administrations (and 3 per cent by value) administration had been the procedure selected solely to provide a convenient method of sale of a business or package of assets when this result appeared to have been equally achievable in liquidation. The ‘disenfranchising’ of unsecured creditors in administration will be returned to below in considering accountability within the administration process.

Responsiveness

Turning from banks’ incentives to use administration to the need for rescue actions to be taken decisively and rapidly, there may be concerns that the move from administrative receivership to the new administration may reduce the ability of key players to behave in this manner. As noted above, the British Bankers’ Association (BBA) has for some time argued that receivership operated as an effective way of saving businesses (not necessarily companies) because receivers, acting for the banks, could operate very dynamically.172 The BBA’s fear about the new administration is that it will involve more parties, delays and uncertainties and will accordingly make rescues more difficult than under receivership. ‘Concentrated creditor’ theory173 holds that a multiplicity of creditors increases negotiating frictions whereas the concentration of the old receivership system reduced these. Similarly it can be contended that the inclusiveness of the post-EA regime, and the enfranchising of parties other than floating charge holders, increases negotiation costs relative to receivership174 and reduces the chances of rapid and effective responses to corporate troubles. It is further arguable that, in the past, the existence of receivership, and its potential use, served a useful purpose in concentrating the minds of all the classes of creditor involved with the potential rescue of a troubled company – that it was this prospect that gave urgent life to many a general agreement on reorganisation and rescue.175 In contrast, the post-EA regime involves no such draconian fall-back position and in other ways it also increases the incentives of the broader band of creditors to contest strategies and actions – for instance by ringfencing provisions to increase the prospects of unsecured creditors.

172See BBA, Response to White Paper and BBA, Response to the Report by the Review Group on Company Rescue and Business Reconstruction Mechanisms (April 2001) (‘BBA,

Rescue’). On the various advantages of creditor concentration see J. Armour and S. Frisby, ‘Rethinking Receivership’ (2001) 21 OJLS 73 at 84.

173See Armour and Frisby, ‘Rethinking Receivership’.

174See the discussion at pp. 429–35 below.

175See Armour and Frisby, ‘Rethinking Receivership’.

This could be said to be a statutory trading-off of efficient rescue in favour of more fairness to unsecured creditors.

As a counterbalance to such fears, however, it can be pointed out that in many recovery scenarios there is little point in making rescue-related decisions quickly (for example to seek to ensure that requisite funds are available) if the conditions that underpin continued trading are not sustained – and one thing that the EA does do is to increase the incentives to support rescue of those business partners who are unsecured creditors. Those incentives will be encouraged not merely by the administrator’s duty to consider their interests (as compared to the receiver’s duty to act in the interests of the floating charge holder) but also by the abolition of Crown preference and the ring-fencing provisions set out in sections 251 and 252 of EA 2002.176 Both of these reforms increase the anticipated returns to unsecured creditors in a potential liquidation. This, in turn, may reduce the risks faced by unsecured creditors in

supporting the rescue – though it will not always do so on a dramatic scale.177

Decisive action in pursuit of rescue demands that administrators act to further their statutory rescue objectives in a purposive way. They have, as noted, a statutory duty to perform their functions ‘as quickly and effi- ciently as is reasonably practicable’178 but, as far as rescue is concerned, the administrator’s statutory objectives, as established by Schedule B1, paragraph 3(1), do not even give absolute priority to rescue. The administrator must act with the aim of rescuing the company as a going concern179 unless he thinks that it is either not ‘reasonably practicable’

176See Insolvency Act 1986 s. 176A.

177See H. Rajak, ‘The Enterprise Act and Insolvency Law Reform’ (2003) Co. Law. 3. Under the ‘ring-fencing’ or ‘prescribed part’ provisions the quantum of the ‘prescribed part’ of funds reserved for unsecured creditors out of property otherwise available for distribution to the holders of a floating charge is established by Statutory Instrument: see Insolvency Act 1986 (Prescribed Part) Order 2003 SI 2003/2097 (see p. 387 above). Without such a ‘ring-fencing’ measure the consequence of the abolition of the major part of the Crown’s preferential status as a creditor would be a windfall for the charge holder. John Armour argues that unsecured creditors may in fact be worse off in that they will receive only a trivially small increase in their expected payout on insolvency through the prescribed part while facing the risk that, if fragmented capital structures make it more difficult for banks to orchestrate workouts, the probability of default may increase: ‘Should We Redistribute in Insolvency?’ in J. Getzler and J. Payne (eds.), Company Charges: Spectrum and Beyond (Oxford University Press, Oxford, 2006) p. 223. See also ch. 3 above.

178Insolvency Act 1986 Sch. B1, para. 4. 179 Under Sch. B1, para. 3(1)(a).

to achieve it or that other actions will produce a better result than winding up for the creditors and that this would be a better result for the creditors as a whole than seeking to rescue the company.180 Only if he thinks that neither of these objectives can reasonably practicably be achieved can property be realised in order to make a distribution to one or more secured or preferential creditors.181 As has been pointed out above, the terms of the EA mean that it is arguable that an administrator is obliged to pursue a going concern sale where he thinks this will serve creditors better than efforts made to rescue the company – even where it might be possible to rescue the company.182 Primacy is accordingly given to maximising overall returns to creditors, rather than to rescue per se.

The courts have made it clear that they are inclined to encourage the development of administration as a streamlined and cost-effective regime. In the cases of Re Transbus International Ltd183 and Re Ballast plc184 the courts indicated that para. 68(1) – which provided that the administrator shall manage the company’s affairs in accordance with the proposals approved by the creditors’ meeting and any directions given by the court – meant neither that the administrator had to await the creditors’ meeting before acting, nor that he or she could not act without court directions. The two cases suggest, additionally, that the courts are keen to defer to the administrator’s commercial judgement and to allow a considerable margin to such judgements.185 Such judicial approaches are designed to allow the administrator to act in decisive ways without fear of delays or second-guessing from the judicial oversight process.

Decisiveness is also called for on the part of company directors. Ever since the Cork Report commentators have urged that the purposes of rescue and the maximising of returns to creditors will be served best where the directors of troubled companies do not delay unduly in calling in rescue professionals.186 It is, after all, the directors of a company who,

180Under Sch. B1, para. 3(3). For consideration of the likelihood of achievement of this purpose and potential abuse of the administration process see Re British American (Holdings) plc [2005] BCC 110, [2005] 2 BCLC 234; Doltable Ltd v. Lexi Holdings [2006] BCC 918.

181Under Sch. B1, para. 3(4).

182See p. 383 above; Frisby, ‘In Search of a Rescue Regime’, p. 262.

183[2004] 1 WLR 2654, [2004] BCC 401. 184 [2005] 1 WLR 1928, [2005] BCC 96.

185See A. Walters, ‘Corporate Restructuring under Sch. B1 of the Insolvency Act 1986’ (2005) 26 Co. Law. 97.

186See e.g. Cork Report, ch. 10 and generally D. Milman, ‘Strategies for Regulating Managerial Performance in the Twilight Zone’ [2004] JBL 493.

in the main, must be relied upon to trigger rescue-oriented proceedings. These are the parties who have the requisite hands-on knowledge of a company’s immediate state of affairs rather than the creditors or shareholders. What the EA 2002 does do to expedite rescues is to move from the old regime – in which an administrator could only be appointed by an order of the court on a petition by the company or its directors or creditors187 – to the new process, which allows a company to enter administration out of court on application by the company, its directors or the holder of a qualifying floating charge.188

Statutory procedures are one thing, incentives to resort to these another, and, from the directors’ point of view, the nature of the regime being entered may, as noted, be highly material. A difficulty with an insolvency practitioner or practitioner in possession (PIP) regime is that it demands that the directors give up control of the company and so offers directors only limited encouragement to seek early help. For a start, the practitioner in possession, the administrator, is likely to be a person of the bank’s choice rather than their own. If the company or its directors wish to appoint an administrator out of court they must give the holder of a qualifying floating charge five days’ notice189 and that holder may then appoint their own administrator in the interim period.190 The qualifying floating charge holder’s appointment prevails – as would also be the case where the application to court procedure is followed. The danger is that if the company’s managers anticipate that any formal procedure will involve their giving up the reins of office they will tend to delay commencement of entry into such a procedure beyond the point when the situation calls for external help and involvement. During such a troubled period, moreover, the company directors are likely to take unjustifiably large business risks in the hope, not merely of rescuing the company from its troubles, but of clinging onto their offices. Further dangers are that the directors will dissipate the going concern value of the company’s assets and, in doing so, will prejudice any rescue operations and force the company into liquidation. Such delays will

187(Pre-15 September 2003) Insolvency Act 1986 s. 9(1).

188See paras. 22 and 14. As noted above, however, the company’s inability (or likely inability) to pay its debts is a prerequisite for court appointments of administrators at the behest of the company, its directors or its (non-QFC) creditors (para. 11) and for out-of-court appointments by the company or by directors under paragraph 22 (see para. 27(2)(a)). On valid appointment of administrators out of court see Fliptex Ltd v. Hogg [2004] BCC 870.

189Para. 26. 190 Para. 14.

accordingly be likely to diminish the value of the assets available for distribution to creditors.191

The disincentives to seek help that flow from PIP might be sought to be countered by legal liabilities for directors who wrongfully trade192 or by disqualification provisions.193 The effectiveness and desirability of such responses to problems of overtrading have, however, been questioned194 on the grounds of their limited deterrent value and because the imposition of such liabilities may chill healthy entrepreneurship. Here debtor in possession (DIP) systems offer a contrast in so far as they leave the directors in charge of the company and this removes at least one disincentive to seeking help. As Hahn argues: ‘Given the shortcomings of the stick, handing management a carrot may prove more effective. To accomplish this … some “tax” needs to be paid to those decision makers. Leaving management in control of the debtor corporation while the reorganisation is pending is precisely that tax.’195

The danger of DIP, however, is that this may distort the choice of procedure entered into.196 In a DIP system, managers who opt for liquidation face immediate replacement by an appointed trustee in liquidation. If they opt for reorganisation they may remain in office. They will, accordingly, tend to file for reorganisation197 even in circumstances where liquidation would be judged the better course of action for the creditors and the corporation as a whole. Such an inclination will be encouraged where, as will often be the case, the managers expect that they will be able to use their control in reorganisation proceedings to obtain value for themselves in the reorganised corporation198 or they

191D. Hahn, ‘Concentrated Ownership and Control of Corporate Reorganisations’ (2004) 4 JCLS 117; J. Day and P. Taylor, ‘The Role of Debt Contracts in UK Corporate Governance’ (1998) 2 Journal of Management and Governance 171.

192Insolvency Act 1986 s. 214. See ch. 16 below.

193Company Directors’ Disqualification Act 1986. See ch. 16 below.

194See M. White, ‘The Cost of Corporate Bankruptcy: A US–European Comparison’ in J. Bhandari and L. Weiss (eds.), Corporate Bankruptcy: Economic and Legal Perspectives

(Cambridge University Press, Cambridge, 1996); Milman, ‘Strategies’, pp. 498–9.

195See Hahn, ‘Concentrated Ownership’, p. 141.

196See e.g. D. Bogart, ‘Unexpected Gifts of Chapter 11: The Breach of a Director’s Duty of Loyalty Following Plan Confirmation and the Postconfirmation Jurisdiction of Bankruptcy Courts’ (1998) 72 Am. Bankr. LJ 303.

197P. Aghion, O. Hart and J. Moore, ‘The Economics of Bankruptcy Reform’ (1992) 8

Journal of Law, Economics and Organisation 523; Hahn, ‘Concentrated Ownership’.

198See M. Bradley and M. Rosenzweig, ‘The Untenable Case for Chapter 11’ (1992) 101 Yale LJ 1043. On DIP financiers filling the ‘governance vacuum’ in Chapter 11 see D. Skeel, ‘The Past, Present and Future of Debtor-in-Possession Financing’ (2004) 25 Cardozo LR 101.

may anticipate being able to use their period of control in order to serve their ongoing career opportunities. Such a bias in favour of reorganisation means that managers will not consider choices of insolvency proceedings in undistorted ways and they will not make judgements in a detached, expert manner with an eye to efficient rescue.

The advantage of PIP is that it involves a lower risk of bias or delay in decisions to liquidate since control under all the procedural options will move from directors to independent professionals.199

To return to PIP as established in the new administration: if a problem is that the new process fails to encourage directors to seek help, can the banks be relied upon to institute rescue processes in a timely fashion? The answer to this question turns on the impact of the EA reforms on banks’ rights, incentives and attitudes. Here one relevant consideration, as already indicated, is the array of legal uncertainties that the EA reforms may involve. This is a statute that provides a complex set of objectives and which may make the administrator’s actions seem highly vulnerable to challenge.200 It also involves uncertainties with respect to the administrator’s allocation of realisations to fixed and floating charges for the purpose of identifying the funds covered by ring-fencing under the Insolvency Act 1986 section 176A.

Such uncertainties may sow the seeds of doubt about rescue in the minds of the banks. The banks may expect procedural and legal costs to be high in post-EA rescues and this may lead them to avoid lending with floating charge security and to move, as noted, towards greater use of secured, asset-based financing and more personal security. The effect of the post-EA regime may, as a result, be the production of a fragmentation of security that will not prove rescue-enhancing. As Prentice has pointed out, the Act does not affect the right of banks to characterise charges as they see fit, to insert the terms and conditions that they consider appropriate and to control the timing of any enforcement action.201 The banks,

199Hahn, ‘Concentrated Ownership’.

200See Sch. B1, para. 3(1). The reality may be that the judges prove reluctant to interfere with the judgements of administrators (at least where aims are phrased subjectively): see notes 361–5 below and accompanying text. There is, as yet, a ‘conspicuous’ absence of case law where administrators have been sued for breach of duty: see Keay and Walton, Insolvency Law, p. 116. The authors comment, however, that this is likely to change as administration begins to take over from administrative receivership ‘as the most common non-terminal corporate insolvency procedure’ and actions under para. 75 for breach of equitable or common law duties become more frequent.

201See D. Prentice, ‘Bargaining in the Shadow of the Enterprise Act 2002’ (2004) 5 EBOR 153 at 156.

when lending in the shadow of the EA 2002 reforms, will be free to determine the property that is subject to the charge and the type of charge securing the debt. If they are induced by the uncertainties of the EA regime to be selective about the company’s assets that are subject to a charge this will affect the collectivity and coverage of post-EA rescue processes. An advantage of the former regime was that an administrative receiver managed the whole of the corporate property and that the banks

were induced to opt for charges that were as comprehensive as possible.202 This may not be the case with the post-EA processes and frag-

mentation of the secured assets may ensue. A bank may, accordingly, take a fixed charge over certain corporate assets that are sheltered via the creation of a special purpose vehicle (SPV) that is a subsidiary of the parent company.203 The overall effect will detract from efficient rescue in so far as the administrator is likely to face more serious problems of asset co-ordination than was the case for administrative receivers. Rapid, decisive, rescue-orientated action will be the more difficult in the face of such fragmentation.204

The inclination of the banks to lend by means of secured asset-based financing may, moreover, be strengthened by the EA’s ring-fencing, for the benefit of unsecured creditors, a prescribed part of the funds otherwise available to floating charge holders.205 Even when banks do lend under floating charge security they will tend to ask for higher rates of interest in reflection of the post-EA uncertainties that, from their point of view, compare badly with the attractions of the old administrative receivership system. The need to demand such raised rates may, in turn, produce a shift towards raising company financing through other routes such as factoring, discounting, leasing or hire purchase arrangements.206

There are implications here for the role of the banks in acting to institute rescue proceedings at the optimal time. Proponents of the

202Ibid.

203Ibid., p. 7. A fixed charge can be taken over the parent company’s shares in the SPV. See also Insolvency Act 1986 Sch. B1, paras. 70 and 71, but, as Prentice notes, these provisions need the appointment of an administrator and, in the case of a fixed charge, a court order. See also ch. 3 above.

204See also ch. 7 above. On the comparative efficiency of debtor-oriented (as opposed to creditor-oriented) insolvency regimes where debt is not concentrated, see S. Franken, ‘Creditor and Debtor Oriented Corporate Bankruptcy Regimes Revisited’ (2004) 5 EBOR 645.

205Insolvency Act 1986 s. 176A; see pp. 387, 398 above.

206See Davies, Insolvency and the Enterprise Act 2002, p. 50.