The increase of insolvency cases has brought the United Kingdom’s bankruptcy laws into the limelight once again. Where a company falls into financial distress there are, broadly, three routes it can take: immediate liquidation, trading out of its difficulties, or a disposal of the assets. Unfortunately, the number of companies immediately entering liquidation has increased dramatically, leading to the UK ranking lower than previous years on the World Bank’s “ease of doing business” rankings. Insolvency practitioners have pointed out that companies are not using the debt restructuring mechanisms available under English law, namely “administration”. This is because the current regime is ineffective, outdated and in dire need of reform.
Administration is a procedure by which an external manager, an administrator, is appointed to manage the company. It is an insolvency procedure, which means the company can only make use of it to restructure its debts once the company is insolvent. The potential for early attention being given to the company’s financial difficulties is therefore diminished. The requirement to wait until the company is insolvent also gives rise to other problems. Jennifer Payne (Professor of Corporate Finance Law, University of Oxford) points out that entry into administration will generally trigger cross-default clauses or contractual provisions for acceleration of liability and termination of contracts. As if that wasn’t off-putting enough, the administrator sidelines the existing management of the company, presuming that the company has become insolvent due to poor management. The management is basically ignored. So much so that the proposals for achieving the purpose of the administration are prepared and submitted by the administrator rather than the directors of the company. Although a rational argument, the reality is that most cases of insolvency are a result of other issues rather than poor management. The directors are eager to keep the company prosperous as their jobs and reputation are at risk. Thus, in most cases, the directors may be in a better position to rescue the company as they are familiar with the know-how of the company. And the fact that administration demonstrates an unwillingness to interfere with the rights of creditors also deters directors from using administration. These are only a few of the problems associated with the current administration mechanism. The list goes on.
Surely with this many faults and the market crying for changes, one would imagine something to be done about this. Although talks of reform have been on the table for quite some time, the reality is that the UK Parliament has been busy with Brexit negotiations resulting in insolvency reforms going ignored. However, one need not look further to write up a proposal. Inspiration can be drawn from the United States. In the US, Chapter 11 (Chapter 11 of the Bankruptcy Code generally provides for reorganisation, usually involving a corporation or partnership), unlike the UK administration which is creditor friendly, is considered company friendly. The court-driven process allows the management, who are not sidelined, to focus on restructuring their debts without the fear of contract termination. The Chapter 11 Automatic stay is probably the strongest stay in the world, preventing creditors from taking their assets back. The incentive behind the stay and the Chapter 11 procedure is to keep the business running for as long as possible. And if we want our economy to prosper, companies need to get back on their feet in the early stages of financial difficulties. Chapter 11 makes this happen. Our debt restructuring mechanisms, administration in this case, are not as effective in saving the company. Introduced in 1985, with the intention to promote a rescue culture in the English market, administration does very little to help preserve the company. And with more and more companies on the road to liquidation, there has never been a more need of reform in this area.