Financial Restructuring and Transactions IFT Information Note: No Introduction to Insolvency Processes Schemes of Arrangement and COMI shifting

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1 INTRODUCTION This note is intended to act as an introduction to corporate insolvency procedures under the Insolvency Act 1986 (the Act ) (as amended by The Enterprise Act 2002) and otherwise together with schemes of arrangement under the Companies Act It is an outline only, and particular areas are covered in more detail in other notes. This note consists of three parts: Part One - The main Insolvency processes- which in England and Wales are Administration (where the company has a trading business) and Liquidation (where the company is being wound up after trading has ceased). IFT Members will probably encounter Administration in the context of a Pre pack which is also covered briefly in this note. This then leads on the a discussion of the ability to utilise English Insolvency processes (particularly pre pack administrations) through COMI shifting. Part Two- Compromises and Solvent Solutions Schemes of Arrangement and to some extent CVAs are tools that are used to deal with reluctant or hostile creditors or to affect a Cram down. Part Three The Archaic and Exotic Once the principal Insolvency regime receivership is now either used for property related assets or is becoming rarer with the passage of time. LPA or fixed charge receiverships are mainly limited to property. Administrative Receiverships as they require debentures from before 2003 are rare and are really historic. PART ONE THE MAIN INSOLVENCY PROCESSES ADMINISTRATION Administration under the Act existed before the Enterprise Act 2002, but has been simplified, streamlined and expanded to place a greater emphasis on the rescue of failing businesses. There are two routes into administration:- 1. An out of court appointment of administrators by (i) the holder of a qualifying floating charge (i.e. a charge over the whole or substantially the whole of the company s property) or (ii) by the company or its directors. The majority of out of court appointments are made by directors, in close liaison with the floating charge holder. It should be noted that due to recent case law there is considerable complexity over the appointment of an Administrator by a Company and specialist legal advice should be obtained in relation to any such appointment. 2. A Court appointment of administrators on the Application of the holder of a qualifying charge, a liquidator or by the company or its directors or creditors. The main use of the court based process is to obtain international recognition or to deal with winding up IFT Information Note Page 1 of 8

2 petitions as the court based process is more expensive and incurs the delay of a hearing compared to the form based out of court process. For a Court appointment to be made the company must be unable or unlikely to be unable to pay its debts. This is assessed on the usual cashflow and balance sheet tests. If a winding up petition is pending a floating chargee can still appoint out of court but all other types of appointment must go via the Court. Administration has a statutory purpose which must be satisfied. This purpose is threefold:- the rescue of the business as a going concern; if this is not possible, a better result for creditors than would be achieved on a winding up; and if neither of the above are possible the realisation of the company s assets for distribution to secured or preferential creditors. The role of the administrator is to achieve the statutory purpose acting in the interests of all creditors (and not simply to look after the interests of the appointor). The administrator has a duty to act quickly and efficiently. A statutory moratorium on enforcing legal process against the company will arise. This takes effect from the occurrence of:- notice of intention to appoint an administrator being filed at Court; notice of intention to appoint being (i) given by the holder of a qualifying a floating charge to the holder of a prior floating charge and (ii) filed at Court; or an application to Court for an administration order. IFT Information Note Page 2 of 8

3 An interim moratorium takes effect on the occurrence of the above event; the full moratorium comes into force on the making of an administration order or appointment of administrators. The effect is to stay any legal enforcement process against the company without court or the Administrator s permission. Any winding up proceedings will be dismissed once the administration starts. It is next to impossible to find out if an interim moratorium is on foot and great care is needed if one suspects it might be. PRE PACKAGED ADMINISTRATIONS IFT Members may encounter Administration in the context of a pre pack which is a way to deal with creditor cram down. Essentially the purchaser for the business is lined up before the company is placed into administration. The business is then sold by the Administrator for market value with the sale proceeds being distributed in accordance with the priority arrangement. The sale can be to an arm s length purchaser or to a purchaser which is controlled by the secured lender. If the sale is to a company owned by the secured lenders the effect is that they will own all the equity and have reduced to debt. The effect of this is to cram down all of the equity investors and the debt which is outside of the value break. Look at Note 127. Pre Packaged Insolvencies CHANGING JURISDICTION The advantages of administration (particularly pre packs to affect cram downs) have led to attempts by non UK corporates to utilise it by changing jurisdiction. This trend is also driven by administration being perceived as creditor friendly and the familiarity with the concept of UK based financiers. The ability to utilise administration is governed by the location of the companies Centre of Main Interest or COMI under the EU Council Regulation 2000 on insolvency proceedings (Insolvency Regulations) Ironically, one of the aims of the Insolvency Regulation was to prevent companies from transferring assets or judicial proceedings from one EU Member State to another in order to obtain a more favourable legal position on insolvency or forum shopping. The Insolvency Regulation provides that the courts with sole jurisdiction to open such main proceedings are those of the EU member state where the company has its COMI. As a result determining the COMI determines the applicable insolvency law. Given the differences between national insolvency laws, this can have a significant effect on secured creditors' rights. Determination of COMI The Insolvency Regulation provides (rather than a definition) that COMI is presumed to be at a company s registered office unless this presumption can be rebutted by factual circumstances. These factors must show the company s COMI or actual centre of management and supervision of its interests is located other than at its registered office. IFT Information Note Page 3 of 8

4 The Courts' approach to identifying COMI is that these factors must be ascertainable both objectively and to third parties, particularly creditors, dealing with the company and from information publically available. Internal factors relating to central management and control are relevant but not decisive. COMI migration As it is not possible to simply shift the COMI of a company by re-locating its registered office in distressed situation, it is the manipulation of the very factors that are used to ascertain COMI which are used to migrate COMI. The COMI migration is achieved by demonstrating that the place where the company conducts the administration of its interests on a regular basis, as ascertainable by third parties, is situated within the preferred jurisdiction. This is done by establishing the factors set out below in the preferred jurisdiction before commencing the preferred restructuring proceedings; the location of the debtor s headquarters; the residence of those who actually manage the debtor and the place where that management is conducted; the location of the debtor s primary assets; the location of the majority of the debtor s creditors or of a majority of the creditors who would be affected in the particular case; the jurisdiction whose law would apply to most contracts or disputes; the place where any negotiations with creditors are conducted; whether the debtor has notified creditors and / or publicised that its place of conduct of business has moved and / or is elsewhere than its registered office; where the debtor holds its principal bank accounts / manages its principal financing; and whether it has registered as a foreign company under the law of a domicile other than that of its registered office. As a consequence of this development a number of non-english companies have affected restructurings through the use of the cram down affected by pre pack administrations. Later in this paper this trend of England being a preferred restructuring destination is again shown by reference to schemes of arrangement. In the case of large companies, or listed companies, a Scheme of Arrangement under the Companies Act 2006 can also be used to effect a compromise with creditors or any class of them. LIQUIDATION IFT Information Note Page 4 of 8

5 There are 3 types of liquidation. A Members Voluntary Liquidation is a non insolvent dissolution of a company. A Compulsory Liquidation is the winding up of a company by its creditors. The Creditors Voluntary Liquidation is the shareholders deciding it is time for the company to go into liquidation and the creditors deciding the identity of the Liquidator. MEMBERS VOLUNTARY LIQUIDATION An MVL is a solvent winding up, often used as a tax efficient way to distribute a company s assets. The directors swear a statutory declaration that the company will be able to pay its debts in full plus interest for a specified period of up to a year. If the director s statutory declaration of solvency proves to be incorrect there is a possibility of personal liability for the directors. Thereafter a general meeting of the company is called at which the members resolve to wind the company up. A liquidator is appointed and winds up the company s affairs in the interests of creditors. After payment of debts and expenses, surplus assets or the proceeds of sale are distributed to members in accordance with their rights in set out in the company s Articles of Association. CREDITORS VOLUNTARY LIQUIDATION A voluntary liquidation is a CVL if it is not an MVL i.e. there is no statutory declaration of solvency there are two routes for a company to enter into a CVL:- the members (i.e. the shareholders whose names are in the register of members) resolve by simple majority to wind the company up; or the liquidator calls a meeting of the creditors of a company in an MVL when it becomes apparent that the company will be unable to pay its debts. PART TWO -COMPROMISES AND SOLVENT SOLUTIONS COMPANY VOLUNTARY ARRANGEMENTS A CVA is a proposal made by a company to its creditors (usually to pay less than the full amount due). It is made by the directors, an administrator or a liquidator. The insolvency practitioner will act as Nominee and call a meeting of creditors to consider the proposal. If it is approved by in excess of 75% of creditors by value, present or voting by proxy in favour it binds all unsecured creditors whether or not they received notice of the meeting. If the proposal is approved the nominee becomes supervisor of the CVA. The rights of secured creditors are retained. CVAs have been used to great effect with landlords in relation to large retail estates where the variation of the lease terms has been effected across the estate often against the back drop of the alternative being a pre-packaged Administration. SCHEMES OF ARRANGEMENT IFT Information Note Page 5 of 8

6 A scheme of arrangement is a compromise or arrangement between a company and its members and creditors (or any class of them) and can be used to effect a reorganisation of a company or group structure including merger and demerger. This has given rise to schemes being used in a large number of debt reduction strategies. One key feature of a Scheme is that it is not a formal insolvency process, a fact which makes their use more appealing to directors and sponsors wishing to avoid any perceived insolvency-related stigma. A scheme is in effect a court sanctioned statutory compromise and requires approval by at least 75% in value and majority in number of each class of members or creditors who vote on the scheme. So in effect the majority of the creditors or members in a class can drag along the minority of dissenting creditors in that class. The court s permission is required at the first hearing to convene the meetings of the various classes of creditors and members. The hearing effectively looks at the composition of the classes for voting purposes and its fairness. Meetings of creditors and members are then held as directed by the court usually on 21 days notice. If the necessary majorities of the members and creditors vote for the scheme the court will then at a second hearing sanction the scheme. This second hearing gives creditors and members the opportunity to object to the mechanics of the scheme implementation. The court will also consider whether the approved scheme is fair. If the court sanctions the scheme it will bind all the members or creditors of the affected classes. Schemes have caused great excitement in the restructuring world firstly due to the appetite of the English courts to recognise them in other jurisdictions and secondly due to their flexibility. The ability for EC member states to use schemes arises as schemes are not an insolvency process and therefore avoid the legislation which restricts insolvency based cram down remedies to the jurisdiction where the company s centre of main interests or COMI is located, as discussed above. The English courts have therefore sanctioned schemes involving a host of EC domiciled companies. The flexibility of schemes is demonstrated in them being used particularly effectively in dealing with hold out creditors within a class ( without the need for their individual consent) and also to take equity by overriding the any provisions contained in intercreditor agreements which would otherwise have blocked the proposed investment. Schemes can also allow a company whose business is being impaired by the existence of significant contingent claims (such as litigation relating to industrial injuries) to reach a binding, court-approved, compromise with those potential claimants, effectively ring-fencing the problem. PART THREE THE ARCHAIC AND THE EXOTIC LPA RECEIVERSHIP IFT Information Note Page 6 of 8

7 Fixed Charge Receivers originally arose out of the powers granted by the Law of Property Act 1925 ( LPA ) to secured lenders with the benefit of a mortgage over land to appoint a receiver. However now a fixed charge receiver can be appointed by the holder of a fixed charge over the assets covered by that charge.the powers of a fixed charge receiver derive from the LPA which entitles him to the rent and income from the land, but are supplemented by a whole host of powers contained in most modern charges. Perhaps most critically the power of sale must be included in the charge provisions. Some charges/mortgages also give a power to trade a business or deal with the asset in another way such as vote shares. A fixed charge receiver realises the property over which he has been appointed and pays the proceeds to the secured lender to satisfy the debt. Any surplus is paid to the next ranking charge holder or released to the borrower. The fixed charge receiver acts as agent for the borrower. It is important to note that the insolvency of the borrower is not required for a fixed charge receiver to be appointed. It is enough that the power to appoint has arisen under the mortgage or charge most usually through the occurrence of an event of default or failure to pay following demand. However, a turnaround professional needs to be aware that a lender with a fixed charge or mortgage over property or shares may take steps to enforce security before any formal insolvency proceedings if the company has missed payments or is otherwise in breach of the relevant loan agreement. This is most likely where the value of the assets exceed the amount due. Maintaining dialogue with the lender may go some way to preventing unpleasant surprises. Fixed charge receiver can be appointed to shares and therefore cease control of a group from the holding company. This is also something turnaround professionals should be alive to as this security structure is very common in groups with non UK subsidiaries. ADMINISTRATIVE RECEIVERSHIP An administrative receiver is appointed by the holder of a floating charge over the whole or substantially the whole of a company s property. To promote rescue culture the Enterprise Act 2002 provided that a secured creditor can only appoint an administrative receiver if the floating charge pre-dates 15 September 2003 (there are certain limited exceptions to this). The floating charge must empower the secured creditor to appoint a receiver upon the happening of specified events usually the occurrence of an event of default (as defined in the charge) or non-payment after demand. Unlike an LPA receiver an administrative receiver has extensive powers under the Act and effectively assumes control of the company s affairs. Like an LPA receiver an administrative receiver s primary duty is to his appointor and his principal concern will be to maximise the return to the secured creditor rather than to secure the rescue of the business. In the last few years administrative receiverships have become rare and are now usually only used when there are obvious tax advantages to be had (mostly to do with cut off dates for CGT and corporation tax). IFT Information Note Page 7 of 8

8 The liquidator winds up the company s affairs by realising the company s assets and paying debts. Any surplus is distributed to members. The rights of secured creditors are retained in a CVL. If sufficient creditors object to the members choice of liquidator they can vote him out of office at the first creditors meeting and appoint a person of their choice. COMPULSORY LIQUIDATION In compulsory liquidation a company s affairs are wound up by the court. A winding up petition may be presented by:- the company; its directors; one or more creditors; one or more shareholders; an administrator; or an administrative receiver, the official receiver or the Secretary of State (on public interest grounds). The main ground for presenting a petition is that the company is unable to pay its debts. Ability to pay is measured by the usual cashflow and balance sheet tests. A demand can be made on the company if it owes the creditor more than 750. The company has 21 days to satisfy the demand and if it fails to do so it is deemed insolvent. A demand is not a mandatory prerequisite and it is possible for a petition to be taken out in respect of an admitted debt without making any sort of demand. This can be a disaster for all. If a winding up order is made the business ceases to trade, directors powers and employment contracts are terminated. The liquidator realises the company s assets in the interests of all creditors. The rights of secured creditors are retained. All dispositions of assets made after the date of the petition (not the order!) are void. IFT Information Note Page 8 of 8