Overview of Part 10 (Insolvency) and routes into administration

In a nutshell, the Enterprise Act 2002 (the "Act"):

• restricts the appointment of administrative receivers;
• abolishes Crown preference;
• provides for a prescribed part of floating charge assets to be made available to unsecured creditors;
• requires liquidators to seek sanction to bring voidable transaction and wrongful trading-type proceedings; and
• streamlines the administration procedure and makes it the rescue device of choice.

Restricting the appointment of administrative receivers

Holders of floating charges created on or after 15 September 2003 will no longer be able to appoint an administrative receiver unless these charges fall within a small number of fairly limited exceptions. The exceptions are: floating charges created before the Act comes into force, capital market arrangements, public-private partnerships, utility projects, project finance and financial market contracts and registered social landlords. The government wants to move away from administrative receivership which was perceived to be damaging the economy, and towards collective proceedings which are supposed to be for the benefit of creditors as a whole.

Abolishing Crown preference

For companies which go into receivership, administration or liquidation on or after 15 September 2003, monies owed to the Crown will no longer enjoy any preferential status. This means that unpaid NIC and PAYE, VAT and social security contributions will no longer enjoy any preferential treatment out of the insolvent company's assets, but instead will be treated the same as other ordinary unsecured debts. This is largely believed to be the quid pro quo for taking away the banks' rights to appoint administrative receivers. Preferential debts are not abolished altogether, because contributions to occupational pension schemes and remuneration of employees will still remain (subject to the existing defined limits).

Prescribed part of floating charge assets for unsecured creditors

Remembering that preferential creditors are paid out of floating charge assets in priority to the floating charge holder, the government did not want to give floating charge holders all the benefit of the abolition of Crown preference. It has therefore legislated to ring-fence a proportion of floating charge assets and make it a duty of the relevant officeholder to make them available to ordinary unsecured creditors. The percentage of floating charge assets comprising the prescribed part is 50% of net floating charge assets up to £10,000 and 20% over £10,000 subject to a maximum prescribed part of £600,000.[1] Pre-Enterprise Act floating charge holders may however benefit from a windfall because whereas the abolition of Crown preference will affect all insolvencies which commence on or after 15 September 2003 this ring-fence provision will only apply to floating charges created on or after 15 September 2003. Therefore secured creditors with floating charges created pre-Act, but which have lent to a company which becomes insolvent post-Act will benefit from the abolition of Crown preference, but not see a portion of their floating charge assets allocated to unsecured creditors. Enjoy it while it lasts.

Liquidators' powers

Under the Act, all liquidators (not only those of compulsory liquidations) will need to seek sanction (from the creditors' committee, creditors or court as appropriate) before bringing proceedings for wrongful or fraudulent trading, and the set of provisions used to attack voidable transactions (e.g. preferences and transactions at an undervalue). This provision is largely a tidying up exercise introduced following a string of cases such as Lewis v Commissioners of Inland Revenue (re Floor Fourteen Ltd)[2]. This, together with an amendment to rule 4.218 of the Insolvency Rules to make the costs of any related legal proceedings a liquidation expense, should remove the impediment liquidators experienced in bringing these types of proceedings. This should help to make these types of proceedings the deterrent they were intended to be.

Streamlining administration

In place of the old route into administration by petitioning the court, there will now be three entry routes:

• application to court by the company or a majority of its directors, or a qualifying floating charge holder or one or more creditors;
• out of court appointment by a qualifying floating charge holder; or
• out of court appointment by the company or a majority of its directors.

Click here to find out how to order our wall chart which sets out these entry routes into administration.

Despite the out of court entry routes, the administrator will remain technically a court-appointed officer. As before, administrators will have to be licensed insolvency practitioners.

The other area of major overhaul has been the purposes of administration. The old four purposes of administration have been replaced by one new purpose, comprising three objectives. But whereas the old four purposes were alternatives, in the new regime, the three objectives are structured in a fairly rigid hierarchy.

The first and primary objective is to rescue the company as a going concern. Notice that this does not necessarily mean rescuing the business as a going concern. It is the corporate entity which must be rescued. This may mean we see fewer business and asset sales and more companies in administration rehabilitating using company voluntary arrangements or section 425 Companies Act 1985 schemes. The second and third purposes are respectively:

• achieving a better result for the company's creditors as a whole than would be likely if the company were wound up (without first being in administration), or
• realising property in order to make a distribution to one or more secured or preferential creditors.

Only if the primary rescue objective is not reasonably practicable, or the administrator thinks that the second objective would achieve a better result for the company's creditors as a whole, can the administrator pursue the second objective (which might involve a business sale). And the third objective is one of last resort, to be used only if the administrator thinks that it is not reasonably practicable to achieve either of the first two objectives and, importantly, the pursuit of the third objective will not unnecessarily harm the interests of the creditors of the company as a whole.

Whatever objective the administrator ultimately pursues, he or she is required to carry out his or her functions as quickly and efficiently as is reasonably practicable and, save for third objective cases, in the interests of the company's creditors as a whole.

It remains to be seen how much court time is taken up debating the implementation of these objectives.

Only 8 weeks after appointment, the administrator must have sent out his proposals to creditors. The initial creditors' meeting must take place within 10 weeks of appointment unless the company's creditors will be paid in full, or if there are insufficient assets to make a distribution to unsecured creditors other than the ring-fenced prescribed part mentioned above, or if neither of the first two objectives (i.e. rescue and better result for creditors as a whole) can be achieved.

The form of the proposals are much more prescribed than currently. For instance, the administrator must address how the administration is likely to end, and if in a creditors' voluntary liquidation, the proposals must say who the liquidator will be, and give the creditors the opportunity to object. If subsequently there are any substantial revisions to the proposals, the administrator has to call another creditors' meeting to approve the revisions. One saving grace though, which may be useful for small insolvencies, is that creditors' meetings can be held by correspondence.

Another notable change from the existing administration regime is a new power to enable administrators to make distributions to creditors. This power can be used without sanction for distribution to secured and preferential creditors, but only with consent of the court for distributions to unsecured creditors. There are new administration set-off provisions contained in the new accompanying rules to go with the new power.

Gone, apparently, are the days of administrations which lasted over a decade. The new administrations will apparently be tied up in under a year, unless the creditors agree to extend the period by six months, or the court orders an extension for a specified period. Given the amount of work that needs to be done during that period, this part of the reform seems a little unrealistic, but time will tell.

Part 2 of this series will deal with the nine new methods of exiting administration and the issues they present both for insolvency practitioners and for creditors. For more information, please contact Inga West at inga.west@cms-cmck.com or on + 44 (0) 20 7367 3478 or Ashley Smith at ashley.smith@cms-cmck.com or on +44 (0) 20 7367 2154.

[1] Insolvency Act 1986 (Prescribed Part) Order 2003

[2] [2002 EWCA (1869, CA (20.12.2002)]