value of contracts and may impede the general efficiency of business operations by making suppliers and customers less confident in dealing with possibly troubled companies.282 In the EHYA world, it could be cautioned, customers and suppliers will face higher business costs since they will feel the need to expend more resources than at present on checking the viability of companies that they enter into business relationships with.

Equity conversions

A more radical and ‘market’ approach to the design of a cost-effective rescue regime is the proposal put forward by Aghion, Hart and Moore.283 In the suggested procedure, the administrator would convert the company into an all-equity firm and allocate rights to this equity among the former claim holders in exchange for their former claims. Senior creditors would be given equity, junior creditors and former shareholders would be given options to buy equity; the IP would invite bids for all or part of the ‘new’ firm. Non-cash bids might include proposals to reorganise the firm as a going concern and to take on new debts. These two tasks would be completed within a specified time, say within three months, and then junior creditors and former shareholders would decide whether to exercise their options. Following this stage, the new shareholders would vote on which bid to select and the firm would exit from insolvency. Junior creditors would thus be required to buy out senior creditors before they receive anything.

Aghion, Hart and Moore aim to offer a regime that is quick, cheap and leaves minimal discretion in the hands of the judiciary and experts. Their main goal is the Jacksonian one of maximising the total value of the proceeds (measured in money terms) that are received by existing claimants. The main perceived evils countered are, first, the danger that senior creditors will vote for liquidation when this serves their interests

282 See the concerns expressed by the Insolvency Service in concluding that there was not ‘sufficient evidence to show that the UK needs [the EHYA] procedure’: IS letter of 8 May 2008 to the Managing Director of the EHYA (reproduced on the IS website, www.insolvency.gov.uk). The IS expressed particular concerns which have been noted above: see p. 420, n. 277. In the autumn of 2008 discussions between the IS and the EHYA were still ongoing, however.

283 P. Aghion, O. Hart and J. Moore, ‘ A P roposal for Bankruptcy Refor m in the U 9 IL&P 103, summarised in DTI 1993, Appendix E.

but is not in the general interest of affected parties and, second, the tendency of the administrator when exercising discretion to be involved in inefficient and time-consuming bargaining in an attempt both to secure agreement on taking a firm forward and to decide how to distribute the resulting cash or securities.284

The regime’s proponents point to a number of its supposed strengths.285 First, conversion to equity gives the main creditor (‘the bank’) a stake in the recovery of its debt (assumed to be secured by a floating charge) but also an interest in equity value increases beyond that point. This reduces the bank’s incentive to enforce its debt prematurely when it is probable that waiting would increase returns or rescue prospects. The bank also has an incentive to sell the company for as much as possible, rather than for merely enough to satisfy its security. Second, the banks in general may end up holding equity more often than at present and this may have a desirable effect on their propensity to appraise and monitor corporate debtor performance. Third, the system overcomes the fast-increasing problems that administrators face in attempting to negotiate resolutions of problems when different creditor groups have divergent interests. Fourth, the regime avoids the voting distortions that present administration arrangements may produce when junior creditors are placed in a position where they can, without justification, block plans and extract more money than they are allowed under priority. Finally, the system reduces the need for a moratorium because it allows the companies with good prospects to be saved within either administration or receivership.

A number of objections to the scheme and a number of potential difficulties can, however, be identified.286 In the first instance, some confusion surrounds the issue of entitlement to instigate the equity conversion, with critics noting that a single unsecured creditor might be able to trigger the process irrespective of the amount owed and questioning whether a small unsecured creditor would have the right to

284The Enterprise Act’s removal of the floating charge holder’s right to appoint an administrative receiver to some extent reduces dangers of precipitate and self-interested actions by floating charge holders but the administrator’s duty to act in the interest of all creditors does not remove the practical power of the large creditor: see pp. 428–9 below.

285See P. Aghion, O. Hart and J. Moore, ‘Insolvency Reform in the UK: A Revised Proposal’, Special Paper No. 65 (LSE Financial Markets Group, January 1995) and in (1995) 11 IL&P 67.

286For criticism see Brown, Corporate Rescue, pp. 680–4.

displace an administrative receiver or an administrator appointed by the court.287

It can also be objected that if the procedure is not made compulsory it will add little to present procedures. In many schemes of arrangement, formal and informal, there is an element of debt/equity conversion and shareholders or junior creditors can always ‘buy out’ senior creditors: for example, by managerial buyouts of the business.288 The position of the unsecured creditor in the scheme also gives ground for concern. Such creditors will only retain the right to claim outstanding debts if they exercise options to buy shares in the company by a specified date. All the equity in the scheme is, after all, given to the holder of the floating charge and unsecured creditors have to purchase their equity. This has been called a ‘fundamental injustice’ as it requires a group of creditors who have lost money to put up further funds to keep their debt alive.289 Junior creditors may also be placed in a difficult position if they find it difficult to sell their options and, if these lapse, the effect will be to leave the senior creditors with all the equity.290 The conversion proposal can indeed be seen as allowing floating charge holders to exploit their superior resourcing, information and bargaining positions in a manner that worsens the predicament of unsecured creditors. This is liable to be the case since the very factors that lead to the granting of unsecured loans will produce poor positioning to effect purchases of equity options, notably: informal modes of business operation; lack of familiarity with legal structuring in commercial relations; modest levels of staffing operations; and modes of business operation involving large numbers of small, fast-moving transactions and players. Of all creditors, the unsecured creditors are least likely to be able to put their hands on cash at short notice in order to purchase equity shares. As a result of their poor positioning, unsecured creditors will tend to be worse off within an equity conversion scheme than under many alternative arrangements. As is to be expected with proposals based on economic efficiency-seeking, there is a neglect of

287See A. Campbell, ‘The Equity for Debt Proposal: The Way Forward’ (1996) 12 IL&P 14 at 15.

288Brown, Corporate Rescue, p. 680, who concedes that Aghion, Hart and Moore acknowledge this point in ‘Insolvency Reform in the UK’, at p. 70. On schemes of arrangement see ch 12 below.

289J. Francis, Technical Secretary of the Society of Practitioners in Insolvency, ‘Insolvency Law Reform: The Aghion, Hart and Moore Proposals’ (1995) (Winter) Insolvency Practitioner, p. 10, quoted in Campbell, ‘Equity for Debt Proposal’, p. 15.

290Brown, Corporate Rescue, p. 680.

distributional justice issues and an inbuilt bias in favour of giving more to those who already have. Those who already have tend, after all, to be the parties who are best placed to make use of the opportunities on the table.

The deadlines involved in the conversion proposal only exacerbate the position of the unsecured creditor. Tight time limits are involved and options have to be exercised before the IP’s plan is placed before the shareholders’ meeting. As has been commented: ‘At this stage it is unlikely that such creditors would have sufficient information to make an informed decision about the survival prospects of the company and exercising options could amount to throwing good money after bad.’291 From the point of view of the strongest players – the banks with the floating charges – the position is, in contrast, rosy. The conversion process allows the bank to commence formal proceedings, trigger the conversion procedure and force the unsecured creditors to buy them out or else give up all their claims.292

As for the hope that an equity conversion scheme will keep transaction costs, and particularly legal costs, low, this may not be achievable in practice. There is the potential for much litigation and the need for a good deal of court supervision within the scheme in relation to issues of asset valuation, protections against abuse, control of the process and bias; the acceptability of the decisions of the IP; whether ‘urgency procedures’ can be used to meet deadlines; and the discretion exercised by the IPs. Administrators, in particular, may be placed in a difficult position if they are seeking bids for the company and, at the same time, assisting junior creditors to dispose of their options. As one commentator has cautioned: ‘Widespread adoption of this procedure will generate new forms of potential duties and liabilities as administrators.’293 The difficulty, in short, is that without legal oversight and controls, the very considerable discretions exercisable by IPs are open to abuse and liable to prompt many disputes in court. If, on the other hand, a high level of court supervision is involved, the scheme loses one of its heralded virtues. On the question of asset valuation, there are particular difficulties. The scheme’s proponents suggest that disputes can be avoided by incorporating (in relation to fixed charges at least) ‘forced sale’ valuations by professional firms. Here there is a huge potential for fee paying, expense, litigation and delay. It is by no means the case, moreover, that

291Campbell, ‘Equity for Debt Proposal’, p. 15.

292Francis, ‘Insolvency Law Reform’, p. 4. 293 Brown, Corporate Rescue, p. 680.