Insolvency Oracle

Developments in UK insolvency by Michelle Butler


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The Future is… Complicated

 

 

1933 Yosemite

My autumn has been a CPE marathon: SWSCA, the R3 SPG Forum, the IPA roadshow, and the ICAEW roadshow. Thus I thought I’d try to summarise all the legislative and regulatory changes currently in prospect:

Statutory Instruments

  • Enterprise & Regulatory Reform Act 2013;
  • Deregulation Bill (est. commencement: May/October 2015);
  • Small Business, Enterprise and Employment Bill (October 2015 for IP regulation items, April 2016 for remainder);
  • The exemption for insolvency proceedings from the Legal Aid, Sentencing and Punishment of Offenders Act 2012 (“LASPO”) comes to an end on 1 April 2015;
  • New Insolvency Rules (est. to be laid in Parliament in October 2015, to come into force in April 2016); and
  • A plethora of SIs to support the Bankruptcy and Debt Advice (Scotland) Act 2014 (coming into force on 1 April 2015, but, regrettably, I feel so out of the loop on Scottish insolvency now that I don’t dare pass comment!)

Consultation Outcomes

  • IP fees (consultation closed in March 2014);
  • DROs and threshold for creditors’ petitions for bankruptcy (consultation closed in October 2014); and
  • Continuity of essential supplies to insolvent businesses (consultation closed in October 2014).

Revision of SIPs etc.

  • Ethics Code Review;
  • SIP 1;
  • SIPs 16 & 13;
  • SIP 9 (depending on how the government turns on the issue of IP fees);
  • New Insolvency Guidance Paper on retention of title; and
  • Other SIPs affected by new statute.

 

Enterprise & Regulatory Reform Act 2013

The Insolvency Service’s timetable back in 2013 was that the changes enabled by this Act would be rolled out in 2015/16, but I haven’t heard a sniff about it since. However, the following elements of the Act are still in prospect:

  • Debtors’ bankruptcy petitions will move away from the courts and into the hands of SoS-appointed Adjudicators (not ORs).
  • There was talk of the fee being less than at present (£70 plus the administration fee of £525) and of it being paid in instalments, although my guess is that the Adjudicator is unlikely to deal with an application until the fee has been paid in full.
  • The application process is likely to be handled online. Questions had been raised on whether there would be safeguards in place to ensure that the debtor had received advice before applying. This would appear important given that the Adjudicator will have no discretion to reject an application on the basis that bankruptcy is not appropriate: if the debtor meets the criteria for bankruptcy, the Adjudicator must make the order.

The ERR Act is also the avenue for the proposed revisions to Ss233 and 372 of the IA86 – re. continuity of essential supplies – as it has granted the SoS the power to change these sections of the IA86.

The Deregulation Bill

Of course, the highlight of this Bill is the provision for partial insolvency licences. It was debated in the House of Lords last week (bit.ly/1tBmMhe – go to a time of 16.46) and whilst I think that, at the very least, the government’s efforts to widen the profession to greater competition are nonsensical in the current market where there is not enough insolvency work to keep the existing IPs gainfully employed, my sense of the debate is that the provision likely will stick.

I was surprised that Baroness Hayter’s closing gambit was to keep the door open at least to press another day for only personal insolvency-only licences (rather than also corporate insolvency-only ones).  Will that be a future compromise?  What with the ongoing fuzziness of (non-FCA-regulated) IPs’ freedom to advise individuals on their insolvency options and the rareness of bankruptcies, I wonder if the days in which smaller practice IPs handle a mixed portfolio of corporate and personal insolvencies are numbered in any event.

The Deregulation Bill contains other largely technical changes:

  • Finally, the Minmar/Virtualpurple chaos will be resolved in statute when the need to issue a Notice of Intention to Appoint an Administrator (“NoIA”) will be restricted to cases where a QFCH exists.
  • The consent requirements for an Administrator’s discharge will be amended so that, in Para 52(1)(b) cases, the consent of only the secured creditors, and where relevant a majority of preferential creditors, will be required. At present Para 98 can be interpreted to require the Administrator also to propose a resolution to the unsecured creditors.
  • A provision will be added so that, if a winding-up petition is presented after a NoIA has been filed at court, it will not prevent the appointment of an Administrator.
  • In addition to the OR, IPs will be able to be appointed by the court to act as interim receivers over debtors’ properties.
  • It will not be a requirement in every case for the bankrupt to submit a SoA, but the OR may choose to request one.
  • S307 IA86 will be amended so that Trustees will have to notify banks if they are seeking to claim specific after-acquired property. The government envisages that this will free up banks to provide accounts to bankrupts.
  • The SoS’ power to authorise IPs direct will be repealed, with existing IPs’ authorisations continuing for one year after the Act’s commencement.
  • The Deeds of Arrangement Act 1914 will be repealed.

The Small Business, Enterprise and Employment Bill

I won’t repeat all the provisions in this Bill, but I will highlight some that have created some debate recently.

The proposed new process for office holders to report on directors’ conduct proved to be a lively topic at the RPB roadshows. There seemed to be some expectation that IPs would report their “suspicion – not their evidenced belief – of director misconduct” (per the InsS slide), although this was downplayed at the later R3 Forum.  My initial thoughts were that perhaps the Service was looking to produce a kind-of SARs-reporting regime and I wondered whether that might work, if IPs could have the certainty that their reports would be kept confident.

However, I suspect that the Service had recognised that IPs would have difficulty with the proposed new timescale for a report within 3 months, but hoped that this would be mitigated if IPs could somehow be persuaded to report just the bare essentials – to enable the Service to decide whether the issues merit deeper enquiries – rather than putting them under a requirement to collect together substantial evidence. I suspect that the Service’s intentions are reasonable, but it seems that, at the moment, they haven’t got the language quite right.  Let’s hope it is sorted by the time the rules are drafted.

Phillip Sykes, R3 Vice President, gave evidence on the Bill to the Public Bill Committee a couple of weeks ago (see: http://goo.gl/V1XSbX or go to http://goo.gl/jSTmI0 for a transcript).  Phillip highlighted the value of physical meetings in engaging creditors in the process and in informing newly-appointed office holders of pre-appointment goings-on.  He also commented that the proposed provision to empower the courts to make compensation orders against directors on the back of disqualifications seems to run contrary to the ending of the LASPO insolvency exemption and that the suggestion that certain creditors might benefit from such orders offends the fundamental insolvency principle of pari passu. Phillip also explained the potential difficulties in assigning office holders’ rights of action to third parties and described a vision of good insolvency regulation.  Unfortunately, he was cut off in mid-sentence, but R3 has produced a punchy briefing paper at http://goo.gl/mBeU30, which goes further than Phillip was able to do in the short time allowed by the Committee.

Last week, a new Schedule was put to the Public Bill Committee (starts at: http://goo.gl/sY5QUG), setting out the proposed amendments to the IA86 to deal with the abolition of requirements to hold creditors’ meetings and opting-out creditors.  A quick scan of the schedule brought to my mind several queries, but it is very difficult to ascertain exactly how practically the new provisions will operate, not least because they refer in many places to processes set out in the rules, which themselves are a revision work in progress.

IP Fees

The consultation, which included a proposal to prohibit the use of time costs in certain cases, closed in March 2014 and there hasn’t exactly been a government response. All that has been published is a ministerial statement in June that referred to “discussing further with interested parties before finalising the way forward” (http://goo.gl/IbQsLd).  The recent events I have attended indicate that the Service’s current focus is more on exploring the value of providing up-front fee estimates together with creditors’ consent (or non-objection) to an exceeding of these estimates, rather than restricting the use of the time costs basis.  I understand that the government is expected to make a decision on how the IP fees structure might be changed by the end of the year.

Revision of SIPs etc.

I have Alison Curry of the IPA to thank for sharing with members at the recent roadshows current plans on these items:

  • A JIC review of the Insolvency Code of Ethics has commenced. Initial findings have queried whether the Code needs to incorporate more prescription, as it has been suggested that the prevalence of “may”s, rather than “shall”s, can make it difficult for regulators to enforce. The old chestnuts of commissions, marketing and referrals, also may be areas where the Code needs to be developed.
  • Although RPB rules include requirements for their members to report any knowledge of misconduct of another member, it has been noted that, of course, this is not effective where the misconduct involves a member of a different RPB. Therefore, the JIC is looking to amend SIP1 with a view to incorporating a profession-wide duty to report misconduct to the relevant RPB or perhaps via the complaints gateway.
  • As expected, SIP16 is being reviewed in line with Teresa Graham’s recommendations. This is working alongside the efforts to create the Pre-pack Pool, which will consider connected purchasers’ intentions and viability reviews. A consultation on a draft revised SIP16 is expected around Christmas-time. I had heard that the target is that a revised SIP16 will be issued by 1 February 2015 and the Pool will be operational by 1 March 2015, but that seems a little optimistic, given the need for a consultation.
  • SIP13 is ripe for review (in my opinion, it needed to be reviewed after the Enterprise Act 2002!) and it is recognised that it needs to be revised in short order after SIP16.
  • A new IGP on RoT has been drafted and is close to being issued. We received a preview of it at the IPA roadshow. To be honest, it isn’t rocket science, but then IGPs aren’t meant to be.
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The Small Business Enterprise and Employment Bill: Part 2 – insolvency odds and sods

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My second post on the Small Business Enterprise and Employment Bill focuses on the proposed changes to the Insolvency Act as a consequence of the Red Tape Challenge… with a couple of sneaky additions thrown in.

Changes to the Insolvency Act 1986

The Red Tape Challenge proposals require changes both to the Act and the Rules. Therefore, this Bill is not the whole story and many of the practicalities of the new processes will only become evident when the Insolvency Rules are changed.

The Insolvency Service’s current targets on the Rules consolidation exercise appear to be finalisation of the statutory instrument in October 2015 so that it has an effective date of April 2016.

The Bill’s Impact Assessment (“IA”) summarises the changes as follows:

1. “Removing meetings of creditors as the default position in insolvencies
2. Abolition of final meetings
3. Removal of requirement for liquidator to be present at a S98 meeting
4. Opting out of further correspondence
5. Administration extensions
6. Allowing an office-holder to pay a dividend in respect of a debt of less than £1,000 without the need for the creditor to submit a formal claim
7. Removal of requirement to seek sanction for certain actions in liquidation and bankruptcy
8. Crystallisation of Scottish floating charges
9. Abolition of Fast Track Voluntary Arrangements
10. Official Receiver to be appointed trustee on the making of a bankruptcy order
11. Clarification that a court application under paragraph 65 of Schedule B1 is not required where an administrator intends to make a prescribed part payment to unsecured creditors
12. Clarification that a progress report must be issued to creditors where the liquidator changes within the first year of a CVL
13. Alignment of the time limit for an appeal against the outcome of an IVA where there is no interim order with that where there is an interim order in place”

“Deemed consent” and non-physical meetings

The savings that will result from complete removal of “physical” meetings seem to be built on the premise that all IPs are charging room hire of £64 and 1.5 hours of administrator/manager time each time a meeting is “held”. Although the vast number of circulars still refer to a place and time for meetings, I suspect that rarely does this involve any more cost than if the business were conducted by correspondence.

Firstly, the Bill introduces a “deemed consent procedure” (S110 and 111) that seems to work like this:

• The office holder provides creditors with written notice of his “proposed decision” on a matter.
• If less than 10% (or perhaps “10% or less” – the IA does not make it clear and the Rules will prescribe this) of total creditors by value object to the proposed decision, the creditors are treated as having made the decision.
• If more than 10% (or “10% or more”) object to the proposed decision, then the office holder must follow a “qualifying decision procedure”.

The Bill lists several decisions that cannot be handled by the deemed consent procedure:

• “Any matter relating to a proposal” for a VA;
• Removal of an office holder;
• “Any matter relating to the remuneration of an office holder”, which I guess will wrap in S98s and consideration of Administrators’ Proposals (unless Para 52(1)(b) applies);
• Where the court so orders; and
• “Any matter prescribed as an excluded matter by the Rules”.

The IA suggests that the process will not disadvantage small-value creditors, as “they will still have the facility to object to [the proposals] and raise any concerns with the office holder, who will in turn have a duty to consider whether deemed consent is the most appropriate mechanism to use”, which seems most odd: does the Service expect office holders to start the deemed consent process and, even if the 10% threshold has not been passed, they might decide that minority objecting creditors deserve a voice and thus they can spend estate monies in following a more inclusive decision-making process? This also seems contrary to the Bill, which states that, if less than the prescribed proportion of creditors object, the creditors are to be treated as having made the proposed decision (S246ZF(4) under S110).

The IA does point out that use of the deemed consent procedure is discretionary; it states that “office holders will be able to use their experience to identify situations where the creditors are unlikely to agree with its use” and thus go straight to an alternative decision procedure. However, the Service also waves the stick of regulatory action, if it seems that an IP has lost sight of achieving “value for money”.

The Bill’s memorandum states: “in most cases the intention is that the office holder will be able to use a process of deemed consent”. However, given the exclusions listed above, how many opportunities will there be for the deemed consent procedure in any event? How many meetings (other than final meetings, which are dealt with elsewhere) do not include a resolution on fees?

The Bill doesn’t prescribe the qualifying decision procedures – the Rules will “prescribe examples of procedures” – but the IA indicates that these will not include a physical meeting, unless 10% or more request a physical meeting. The procedures will include business by correspondence, remote meetings, and electronic voting.

Given that most meetings are convened at present to deal with the excluded matters listed above and that physical meetings will not be an option unless creditors ask for one, I really cannot see why the IA has estimated a reduction of only 50% in the number of physical meetings. It states that “50% was seen as prudent, given because this will be ‘new ground’ for office holders and creditors, who may feel decide (sic.) that they would prefer to have meetings in some cases”. Don’t you get it, Insolvency Service? How many times do we have to say it? On the whole, creditors don’t vote! Why on earth would they – in 50% of cases! – ask for a physical meeting?!

The IA states that “it is not anticipated that the time taken to undertake a virtual meeting will be any more or less than the time taken to undertake a physical meeting” – I agree – but it then states “where a physical meeting is not being held the proportion of instances where a virtual or remote meeting is held is likely to be small, given that deemed consent will be available as well as other cheaper methods”. The IA then applies a best estimate of 50% reduction in meetings, whether virtual or physical, and eliminates entirely the time costs of an estimated 1.5 hours for holding a meeting. Crazy! As is clear above, there will barely be an opportunity to use deemed consent and, as the time incurred in completing unattended meetings is mostly about collating and considering proofs and proxies and drafting minutes, these pretty-much will still need to be spent in any other decision procedure. Okay, business by correspondence will be cheaper than a physical or virtual meeting where people actually turn up, but it is not cost-free!

Is it any wonder that the Service has managed to come up with savings for this measure alone of £50 million over ten years?!

Final meetings

The IA states that the proposal “scraps all final meetings of creditors where they occur”, although the Bill (S114) provides only that the SoS be empowered to remove Insolvency Act meetings, so I think there is another step required to amend S106 etc. It is not clear whether the Service envisages that the deemed consent procedure will apply to a proposed resolution for release, or whether the draft final report simply will be issued and creditors will need to request a meeting, if they want to object to the office holder’s release.

The IA suggests that this measure will save £6 million per year (in addition to the £50 million above), based on room hire of £64 per meeting and 45 minutes of time, although, if the deemed consent procedure were necessary, it will carry with it some costs to wrap up. The Bill does not refer to any requirement to tell creditors the outcome of any attempt at obtaining deemed consent; hopefully the Rules changes will add nothing, as this would return any costs saved in abolishing final meetings.

S98 meetings

The Bill and IA seem confused over the fate of S98 meetings: are they being abolished? If not, who gets to decide how they should be held? And practically, how can such decisions be managed?

One thing is clear: the need for the company’s liquidator to be present at the S98 meeting will be removed (although it is not in the Bill, as it is a Rules provision). The IA states that “in most cases it will be an insolvency manager who has best knowledge of the intricacies of a CVL rather than the office holder themselves and it represents much better value for the creditors for that person to attend the meeting” – charming! Don’t they think that creditors will want and deserve to see the liquidator in person? The IA does acknowledge that, if there is significant creditor interest in the proceedings, suggestion of director misconduct or “negotiations that the office holder in person may wish to lead”, the IP may “feel that their presence would be necessary or beneficial”. The IA estimates this may occur in 30% of cases.

I know that some have aired grave concerns over the prospect of creditor disengagement by abolishing physical S98 meetings. Chuka Umunna MP commented on this when the Bill had its second reading – see column 922 at http://goo.gl/VGOE07.

But are physical S98 meetings being abolished? The IA estimates there will be a 50% reduction in physical S98 meetings, which suggests that they aren’t. However, from my reading of the Bill, it seems that S98s will be subject to the “qualifying decision procedure” rules, which means that a physical meeting could only be held where over 10% of creditors request one, so, without this, an IP may only decide to “attend” a meeting remotely. Also don’t directors technically convene S98 meetings..? So a director who doesn’t want to face creditors – even remotely – can decide to conduct business by correspondence..?

Given that creditors only receive seven days’ notice of S98 meetings, I am not sure how a creditor’s request for a physical meeting will work practically. Presumably, directors/IPs may do well to predict cases where there is likely to be sufficient creditor interest and set up a meeting room in advance (although this will be wasted if the requisite creditors do not request a meeting). Otherwise, they could be looking at expensive last-minute conference room bookings – and you would need to give timely notice to all creditors of the venue – or a postponed S98 meeting, albeit not for long given the need to get on with the liquidation and the Centrebind restrictions.

So much for saving costs!

Creditors’ circulars

The Bill provides (Ss 112, 113) that creditors may opt out of receiving correspondence from office holders (excluding notices of (proposed) distributions, which presumably include notices of intended dividends).

Again, I think the Service has over-estimated the savings to be made: personally, I cannot see their assumption of 20% of creditors deciding to opt out becoming reality, although apparently “a representative of a leading firm of insolvency practitioners, a partner in a large regional firm, and a major creditor representative all said that they agreed that the assumption was reasonable and two of them thought the 20% figure to be conservative”, so what do I know..? I also note the IA assumption that no creditors will opt out where the OR is in office: if this provision is such a cost-saver, why is it only being imposed on IPs? They have also provided no provision for the costs to the office holder of managing two creditor databases.

What I want to know is: where has the other Red Tape Challenge proposal gone? If the Service is serious about IPs’ saving costs, then they should progress the proposal to allow office holders to post everything on a website without the need to write to each creditor every time notifying them that the document had been released. Maybe this will turn up in the Rules revision…

Extending administration extensions

Para 76(2)(b) of Schedule B1 is to be changed so that an administration may be extended by up to one year by consent (S115).

It is a shame the Service has not taken this opportunity to change the consent requirements, so that it does not require the administrator to seek the approval of every secured creditor, irrespective of their recovery prospects. Oh well. This may mean that the Service’s prediction that all administrations set to last up to two years will be extended by consent in future may prove to be an over-estimate also.

Dividend processes

Ss119 and 120 of the Bill provide for creditors who have not proved small debts (to be prescribed, although the IA proposes a threshold of £1,000) “to be treated as having done so”. The IA points out that, as with any proving creditor, this does not stop the office holder asking for further evidence from the creditor if thought necessary, although it states that this measure will “permit the insolvency office holder to rely upon the debtor’s own records”. Also, a creditor can always submit a proof, if it is owed more than the debtor’s records indicate.

I must admit that I have often struggled with the office holder’s duty as regards adjudicating on claims and I have even more difficulty with it in this “value for money” world: on the one hand, an office holder is expected to be diligent to ensure that he distributes the estate’s monies to those who are entitled to it; however, on the other hand, every minute he spends on scrutinising claims, asking for, and examining further evidence, eats away at the funds available to distribute. I guess this provision sets out more clearly the government’s expectation: just take small claims as read… unless you have reason to doubt them, e.g. if you think that the director who swore the SoA has added all his friends and neighbours to the list of creditors.

A Red Tape Challenge proposal that would really help put this measure into context is that small dividend payments – £5 or £10 were mentioned – would not be sent to individual creditors, but would be pooled for use by the disqualification unit or the Treasury. If this also were introduced, then, yes indeed, don’t waste any time considering whether to admit small claims, as the chances are that those creditors will not see their dividends anyway. However, this proposal hasn’t made it to the Bill. Is it another one for the Rules or will we never see it again..? (UPDATE 02/11/2014: I understand this proposal has now been dropped, as the Service had received advice that it would prove too contentious to deprive certain creditors of the right to receive a dividend, however small that might be.)

The Bill includes two measures affecting administration distributions. The IA describes them as clarifications and as removing ambiguities, although personally I think that the provisions change the Act, which seems pretty clear-cut to me.

S116 contains two parts:

• To Paragraph 65(3) will be added the power to distribute the prescribed part in an administration.
• Paragraph 83 will include a further restriction on moving from administration to CVL: this will only be possible where the administrator thinks that a non-prescribed part distribution will be made to unsecured creditors.

It is a shame that Schedule B1 of the Act is not being amended so that dividends generally can be paid through administration. The IA hints at why this is not considered appropriate: it states that liquidation “provides for more engagement” of unsecured creditors. Personally, I see no difference in creditor engagement in administrations and liquidations: there are the same powers to form a committee and to approve fees (as we are not talking about Para 52(1)(b) cases here), and the changes to liquidators’ powers mentioned below bring the office holders’ needs to seek sanction on a par. The IA has estimated a cost of £8,250 on converting an administration to liquidation, so why not save by eliminating the need to move to liquidation?

Pre-packs

S117 of the Bill is the Dear IP 62 threat to “ban ‘pre-pack’ administration sales to connected parties if certain criteria are not met”. The Bill’s memorandum elaborates, referring to Teresa Graham’s recommendations: “Clause 117 is in response to the recommendation to take a legislative power to legislate in the event that the recommendation to establish third party scrutiny is not adopted on a voluntary basis… It is considered that by taking a legislative power, this will act as an incentive to encourage connected parties to adopt the voluntary proposals set out in the Graham Review”. Hmm… I can’t see that the threat of future legislation is going to matter one jot to connected parties presently contemplating a sale! However, “the Government is fairly confident that voluntary reforms backed by this ‘backstop’ power will act as sufficient incentive to change behaviours and so it will not be necessary to exercise the power.” I know that R3 and others are working frantically to see what can be done with the Graham recommendations and I will not list my own views and concerns, as there have been plenty of other loud critics.

The Bill empowers the SoS to make regulations “prohibiting or imposing requirements or conditions in relation to the disposal hiring out or sale of property of a company by the administrator to a connected person in circumstances specified in the regulations”. Note that regulations may not be limited to pre-packs, but may affect any transaction involving a connected person (which is also defined by the section), whenever they occur and however large or small the property transferred. This fits in with Teresa Graham’s recommendations, although I haven’t seen any commentary refer to this wider scope.

S117 provides that, in particular, future regulations may require approval (or provide for the imposition of requirements/conditions) by creditors, the court, or “a person of a description specified by the regulations”.

Other fixes

The Bill also contains:

• S107: the proceeds of claims or assignments arising from Ss213, 214, 238, 239, 242, 243, and 244 are not to be available for floating charge holders, i.e. they will not be part of the company’s net property. I believe that some have expressed concern over this, but doesn’t this simply put case precedent into the Act?

• S108: liquidators may exercise any of the powers in Parts 1 to 3 of Schedule 4 of the Act without sanction (S109 provides similarly in relation to trustees and Schedule 5)… although I’m wondering why the Parts need to exist at all.

• S118: provides that, when an administrator of a Scottish company obtains permission from the court to pay a dividend to unsecured creditors, floating charges crystallise.

• S121: the OR will become trustee on the making of a bankruptcy order (if an IP isn’t made trustee at that time). The IA explains that the motivation for this is to improve the efficiency of asset realisations by not restricting the OR’s immediate activities only to protecting the estate. I can see some value in having the bankrupt’s estate vest in the OR immediately on bankruptcy, avoiding some of the confusion illustrated in the Pathania v Adedeji case (http://goo.gl/AcktAk), although there is obvious concern that this process disenfranchises creditors, as this erodes creditors’ opportunities to make a decision on who they want to administer the estate.

• S122: changes S262(3)(a) of the Act so that the 28 day time period for challenging an IVA meeting decision counts from the decision where there is no interim order and from the filing of the report to court in interim order cases… although I’m wondering why the time of the meeting’s decision could not work for all cases; it’s hardly “alignment”, as the IA suggests.

• S124: removes reference to producing progress reports only for (E&W) VLs that last longer than one year. This deals with the nonsensical position that, if the liquidator changes during the first year, it seems that he must predict if the case will last longer than one year in order to decide whether to issue a progress report on the change-over – an issue highlighted by Bill Burch (http://goo.gl/6K4a4E) – although it does not deal with the unnecessary costs of issuing progress reports mid-year and the re-setting of deadlines caused by changing liquidators. Courts usually deal with these matters in block transfer orders, but let’s hope that the revised Rules will effect a change.

That’s almost the whole of the Bill’s insolvency measures covered. It just leaves the provisions impacting on IP regulation… for another day.


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The Small Business, Enterprise and Employment Bill: Part 1 – Directors

IMGP0277 This “Small” Bill will have a big impact on IPs. Not only does it include the widely-publicised reserve powers to ban pre-packs and appoint a single insolvency regulator, but it will result in a completely new D-reporting process and will relegate physical creditors’ meetings to something that only creditors can request. The Bill contains many other smaller items that will require significant overhauling of templates and checklists… far more than the 7 hours estimated in the Impact Assessment!

The Bill’s government webpage is at http://goo.gl/VwKvPe and I have sketched out (to help myself get an overview) the clauses that will impact IPs here: Insol relevant provisions Jul-14

In this first post, I cover the key changes to reporting on directors and actions arising from directors’ misconduct. My next post will deal with the changes to the IP regulation regime, pre-packs, and the numerous technical changes to the Act.

D-Reporting

I know that R3 spins this as a success – the move from burdensome paper reports to something far speedier online – but I have to say that I am more sceptical about the advantages of this process for IPs.

The Impact Assessment (“IA”) describes the present problem as delayed reporting because “the IP must be satisfied that there is evidence of unfit conduct… The proposed design of the new form would require the IP to highlight (at an earlier stage) information or behaviour which may indicate unfit conduct as opposed to providing a significant amount of justification and evidence at that stage.” The Bill sets the timescale for submitting a report to within three months of appointment – the rationale, it says, being that “the SoS would be able to better consider behaviour identified by the IP” at this earlier stage [why?] and “the quality of information should improve due to the return being submitted with greater proximity to events” [really?] – although I thought it was charming that, in the same breath, the Bill is providing the Service with an extra year in which to commence disqualification proceedings.

Personally, I expect that this change will result in a greater number of ‘clean’ reports, as IPs will have less knowledge of past events at three months than at six months. However, as IPs will be “under an ongoing obligation to report any new information that he/she considers should have been included in the return”, I cannot see that this will result in less, or even the same amount of, work for IPs in the long run. The forms themselves might also require more work, as “there are also other pieces of information not currently requested which R3 states that IPs could usefully provide”.

The IA estimates only one hour for IPs (nothing for other staff) to familiarise themselves with the new process and one hour per director in completing the new return where misconduct is indicated, which I can see, depending on the final form of the return, would be a reduction over the present demand, although the IA has provided no time costs in relation to providing additional information to the SoS after a return has been submitted.

One sentence that really got my goat was: “Analysis undertaken on a sample of 250 cases where D1 reports were submitted but not proceeded with indicated that a significant percentage of them should not have been submitted”. Should not have been submitted?! What can the government mean? Are IPs failing to meet their statutory obligations?

I am reminded of a question raised by the House of Commons BIS Select Committee when it interviewed Richard Judge and Graham Horne in 2012 about the apparent disparity between the number of D1s filed – around 5,000 per year – and the number of disqualifications. I remember Dr Judge stating that this meant there were “5,000 indications of misconduct… there are people that are innocent in that” and Mr Horne chipping in quickly to clarify that IPs are required by statute to report directors who, by analogy, drove at 31 mph in a 30 mph zone; technically, the conduct might be reportable, but of course not all such directors will be pursued to disqualification. Although switching to a system in which IPs simply provide the facts and leave the SoS to decide whether the director’s behaviour merits action may avoid future discomfort in answering such questions, it seems to me that nothing here changes the statutory obligation for IPs to waste time reporting on the 31 mph drivers.

Compensation Awards

The IA gives us a clear hint at what has driven this measure. It states that “a frequent complaint in Ministerial correspondence from creditors is that although disqualification can prevent a director acting as a director in future, it provides no compensation to those who have suffered from their misconduct”. What types of cases might attract compensation awards? The IA states that “it is reasonable to believe that compensation could be sought from, at least those cases where there has been an identifiable loss to creditors, for example: misapplication of assets, transactions to the detriment, criminal matters and accounting records” – that’s quite a list! The IA continues: “it is also reasonable to assume that whatever the allegation, the SoS will also seek compensation for those cases where there are a lot of unsecured creditors or ‘vulnerable’ members of the public who have lost out”.

However, the IA presents a confusing picture as to how the government envisages the process of seeking compensation awards against disqualified directors working – in tandem? – with the activities currently carried on by office holders in challenging antecedent transactions. For example, the IA states: “the option of the SoS seeking a compensation order or agreeing a compensation undertaking from a miscreant director will enable greater financial redress for creditors, where the office holder (IP) has not taken any of the available actions him/herself or it is considered that further action in addition to that taken by the IP is merited”. Fair enough, as the IA points out, this may be because the office holder has insufficient funds to pursue the case (although I am irritated by the comment that an IP might feel “they don’t have the specialist expertise to bring a claim”). But, I wonder, will this exacerbate the difficulties in reaching settlements with directors who, notwithstanding any settlement agreed with the IP, could then be pursued by the SoS? At least the IA recognises that there are likely to be fewer disqualification undertakings under the future regime, as directors are less likely to give in without a fight.

Do you wonder whether this could result in the SoS and IP fighting between themselves as to who might chase after the director’s finite pot first? The IA states that IPs “should be able to proceed with any action they deem appropriate before the SoS”. Well, that’s alright then.

The Bill also indicates that compensation may be awarded to a particular creditor or creditors, a class or classes of creditors, or it may form a contribution by the director to the assets of the company. However, the IA states “the compensation award will be awarded direct to creditors” (although it makes no provision for the Service’s costs in collecting the monies from the director, adjudicating on creditors’ claims, or paying a distribution). This quote appears in the context of “free-riding amongst liquidators”! It seems that some consultation responses suggested that office holders might not pursue claims themselves, but they might sit back, wait for the Service to do the work, and then pop up to collect the funds and take a fee. The IA does nothing to counter this libellous title and simply states that, because the award is direct to creditors, they “do not think the risk of ‘free-riding’ is high” and “no evidence exists on the likely number of cases of free-riding by liquidators”. Come on, Insolvency Service, we expect better of you than that!

I am also puzzled by the repeated references to improving gateways so that the SoS and IPs might share information better, for example, “to better enable successful recovery actions to be taken forward by the office holder”. As far as I can tell, the gates only swing one way (unless there is something in the OR’s handover) and will continue to do so; there are no proposals in the Bill to help IPs have greater access to information, although the IA suggests that things may change “through updating internal guidance used by Insolvency Service staff”.

I was also puzzled at the IA highlighting a “risk” that “this will result in compensation orders being made for the benefit of HMRC as they are the major unsecured creditor in the majority of insolvencies”. Personally, I don’t see that a bit of recompense to the public purse is a bad thing. Instead of the IA pointing to the Bill’s reference to factors that the court/SoS would consider – the amount of loss, nature of misconduct, and any recompense already paid – it answered this by referring to the fact that the court/SoS could determine that compensation be awarded to a particular creditor or class or group of creditors “taking into account what is equitable in all the circumstances”. Could the prospect of deviating from the pari passu rule, especially if HMRC might not get a look-in at all, result in some creditors calling for office holders to resist taking action and leaving it to the SoS?

Power to assign certain rights of action to third parties

The apparent “problem” that the government is seeking to fix is the lack of court applications as regards wrongful and fraudulent trading (which are both extended under the Bill to Administrators), transactions at undervalue etc. However, the IA acknowledges that “a lot” of claims are settled out of court (they have heard upwards of 90%) and it reports that the other principal reasons for lack of court actions given in the consultation responses were the targets’ lack of assets and the high evidential bar necessary, so the government acknowledges itself in the IA that the Bill’s provisions are unlikely to result in many more cases going to court.

The IA does not mention the issue for an IP who agrees to share in the proceeds of any action assigned to a third party: won’t the risk of an adverse costs order deter IPs from entering into some assignments? The IA points out a risk “of speculative or opportunistic claims being brought against directors who may be ill placed to defend themselves. However, this risk should be small as we expect insolvency professionals to have regard to existing professional and ethical standards in judging when to assign causes of action.” But in the next paragraph the IA refers to the IP’s duty to maximise returns to creditors: could an IP really be justified in turning away third parties offering to pay for rights of action, if it represented a good deal for creditors?

The IA appears more thoughtful in relation to the justification for IPs selling to a third party, who after all is looking to make a profit from the action: they feel that IPs may be justified as the third party’s greater appetite for risk and economies of scale in taking the action forward compensate for the discount on the action suffered by the estate. The IA also makes the sensible point that simply opening the way for third parties may improve IPs’ negotiating position in pursuing claims directly from directors.

My part 2 on the Bill will follow in a week or so (once I’ve done some real work!)

(UPDATE 25/09/14: I read an excellent blog on the subject of the director provisions of the Bill from Neil Davies & Partners – http://goo.gl/uYp3RU.  I was particularly intrigued by the observations on the complications that could arise from the provision to empower the SoS to pursue compensation orders.)