Insolvency: the low-down on reform

Vernon Dennis and Alexander Fox discuss how insolvency legislation will be affected by the Enterprise Act 2002

Several issues relating to corporate insolvency reform are explored by the Enterprise Act 2002.

This huge piece of legislation, consisting of 281 sections and 26 schedules, also deals with such diverse areas as competition, fair trading, and consumer affairs.

The changes relating to corporate insolvency reform are likely to be introduced after April 2003.

These are:

- Abolition of Crown preference.

The preferential status of debts owed to the Inland Revenue and Customs & Excise is removed.

However, it should be noted that preferential creditors do not disappear entirely, with certain categories remaining (for example, employee claims and the Crown's subrogated rights in respect of salary and wages).

- A share of assets for unsecured creditors.

The abolition of Crown preference will not provide a complete windfall to floating chargeholders.

Instead, a prescribed amount (as yet to be determined) will be made available from floating charge realisations for unsecured creditors.

- The restriction of administrative receivership.

After the start of the Act, a floating chargeholder will only be able to appoint an administrative receiver in certain prescribed specialist areas (for example, capital markets) or pursuant to a loan contract and floating charge created before the start of section 250 of the Act.

- A revised administration procedure has been introduced, whereby an administrator may be appointed by court order or out of court by either a floating chargeholder or the company and/or its directors.

The Act provides for a single purpose for administration, which is intended to place greater emphasis on company rescue.

An administrator must perform its functions with the objective of: (a) rescuing the company as a going concern, or if the administrator thinks this is not reasonably practicable, or it is in the interests of the creditors as a whole; (b) achieving a better result for the company's creditors as a whole than would be likely if the company were first wound up, or if the administrator thinks neither (a) or (b) is reasonably practicable, (c) realising property to make a distribution to one or more secured or preferential creditors, without unnecessarily harming the interests of other creditors.

The process is speeded up, with a statutory duty placed on the administrator to perform his functions as quickly and efficiently as reasonably practicable.

As well as providing a quicker out-of-court route for appointment, proposals should be put to creditors within eight weeks and a creditors' meeting held within ten weeks of appointment.

The administration should proceed for a maximum of 12 months.

These time limits may be extended by creditor consent (for certain limited periods) or by court order.

It should be noted that the floating chargeholder will possess an effective veto over the choice of administrator and may still appoint in circumstances (out of court) even where the company is not insolvent, provided such power is contained in the charge documentation.

While appearing radical, the reforms perhaps do not signify the great shift in power from floating chargeholders that was first anticipated.

There are also issues relating to personal insolvency reform which are likely to be introduced after April 2004:

- Duration of bankruptcy.

In most cases, an individual will be discharged from bankruptcy no later than 12 months after commencement.

The official receiver may file a notice at court, effecting earlier discharge once his investigations are completed, or if thought unnecessary.

- Bankruptcy restriction orders.

To counteract the perceived liberalisation of bankruptcy regime, certain 'culpable' bankrupts whose conduct is such that some court sanction is thought appropriate will be subject to a new bankruptcy restriction regime.

The effect of a bankruptcy restriction order is to extend the restrictions of the bankruptcy for a period of between two and 15 years.

The procedure will be similar to Company Director's Disqualification Act proceedings and agreed undertakings may be given, replacing the need for a hearing.

- 'Sunset provision'.

To counter a perceived injustice, a late amendment to the Enterprise Act, dubbed the 'sunset provision', was introduced.

This provision provides that the trustee in bankruptcy must take steps to realise the bankrupt's interest in the principal residence of the bankrupt, bankrupt's spouse or former spouse within three years (calculated from the date of bankruptcy), otherwise it will cease to form part of the bankrupt's estate and automatically revert back to the bankrupt.

A further amendment provides that where the trustee in bankrupt's interest is below a certain prescribed value (as yet to be determined) proceedings will be dismissed.

During the Parliamentary debates, a figure of 5,000 was suggested, and it was made clear that proceedings should be dismissed if the return is only likely to cover professional fees.

- New fast-track individual voluntary arrangement (IVA) procedure.

To encourage greater debtor rehabilitation and a better return to creditors, a new procedure seeks to encourage bankrupts to enter IVAs post-bankruptcy.

The IVA will be run by the official receiver who will put the bankrupt's written proposal to the creditors, who will have the option of acceptance or rejection.

If accepted, the bankruptcy order will be annulled.

- Revised income payment order procedure.

Payments made by a bankrupt whose level of income exceeds that required for his reasonable needs and that of his family will continue after discharge, for a total of up to three years from commencement of the date of bankruptcy.

Income payment agreements can also be entered into, avoiding hearing.

- Bankruptcy restriction amendments.

The restrictions on bankrupts holding certain public offices have been liberalised in a further attempt to reduce the stigma of bankruptcy.

There is concern that liberalisation of the bankruptcy regime will encourage a rise in bankruptcy levels.

In the White Paper proceeding the Act, the government stated a belief that only 7% to 12% of all bankrupts were in any way culpable.

Consequently, the vast majority are likely to be released from bankruptcy, possibly within a period of six to eight weeks.

As the penalty of a bankruptcy restriction order will have greater impact on trade debtors rather than consumers, most bankrupts will be unconcerned with this measure.

Furthermore, a consumer may place little value on receiving an annulment of bankruptcy (following a fast-track IVA).

In the US, where there is a similar liberal regime, about 1.5 million individuals enter bankruptcy each year.

If this rate were followed in the UK, there would be a rise in bankruptcy orders from 25,000 to 300,000, the social and economic cost of which would be significant.

Vernon Dennis is a partner and Alexander Fox is a senior solicitor at London-based Manches.

They are co-authors of The New Law of Insolvency: Insolvency Act 1986 to Enterprise Act 2002, published by Law Society Publishing this month.

The book deals with legislative reform affecting insolvency law and practice since 1986, including the present Enterprise Act reforms.

It can be ordered from Marston Book Services, tel: 01235 465 656, at 49.95 plus 3 postage and packing