A comparison: company rescue under UK administration and US Chapter 11 Standard Note: SN/HA/5527

Last updated: 18 May 2010

Author: Lorraine Conway, Home Affairs Section

Section Home Affairs Section

In the UK, a company is insolvent if it cannot meet its debts as and when they fall due. Broadly speaking, an insolvent company has two options: compulsory liquidation or company rescue via administration. Under the Insolvency Act 1986 (IA 1986) and the Enterprise Act 2002 (EA 2002), compulsory liquidation (or ‘winding up’) involves the closing down of the business and the realisation of company assets for the benefit of creditors. In contrast, administration provides an opportunity to rescue the company or its business. The administration procedure is designed to hold a business together while plans are formed either to put in place a financial restructuring to rescue the company, or to sell the business and assets to produce a better result for creditors than a liquidation. It is possible for a viable business in financial difficulty to emerge in tact from administration. In the US, an insolvent business also has two options under the US Bankruptcy Code: file with a federal bankruptcy court for protection under either Chapter 7 or Chapter 11. Chapter 7 deals with liquidation; under Chapter 7 the business stops trading and all assets are sold for the benefit of the creditors. In contrast, the aim of Chapter 11 is to restructure debts and save the business. It is also possible for a viable business in financial difficulty to emerge in tact from Chapter 11 proceedings. Comparisons are often made between UK administration and US Chapter 11 proceedings. They share the same purpose: to rescue a viable business in temporary financial difficulty. The EA 2002, which came into force in September 2003, substantially reformed the administration procedure. However, it has been argued variously that the Act could have gone much further - it could have introduced in the UK new procedures more akin to Chapter 11 of the US Bankruptcy Code. Certainly, at the time of this insolvency law reform in the UK, comparisons were made to Chapter 11. This note has two aims. First, to outline the background to the reform of administration in the UK in order to facilitate greater company rescue and second, to provide a comparison between the UK administration insolvency procedure and US Chapter 11. Separate Library note SN/HA/4915 provides an explanation of how administration works in practice in the UK. Another Library note SN/HA/4798 provides an overview of Chapter 11 and an explanation of how this insolvency procedure works in the US.

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Contents

1  Introduction 2 

2  Government consultations on Chapter 11 type reforms in the UK 2 

3  Overview of administration under the EA 2002 3 

4  Comparisons between the UK administration and US Chapter 11 4 

1 Introduction The Enterprise Act 2002 (EA 2002), which came into force in September 2003, substantially reformed administration law in the UK. However, it has been argued variously that the EA 2002 could have gone further - it could have introduced US Chapter 11 type procedures in the UK. Certainly, at the time of this insolvency law reform, comparisons were made to Chapter 11 procedures under the US Bankruptcy Code. 2 Government consultations on Chapter 11 type reforms in the UK Reform of the UK insolvency law regime was considered in December 1998 in the Government’s White Paper ‘Our Competitive Future: Building the Knowledge Driven Economy’.1 In this White Paper, the Government announced its intention to review arrangements for business rescues and reassess the relative rights of creditors, including possible changes to the Crown’s preferential status. The Government’s aim being to encourage risk-taking and facilitate company rescue when things go wrong. It argued that when fundamentally viable businesses are lost there are consequences for creditors, employees and the wider economy. A joint DTI and Treasury working party was set up in 1999 to review company rescue and business reconstruction mechanisms. In September 1999, this working party published a consultation document, ‘A Review of Company Rescue and Business Reconstruction Mechanisms’.2 A principal theme of the document was whether there was a need to shift the balance of the UK insolvency regime from being creditor-friendly to being debtor-friendly. In its report, which was published for consultation in November 2000, the Working Party recommended certain legislative changes. These recommendations were considered in the Government’s White Paper, ‘Insolvency – A Second Chance’, published in July 2001.3 In the foreword to this insolvency White Paper, Patricia Hewitt, Secretary of State for Trade and Industry, explained the main aim of insolvency reform:

Promoting enterprise will boost UK business and improve productivity. Our Enterprise Bill will strengthen competition and the power of consumers by radically reforming competition law, transforming our approach to bankruptcy and corporate rescue and

1 Department of Trade and Industry (now Business Innovation and Skills) White Paper, Our Competitive Future:

Building the Knowledge Driven Economy, 1998 2 Department of Trade and Industry (now Business Innovation and Skills) and HM Treasury consultation

document, A Review of Company Rescue and Business Reconstruction Mechanisms, November 2000, http://www.insolvency.gov.uk/insolvencyprofessionandlegislation/con_doc_register/con_doc_archive/consultation/condoc/condocreport.htm

3 Department of Trade and Industry (now Department of Business Innovation and Skills), ‘Insolvency – A Second Chance’, 2001, Cm 5234, http://www.insolvency.gov.uk/cwp/cm5234.pdfe

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promoting new safeguards for consumers. We believe that promoting enterprise will release the entrepreneurial skills of the British people. In this White Paper I am setting out my proposals for the reform of insolvency law. Companies in financial difficulties must not be allowed to go to the wall unnecessarily. Administrative receivership, which places effective control of the direction and outcome of the procedure in the hands of the secured creditor, is now seen by many as outdated. There are many other important interests involved in the fate of such a company, including unsecured creditors, shareholders and employees. We propose to create a streamlined administration procedure, which will ensure that all interest groups get a fair say and have an opportunity to influence the outcome.4

At the time that these proposals were considered, a comparison was made between the UK regime and the entrepreneurial regime in the US. It was argued that bankruptcy in the US does not have the same stigma as it has in the UK. To some extent, it was this theme which drove the reforms of the EA 2002. 3 Overview of administration under the EA 2002 In terms of reform of corporate insolvency and restructuring, the EA 2002 fell short of implementing a full Chapter 11 style process. The main corporate insolvency measures introduced by the Act were:

• a streamlined administration procedure (making it more efficient and accessible in order to facilitate the rescue of viable companies)

• the ‘out of court’ appointment of insolvency practitioners to act as administrators • the abolition of administrative receivership (with certain exceptions)

• the introduction of new powers to extend certain insolvency proceedings, with

modifications, to foreign companies, Industrial and Provident Societies and Friendly Societies

The EA 2002 promotes administration as an important vehicle for company rescue. The original characteristics of administration, as introduced by the IA 1986, were retained: its collective nature, its moratorium, and the opportunity to achieve different outcomes for businesses. Other characteristics of administration introduced by the EA 2002 include:

• without court order entry into the procedure; • the express power for the administrator to distribute realised assets; • new exit routes from administration into dissolution and voluntary liquidation; and • a faster and fairer procedure

Under the EA 2002 the primary aim of administration is to rescue the company as a going concern (i.e. with as much as possible of its business) where it would provide the best result for the company's creditors as a whole. If this is not possible, then the aim of the administrator is to perform his functions with the objective of achieving a better return for creditors than would be achieved in a winding-up. For example, a better return may result from trading on for a period whilst seeking to sell off the business and/or assets.

4 Ibid

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4 Comparisons between the UK administration and US Chapter 11 Some insolvency specialists have argued variously that the EA 2002 was a missed opportunity for more radical reform of the UK administration procedure. In making their case, they point out that the EA 2002 failed to introduce:

• The US concept of the ‘debtor stays in possession’ (DIP). Under the EA 2002, the administration process does not leave directors in possession of a company with the benefit of a statutory moratorium on creditor action and enforcement of security.5 Instead, an insolvency practitioner is appointed administrator with responsibility for the day-to-day running of the business and the goals of the administration.

• The US concept of a DIP priority financing arrangement. In the US, there is an

established industry of DIP lenders who, because of the super-priority status granted to them in a Chapter 11 process, will make funding available to support a company through its restructuring. This is significant because it means that a US company in financial difficulties is not dependent on attempting to persuade its existing banks to lend more money.

• Chapter 11 provisions as apply to so-called ‘executory contracts’ and leases. Chapter

11 renders unenforceable any provision purportedly terminating a lease or executory contract by reason of the debtor’s financial difficulties. Under the UK administration process of the EA 2002, it is argued that administrators often struggle to hold together and sell a business as a going concern without these powers.

However, other insolvency specialists have argued that the EA 2002, and the reformed administration procedure it has introduced, has carefully avoided problems associated with US Chapter 11 style proceedings. For example, it is argued that:

• Chapter 11 imposes greater administrative burdens on the debtor business than the EA 2002. The DIP is subject to substantial financial reporting requirements to creditors and other interested parties. This imposes a significant administrative burden on the DIP, not least because all parties have the right to be consulted during the Chapter 11 process. In contrast, most of the provisions of the EA 2002, which sought to give greater powers to creditors’ committees, were dropped by the time the Act came into force.

• Chapter 11 procedures is excessively lenient in giving an ‘escape route’ to the

incompetent management of a failing company, damaging the efficiency of the economy as a whole and allowing poor managers to continue managing. This is not the case with administration.

It is worth pointing out that in the UK, it is the responsibility of the Insolvency Service to keep under review the effectiveness of all insolvency legislation including the EA 2002.6

5 It is correct that changes introduced by the Insolvency Act 2000 introduced a statutory moratorium to protect

companies seeking a Company Voluntary Arrangement, but this protection is only available to small companies (a company that has a turnover of not more than £2.8m and/or a balance sheet total of not more than £1.4m and no more than fifty employees)

6 The Insolvency Service is an executive agency of the Department of Business Innovation and Business (BIS)