United States: The UK Insolvency Bill – An Update

After nearly seven years of intermittent consultation, the UK Government has finally published an Insolvency Bill. If enacted by Parliament in its present form, it will introduce the long-awaited debtor-based moratorium in support of corporate restructuring. But a number of crucial flaws mean that the moratorium will be of very limited application, at least for the foreseeable future.

• There will be no reform of the floating charge. A floating charge gives a creditor security over all of a company’s assets, including trading stock and chattels. On enforcement of a floating charge, the secured creditor can appoint an administrative receiver over all of the company’s assets.
• Secured creditors will not be required to give notice before appointing administrative receivers. In consequence, most insolvent companies will not have the opportunity to seek a moratorium following default because the banks will be able to launch a pre-emptive receivership appointment.
• The moratorium will only be available to the smallest companies, i.e. companies which meet two of the following three criteria, (a) turnover not exceeding £2.8 million, (b) gross assets not exceeding £1.4 million, and (c) not more than 50 employees. The moratorium will not be available to insurance companies, banks or certain brokers or intermediaries.
• There are no provisions to help companies secure working capital to fund trading pending a restructuring. Although the Working Party reviewing corporate rescue mechanisms appears to favour the introduction of some form of super-priority security for such finance, no such proposals are to be found in the Bill.

Reform of UK insolvency law is overdue. Compared to those of other leading nations, the UK’s insolvency laws have long been heavily weighted in favour of secured creditors. The banks’ right to enforce their fixed and floating charge security by appointment of an administrative receiver, rather than having to rely on collective bankruptcy processes, have depressed returns to unsecured creditors and shareholders from insolvent UK companies.

Reform matters particularly to unsecured creditors who, according to a recent survey by the Society of Practitioners of Insolvency, receive on average only a 7% return on their claims on insolvency and, in 65% of cases, receive no return at all. (In the US, where insolvent companies can be restructured through the collective Chapter 11 procedure, returns for unsecured creditors generally range from 31% for subordinated debt to approximately 48% for senior unsecured debt.)

Returns on unsecured debt in insolvency will only be improved by reducing drastically the unilateral enforcement rights of secured creditors. Achieving these results will take a serious commitment to reform, which the UK government appeared to have following a fact-finding visit to the United States by the Secretary of State for Trade and Industry in 1999. Sadly, the UK government’s proposals are anything but revolutionary. The need for a moratorium as part of the CVA procedure has been widely accepted for many years, and was first proposed by the government in a consultation paper in October 1993. The more controversial issues – the requirement for secured creditors to give seven days’ notice of appointment of administrative receivers and the possibility of allowing super-priority security for rescue financing – were also raised in the October 1993 consultation paper, but have been dropped from the Insolvency Bill.

Curiously, given the Bill’s long gestation, the Government has not awaited the outcome of the review of corporate rescue mechanisms by the Working Party it set up last year before publishing the Bill. Unless radical reform proposals emerge from that review – and the secured creditors’ well-organised and vocal lobby makes that unlikely – it will not add any substantial reforms to those contained in the Bill.

If introduced, the proposed elements of the moratorium procedure will be as follows:

• The directors of a company seeking a moratorium must file with the court a document setting out the terms of the proposed CVA and a statement of the company’s assets and liabilities. They must also file a statement from the nominee (an authorised insolvency practitioner nominated to supervise the CVA) that, in his opinion, the proposed CVA has a reasonable prospect of being approved and implemented, and that the company is likely to have sufficient funds to trade during the moratorium period.
• A company will not be entitled to a moratorium once administrative receivers have been appointed, or if the company is in liquidation or administration. Nor will a company be eligible for the moratorium if it has had a moratorium in place during the preceding 12 months.
• The moratorium will come into effect when the requisite papers are filed at court and will last a maximum initial period of 28 days, until meetings of shareholders and creditors have taken place. The meetings may be adjourned, in which case the moratorium may be extended for a maximum of two months.
• During the moratorium period, creditors will be prohibited from enforcing any security over the company’s property, repossessing goods or levying distress, and from commencing or continuing other proceedings, execution or other legal process except with the leave of the court. In addition, creditors cannot present a winding up or administration petition or appoint receivers during the moratorium period.
• The CVA and moratorium will be supervised by an authorised insolvency practitioner, but the directors will remain in full control of the company. The company may dispose of its property and pay pre-moratorium debts during the moratorium with the approval of either the nominee or the creditors’ committee, if there are reasonable grounds for believing the disposal or payment will benefit the company. Any security granted by the company during the period of the moratorium will only be enforceable if, at the time it is granted, there are reasonable grounds for believing that it will benefit the company.

The Bill enables further reform to be effected by the government by subsequent secondary legislation, without the need for further Parliamentary time. The main points are:

• Despite criticism by the Trade and Industry Select Committee, the Bill currently contemplates the possibility of the moratorium being extended to larger companies by secondary legislation if it proves successful for small companies.
• The government may adopt the UNCITRAL Model Law on Cross-Border Insolvency. The principal effect of adoption would be the recognition of liquidators appointed in other countries, and assistance in the conduct of multinational insolvencies.