Reconciling international insolvency law

With many global businesses in turmoil, Richard Stewart examines the differences between US and UK insolvency proceduresGiven the current gloomy predictions about the global economy and the significant cross-investment between the UK and the US, lawyers on both sides of the Atlantic are facing the task of reconciling US and British principles of insolvency law on behalf of their international clients.One area likely to cause practitioners late-night headaches is melding together US chapter 11 and UK administration rescue packages into a coherent and effective whole.Superficially, the US chapter 11 procedure and UK administration appear to have much in common.

Both are intended primarily to provide companies with a safe haven from creditors and claimants by means of a court-imposed stay on proceedings and enforcement of security.During this period, assets can be liquidated or restructured in an orderly fashion, negotiations take place to satisfy pre-petition creditors, and possibly post-petition lines of credit are established.

At the end of the process, the company will either survive, or will go into liquidation.

However, apparent similarities between administration and chapter 11 proceeds are, on closer examination, deceptive.One striking difference between UK and US practice is reflected in the frequently used expression for chapter 11 proceedings, debtor in possession (DIP).

In the US, the pre-petition management remains in charge of the day-to-day running of the company.

In the UK, the administrator usually becomes the effective management and has the power to dismiss directors.

While the administrator has a right to delegate the exercise of the powers conferred by the Insolvency Act 1986, it is certainly open to question whether a wholesale handing back of the management to the pre-petition board of directors would find favour with most UK judges.

An exception is perhaps the case of companies operating in highly specialised areas beyond the commercial experience of most insolvency practitioners.Another vital difference is that so-called DIP financing is well developed in the US.

Lending institutions offering essential credit lines post-petition can relatively easily obtain enforceable super priority over all other secured and unsecured creditors.

The position is different in the UK.

To begin with, by virtue of section 9(3) of the Insolvency Act 1986, the holder of a debenture over all, or a substantial part, of the company's assets can block the appointment of an administrator by appointing an administrative receiver and refusing to consent to administration.

Assuming that hurdle is overcome, even if one succeeds in obtaining adequate security, the next obstacle to be encountered is that it is by no means clear that the security can be enforced during the administration in the event of a default.An administrator has the power to borrow and grant security on behalf of the company.

However, proceedings against the company and enforcement of security require the consent of the administrator or the leave of the court.

Some practitioners assume that these provisions of the Insolvency Act are directed to pre-petition creditors, but UK insolvency law, unlike legislation in the US, makes no formal distinction between pre-and post-petition creditors.Accordingly, if an administrator approaches a potential lender, then the issue arises whether that lender can rely on any covenant to pay, or enforcement of security during the moratorium imposed by section 11(3).

In the absence of any authority on the point, opinions among insolvency practitioners appear divided.

Some argue that by entering into such agreements, the administrator has in effect consented to proceedings and enforcement.

Others are of the view that the statute qualifies such obligations.One solution that has been proposed is for the administrator to give an express consent to enforcement.

However, there is a view that an administrator would be unwise, or even incapable of giving such a prospective consent.

In this case, the only sure means of obtaining an enforceable security is to obtain the administrator's personal liability for the debt.

Understandably, this is not something which administrators - or their partners - view with enthusiasm, even if the administrator can be confident that the assets available will meet his obligations as secured by the statutory charge.Another possible way around these difficulties is to bring the UK entities within the chapter 11 proceedings.

Various provisions of the Uniform Commercial Code allow US courts to take jurisdiction over foreign companies (for example, if the foreign entity has assets within the US jurisdiction), but it is a requirement that analogous insolvency proceedings are begun in the other jurisdiction.The benefit of this arrangement is that funds can be channelled to the UK entity through the US associated entities while still enjoying the benefits of US debtor in possession principles and super priority.

The only major potential drawback to this structure is related to security.

If the post petition creditors lend to a US entity that then lends on to the UK entity, the creditors cannot take direct security over the UK entity's assets.

They will either have to take a US security interest over the UK charge or else hope that the US basket of security assets is big enough to cover this aspect of the facility without recourse to the UK assets.Administration is still very much the Cinderella of the UK insolvency world and until these issues are satisfactorily resolved, large-scale administrations are likely to remain unattractive options.

It is to be regretted that the opportunity to introduce fully fledged DIP financing into UK law was not taken in drafting the Insolvency Act 2000.

Even more unfortunate is that the current law is unlikely to be clarified until considered at significant cost by the higher courts.

We still have a long way to go in the UK in developing a true corporate rescue culture.Richard J Stewart is counsel at Bryan Cave in London