UK: Corporate Security and the Enterprise Act. What Will Change?

Last Updated: 19 March 2003

Company rescue is the key note of the Enterprise Act (the "Act") which has now made its final passage through both Houses of Parliament and received the Royal Assent on 7 November 2002. The administration provisions are due to take effect in June/July 2003, once the rules have been written.1

Now is the time to look at how this legislation will affect the way in which security is taken, enforced and realised.

What follows is a step by step guide to the main changes.

  • The Act does not affect the rights of holders of floating charges granted before a date, yet to be announced (the Appointed Date), to appoint an administrative receiver under their charge.

  • Charges created after that date will be affected. Holders of floating charges, with some exceptions (discussed below), will not be able to appoint an administrative receiver, but will be able to appoint an administrator if the charge qualifies.

  • There are specific exceptions to the prohibition on the appointment of an administrative receiver to cover major financings in which administrative receivership is used to protect cashflows and to enable the working out of a project or the repayment in full of an issue in the international capital markets.2 Briefly, the exceptions are these:
    • Capital markets arrangements: if a party incurs or is expected to incur a debt of at least £50 million and the arrangement involves the issue of "a capital market investment"3
    • Public private partnership projects with contractual step in rights entitling the person who provides finance to the project conditional rights to take control
    • Utility projects with step-in-rights
    • Project companies involved in a financed project which includes step-in rights
    • Special regimes relating to financial markets, including market charges, system charges and collateral security charges.
  • A charge will qualify if (in one or anumber of charges) the floating charge holder is secured on the whole or substantially the whole of the Company’s property, the charge states that Paragraph 14 of Schedule B1 applies to it, and it gives the floating charge holder the power to appoint an administrator or administrative receiver.

  • Fixed charge security is not affected by the Act and receivers can be appointed under fixed charges as previously.

P.10 Appointment by the Court

  • The Court route is open to the Company, the directors and any creditor. It is unlikely to be used by a floating charge holder unless there is some question over his security or he wishes to take control of an application made by a creditor or the directors of the Company. A floating charge holder may intervene in the process and apply to have his own choice of administrator appointed, provided that he is aware of the application, (as there is no duty to notify him or any administrative receiver until the appointment is made). The floating charge holder who nominates his own choice of administrator will normally have that person appointed unless there are special reasons, based on the circumstances of the case, why he shouldn’t, such as, perhaps, the applicants choice having particular knowledge of the Company’s affairs or the floating charge holder’s choice having a potential conflict.

  • Where an administrative receiver has been appointed, any application to appoint an administrator will only succeed if the security under which the administrative receiver was appointed would be discharged under SS 238 to 240 or 245 IA 1986 (transactions at an undervalue, preferences and invalid floating charges,).

P.14 Appointment out of Court

  • The route most commonly used by the floating charge holder to enforce any floating charge security created after the appointed date will be the appointment of an administrator out of court under the P.14 route.

  • In order to take this route the floating charge holder must not only have a qualifying floating charge over the whole or substantially the whole of the Company’s property but it must be "enforceable". Whilst not defined in the Act, this term would be expected to carry its natural meaning i.e. that the power to appoint has arisen under the floating charge. It should not, therefore, be necessary to amend floating charge documentation in this respect, although, insofar as it does not refer to the floating charge being "enforceable", it may be prudent to consider an amendment to reflect the wording in the Act.
  • Although demand will still be made under the floating charge to trigger an appointment there is no requirement to notify the Company of the appointment prior to it being made and consequently, as with administrative receivership, the element of surprise remains intact.
  • The process of appointment is commenced by the appointor filing the prescribed documentation at court, including a notice of appointment containing a statutory declaration that the charge qualifies, that it is enforceable and that the appointment is in accordance with Schedule B1. The proposed administrator must be identified, he must state that he consents to the appointment and that the purpose of the administration is reasonably likely to be achieved. There is no requirement at this stage for him to specify the objectives of the administration.
  • The documents to be filed at court have to be in the "prescribed" form, which has not yet been finalised but is unlikely to require more than the minimum of information. Subject to the floating charge holder checking the charge carefully to ensure that it qualifies and is enforceable, the onus is on the proposed administrator to satisfy himself that the purpose of administration is reasonably likely to be achieved. He can, in this respect, rely on the information given to him by the directors unless he had reason to doubt its accuracy, although in reality he is likely to consult at some length with the directors as to the viability of the administration and the Company’s bank or other funders to secure funding for the administration. As long as the nominee has reached his decision in good faith using his professional skill and judgment he is unlikely to be censured by a court if he gets it wrong.4

P.22 Appointment

  • The Company and /or its directors may appoint an administrator, but before doing so they must give 5 business days notice to any floating charge holder to enable it to appoint its own choice of administrator. If it chooses to do so it will then follow the P.14 route.

  • In practice it is likely that the floating charge holder will be consulted beforehand, in most cases, as the Company will require funding throughout the administration.

Moratorium

  • There is a moratorium from the date an administration application is filed in court under P.10 and from the date when the documents are filed in court under P’s14 and 22 until the appointment takes effect. In the case of P.14 appointments this is likely to be very short if not non-existent. In the case of P.22 appointments the moratorium will not exceed 10 days.

Purpose of Administrator’s Appointment

  • Nowhere is Company rescue highlighted more strongly than in the way in which the administrator is required to perform this function. Under the present law it is possible to specify a number of purposes in the alternative. The most widely used are the survival of the Company or part as a going concern and/or a more advantageous realisation of assets than would be effected on a winding up.

  • In contrast, the Enterprise Act specifies in order of priority the objectives for which an administrator must perform his functions, top of the list being the rescue of the Company as a going concern. If he thinks that objective is not reasonably practicable, the administrator can perform his functions with the objective of achieving a better realisation for creditors than would be achieved on a winding up. Only if he thinks that neither of the first two objectives are reasonably practicable can he perform his functions with the objective of making a distribution to secured or preferential creditors and then only without unnecessarily harming unsecured creditors. It is worth noting that while the test is subjective, the administrator will be required to exercise his professional skill and judgment in deciding whether the objectives are reasonably practicable.
  • The administrator has an overriding duty, except where he was appointed for the purpose of distribution to secured or preferential creditors, to act "in the interests of the creditors as a whole".
  • This puts beyond doubt the duty of an administrator as being to all the creditors as a whole, rather than any one class of creditors. That being so, with the need to fund the administration, in the majority of cases the administrator will not be able to achieve the objective of rescuing the Company and possibly not a better realisation for creditors than on a winding up without the support of its bank and floating charge holder. The bank is therefore in a strong position initially, especially when coupled with its ability, in almost every case, to select the administrator. However, once appointed, it is likely that the costs of administration will exceed those of an administrative receivership and floating charge holders may find that they are, effectively bearing additional costs.

Administrator’s Proposals and Term of Appointment

  • Once appointed the administrator is required to come up with proposals within 8 weeks and to hold his first creditors’ meeting within 10 weeks, which represents an extension to the very tight timetable originally proposed. (Originally the time limits were 28 days for proposals and 42 days for the meeting.) He is, however, subject to an overriding duty at all times to perform his functions as quickly and efficiently as is reasonably practicable. His initial appointment is for twelve months but can be extended5 before it expires, for up to six months, with the consent of all the secured creditors and 50% of the unsecured creditors or at any time before expiry with the leave of the court. Consequently, if a secured creditor does not agree to a further extension he can force the administrator to apply to court for an extension and will, presumably, be entitled to be heard on any application.

Dealing with Security

  • As previously, the administrator has the power to dispose of floating charge property in the administration on the basis that the floating charge holder retains its priority. He can also dispose of non floating charge security6 and property subject to a hire purchase agreement, with the leave of the court, but subject to top up provisions where the net proceeds are less than the market value to bring the proceeds up to the market value. The principles on which the court will grant leave were set out in the case of Atlantic Computers7 which emphasised the need to balance the rights of the secured creditor against those of the Company in administration. The Act, however, provides that the Court will grant leave where the Court thinks that disposal of the property would be likely to promote the purpose of the administration. It is feasible that different tests may be applied depending on the stated purpose of the administration, i.e. in cases where Company rescue is the stated purpose, the court may, in appropriate cases, be more prepared to grant leave, than it would where the stated purpose is a distribution to secured or preferential creditors. It may also be influenced in favour of the Company by the requirement for the administrator to top up the difference between the proceeds of sale and the market value in relation to non floating charge security and HP agreements.

Crown Preference and Distribution to Unsecured Creditors

  • Crown preference has been abolished in so far as it relates to Inland Revenue, Customs & Excise debts and Social Security Contributions. The new section, 176A of the Insolvency Act 1986, provides that the liquidator, administrator, provisional liquidator or receiver (but not an administrative receiver), has to make a prescribed part of the Company’s property available to unsecured creditors.

The intention was to make it as close to the amount which has traditionally gone to preferential creditors as possible. On 10 February 2003 it was announced that the prescribed part would be 50% of the first £10,000 of net property and 20% thereafter up to a maximum of £600,000. The only limitation on this duty is if the administrator (or other office holder) obtains an order from the Court that the cost of making a distribution would be disproportionate to the benefits. This provision was the subject of much debate and the final version is the result of an amendment introduced in the House of Lords8. The circumstances contemplated include where there are very few funds and/or there are so many creditors competing for the funds available that it would be an administrative nightmare to try and effect a distribution.

  • An important point to note for holders of floating charges granted before the appointed date is that no part of the monies which are payable to them are subject to distribution to unsecured creditors, so, in a nutshell, they have a windfall, benefiting from the abolition of Crown preference, but not having to share their windfall with unsecured creditors. This should encourage the taking of floating charges before the Appointed Date.

Power to distribute and make payments

  • It has long been regarded as a disadvantage of administration that the administrator has no power to make a distribution. This is corrected by the Act. The administrator has the right to make a distribution to secured and preferential creditors (now only employees) and also to unsecured creditors provided he has permission from the court. This will serve to reduce the costs associated with a straightforward distribution and exit, particularly where there is no surplus for unsecured creditors, when the administrator can simply file a notice of dissolution.

  • In addition, the administrator can now make payments other than distributions or in accordance with his powers under Paragraph 13 of Schedule 1 of IA 1986 (to make payments as necessary or incidental to the performance of his functions) if he thinks it likely to assist achievement of the purpose of the administration. This will enable the administrator to make payments which are necessary for the ongoing success of the administration e.g. a key supplier who will not supply unless some or all of its arrears are paid. Any such payment would have a direct effect on recoveries by floating charge holders, but the provisions are entirely consistent with the administrator's duty to act in the interests of all creditors.

Balancing provisions

  • It should be noted that there are provisions in the Act enabling creditors or members of the Company to apply to court complaining that the conduct of the administrator has or would unfairly harm the interests of the applicant and/or that he is not performing his functions as quickly or efficiently as is reasonably practicable.

  • The administrator must also apply to end the administration if he thinks that the purpose of administration cannot be achieved, if he thinks that the Company should not have entered into administration or he is required to do so by a creditors meeting. These safeguardsare designed to balance the administrator’s extensive powers.

Summary

Those holding floating charges with grandfather rights are unaffected. They retain all their original rights and also benefit from the abolition of Crown preference. In practice, these charges will continue to be effective for a number of years to come.

What difference does the Act make to those holding floating charges created after the Appointed Date? The principal, stated, philosophical difference is that the administrator whether their appointee or not, does not owe his primary duty to the floating charge holder. His duty is to act (except in limited circumstances) in the interests of all creditors. That, however, is in practice how the administrator’s role has always been perceived and it has not deterred the increase in popularity of administrations even where there has been the opportunity for the floating charge holder to appoint an administrative receiver.

In reality, the floating charge holder will often continue to control whether there is an administration, through the need for funding, to influence the appointment of the administrator and, given the requirement to obtain the consent of the secured creditors, any prolongation of the administration. It retains its priority on any sale of floating charge property and the requirement that it share part of the proceeds of realisations with unsecured creditors is neutral when balanced out with the abolition of crown preference.

1 The provisions are to be found in Part X and Schedule 16 of the Enterprise Act. (Schedule B1 to the Insolvency Act 1986 ("IA 1986")). References are to paragraphs in Schedule 16 unless otherwise stated.

2 SS 72A to H of Part 10 of the Act.

3 It is possible that a broader definition of capital market arrangement will be established. The government is to take soundings and if so, it will be enacted by statutory instruments.

4 T&D Industries plc (in administration) [2000] 1 BCLC471.

5 Amendment from initial three months introduced on 21 October 2002.

6 Security is not defined and will therefore bear the meaning given to it in S248 1(B) IA 1986, as "any mortgage charge, lien or other security" which could lead to the result that a lien holder could demand the full amount of its debt as the price of releasing property subject to its lien.

7 Re. Atlantic Computer Systems [1992] Ch 505 [1990] BELBS9.

8 (Hansard) 21 October 2002. with the administrator’s duty to act in the interests of all creditors.

Click here to view "Enforcing security - what are the options, Realisations - the impact of rescue culture".

Article by Kevin Pullen, Stephen Gale and Laurence Elliot

© Herbert Smith 2003

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

For more information on this or other Herbert Smith publications, please email us.

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