the ways in which these are managed. A third group, however, will take the opportunity to improve its performance by embedding its reporting and risk management systems within the general structure of management and decision-making within the company. Companies in this group will seek to develop best practice methods so that their reports not merely will identify key business risks but will be able to isolate risks that potentially threaten the viability of the business and deal with these alongside other categories of serious and less serious risk. Such companies will describe how the various categories of risk are managed, how risk management systems are organised, evaluated, updated and reported on within management. They will describe how risk management responsibilities are allocated, how information on risks is collected and disseminated and how outsourced risks are dealt with. These section 417 reports will be used by leading companies to persuade stakeholders that the managers of the company are both able to identify any risks that threaten either the business or its achievement of corporate objectives, and are able to manage the full array of risks in a systematic and auditable manner.

The emergence of best-practice reporting is liable to lead, in turn, to a new emphasis on managing insolvency risks in a more open and more preventative manner. This development is likely to be driven ahead as investors and the major lenders to companies – the banks – see the value of best-practice disclosures in informing them about both the risks their debtors are facing and the quality of their debtor companies’ managerial responses to such risks.76 A key point here is that, although the requirement to report on factors likely to affect future business development only applies to quoted companies (of whom many will already produce reports on such lines), this institutionalisation of the requirement may well encourage the banks to demand at least elements of such reporting from a wider range of companies to whom they lend. The banks may thus be increasingly inclined to use their lending power to insist that

76 The Financial Times commented that ‘it is in companies’ interests to produce an insightful statement. There is a lot of investor pressure for this kind of information to be made available. In fact, almost half leading listed companies already produce such information although it may not be grouped under one heading in their annual reports.’ (Financial Times, Editorial, 26 November 2004.)

companies who borrow from them conform to processes akin to best practice reporting. In doing so, they will not only gain new stocks of information but also sharpen their focus on how insolvency risks are managed. Another step away from debt collecting and towards a preventative philosophy will have been taken.

That step, moreover, is reinforced by the Government’s response to the Enron/WorldCom international accounting debacles.77 This took the form of the Companies (Audit, Investigations and Community Enterprise) Act 2004. This statute encouraged a higher level of preinsolvency scrutiny of corporate management by introducing a new rigour to directorial disclosures to auditors. Section 9 of the 2004 Act inserted section 234ZA into the Companies Act 1985 to demand that directors state in their directors’ report that there is no ‘relevant audit information’ that they know of and which they know the auditors are unaware of.78 To such ends, directors must take all the steps that they ought to take as a director in order to become aware of any relevant audit information and to establish that the company’s auditors are aware of that information. Directors are to take those steps and make enquiries as required by their duty to exercise reasonable care, skill and diligence as assessed on a combined objective/subjective standard as specified in section 214 of the Insolvency Act 1986.79 The 2004 Act, moreover, made directors criminally liable if they make a false statement of the above kind – if they knew (or were reckless that) it was false and if they failed to take reasonable steps to prevent the report from being approved.80 The effect is to enhance auditors’ powers of scrutiny and, regarding potential risks to companies, shifts the focus of attention further in advance of the point when such risks have turned into insolvency realities.81

77On reactions to Enron see S. Griffin, ‘Corporate Collapse and the Reform of Boardroom Structures – Lessons from America?’ [2003] Ins. Law. 214; D. Kershaw, ‘Waiting for Enron: The Unstable Equilibrium of Auditor Independence Regulation’ (2006) 33

Journal of Law and Society 388.

78Section 234ZA applied to directors’ reports from financial years beginning on or after 1 April 2005. It has been replaced in equivalent terms by s. 418(2) of the Companies Act 2006.

79On Insolvency Act 1986 s. 214 see ch. 16 below.

80See now the replicated rules in Companies Act 2006 s. 418(5)–(6).

81On governmental concerns to increase the transparency and accountability generally in corporate operations see the White Paper, Company Law Reform (Cm 6456, March 2005), especially ch. 3.

Increased attention to managerial performance and directorial business risk management has also been encouraged by other changes. Thus, a more intense spotlight has come to rest on directors as the Department of Business Enterprise and Regulatory Reform (BERR) has stepped up its use of disqualification powers. As we will see in chapter 15, a significant reform introduced by the Insolvency Act 2000 was the permitting of disqualification undertakings to be accepted by out-of- court agreement between a director and the Disqualification Unit of the Insolvency Service.82 The disqualifications involved are identical to those that would be imposed by a court and the streamlined process offered by the 2000 Act has produced a dramatic rise in disqualifications – from a little under 400 in 1995 to 1,200 in 2006–7 (of which 80 per cent were by way of undertakings).83 It is in more rigorous control of managerial diligence that the increasing scrutiny of pre-insolvency management can principally be seen.

It has also been suggested that the Crown’s loss of its preferential status since September 200384 may put yet more monitoring pressure on directors. This loss, the argument runs, may make the Crown ‘increasingly vigilant in seeking to recoup some of this loss, possibly by funding actions against directors’.85 In the face of the above kinds of pressure it is to be expected not only that many directors will feel that they are under ever more intense scrutiny but also that they will feel the need to respond to this by making more certain that they can justify the actions and judgements that they have effected.

This series of developments points towards a shift from ‘debt collection’ to ‘risk management’ approaches in corporate insolvency law and procedures. Such a shift might be explained by citing new governmental concerns to maximise rescue opportunities.86 There is, however, another account that links a recasting of corporate insolvency philosophy to

82See ch. 16 below. See also A. Walters, ‘Directors’ Disqualification after the Insolvency Act 2000: The New Regime’ [2001] Ins. Law. 86; Insolvency Act 2000 s. 6 (introducing a new s. 1A into the Companies Directors’ Disqualification Act 1986); Insolvency Act 2000 (Commencement No. 1 and Transitional Provisions) Order 2001 (SI 2001/766) (C27).

83Insolvency Service Annual Report 2006–7, p. 15.

84See Enterprise Act 2002 s. 251. (Paras. 1, 2, 3–5C, 6 and 7 of the Insolvency Act 1986 Sch. 6 are deleted.) See further ch. 14 below.

85See D. Leibowitz, ‘Cover Charge’, The Lawyer, 10 November 2003.

86On the Blair Government’s espousal of rescue objectives see e.g. Productivity and Enterprise: Insolvency – A Second Chance (Cm 5234, July 2001); Secretary of State for Trade and Industry’s statement at HC Debates, col. 53, 10 April 2002.

other identifiable and deep-seated movements in the cultures of public and private governance. What is observed in relation to recent insolvency developments is in line with the elements of what has been dubbed the ‘audit explosion’.87 As described by Power, audit is ‘an emerging principle of social organisation which may be reaching its most extreme form’.88 At its heart is the idea that control systems within organisations – be they corporations or government departments – must be auditable and audited. In public and private systems ‘there is a commitment to push control further into organisational structures, inscribing it within systems which can then be audited’.89 Such ‘demands and aspirations for accountability and control’90 are accompanied by a new emphasis on allocating increasing scrutiny powers to outside monitors and developing the role of independent scrutiny as a substitute for professional judgements or trust.91 Audit becomes a way of reducing risks through the review of control systems. It can be seen in those corporate governance requirements from Cadbury to the Companies Act 2006 that seek to create layers of regulatory systems so as to allow performance at one level to be measured and held accountable at another. It is also exemplified in the new culture of quality assurance – as encountered in the idea of total quality management (TQM). This seeks to make management control systems transparent, accountable and accessible to stakeholder scrutiny and input.92 Such appetites for the ‘layering’ of control processes, moreover, are only encouraged by accounting debacles such as Enron and WorldCom which produce political currents in favour of ever more transparency and accountability.

The appetite to audit is echoed in another new drive – towards seeing governmental, regulatory and business challenges in terms of needs to manage risks. Thus, in recent years there have been explosions of initiatives to spread risk management across government, of ‘risk-based’

87See M. Power, The Audit Explosion (Demos, London, 1994); Power, The Audit Society: Rituals of Verification (Oxford University Press, Oxford, 1997); Power, The Risk Management of Everything (Demos, London, 2004).

88 Power, Audit Explosion, p. 47. 89 Power, Audit Society, p. 42. 90 Ibid., p. 6.

91Ibid., pp. 1, 47; Power, Risk Management of Everything, pp. 10–11: ‘the risk management of everything is characterised by the growth of risk management strategies that displace valuable – but vulnerable – professional judgement in favour of defendable process’.

92Stakeholders here may include business partners: see H. Collins, ‘Quality Assurance in Subcontracting’ in S. Deakin and J. Michie (eds.), Contracts, Cooperation and Competition (Oxford University Press, Oxford, 1997), pp. 285–306.

approaches to regulation93 and of risk-centred strategies for corporate management.94 In the regulation field, for instance, this development can be seen in regulators’ growing inclinations to move away from securing results through externally imposed ‘command and control’ regimes that target errant corporate behaviour directly and towards ways of pushing regulatory tasks down into the regulated organisations. The new hope lies in using regulatory systems that target enforcement actions according to analyses of the risks presented by regulated companies and which adjust regulatory activities in a way that is ‘responsive’ to the internal control processes of regulated companies.95 Some such systems, indeed, may more actively deploy monitoring, review and incentive systems to audit and influence the self-control mechanisms of corporations.96 Within the environmental field, in particular, the last two decades have seen a mushrooming of schemes that see the auditing of private management systems, rather than external regulation, as the route to optimal results.97 This is a development that creates a new role for intermediaries:

93 See J. Black, ‘The Emergence of Risk Based Regulation and the New Public Risk Management in the UK’ [2005] PL 512, who argues that central government is ‘awash’ with initiatives to promote risk management; Financial Services Authority, A New Regulator for the New Millennium (FSA, London, 2000). On the need to extend riskbased regulation across government see P. Hampton, Reducing Administrative Burdens: Effective Inspection and Enforcement: Final Report (HM Treasury, London, March 2005) (the Hampton Review). On governmental willingness to see managerial, operational and regulatory issues as risk issues see e.g. National Audit Office, Supporting Innovation: Managing Risk in Government Departments (NAO, London, 2000); Health and Safety Executive, Reducing Risks, Protecting People (HSE, London, 2001); Cabinet Office, Risk: Improving Government’s Capacity to Handle Risk and Uncertainty (Cabinet Office, London, 2002); C. Hood, H. Rothstein and R. Baldwin, The Government of Risk (Oxford University Press, Oxford, 2001).

94 On risk management in the private sector see e.g. Basel Committee on Banking Supervision, Sound Practices for the Management and Supervision of Operational Risk

(Bank for International Settlements, Basel, 2001); A. Waring and A. Glendon, Managing Risk (Thomson, London, 1998); P. Shimell, The Universe of Risk (Financial Times/ Prentice Hall, London, 2002); M. McCarthy and T. Flynn, Risk from the CEO and Board Perspective (McGraw-Hill, New York, 2004); T. Barton, W. Shenkir, P. Walker et al., Making Enterprise Risk Management Pay Off (Financial Times/Prentice Hall, London, 2002); M. Power, Organised Uncertainty: Designing a World of Risk Management (Oxford University Press, Oxford, 2007).

95See I. Ayres and J. Braithwaite, Responsive Regulation (Oxford University Press, New York, 1992). See also N. Gunningham and P. Grabosky, Smart Regulation (Oxford University Press, Oxford, 1998).

96See e.g. C. Parker, The Open Corporation: Effective Self-regulation and Democracy

(Cambridge University Press, Cambridge, 2002). For a critique see R. Baldwin, ‘The New Punitive Regulation’ (2004) 67 MLR 351, 374–83.

97Power, Audit Society, pp. 62–5.

‘consulting markets thrive in the margins of regulatory initiatives. Where central agencies wish to effect management changes in target organizations, management consultants take on the role of mediating regulatory compliance and economic strategy.’98

Risk has developed as an organising concept so that, whether governmental, regulatory or business challenges are found in the public or private sectors, they are approached as questions of risk management.99 The twin appetites for audit and risk management, moreover, combine to create a pervasive thrust towards dealing with problems or meeting opportunities through auditable risk management systems.100

The parallels with recent changes in the field of corporate insolvency are manifest. As will be seen in chapter 7, the banks are increasingly concerned to deal with corporate troubles by subjecting companies’ management and risk control systems to external scrutiny. They look for measurable quality from management teams. In troubled times they push their ‘care’ down into management structures and increasingly use independent specialist professionals to evaluate and assist those who underperform and bring the company into danger. The common cultural factor across all these public and private fields is an appetite for, and a faith in the value of, exposing managerial or control systems to measurement, audit and review. The move from debt collection to insolvency risk management is as consistent with that culture as the changes that have recently been seen in public management, regulation or corporate management.

As far as bank strategies are concerned, an additional respect in which insolvency law and practice has moved from a reactive towards an anticipatory philosophy has been in the approaches that the banks have adopted when lending to potentially troubled companies.101 The banks have long used the conditions of loan agreements to keep in touch with corporate performance and managerial behaviour. They have used

98Ibid., pp. 64–5; M. Henkel, Government, Evaluation and Change (Jessica Kingsley, London, 1991).

99See P. Bernstein, Against the Gods: The Remarkable Story of Risk (Wiley, New York, 1996); Power, Risk Management of Everything; Black, ‘Emergence of Risk Based Regulation’; U. Beck, Risk Society – Towards a New Modernity (Sage, London, 1992).

100See Power, Risk Management of Everything, pp. 27–8: ‘The private world of organisational internal control systems has been turned inside out, made public, codified and standardised and repackaged as risk management.’

101On banks and distressed companies see J. Franks and O. Sussman, ‘The Cycle of Corporate Distress, Rescue and Dissolution: A Study of Small and Medium Size UK Companies’, IFA Working Paper 306 (2000).

negative covenants in which the borrower agrees not to undertake certain behaviour or change the business in specified ways. They have employed positive covenants to ensure that the borrower supplies the lender with a variety of information on a regular basis and they have used financial covenants (positive as well as negative) to regulate different aspects of financial performance such as gearing, liquidity, profitability or levels of borrowing or working capital.102 Such conditions have given the major lenders a good deal of power to monitor corporate managers.103 Since the late 1990s, however, it is arguable that UK banks have adopted a newly organised and proactive approach to their debtor relationships – one that seeks to respond to corporate troubles at a far earlier stage of development than formerly. This approach is manifest in the increasing rigour with which the banks now attend to three things: early warning signals for corporate troubles; the quality of a company’s management (most notably its capacity to steer a path through troubles); and the company’s performance in managing the business risks it faces.

New attention to early warning signals is founded on the more active monitoring of data. The British Bankers’ Association issued a Statement of Principles in 1997 (revised in 2001 and 2005).104 This document makes it clear that when banks lend to small and medium enterprises, they will normally agree what sort of monitoring information will be required. Included within that information will be a comparison of forecasts and actual results (based on a number of stated performance indicators) as well as details on how the company’s bank accounts are

102See Day and Taylor, ‘Role of Debt Contracts’. See further J. Day, P. Ormrod and P. Taylor, ‘Implications for Lending Decisions and Debt Contracting of the Adoption of International Financial Reporting Standards’ [2004] JIBLR 475; J. Day and P. Taylor, ‘Financial Distress in Small Firms: The Role Played by Debt Covenants and Other

Monitoring Devices’ [2001] Ins. Law. 97; H. DeAngelo, L. DeAngelo and K. Wruck, ‘Asset Liquidity, Debt Covenants and Managerial Discretion in Financial Distress: The Collapse of L. A. Grear’ (2002) 64 Journal of Financial Economics 3; M. Harris and A. Raviv, ‘Capital Structure and the Informational Role of Debt’ (1990) 45 Journal of Finance 321.

103On the conditions under which lenders will deal with lending risks through monitoring as opposed to other methods (e.g. increasing security or raising interest rates) see G. Triantis and R. Daniels, ‘The Role of Debt in Interactive Corporate Governance’ (1995) 83 Calif. L Rev. 1073; S. Franken, ‘Creditor and Debtor Oriented Corporate Bankruptcy Regimes Revisited’ (2004) 5 EBOR 645; T. H. Jackson and A. T. Kronman, ‘Secured Financing and Priorities Among Creditors’ (1979) 88 Yale LJ 1143; R. Scott, ‘A Relational Theory of Secured Financing’ (1986) 86 Colum. L Rev. 901. See also ch. 3 above.

104BBA, Statement of Principles.

used. The banks now monitor such information on an ongoing basis and use it not only to place the debtor in a risk category105 but also to provide early warning signs of trouble. There are, indeed, indications that lenders see the provision of early warning signals as by far and away the main purpose of deploying covenants in loan agreements.106 When difficulties are signalled it will be usual to refer the company to an ‘intensive care’ unit of the bank – or ‘Business Support Team’.107 At this stage, the bank’s involvement becomes more active and may involve the appointment of an accountant to conduct an independent business review (IBR).108 The bank and the debtor company will then agree a way forward after considering the recommendations that emerge from the IBR. Companies in such circumstances are heavily reliant on the bank’s support and, at this stage, managers will have little choice but to accept the turnaround strategies initiated by the bank.109

Turning from early warning signals to the control of management, there has been a similar movement towards pre-insolvency action. The approach of Barclays Bank in the post-millennium period exemplifies this change.110 When a company is first introduced to a Barclays’ Business Support Team, that unit will focus increasingly on the quality of the management group and the need to help it to deal with the troubles confronting the company. This will involve, first, a structured approach in assessing the strengths and weaknesses of the company’s management and whether it is capable of meeting the challenges faced.111 If changes

105See Armour and Frisby, ‘Rethinking Receivership’, pp. 92–3: ‘banks increasingly differentiate the riskiness of their borrowers, and charge accordingly’. The companies will pay a premium rate (a) because they present higher insolvency risks and (b) to pay for the higher level of care that they receive from the bank.

106See Day and Taylor, ‘Role of Debt Contracts’, p. 183.

107See L. Otty, ‘Banking on the Managers’ (2002) Recovery (Winter) 12.

108Armour and Frisby, ‘Rethinking Receivership’, p. 92; BBA, Statement of Principles, para. 2.3.

109See Armour and Frisby, ‘Rethinking Receivership’, who comment (at p. 93): ‘should bank support be withdrawn at this stage, the company would be insolvent in the “cash- flow” sense’. (On cash flow and balance sheet tests and definitions of inability to pay debts see ch. 4 above.)

110See Otty, ‘Banking on the Managers’ (Mr Otty was then Business Support Director at Barclays); J. Dewhirst, ‘Turnabout Tourniquet’ (2003) Financial World 56. The Royal Bank of Scotland set up a Specialised Lending Services Division in 1993 which focuses on restructuring, rescue and intensive care. More than 1,000 companies are in the unit’s care at any one time and its head, Derek Sach, claimed that the Division returns around 80 per cent of businesses back to good health: see Financial Times, 31 January 2005, p. 24.

111Otty, ‘Banking on the Managers’, p. 12.

are needed in that team, or if ‘skills or experience gaps’ need to be filled, then additional or replacement personnel will be introduced through specialist suppliers.112 This may involve bringing on board experts in rescue. As a leading rescue professional commented: ‘Introducing the concept of turnaround professionals and helping to find the appropriate individual are becoming an increasingly important part of our solutions tool bag.’113 Reference to such specialists is facilitated by the emergence of these providers within the marketplace (a matter returned to below) and a significant role is played, in this regard, by organisations such as the Institute for Turnaround, Proturn and EIM Turnaround Practice.114

Once again, the effect of this change is, in practice, to focus attention on an earlier stage of corporate troubles than ever before. It is a development driven, not least, by the concern of the large banks to use their monitoring skills to gain market advantage. As Barclays’ Chief Executive, Matt Barratt, said of the new attention to managerial performance: ‘The ability to make good decisions regarding people represents one of the last reliable sources of competitive advantage.’115

Alongside such new attention to early warning signals and to management has come an increasing lender interest in the way that companies are dealing with risks. When Business Support teams become involved with a company’s management, or when independent business reviews are carried out, a central task will involve identifying the key business issues and risks that have to be responded to. At such times the capacity of managers to recognise and to meet these challenges comes under review and a spotlight is placed on the risk management capabilities of the team of directors and senior managers in place. Banks and review teams will not, in such processes, confine their attention to assessing the probability of insolvency or of turnaround – they will be looking to see

112 E.g. FD Direct or Proturn Executive in Barclays’ case: see ibid. 113 Ibid., p. 12.

114The Society of Turnaround Professionals was established by R3 and was retitled the Institute for Turnaround in 2008: see ch. 5 above and ‘Turnaround Talk’ (2001) Recovery (September). On the work of the turnaround specialist see R. Bingham, ‘Poacher Turned Gamekeeper’ (2003) Recovery (Winter) 27. On turnaround professionals and governance issues see ch. 5 above and V. Finch, ‘Doctoring in the Shadows of Insolvency’ [2005] JBL 690.

115Otty, ‘Banking on the Managers’. For a mid-credit crisis view that the banks have learned lessons from past recessions and are now able to spot customers’ problems earlier see A. Sakoui, ‘The Delicate Task of Restructuring Lehman Begins’, Financial Times, 27 October 2008.

whether the managers in position can overcome the company’s troubles on their own or whether they need active assistance to manage the risks at issue. This, once more, involves a newly proactive approach in dealing with the prospect of corporate insolvency. There may be some evidence, moreover, that a considerable amount of insolvency-related work is now being done at such earlier stages in corporate troubles. Armour and Frisby, for example, reported in 2001 that, in their survey of a number of accountants, banks and lawyers who were regularly involved in receivership, their interviewees stated that only a minority of firms that are the subject of an IBR subsequently enter formal insolvency proceedings.116

Reinforcing such a movement towards insolvency risk management has been a developing stakeholder confidence in the ability of specialists to devise and implement rescue strategies. One managing director of a mergers and acquisitions group summarised the market changes over the decade to 2002 in the following terms:

Turnaround opportunities are increasing because tighter market conditions, high leverage, bad management and over-trading are squeezing poor performers out. In the past, if a company was facing insolvency, it was seen to be prudent to cut one’s losses and liquidate what was salvageable to pay off key creditors. Nowadays, investors and businesses have sophisticated mechanisms for quantifying and evaluating risk. So the focus is shifting toward bespoke solutions to what can be temporary strategic problems.117

As a culture of rescue and recovery has been developed by lenders and encouraged by the Government,118 the market has responded by providing the skills that are designed to prevent corporate disaster. Thus, one business underwriting manager has written of recent changes: ‘The growing culture of rescue and recovery from a commercial and statutory viewpoint has raised the profile of turnaround finance. There is a cadre of better quality professionals around to assist businesses in turnaround, as well as assisting the lender. Lenders are now more likely to examine the possibilities of rescue and seek alternative solutions.’119 As noted in

116Armour and Frisby, ‘Rethinking Receivership’, p. 94. (The authors do, however, caution about the lack of qualitative data on this issue.) See also the Royal Bank of Scotland’s claim to turn around 80 per cent of companies in its intensive care: p. 267 above.

chapter 5, a burgeoning group of new specialists has come onto the scene. They all have a role in assisting banks or companies to effect turnarounds but come with a variety of labels, notably: turnaround professionals, company doctors, business recovery professionals, risk consultants, solutions providers, debt management companies and cash flow managers.120 Very often the main lending bank will call in such actors as part of a process in which the troubled company’s management capacity is reviewed; a strategy for turnaround is devised; arrangements for reorganising and refinancing are set up; and a programme for implementing necessary changes is put into effect. Banks’ incentives to monitor the signs of corporate distress can be expected to grow as they develop confidence in the turnaround capacities of their own staff and of relevant specialists. This, in turn, is likely to produce an increasing bank inclination to intervene in corporate affairs before troubles become potentially terminal.

If such a shift in inclination is typified as a movement from debt collection towards risk management, it might be questioned, first, whether it is possible to quantify this shift – to state how much more work in response to corporate decline is now being done at the informal turnaround as opposed to the formal statutory procedure stage. Second, it might be asked whether the banks are not so much moving towards a focus on risk management as merely relocating their debt collection activities from the formal to the turnaround stage.

On the first issue, a fundamental difficulty in quantifying the amount of work done in the turnaround period is that this will usually be carried out in an undisclosed manner in order to protect the reputation and business prospects of the troubled company.121 What can be pointed to, however, is the dramatic growth in the amount of turnaround servicing that is now being offered by a growing number of specialists.122

120See D. MacDonald, ‘Turnaround Finance’ (2002) Recovery (Winter) 17. On the role of credit insurers in turnaround see M. Feldwick, ‘Engaging Credit Insurers in the Turnaround Process’ (2006) Recovery (Autumn) 32; G. Jones, ‘Credit Insurance: A Question of Support’ (2004) Recovery (Summer) 21.

121See Finch, ‘Doctoring in the Shadows’.

122See MacDonald, ‘Turnaround Finance’; Finch, ‘Doctoring in the Shadows’. As for the relative proportions of work on corporate troubles that are done through turnarounds and formal procedures, little light, unfortunately, is thrown on the issue by statistics on the ratio between those firms which have undergone turnaround activity (e.g. IBRs) and those of these which subsequently enter formal proceedings. Such statistics leave out of account the number of firms who enter formal procedures without going through any prior turnaround activities.

On the second question, it would be unrealistic to contend that the banks do not, at least at times, act in their own best interests, with the primary aim of debt repayment, whether they are operating at the turnaround or formal procedures stage of corporate decline.123 As noted above, though, there is increasing evidence that in, say, operating intensive care procedures, the banks are routinely prepared to stimulate activities that are designed to enhance the troubled companies’ risk management systems and prospects rather than merely to produce early debt repayment. It should be emphasised, moreover, that when banks instigate the intervention of a company doctor in the affairs of a troubled enterprise, that company doctor will, in the vast majority of cases, be employed not by the bank but by the company and will be legally and professionally obliged to act in the interests of the company and not the bank.124 It is to be expected, moreover, that the earlier that a bank intervenes in the decline of a company’s fortunes, the greater will be the bank’s incentive to pursue rescue, rather than debt recovery, objectives. This is because the earlier the intervention, the smaller will be the risk of non-repayment to the bank and the greater the prospect of successful turnaround.

All of the above points, however, must be set in the context of the ‘new capitalism’ (as discussed in chapter 3). In the developing world of credit derivative trading there may be new possibilities of dealing with risks that lead a bank towards exit from its relationship with the troubled company rather than in the direction of doctoring and rescue. In relation to the USA, in particular, it has been argued that, thanks to the explosive growth of credit derivatives, debt holders such as banks and hedge funds will often deal with the risks attached to a troubled company by buying credit or loan default swaps, which trigger payments if the company fails. This brings two noteworthy effects that may prejudice rescue: uncertainty regarding the creditor’s position and a ‘decoupling’ of creditor and company interests that involves incentives to oppose restructuring and rescue. As one practitioner has said of such creditors:

123On the banks’ tendencies to better their own positions during rescue processes see Franks and Sussman, ‘Cycle of Corporate Distress’.

124If the company doctor is a member of the Institute for Turnaround (IFT) he will be obliged by that Institute’s Code of Ethics to act for the company in a manner that is impartial and free from any external pressures or interest that would weaken his professional independence (Code of Ethics, Appendix, para. A.2).

Where their interests lie is less predictable, especially if they also hold credit default swaps. Their financial interests may be best served by forcing a default if they are on the right side of a credit default swap position. The problem is compounded by creditors not having to disclose derivatives positions, making it very difficult for companies and regulators to find out their real intentions.125

In so far as the derivatives market facilitates dealing with risks by methods that may ‘decouple’ the creditor from the company, it is to be expected that this may cut against the trend for banks to indulge in doctoring. Similarly it can be said that rescues may not be encouraged by a process of risk spreading that makes interests and incentives ever more complex and opaque. What, however, of the prevalence of such derivatives-based decouplings of creditor and corporate interests? The pioneering commentators in this area suggest that, in the absence of disclosure requirements regarding strategies for risk spreading, ‘we

simply do not know’ the extent to which economic exposures are shed in this way.126 As for the position in the UK, these are not uncharted

issues. In relation to the collapse of the Marconi restructuring talks in 2002, difficulties allegedly arose because some banks had used credit derivatives to lay off risk to the extent that they stood to gain more from Marconi defaulting than from a restructuring.127 Looking forward past the 2007–8 credit crisis, these are matters to be monitored since the credit derivatives market is global and UK creditors are just as free as their US counterparts to ‘decouple’ from the company without being subject to any organised provisions calling for disclosure on the extent of that decoupling.

125 See H. Hu and B. Black, ‘Equity and Debt Decoupling and Empty Voting 11: Importance and Extensions’ (2008) 156 University of Pennsylvania Law Review 625. An administrator, Tony Lomas of PWC, appointed to Lehman Brothers International (Europe) stressed in 2008 that, in the wake of Lehman’s collapse, funds and other counterparties of Lehman faced having their positions ‘frozen for some time’ because of the complexities of resolving individual positions and that such complexities were serious impediments to restructuring: see Sakoui, ‘Delicate Task of Restructuring Lehman Begins’.

126Michael Reilly of the financing and restructuring practice at Bingham McCutchen, reported in F. Guerra, ‘Derivatives Boom Raises Risk of Forced Bankruptcy for

2 November 2004.