Rethinking rescue

floating rather than fixed. The arrival of the ‘pre-packaged’ administration has led to new levels of concern regarding the undermining of statutory procedures and the substitution of closed agreements for traditionally more transparent processes.

Rescue procedures, it should furthermore be pointed out, operate as packages. If, accordingly, we ask whether the procedures that have been discussed in the last five chapters are appropriate or capable of improvement, we should consider not merely the individual processes involved but the broad package of procedures on offer. If that package is assessed, this raises the issue of coherence and whether the different procedures hang together in sympathy or undercut each other. It may be argued that it is beneficial to provide companies with a number of different routes to rescue, but that contention will only hold if those routes are in harmony. If some modes of rescue undermine others, the effect of variety may not be benign choice but inefficiency and confusion.

An overall assessment of rescue procedures must also bear in mind that different procedures may be applied to different stages of corporate troubles. Some routes into the post-Enterprise Act administration, for instance, demand that the company is, or is likely to be, unable to pay its debts.3 Other routes do not,4 nor is the CVA procedure tied to insolvency or near insolvency. The importance of this point is that at different stages of corporate difficulty, the aspirations and objectives of parties may vary. At a very early stage of corporate trouble it will be natural for directors and other parties to focus on rescue and the machinery for achieving this. On the brink of insolvency, the law and the involved parties may be concerned with how the remaining assets can be most efficiently distributed to creditors. These differences of emphasis are also likely to be reflected in the extent to which different parties’ rights stand to be adjusted so as to encourage rescue. When rescue is the chief end it will be appropriate to facilitate this objective by adjusting creditors’ rights (for example, by prohibiting enforcement of these). When distribution is the main objective, the emphasis will more properly be on the effective enforcement of creditors’ rights.

A difficult situation arises when shareholder interests in a company are diminishing in a period just before insolvency. What is special about insolvency – and rescue more particularly – is that the nature of the game

3See IA 1986 Sch. B1 para. 11(a); para. 22 with para. 27(2).

4Ibid., paras. 14 and 35: administration applications by holders of qualifying floating charges.

and even the list of players will vary as the company progresses through difficulties towards insolvency or turnaround. This can be seen in the position of a shareholder of a company. When a healthy company is operating, the directors may be perceived as working to further the shareholders’ interests.5 In an insolvency the position has changed. The company cannot pay its debts and the directors are now operating not with the company/shareholders’ assets but with those of the creditors.6 The interests of the creditors, at this stage, fall to be looked to as primary objects of directorial endeavour and procedural fairness to creditor interests becomes a first priority.

The difficulty for a designer of rescue procedures is that a procedure may operate across corporate life, from the situation in which the company is essentially healthy but needs to reorganise or adjust operations, right through to the company’s entry into insolvency. The procedure may thus have to protect rights that are shifting in relationship to each other and it will have to operate fairly when what is procedurally and substantively fair will change in accordance with the shifts in rights that occur as the company nears insolvency.

How then should a system of rescue procedures be designed?7 Do present rescue procedures match up to such a design? First, there should be clarity concerning the objectives in sight – the ends that are to be achieved efficiently. This means that a rescue system must be precise about the relative weights to be given to rescue and asset distribution. Nor should it be forgotten that the same insolvency laws that serve rescues may also need to accommodate the purposes of healthy operating

5On views of shareholders as the owners of the company or as the residual claimants of its assets see, for example, H. Butler, ‘The Contractual Theory of the Corporation’ (1989) 11 Geo. Mason UL Rev. 99; R. Sappideen, ‘Ownership of the Large Corporation: Why Clothe the Emperor?’ (1996–7) 7 King’s College LJ 27. On different characterisations of the nature of a shareholder’s interest see E. Ferran, Company Law and Corporate Finance (Oxford University Press, Oxford, 1999) pp. 131–3. On the status of groups other than shareholders as ‘residual claimants’ see Sappideen, ‘Ownership’; G. Kelly and J. Parkinson, ‘The Conceptual Foundations of the Company’ [1998] 2 CfiLR 174. (The formulation of s. 172 of the Companies Act 2006 makes it clear that – in the context of a director’s duty to promote the success of the company – the company means the shareholders and gives effect to a principle of ‘enlightened shareholder value’. For a discussion of arguments relating to the ‘stakeholder analysis’ of companies see T. Beauchamp and N. Bowie (eds.), Ethical Theory and Business (5th edn, Prentice Hall, Upper Saddle River, N.J., 1997) ch 2.)

6See West Mercia Safetywear Ltd v. Dodd [1988] 4 BCC 30, [1988] BCLC 250, per Dillon LJ. See also ch. 16 below.

7For a general guide to such design see United Nations Commission on International Trade Law (UNCITRAL), Legislative Guide on Insolvency Law (UN, New York, 2005).

companies. It would not, for instance, make sense to create efficient rescue procedures if the processes interfered unduly with, or imposed excessive costs on, healthy companies (for instance, because the rescue procedures can be abused for non-rescue reasons, as some fear may be the case with Chapter 11 in the USA). There is, accordingly, a balance to be set between rescue and operational concerns.

It may well be that at different stages of corporate life and decline, the optimal balances of different objectives will change. Rescue processes can cope with such difficulties but it is undesirable for different rescue procedures to target priorities divergently when operating at the same stage in corporate troubles. Here we saw the problems with the system of floating charges and the tension between pre-Enterprise Act administrative receivership and administration. The administration regime incorporated a moratorium and gave protection from creditors, and in doing so it effected a particular balance between ongoing corporate concerns (for example, to obtain financing when healthy), the interests of creditors and the wider interests to be served by rescue. The floating charge and administrative receivership system undermined administration (not to say schemes of arrangement and CVAs) and did so by setting out to achieve different ends (notably protection of the floating charge holder’s interest) at the same time as schemes of arrangement and CVAs looked to broader rescue interests. Insolvency law spoke with two voices and provided one procedure that undermined another. The route to a clearer design of insolvency/rescue regime is to decide on the appropriate balance of interests and to set up a procedure that pursues those interests consistently with that balancing. This argument favours a movement towards a ‘single gateway’ rescue regime where possible – and indeed the Enterprise Act 2002 moved in this direction by restricting the use of administrative receivership in favour of the enhanced administration process.

A second prerequisite of clear rescue design is the identification of those values to be pursued in a rescue. Again these need to be targeted with consistency. This book, as indicated in chapter 2, argues that emphasis should be given to efficiency, expertise, fairness and accountability throughout the various stages of rescue. Efficiency, it has just been noted, demands clarity concerning objectives, and one recurring message of the last five chapters has been that efficiency in rescue may require that directors are able to resort to a rescue procedure before the chances of turnaround have become hopeless. Here the addition by the Insolvency Act 2000 of a small companies’ moratorium to the CVA procedure may

be helpful, but questions can be asked about the continued requirement that when directors or the company seek entry to administration the company must be, or be likely to become, unable to pay its debts.8

Turning to the issue of expertise, if we consider the allocations of managerial and oversight functions in English rescue procedures – and do so with a view to the trust impliedly being placed in different experts – we see quite different assumptions being made. Many informal rescue procedures, including the London Approach, rely on a process of negotiation between the companies, directors, the bank(s) and other creditors. If formal processes are examined, we see that schemes of arrangement place faith in the expertise of the directors, subject to court oversight, and there is no need to resort to an independent IP to formulate or implement the scheme. The directors remain in control and a great deal of faith is placed in their initiative and ability to take corrective steps to avert disaster. The CVA, in contrast, places control in the hands of an external expert. The company’s directors, as noted, may propose a CVA but this must provide for a nominee to supervise the CVA’s implementation and the nominee must be qualified to act as an IP in relation to the company.9 This faith in the expertise of the independent IP may sometimes be well placed (increasingly so as IP experience with CVAs grows) but any expert judgement may have to survive an extended negotiation procedure, involving the IP, the directors, the banks and other creditors. This negotiation, moreover, may be conducted in a context of only limited trust. At the end of the day, then, expertise has to flow from a process of co-ordination with the IP at the helm.

In administration, the expertise of the IP is again central in both setting up the process and implementing it, but, given the role of the company’s directors in instituting 70 per cent of non-court-order entries into administration,10 the skill of those directors in seeing the need to institute an administration is also important. As noted, the company has to be near to, or actually, insolvent for directors or the company to trigger administration and the window of rescue opportunity is, accordingly, very narrow. This gives more prominence to the galvanising role of the company directors. The law here trusts the directors’ expertise too little

8See IA 1986 Sch. B1, paras. 11(a), 12(1)(a) and (b), 22 with 27(2)(a).

9Note that with the ‘small company’ CVA, established by the Insolvency Act 2000, nominees do not specifically have to be IPs: see ch. 11 above.

10Insolvency Service, Enterprise Act 2002 – Corporate Insolvency Provisions: Evaluation Report (IS, London, 2008) p. 25. The IS Report indicates that around 65 per cent of administrations are non-court-order and 30 per cent are by court order (5 per cent are route uncertain).

to allow the debtor to stay in possession, but sets up a procedure whose rescue prospects depend crucially on the same directors.

To summarise, in looking for the expertise that will generate successful rescues, insolvency law operates with a scattergun approach rather than a considered analysis of informational position, training, disinterestedness, specialist knowledge of the market, ability to judge financing options or commitment to implementation for rescue purposes. The formal procedures relevant to rescue again speak with inconsistent voices: schemes of arrangements are marked by high trust in directors; CVAs look to independent experts and negotiated or group expertise; and administrations look to independent experts that rely on directorial triggers. To repeat, a system of insolvency law that is thought through should operate on assumptions concerning expertise that are consistent rather than vacillating. These assumptions, moreover, could be based on analyses of the kind of factors noted above, along with the host of others that together underpin the exercise of independent judgement. All of these discrepancies are compounded by the growth of processes such as the pre-packaged administration that do much of the ‘traditional’ work of rescue procedures through informal mechanisms and which are largely unregulated, unstructured and varying in approach.

A discussion of accountability within rescue procedures proceeds on similar lines. Schemes of arrangement involve no oversight of directors by IPs but control by meetings of creditors and members together with judicial oversight. CVAs require that IPs structure directors’ proposals and the latter also have to be approved by creditors and members. The skill of the IP is crucial to the flow of information and accountability to creditors and members in a CVA. An array of criminal sanctions and civil liabilities also serves to hold directors to account in cases of concealment, removal or distribution of assets and/or records. General court scrutiny is also made possible by provisions allowing creditors and shareholders to apply for relief. In administration, court involvement has been reduced by the Enterprise Act 2002 reforms and accountability to shareholders is absent in so far as the members are not involved in approval of the administrator’s proposals (which are approved by the creditors alone).11 The accountability found within ‘pre-packs’ contrasts more dramatically with the above descriptions and constitutes a potential undermining of statutory requirements of openness and access.

11Shareholders can, however, apply to the court under the Insolvency Act 1986 Sch. B1, para. 74 if they have a complaint that the proposals will unfairly harm their interests.

Looking at accountability in different insolvency procedures, we again see not only varying rules but also divergent philosophies. Schemes of arrangement build on the notion that directors can be left largely free from monitoring by IPs but CVAs and administrations imply that there is considerable value in specialist control over the directors’ behaviour, proposals and informational roles. In administrations there is no need for shareholders’ approval. This contrast with schemes of arrangement procedures may be defended by some on the grounds that administration necessarily occurs when the company is close to insolvency but it is perhaps jumping the gun to argue that shareholders should drop out of the approval process completely when insolvency is a likelihood, rather than a given.

Finally, the issue of fairness falls to be considered. Considerable emphasis is placed on fairness to minority interests in schemes of arrangement. Meetings of creditors and shareholders have to approve proposals and, as noted in chapter 11, it is the court’s protective stance on this front that produces a complex process with elaborate provisions on notice. In relation to CVAs one means of ensuring fair treatment of creditors is through the approvals mechanism and the requirement of 75 per cent in value approvals. As noted, though, this rule contrasts with not only the class-based system of schemes of arrangement but also the simple majority required in administration. CVAs, moreover, have to be approved by shareholder meetings whereas administrations do not. As argued above, the exclusion of shareholders from votes on administrations may be difficult to justify, at least in the pre-insolvency situations that Schedule B1 of the Insolvency Act 1986 covers. It can also be contended that administrations do not fairly take on board the interests of parties beyond creditors, notably employees. The primary purpose of making an administration order under Schedule B1 paragraph 3 of the Insolvency Act 1986 is rescuing the company as a going concern but the employee stakeholders whose livelihoods are at stake are offered no formal input into the decision-making process governing administration. Where a ‘pre-pack’ administration is used, the particular danger is that less powerful creditor interests may be railroaded to an outcome and have very little say in the route taken or the nature of that outcome.

In summarising on fairness, we see that the law relating to the various insolvency procedures operates with divergent assumptions on the rights of parties involved in insolvency. As a result, the models of fairness implicit in the processes discussed are inconsistent. The law does have to confront the difficult problem of changing balances between the

interests of certain classes. This is apparent in the position of the shareholder in, say, the administration procedure since the shareholder’s interest can be said to be considerable pre-insolvency but diminishing as full insolvency looms. An organised approach to insolvency law would decide which parties have which rights at which stages of insolvency and set the rules accordingly and consistently across the procedures.

To conclude on rescue procedures, the individual procedures possess strengths and weaknesses as outlined, but, as an overall system, they may be said to constitute a disjointed package. There are a number of potential explanations for this state of affairs. Many such explanations are historical and political. Long-established deference to security interest holders as major property owners created a resistance to organised rescue strategies and sets of laws that might be seen as interfering with such property rights.12 Cork’s recommendations were cherry picked and postCork law reforms in this area were for many years piecemeal efforts that failed to take on the broader strategic issues. The Enterprise Act 2002 reforms have been welcomed in many quarters as moving towards a more generally collective regime – though, as seen above, that regime still has to face residual challenges.

The argument presented in this book is that insolvency law can and should take on board the shifting nature of rights and relationships in troubled corporate affairs. Other things being equal, however, it should offer a range of insolvency processes that caters for the values of effi- ciency, expertise, accountability and fairness and does so on the basis of assumptions that are consistent across different procedures. At present, formal and informal rescue processes offer a range of routes to turnaround but that variety creates a potential for tensions and conflicts.

Finally, we should return to the issues raised at the start of this chapter and consider whether current procedures address an outdated set of challenges and fail to provide the rescue procedures that modern restructurings and credit market conditions really require. In chapter 9 we saw that this argument has been presented forcefully by the European High Yield Association (EHYA)13 which has contended that current

12See A. Clarke, ‘Security Interests as Property: Relocating Security Interests within the Property Framework’ in J. W. Harris (ed.), Property Problems from Genes to Pension Funds (Kluwer, London, 1997).

13See EHYA, Submission on Insolvency Law Reform (EHYA, London, 2007), discussed in

R. Heis, ‘Technical Bulletin’ (2007) Recovery (Autumn) 15. On EHYA proposals as

modestly revised ( EH YA, S u b m i s s i on on I n s o l v e n c y L aw R e f o

‘Treasury Urged to Reform Insolvency Laws’, Financial Times, 26 February 2008.

restructuring processes are ill-suited to the growing complexities of capital structures, the dispersion of debt and the multiplicity of parties generally involved with troubled companies. The EHYA’s case for a court-supervised restructuring process deserves to be looked at on its merits – for present purposes, however, it is the making of such a case that raises an important point. It is one thing to decide what is wanted from a corporate insolvency regime and to attempt to design a system accordingly. It is another to ensure that a rescue regime that is good for today’s companies and markets will adjust appropriately to tomorrow’s conditions. The need for monitoring and appraisal is constant and the ongoing challenge is to produce approaches to corporate rescue that both satisfy current concerns and are also responsive to needs for change.