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In the second of his three articles on recent legislative changes to UK insolvency procedures, Gareth Limb looks at the corporate insolvency provisions of the Enterprise Act 2002.

The Enterprise Act 2002 received Royal Assent on 7 November 2002. It will be introduced in England, Wales and Scotland gradually over the next 12-18 months, when the necessary secondary legislation is introduced.

The Government’s approach in effecting reform of corporate insolvency procedures is encapsulated by the following statement from The Insolvency Service:

“A vigorous entrepreneurial society is vital to sustaining economic and social development. While businesses will occasionally fail in competitive markets, viable companies should not be allowed to go to the wall unnecessarily. The Enterprise Act aims to help companies survive and increase accountability and transparency by promoting collective insolvency procedures, in particular Administration – recognised as an effective tool in encouraging company rescue – and restricting the use of administrative receivership. In doing so the Act aims to ensure a better balance between companies and their creditors.”

There are three main areas where changes have been made, and these are explained below.

Administration Orders
In summary, the changes relate to:

• simplifying the procedure for putting a company into administration
• the purpose of an administration
• extending the powers of administrators to make distributions of assets to creditors.

The moratorium that applies when an administration order is made can provide companies in financial difficulty with the vital breathing space needed to develop a rescue package. Providing a quick, easy and cheap route into administration will increase the likelihood of companies (particularly those that are owner-managed) seeing rescue as an option at an early stage – when a rescue plan is more likely to succeed.

At present an administration order can only be made by the Court, which is a complex and expensive process. Consequently, the Enterprise Act 2002 introduces procedures whereby floating charge holders, companies and their directors can appoint an administrator through an out-of-Court procedure merely by giving notice to the Court and various other specified persons. This is in addition to the existing Court route available under the Insolvency Act 1986, which remains the only route available to creditors.

Irrespective of how the administrator is appointed, Court or out-of-Court procedure, the Act replaces the existing four statutory purposes of administration under The Insolvency Act 1986 with a single, clearly defined purpose, albeit with two sub-purposes:

• the prime objective is for the administrator to perform its functions with the objective of rescuing the company as a going concern, which is taken to mean with as much as possible of its business; or
• if this is not reasonably practicable, the administrator should pursue the objective of achieving a better result for the creditors as a whole than would be likely if the company were wound up. If this second objective would achieve a better result for the creditors as a whole than the first, then it may be pursued; or
• where it is not reasonably practicable to achieve either of the above, the administrator’s objective will be to realise property to make a distribution to one or more secured or preferential creditors. However, even where there are insufficient funds to pay unsecured creditors, the administrator must not unnecessarily harm their interests (which reinforces the collective aspect of the procedure).

Irrespective of how it is appointed, the administrator has full power to run the company’s business, acting as the company’s agent. It then has eight weeks from the commencement of the administration to provide the creditors and the Court with a copy of its proposals to achieve the objective of the administration. It must also hold an initial meeting of creditors for the approval of the proposals (with or without modifications) within ten weeks.

Where there are either no funds available for unsecured creditors (other than those as a result of the abolition of Crown preference – see below), or neither the company rescue nor the better result objectives apply, however, the administrator is not required to call a meeting of the creditors.

An administrator has always been able to make distributions to secured creditors, but under the Act it will also be able to distribute funds to any preferential creditors, and also, with the permission of the Court, to unsecured creditors. For an administration to be successful it needs to have a clear exit route tied to its purpose. Where the objective is a company rescue, the administration is most likely to involve the company entering a Company Voluntary Arrangement or a Scheme of Arrangement (under section 425 Companies Act 1985).

If the company cannot be rescued, then the administrator will be aiming to achieve a better realisation of the company’s assets than an immediate liquidation. In such circumstances, where there are no funds available for the unsecured creditors the administrator will realise the company’s assets, make payments to any preferential creditors and fixed and floating charge holders, and then arrange for the dissolution of the company. This is achieved by simply sending a notice to the Registrar of Companies. If, however, there are funds available for distribution to unsecured creditors, the administrator will place the company into voluntary liquidation to enable those funds to be distributed. Again, this is achieved simply by sending a notice to the Court and the Registrar of Companies.

The administration will automatically end 12 months after commencement. This period may, however, be extended for up to six months by consent of the creditors, or for a specified period by the Court.

Administrative Receiverships
The Enterprise Act 2002 is all about “collective” insolvency procedures, i.e. procedures where the office holder has regard for the interests of all classes of creditor. Administrative receivership is not, however, a collective procedure, since the administrative receiver is appointed by, and effectively working solely on behalf of, one creditor, the floating charge holder who appointed it.

The Act provides that floating charge holders who take out their security after the commencement of the Act will lose the right to appoint an administrative receiver. There are, however, exceptions to this restriction so that floating charge holders who took their security after commencement of the Act in specified circumstances, relating to transactions involving capital markets, public private partnerships, utilities, project finance and financial markets, retain the power to appoint. Similarly, any charge holders who took out their security prior to commencement of the Act will retain the right to appoint an administrative receiver.

Abolition of Crown Preference
The Enterprise Act 2002 abolishes the preferential status given to Crown creditors, although the preferential status of certain employee claims and contributions to occupational pension schemes is retained. However, such a change is, of itself, worthless if the order of priority set out in the Insolvency Act 1986 was merely applied without any change, since the assets previously available to the Crown would simply be distributed to the floating charge creditors.

To deal with this, a percentage of such assets will be ring-fenced for unsecured creditors. However, if the ring-fenced fund falls below a certain prescribed minimum, and the office-holder considers that the costs of distributing the fund would be disproportionate to the benefits, he/she is not required to make a distribution. The percentage, prescribed minimum and practical application of this change will be set out in secondary legislation, but the Government has already indicated that the prescribed minimum will be £10,000 and that a sliding scale of percentages will be used.

The abolition of Crown preferential status also applies in personal insolvency proceedings, and the third article in this series will consider the other main changes to such proceedings introduced by the Enterprise Act 2002.

Gareth Limb – Insolvency Compliance Manager, ACCA

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