The Small Business, Enterprise and Employment Act - Corporate restructuring and insolvency changes come into effect

by Dentons

Four important changes to the Insolvency Act 1986 (IA86) will come into force this week (26 May 2015). They do so without transitional provisions and so will apply automatically to existing corporate insolvency proceedings (notwithstanding some lobbying to the government for transitional provisions to be introduced).

The driving force behind the Small Business, Enterprise and Employment Act (the Act) was to save costs, increase transparency and accountability, and remove red tape in many company law and related insolvency law matters.

The rationale behind the changes coming into force today is mainly to dispense with the need to go to court, thus reducing the costs of insolvency procedures and improving returns to creditors.

Other, potentially more far-reaching, changes will come into force in due course - many at the same time as the long-awaited modernisation of the Insolvency Rules (currently expected to be issued in April of next year). For more details see our Implementation Timetable.

1. Creditors can extend administration period for longer

S.127 of the Act has amended paragraph 76(2)(b) of Schedule B1 to the IA86 (Sch B1) to increase the period for which an administration can be extended by the consent of creditors from six months to one year.

Currently, administrations end automatically after 12 months but can be extended:

  • for a further six months by the consent of creditors; and
  • for a specified period by order of the court.

The new law increases to 12 months the period which creditors, by consent, can extend an administration.

Market commentary: Administration is intended as a dynamic rescue procedure. The costs of an administration usually increase the longer an administration goes on.  However, in more complicated administrations, 12 months isn't long enough. Where there were secured creditors, creditor extensions were commonplace; where not, the court list was getting clogged up with extension applications.

According to the Insolvency Service's Impact Assessment "Changes to the law governing insolvency proceedings" dated 26 February 2015 (the Impact Assessment):

  • around 80 per cent of administrations end within 18 months and 11.6 per cent between 18 months and two years; and
  • an administration extension application costs, on average, £5,000.

From these statistics, in up to 80 per cent of cases the six month extension was being used, but a further court extension was unnecessary. The changes might mean that, in the future, with the luxury of a 12-month automatic extension, administrations which may have ended at 18 months might run to 24 months. There may be a resulting increase in costs.

However, the new law will enable costs to be saved in those administrations necessarily lasting between 18 and 24 months, because it will avoid the expense of a court application. It will also save court time, freeing up space in an already busy list. There will be no additional cost for the administration in creditors approving a 12-month extension (as opposed to six), as the process by which creditors consent to the extension has not been changed.

The new law endeavours to strike a balance between encouraging a swift resolution to the procedure and acknowledging the reality that, in many cases, 18 months isn't quite long enough. BIS estimate in its consultation, "Red Tape Challenge - changes to insolvency law to reduce unnecessary regulation and simplify procedures" that this measure will result in savings of approximately £0.98 million per annum.

2. Administrators can distribute prescribed part without court's approval

Paragraph 65(3) of Sch B1 has been amended, creating a carve out from the usual restriction placed on administrators making distributions to unsecured creditors without court approval.

According to the Impact Assessment, the Insolvency Service regards payments from the prescribed part as routine, and that permission from the court is unnecessary. The Insolvency Service has also stated that the cost benefits from this carve out have not been quantified, as it may already be common practice for administrators to distribute the prescribed part without the court's approval due to an element of ambiguity in the current legislation.

Market commentary: It is interesting to note that the Insolvency Service considers prescribed part payments as routine as opposed to ordinary distributions to unsecured creditors, which are arguably also routine. It could even be said that the conflict created by the limited pool available for distribution to prescribed part creditors (up to a maximum of £600,000) on the one hand, and the costs of distribution on the other, means that such distribution is not routine at all. This can be seen from the cases regarding applications for the court to disapply the prescribed part on the basis that the cost of making a distribution would be disproportionate to the benefits.

Some practitioners may also be surprised to observe that the Insolvency Service considers the current legislation to be ambiguous and therefore that practitioners have been distributing the prescribed part whilst in administration without the court's permission. There is no explanation about where this ambiguity comes from. It might be that certain administrators have relied upon paragraph 66 of Schedule B1 which provides that administrators may make distributions despite the restriction contained in paragraph 65(3) of Sch B1 if it is likely to assist achievement of the purpose of administration. However this provision is most commonly used as the basis for making ransom payments to critical suppliers.

Notwithstanding the above, and whilst the cost saving benefits cannot be quantified, this amendment at the very least clarifies the position for administrators in respect of distributing the prescribed part without the need for court approval.

3. Administrators cannot put company into CVL if just to distribute the prescribed part

As a result of clarifying that administrators can distribute the prescribed part without court approval, paragraph 83(1)(b) of Sch B1 has been amended to prohibit administrators from using a CVL solely for prescribed part distributions.

Market commentary: Avoiding the need for exit from administration via a CVL clearly has a cost savings benefit in respect of administrations which post-date the coming into force of this amendment. However, without transitional arrangements, this change may have an impact on existing administration proposals which state that CVL is the proposed exit route but where the move to CVL will not take place before 26 May 2015. The costs implications can be seen as follows:

  • although usually proposals will contain an alternative exit route, any late change in strategy may have cost implications; and
  • where there is no alternative exit route, administrators will need to amend the proposals pursuant to paragraph 54 of Sch B1. This will require a creditors' meeting to be called, however the costs of such may be limited if approval for revised proposals is done by way of correspondence instead of a creditors' meeting pursuant to paragraph 58 Sch B1. The costs implications cannot be overstated, however, since one would expect some sort of communication to be sent to creditors in any event where a distribution is to take place, and the two may be combined.

In summary, for any existing administrations where CVL is the proposed exit route and the only distribution to unsecured creditors is by way of the prescribed part, the likely costs of administrators changing their plans now from what was originally in their proposals may outweigh the costs saving of this amendment.

4. Liquidators and trustees in bankruptcy don’t need the court's sanction to exercise certain powers

Sections 165, 167 and 314 of the IA86 have been amended to allow liquidators and trustees in bankruptcy to exercise any of the powers set out in parts 1 to 3 of Schedule 4 to the IA86 and parts 1 and 2 of Schedule 5 to the IA86 without sanction. Such powers include the power to bring legal proceedings relating to property comprised in the liquidation or bankruptcy estate.

In bankruptcies and compulsory windings up, sanction is required from the creditors committee, or, where there is none, from the Secretary of State or the court. Creditors committees are uncommon, so sanction is normally sought from the Secretary of State or the court, the application to court being most costly. In CVLs sanction may be obtained from the creditors committee, the court, or the creditors in a general meeting. In the absence of a committee, the least costly of these measures is to hold a general meeting of creditors.

The requirement for sanction exists to protect the insolvent estate and ensure that the officeholders act in the best interests of the creditors as a whole. However, in practice, the actual process of obtaining sanction imposes a burden on the officeholder that adds no practical value to the administration of the liquidation or bankruptcy. In the circumstances, the changes to the requirements for sanction are welcomed.

The removal of the requirement to obtain sanction brings the provisions for liquidations and bankruptcies in line with administrations.

Market commentary: According to the Impact Assessment, the total savings from the changes introduced in this area are likely to amount to £1,396,574. The requirement for sanction covered a broad range of powers, and it was therefore common for an officeholder to require sanction during the administration of liquidations and bankruptcies. The direct beneficiaries of the changes are officeholders, who will no longer be required to incur the cost of seeking a sanction, which will also directly lead to increased realisations in the estate for distribution.

For changes relating to personal insolvency, also coming into force today, see our Implementation Table.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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