1 BRIEFING PAPER Number CBP04915, 12 April 2016 Company administration By Lorraine Conway Inside: 1. Over view 2. The administration procedure 3. Advantages and disadvantages 4. What is a pre-pack? 5. Will administration be recognised internationally?
2 Number, 7 April Contents Summary 3 1. Over view What is company administration? What is the purpose of the administration? 4 2. The administration procedure Routes into administration Moratorium The role of an Administrator Payments by the Administrator Effect of administration on employees What will happen at the end of the administration? Advantages and disadvantages What is a pre-pack? Will administration be recognised internationally? 15 Cover page image copyright: Money UK British pound coins by hitthatswitch. Licensed under CC BY 2.0 / image cropped.
3 3 Company administration Summary Insolvency arises when individuals or businesses have insufficient assets to cover their debts, or are unable to pay their debts as and when they fall due. Administration is a legal process. At its heart, it is a company rescue procedure. When an administration order is in place, a moratorium protects the company from legal actions, whilst a survival plan or an orderly wind down of the company s affairs is being achieved. The administration procedure has been extensively reformed since the Enterprise Act 2002 came into force in September 2003, with the aim of making it a more efficient process. In recent years, company administrations (in particular pre-packs) have been in the limelight due to the large number of high-profile administrations on the high street. This Commons briefing paper provides an outline of the main characteristics and objectives of the administration process, including pre-packaged administrations, and the distinctive role of the Administrator. It also highlights why, in certain circumstances, administration can be an important company rescue insolvency procedure. This paper applies to England, Wales and Scotland.
4 Number, 7 April Over view 1.1 What is company administration? Insolvency arises when individuals or businesses have insufficient assets to meet all their debts, or are unable to pay their debts as and when they fall due. It is the company directors responsibility to know whether or not the company is trading whilst insolvent and they can be held legally responsible for continuing to trade in that situation (the offence of wrongful trading). Depending on the circumstances, there are various insolvency procedures open to an insolvent company (see Box 1 below). Box 1: What insolvency procedures may be open to an insolvent company? These fall into six main categories. The first four provide the potential for the rescue of the company or its business, while the last two do not: Administration Company voluntary arrangements Scheme of arrangement Administrative receiverships Compulsory liquidations Creditors voluntary liquidations Company administration is one of a number of formal insolvency procedures. Administration can provide a viable company, in financial difficulty, with a breathing space in which to restructure and rescue the business. It involves the appointment of an Insolvency Practitioner, called an Administrator, who works with the company to put together proposals to rescue the company. The Enterprise Act 2002 (EA 2002) introduced a much simpler procedure for obtaining an administration order. The Government s intention was to encourage a rescue culture. 1.2 What is the purpose of the administration? The EA 2002 sets out a hierarchy of statutory objectives for a company administration. In brief, an Administrator (a licenced Insolvency Practitioner) must perform his functions with the objective of: Rescuing the company as a going concern (i.e. with as much of its business as possible); or failing that
5 5 Company administration Achieving a better result for the company s creditors as a whole than would be likely if the company were wound up (liquidated) (without first being in administration); or failing that Realising (i.e. selling) company assets in order to make a distribution to one or more secured or preferential creditors. The Administrator must perform these functions in the interest of the company s creditors as a whole. In effect, the administration procedure is designed to hold a business together while plans are formed to put in place a financial restructuring to rescue the company as a going concern if possible. If the business cannot reasonably be saved, the second objective is for the administrator to perform his functions with the aim of achieving a better return for creditors than would be achieved in liquidation. For example, a better return may result from trading on for a period whilst seeking to sell off the business and or assets. Where neither of these objectives can be achieved, administration can also be used simply as a mechanism to liquidate assets and distribute the proceeds to secured or preferential creditors. In all cases, the administrator is required to act in the best interests of the general body of creditors. There are various circumstances when administration may be useful, including, where: The company is facing severe cash-flow pressures but there is still a good business to preserve. There is a requirement to quickly sell on the business of a technically insolvent company. Creditors are not willing to agree to an alternative course of action (such as restructuring) or agreement is not possible within a manageable timescale. It is important to note that whilst in administration the company can continue to trade.
6 Number, 7 April The administration procedure 2.1 Routes into administration There are three entry routes into administration. An Administrator can be appointed by: the company or its directors (through a simple out-of-court procedure); or a secured creditor (specifically, a qualifying floating charge holder); or an order of the court (following an application to the court by an unsecured creditor) The first two options allow for the out-of-court appointment of an Administrator (i.e. without a court hearing), provided certain conditions are met. 1 In respect of the first option, a company, acting either through its directors or shareholders (in both cases by passing a valid resolution in accordance with the company s articles) can use a simple out-of-court procedure to appoint an Administrator. However, this would only be appropriate if the company is close to insolvency (but is not already subject to a winding up petition or in liquidation) and has not already been in administration or a Company Voluntary Arrangement (CVA) within the previous 12 months. The company must first give 5 day s prior notice to any qualifying floating charge holder. 2 Out-of-court procedure (i.e. without a court hearing) Appointment of an Administrator initiated by the company In respect to option two, an Administrator can be appointed by a qualifying floating charge holder, 3 following an out-of-court procedure, but only if 2 day s prior notice is given to any holder of prior qualifying floating charge. The company must be in default of the terms of the charge. Appointment of an Administrator initiated by a qualifying floating charge holder 1 Without a court hearing, a simple notice of appointment and statement of opinion by the proposed Administrator (an Insolvency practitioner) needs to be filed at court 2 A qualifying floating charge holder is any creditor holding a floating charge over substantially all of the company s assets, which explicitly allows the creditor to appoint an administrative receiver or, where the charge specifically states that it is a qualifying floating charge, entitling the holder to appoint administrators. 3 A floating charge is taken over all the assets or a class of assets owned by a company from time to time as security for borrowings or other indebtedness. The advantage of a floating charge is that before insolvency it allows the charged assets to be bought and sold during the course of the company s business without reference to the chargeholder. The floating charge is said to crystallise if there is a default. At that stage, the floating charge is converted to a fixed charge.
7 7 Company administration An application can also be made to the court for the appointment of an Administrator by any other creditor (i.e. an unsecured creditor) but a court hearing will be necessary. 4 An application can also be made to the court by a Liquidator; effectively to replace liquidation with administration. Again, there would be a court hearing. 2.2 Moratorium The administration process includes a statutory moratorium, preventing creditors from taking certain enforcement actions (see Box 2 below). This is intended to provide the Administrator with a breathing space, freeing them from creditor pressure, giving them time to formulate proposals, lay them before the creditors and implement those which are approved. This moratorium on insolvency and on other legal proceedings against the company, is sometimes referred to as a protective cloak. Court application for the appointment of an Administrator by an unsecured creditor or the Liquidator The appointment of an Administrator protects the company from other insolvency procedures and stops creditors taking action against assets Box 2: Moratorium in company administration The administration procedure includes a moratorium; it suspends the power of creditors to take certain actions against the company in administration or its property. Specifically, the moratorium prevents the following, unless the Administrator or the Court agree that such actions can be taken: the enforcement of security over the company s property (except in certain specified circumstances under the Financial Collateral Regulations); the repossession of goods in the company s possession under a hire purchase agreement (which term includes retention of title provisions); a landlord s right of forfeiture by peaceable re-entry; the appointment of an administrative receiver; and any legal process (including legal proceedings, execution, distress and diligence) against the company or its property 4 To apply to the court for the appointment of an Administrator requires an affidavit from the party requesting the order, setting out details about the company, with an outline of what is proposed, together with a statement of opinion from the proposed Administrator that the purpose of administration is likely to be achieved.
8 Number, 7 April The role of an Administrator Once in administration, the company is placed under the day-to-day control and management of the administrator. The legal purpose of administration is to achieve any one of three objectives, which need to be addressed in this strict order of priority: Rescuing the company as a going concern. Achieving a better result for the company s creditors as a whole than would be likely if the company were in liquidation. Realising property in order to make a distribution to one or more secured or preferential creditors. The Administrator must give consider the first objective and can only pursue the second or third objective once he is satisfied that the first objective is no longer practical or possible. As an officer of the court, the Administrator is legally required to carry out his function in the best interests of the creditors as a whole. The Administrator has wide powers. In outline, his role is as follows: It is the Administrator s responsibility to formulate proposals and present these to the creditors to vote on. It is not unusual for proposals to include a voluntary arrangement or a compromise with creditors. The Administrator will prepare his formal proposals for achieving the purpose of the administration within 8 weeks and has a further 2 weeks to convene a meeting of creditors to consider them. If creditors agree, it is possible to dispense with a creditors meeting and instead pass resolutions by way of correspondence. If a meeting of creditors is called, details will be sent with the Administrators proposals. The purpose of the meeting is to allow the creditors to consider and vote on the Administrators proposals. The meeting can also elect a committee of between 3 and 5 creditors representatives to assist and oversee the Administrators. The proposals are approved if a majority in value vote in favour. Where the Administrator believes there will be no funds for unsecured creditors, the preferential 5 and secured 6 creditors only approve his proposals. There is no creditor meeting if there is not going to be a dividend paid to the unsecured creditors. It is important to note that the company can continue to trade whilst in administration. 5 In insolvency, preferential creditors are those creditors whose claims rank in priority to other unsecured creditors and floating charge holders (Schedule 6 and sections 175 and 386 of the Insolvency Act 1986 (as amended). They include certain employee claims and contributions to pension schemes. 6 A secured creditor is generally a bank that holds a fixed charge over a business asset or assets. When a business becomes insolvent, sale of the specific asset over which security is held provides repayment for this category of creditor.
9 9 Company administration Administrators are licenced Insolvency Practitioners. If found by the Court to have acted improperly he/she may be made liable for misfeasance. If the Administrator is judged to have acted improperly by his professional body, he/she will be subject to that body s disciplinary proceedings. An Administrator is required to act in the best interests of the general body of creditors 2.4 Payments by the Administrator If there is a sale of all or part of the company s business, Administrators can elect to distribute the proceeds which they have realised to the company s creditors, although they may decide to transfer the proceeds to a Liquidator, who would then deal with the distribution process. In either case, the Administrator or Liquidator is under a duty to make such distributions in accordance with the following statutory order of priority: Secured creditors (i.e. those who have taken security for the debt via fixed and floating charges); Preferential creditors; Unsecured creditors; and Shareholders / members Secured creditors have a fixed charge over a specific asset (such a land, a building, or machinery). The secured creditor will be paid out of the proceeds from the sale of those specific assets, after the costs of realisation have been deducted. When they have a floating charge over an asset, the secured creditor will be paid out of the realisations from those assets, after the costs of realisation, the preferential creditors have been paid in full and the prescribed part (see below) has been set aside (see below). Preferential creditors are unsecured creditors who rank ahead of all other creditors when realisations are achieved from assets where there is no fixed charge registered. Preferential creditors primarily consist of employees for arrears of wages, accrued holiday pay, unpaid contributions to occupational pension schemes and state scheme premiums, all within certain limits. Unsecured creditors are all other non-secured and non-preferential creditors. These are usually the normal trade creditors (i.e. those who have provided goods or services to the business). They rank below Preferential and Secured creditors, with the exception of when the prescribed part is applicable (see below). Trade suppliers often want to take away goods they supplied to the company before it went into administration for which they have not been paid. Usually, they are not entitled to take away these goods until the Administrators have determined retention of title issues (i.e. legal ownership). This involves a process of identifying the stock and reviewing the supply terms. Secured creditors Preferential creditors Unsecured creditors
10 Number, 7 April All unsecured liabilities arising out of obligations incurred before the date of the administration will rank pari passu (i.e. ranking equally) with each other. Shareholders / members will be the last class of creditor to receive a distribution and they will only receive a distribution after everyone else has been paid in full. The prescribed part is a technical provision introduced by the Enterprise Act When a secured creditor has a floating charge registered after 15 September 2003, a proportion of the funds available to them is set aside for distribution to unsecured creditors. This is the prescribed part. 7 Insolvency legislation sets out how the prescribed part is calculated. Shareholders What is the prescribed part? It is important to note that expenses of the administration have priority over other claims except for those of fixed chargeholders. Although the administrator does not assume personal responsibility for contracts entered into on behalf of the company, any liability incurred under a contract entered into whilst the company is in administration will be payable as an expense of the administration. Once a company has gone into administration, creditors are understandably anxious about when they will be paid. The administration process is complex and each case is unique. It obviously takes time to assess the company s position and provide an estimate of the amount or timing for reviewing creditors claims and making a distribution. In most cases, the Administrators will include an update of dividend prospects and, if possible, a timeframe in their proposals and reports. 2.5 Effect of administration on employees If a company in financial difficulty is put into liquidation, then its employees will obviously be made redundant. The company will no longer exist. However, if instead the company is put into administration, then the business (either in whole or in part) may carry on as a going concern and some jobs may be saved. If the Administrator can find a buyer to take over all or part of the business as a going concern, then jobs may be saved. Employees may be transferred to the buyer with their rights protected under special rules that apply to transfers of undertakings 7 In respect of administrations where there are pre 15 September 2003 floating charges, there is no prescribed part
11 11 Company administration 2.6 What will happen at the end of the administration? The Administrator is expected to act quickly and efficiently. In any event, administration automatically ends after 12 months, unless extended by the court or creditors. At the end of the administration, there are various options as to what could happen to the company. It may have: been restored to solvency, perhaps through a Company Voluntary Arrangement (CVA) 8 ; been placed into liquidation normally with the Administrator acting as Liquidator; or, if the Administrator finds he is only able to distribute funds to secured and/or preferential creditors, he can arrange for the company to be dissolved Administration will automatically end after 1 year, unless extended by the court or creditors. In other words, in certain circumstances, administration can be effective in enabling a viable business to survive financial difficulties. 8 A Company Voluntary Arrangement (CVA) is a legal procedure that enables a company to enter into a binding agreement with its creditors detailing how the company s debts and liabilities will be dealt with, and allows the directors to retain control of the company
12 Number, 7 April Advantages and disadvantages Advantages of company administration: Administration can be quick to initiate, especially through the outof-court procedure. Administration offers a moratorium on creditor action. Administration can save a viable company in financial difficulty (perhaps by giving the company a breathing space in which to devise CVA proposals). An Administrator has wide powers to trade on or sell the business as a going concern without the liabilities. A pre-packaged administration can be used to complete sale negotiations begun by the directors or the proposed Administrator prior to the administration. Subject to the agreement of creditors, the administration procedure allows for the restructuring of the company, rescuing the business and preserving jobs. Disadvantages of company administration: The court petition process is subject to the timetable of the court. Eligible floating charge holders have a right to appoint their choice of Administrator. The process can result in a discount on asset values. Trading in administration will involve additional professional costs.
13 13 Company administration 4. What is a pre-pack? A pre-packaged administration (known as a pre-pack) is where an agreement to sell the assets of a failed company is agreed prior to the company going into formal insolvency, and is then usually completed almost immediately after the appointment of the Administrators. When a business needs to be rescued there are often worries about maintaining value both for existing creditors and for prospective purchasers trying to re-start the business. As a result, the practice of pre-packaging the administration process has developed. In a pre-pack a company is placed into administration and the business is sold shortly after the appointment of the Administrator. Often, the insolvency practitioner, the directors and the bank will have obtained valuations, agreed a sales price and drafted contracts to enable the business to be sold immediately after appointment. The purchaser may be new to the company or a competitor but it is also possible that the purchaser may be the existing management. A pre-pack can be an effective way to save a business, but care must be taken to deal with creditor concerns When used appropriately, pre-pack administration can be an effective company rescue procedure. Pre-packs enable the sale of company assets to be undertaken quickly (reducing the likelihood of important contracts being lost), preserving the brand and the value of the business and, ultimately, returns for creditors and jobs. However, there have been concerns about the transparency of the pre-pack administration procedure, in particular: Where businesses are sold to connected parties (i.e. directors, shareholders and others connected with the insolvent company) Possible conflicts of interest for the insolvency practitioner (for instance, when appointed by the floating charge-holder) A lack of involvement of unsecured creditors To address these concerns, a Statement of Insolvency Practice (SIP 16) was issued in January 2009 (and periodically updated), with additional measures being introduced on 31 March The current SIP 16 came into force on 1 November One of the requirements of SIP16 is that Administrators are required to report the full facts of the pre-pack transaction to creditors within 7 days of the transaction taking place.
14 Number, 7 April Following the publication of a Select Committee report in February 2013, 9 the Government announced in July 2013 an independent review of the pre-pack procedure. The Graham Review into Pre-Pack Administration 10 was published in June 2014 alongside Pre-Pack Empirical Research: Characteristic and Outcome Analysis of Pre-Pack Administration 11 by the University of Wolverhampton. In response to the six recommendations made in the Graham report, the Government said it would work with business and industry to implement these recommendations in full. One of the key recommendations of the Graham report was that a pool of independent experts be set up in order to assess and give an opinion upon a proposed pre-pack sale to a connected party, but only if requested to do so by the connected party. On 2 November 2015, the Pre-Pack Pool became operational. The Small Business Enterprise and Employment Act 2015, which received Royal Assent on 26 March 2015, implemented another Graham recommendation, creating a reserve power for the Secretary of State to legislate if necessary. 9 House of Commons Business, Innovation and Skills Committee, The Insolvency Service, Sixth Report of Session , Evidence 67, [HC 675], 6 February 2013, [online] (accessed 7 April 2016) 10 Graham Review into Pre-pack Administration Report to The Rt. Hon Vince Cable MP, Teresa Graham CBE, June 2014, [online] (accessed 7 April 2016) 11 Pre-pack Empirical Research: Characteristic and Outcome Analysis of Pre-pack Administration Final Report to the Grahame Review, prepared by Professor Peter Walton and Chris Umfreville with the assistance of Dr Paul Wilson, University of Wolverhampton, April 2014, [online] (accessed 7 April 2016)
15 15 Company administration 5. Will administration be recognised internationally? Within the EU, company administration is usually recognised automatically under the EC Regulation on Insolvency Proceedings. 12 It should be noted that this Insolvency Regulation is to be replaced by Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings (recast) (known simply as the Recast Insolvency Regulation ). The Recast Insolvency Regulation will apply to insolvency proceedings commencing on or after 26 June Outside the EU, where a jurisdiction has adopted the UNCITRAL Model Law on Cross Border Insolvency, company administration will usually be recognised (although in practice much would turn on the implementing legislation). In other cases, there may be a treaty governing insolvency matters between the UK and the other jurisdiction. If all else fails, it will be a matter of local law as to whether the administration is recognised. 12 Council Regulation (EC) 1346/2000 on Insolvency Proceedings (Insolvency Regulation)
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