‘concentrated creditor’ theory stress the benefits of concentration in encouraging the efficient monitoring of corporate affairs and the summoning of help at the right time during troubles.207 The uncertainties of the EA reforms may, however, diminish creditor concentration as resort is made to wider ranges of financing and this may mean that the banks are less committed to the role of judging the best point for precipitating changes in a company’s management.

A worrying effect of such changes, from the perspective of rescue, is that as banks become more uncertain about their role in rescue proceedings and if they have doubts about the potential of rescue processes to serve banks’ interests quickly and efficiently, they may be increasingly inclined to be impatient with troubled companies and to take direct enforcement action at an earlier stage in corporate decline than was the case before the EA. This opens up the prospect of potentially precipitate bank action which would detract from efficient rescue. Other aspects of post-EA administration – such as the vulnerability of inclusive procedures to delaying tactics by reluctant directors208 – may also produce limited bank patience with post-EA procedures

Super-priority funding

A further aspect of timely rescue is the availability of funds for the purposes of recovery. On this front, a problem with the EA is that it did not provide for a regime of ‘super-priority’ funding209 for administration. For banks, accordingly, the new arrangements are less conducive to rescue funding than was receivership, which gave them a power of veto over administration.210 Such a power, in practice, allowed the banks to use the threat of appointing receivers to negotiate administration strategies that were designed to protect against dissipations of their security during the period of the administration. The banks’ power in such respects has been weakened by the EA reforms and this may reduce incentives to fund rescue attempts.

207See Armour and Frisby, ‘Rethinking Receivership’; J. Franks and O. Sussman, ‘Financial Distress and Bank Restructuring of Small to Medium Size UK Companies’ (2005) 9 Review of Finance 65, suggest that there is evidence that bank domination may make banks ‘lazy’ in monitoring receivers’ costs but not with regard to the replacement of management. On limitations of the concentrated creditor theory, see ch. 8 above.

208See BBA, Response to White Paper.

209This was proposed in the House of Lords but the Government rejected the proposal: see HL Debates, 21 October 2002. See further pp. 408–9 below.

210See IA 1986 s. 9(3).

Companies involved in any potential rehabilitation process face the central problem that funds must be obtained in order to allow a turnaround to be effected:211

Continued trading is essential for some form of going concern to emerge at the end of the process and for a company to continue trading through an insolvency procedure, it will routinely require access to some form of external finance. Unless that finance is available, the rescue will fail, the assets will have to be sold piecemeal and the company will be forced into liquidation.212

When a company enters a formal insolvency process, the difficulties of obtaining financing may increase considerably. At such times creditors will view lending to the company on an unsecured or undersecured basis as a very risky activity in which repayment depends on the success of the proposed rescue. Few lenders, as a result, may come forward under these conditions.

A super-priority regime seeks to address these difficulties by providing that the suppliers of funds during a moratorium are to be given priority over all existing creditors.213 This concept is found in the US Chapter 11 provisions and, in 1993, the DTI invited comments on its suitability in the UK. Such super-priority, the DTI said, might be financed either from cash flow or (in England and Wales) by a lien over specific uncharged assets. Such funds would have to be used only in the ordinary course of business (e.g. to pay employees during the moratorium) and any extraordinary items would have to be authorised by the lender. One advantage of super-priority, suggested the DTI, was that where funds were provided by the main secured lender on such a basis, there would be reassurance to the lender that their security was not being dissipated during the

211R3’s Ninth Survey of 2001 indicated that in one in five cases of failed companies with in excess of £5m turnover, the main factor preventing a positive outcome was lack of funding.

212IS 2000, p. 33. In 1999 the Insolvency Service cited the SPI’s Eighth Survey, indicating that lack of security for extra funding was cited in 51 per cent of cases as a barrier to turnaround and lack of appropriate finance in 43 per cent of cases.

213On super-priority financing generally see McCormack, ‘Super-priority New Financing’ (looking at the UK, USA and Canada); D. Milman and D. Mond, Security and Corporate Rescue (Hodgsons, Manchester, 1999). The INSOL International Statement of Principles for a Global Approach to Multi-Creditor Workouts (October 2000) is endorsed by the Bank of England. Principle 8 states that where additional funding is provided in a standstill period, the repayment of this should ‘so far as practicable, be accorded priority status’.

moratorium. It had to be faced, however, that, should the company fail, the super-priority funding would operate at the expense of other creditors.

The idea of super-priority has, however, been subject to ebbs and flows of favour at the DTI.214 In 1995 the DTI looked at CVA procedures and

rejected super-priority on the grounds that the comfort of super-priority might militate against a lender’s giving proper consideration to the viability of a business. As for the earlier suggestion that super-priority loans might be repaid earlier from cash flow, or secured by a lien over specific uncharged assets, the DTI was concerned that a company contemplating a CVA would not have sufficient cash flows or uncharged assets during a moratorium. Given such worries, the DTI proposed that nominees should be required to consider the availability of funding as part of the initial assessment of the CVA’s prospects of success. If the assessment was favourable, said the DTI, there was no substantial reason why funders would not support the company. In 1999, the Insolvency Service was more favourably disposed and announced that its Review of Company Rescue and Business Reconstruction Mechanisms would reconsider super-priority. Note was taken of London Business School research by Maria Carapeto which showed that of 326 firms that had filed for Chapter 11 protection in the USA, some 135 had raised super-priority (or ‘debtor in possession’) financing which had comprised around 19 per cent of the total debt of the company. About half of the new finance was advanced by pre-petition lenders and high levels of such lending were associated with positive effects on recovery rates.215

In 2000 the Insolvency Service Review Group Report noted that for most CVAs additional funding tended to be provided by owners/directors or by existing lenders, often with the benefit of existing or increased security and/or personal guarantees. New secured finance was available only to the extent that existing secured creditors agreed to this or if the company had uncharged assets or charged assets with surplus value that

214 The DTI became the Department for Business, Enterprise and Regulatory Reform (BERR) on 28 June 2007.

215The IS 1999 makes no reference, however, to the interest rates in Chapter 11 lending. These rates are frequently at a premium. As Gregory notes, ‘Some argue that the total volume of Chapter 11 financing (19 per cent of total company debt) is more of a comment on the cost of Chapter 11 procedures than a reflection of the commercial needs of the company … Statistical comparisons here are actually misleading because like is not being compared with like’: R. Gregory, Review of Company Rescue and Business Reconstruction Mechanisms: Rescue Culture or Avoidance Culture? (CCH, Bicester, December 1999) p. 21. On Chapter 11 procedures see ch. 6 above.

*The position of each individual creditor would be protected and their expected return would be at least the same as if the finance were not provided.

*The courts would need to be given significant discretion and the criteria to be satisfied before super-priority finance was granted would need to be demanding. Practice would no doubt evolve over time regarding the operation of such provisions.

*Secured creditors would need to be given appropriate influence over the selection or confirmation of the insolvency practitioner.219

In such a regime there is an attempt to ensure that a proper judgement is made about the prospects of viability.220 Concerns that superpriority funders will not assess viability on a proper basis are addressed by making the court or tribunal the arbiter on such matters. It is essential, accordingly, that a properly resourced and skilled system of courts or tribunals be established and that these incorporate appropriate insolvency expertise.221 It might be objected that such judgements will not be located in a commercial or market context but, in response, the Insolvency Service’s suggestion is that an option might be to have ‘a system of expert tribunals with a strong commercial flavour dealing with cases on a day to day basis and to focus on the role of the higher courts as resolving disputes as to the application of

the law and reviewing the procedures followed by the expert tribunal’.222

Despite the Insolvency Service considering that there was a case for such an approach to super-priority funding in 2000, the Government declined, two years later, to accept an amendment to the Enterprise Bill that would have created a statutory framework for super-priority financing during administration and which its proponent suggested was essential if administration was to operate as an effective rescue tool.223 The Government took the view that the decision to lend in times of trouble was best left to the commercial judgement of the market and that it would be wrong to offer a guaranteed return to a super-priority investor whether or not the rescue proposals had satisfied

219Ibid., p. 35.

220On the US position see e.g. M. White, ‘Does Chapter 11 Save Economically Inefficient

223Lord Hunt, HL Debates, 29 July 2002, discussed in McCormack, ‘Super-priority New Financing’, p. 713; Davies, Insolvency and the Enterprise Act 2002, pp. 20–6.

the market.224 Such views were taken against a background of con- fidence that the market would meet the financing requirements of troubled companies on appropriate terms. Here consideration was given to the growth of asset financing, factoring and discounting and the increasing orientation of these financing systems towards rescue.225

A potential route to super-priority funding is, however, provided by the Insolvency Act 1986 section 19(5) and Schedule B1, paragraph 99.226 These provisions cover debts incurred under contracts entered into by the administrator, in the carrying out of his functions.227 Such debts are given a priority ranking above that of the administrator’s statutory charge for his own remuneration and expenses (which, in turn, rank above a floating charge in priority of payment from the corporate estate).228 McCormack has argued that the words of paragraph 99 ‘seem sufficiently broad to encompass liabilities under loan contracts entered into by the administrator on behalf of the company’.229 The High Court has also considered the matter. In Bibby Trade Finance Ltd v. McKay230 a financier had provided funds to administrators in order

224For a comment on the ‘regrettable’ failure to provide for super-priority funding see A. McKnight, ‘The Reform of Corporate Insolvency Law in Great Britain – the Enterprise Bill 200 2’ ( 200 2) 17 J IBL 3 24 at 3 33.

225See McCormack, ‘Super-priority New Financing’, p. 713.

226Ibid. See also the discussion concerning IA 1986 s. 19 at pp. 373–5 above.

227Contracts entered into before the administration will not enjoy the priority of those entered into by the administrator in carrying out his functions: see Freakley v. Centre Reinsurance International Co. [2006] BCC 971.

228See Sch. B1, para. 99(3), which provides for payment of a ‘former administrator’s remuneration and expenses’ out of assets in the custody or control of the administrator in priority to any charge which, as created, was a floating charge. Para. 99(4)–(6) gives ‘super-priority’ to debts or liabilities arising out of contracts entered into by the administrators and (regarding ‘qualifying liabilities’) to debts and liabilities under adopted employment contracts. In Re Trident Fashions plc [2006] All ER 140 the Court of Appeal accepted that an expense payable pursuant to rule 2.67 (introduced by the Insolvency (Amendment) Rules 2005 (SI 2005/527)) was actionable by the expense creditor against administrators who had drawn remuneration in priority to such an expense. See further Lightman and Moss, Law of Administrators, pp. 134–45; and p. 417 below.

229See McCormack, ‘Super-priority New Financing’, pp. 727–8.

230[2006] All ER 266. See A. Bacon, ‘Administration Costs: Some Welcome News’ (2007) 20 Insolvency Intelligence 1. In Freakley v Centre Reinsurance International Co. [2006] BCC 971 the House of Lords stated that the power to decide what expenditure was necessary for the purposes of the administration, and which should therefore receive priority, rested with the administrator (subject to the supervision of the court). Lord Hoffmann indicated that it would be unusual for the courts to interfere with the business judgement of the administrator on such matters.