INTRODUCTION: CORPORATE INSOLVENCY
There
has always been a difference of opinion as to who is to be taken care
of the most, while a company gets insolvent: the creditors, the
insolvent, the public, or the other stakeholders? This is the critical
question. Certain theories are there to advance their answers as to
which stake holder should be preferred to others. These theories
include: The Creditors' Bargain Theory, Communitarian Theory and
Multiple Values Approach. These theories differ in preferring to the
interests of different types of stakeholders, but none of them insists
on immediate liquidation of the insolvent companies, because, 'In most
liquidations creditors are going to receive only a small percentage of
what they are owed'.(1) So, what to do with the insolvents?
PICKING UP AN OPTION:
Liquidation:
In
the event of insolvency, the liquidation has been the most common
solution to the problem of insolvency of a company. Insolvency,
nevertheless, is not the only reason for liquidation of a company. A
company may be wound up for a number of reasons, even if it is not
insolvent. However, winding up of an insolvent company may be carried
out either voluntarily or compulsorily. Voluntary winding up is the one
where the share-holders, believing that the company is unable to pay its
debts, decide to wind up the same. On the other hand, compulsory
winding up is executed under the orders of the court. These orders are
passed on the request of the creditors, contributories, the Official
Receiver, or the Department of Trade and Industry; or if the court
itself is of the opinion that it is just and equitable to wind up the
company. Upon winding up, the yield generated by the sale of assets of
the company is distributed among the charge holders, in order of
preference and according to the principle of pari passu (equal treatment
of the creditors of the same class).
Though winding up is the
fate of most insolvent companies, it is not every insolvency that leads
to liquidation.(2) At one time winding up was the only real option
available when a company was insolvent, but as companies became more
critical to commercial life and legislation developed, provision has
been made for forms of insolvency administration other than winding up
.(3) An insolvent company, instead of going directly into liquidation,
can choose any of the alternate options. These options include:
receivership, administration and voluntary arrangements. These aim at
avoiding, or at least minimizing the would-be losses inevitable in the
event of liquidation. First preference of any of them is to save the
company by having a chance of its rehabilitation. However, if the
conditions are hopeless, then, as a last resort, they would go for
winding up the company in the most suitable manner, with minimum
possible losses.
Receivership:
A secured creditor of an
insolvent company, usually a bank, may, instead of going for
liquidation, appoint a Receiver to enforce the security. If the security
or loan agreement, referred to as 'debenture', covers the entire or
almost entire assets of the insolvent company, the receiver steps into
the shoes of the directors and administers the affairs of the company,
so as to realize its assets to pay off the amount due. In such a case,
he or she is called an 'administrative receiver'. An administrative
receiver tries to sell the company as a going concern, to get more value
of the assets. Some researches shows that about 44% of companies in
receivership are sold as going concerns.(4) Sometimes, his efforts to
reach a more beneficial solution bear so much fruit, that a rescue
becomes possible. Nevertheless there is evidence that receivers do
continue to run businesses and on occasions incur a trading loss.(5)
But, primarily, the role of a Receiver is to look after the interests of
the secured creditor and ensure the satisfaction of the debts by the
proceed of the assets that becomes available after their realization.
Once appointed, he or she acts as the agent of the company, and has
power to incur trading liabilities on its behalf, or to procure the
breach of its contracts. The company's directors and other creditors
have few rights to involvement in the decision-making process. Yet the
administrative receiver's primary duties are owed to his appointing
debenture-holder, rather than to the company, and this is the main
disadvantage of receivership as a major corporate rescue procedure.(6)
Furthermore, the appointment of an administrative receiver greatly
restricts the operation of other, more collective insolvency
procedures.(7) Then, the receivership is not a collective insolvency
process, and is largely contractual, arising out of a charge/security
given by a company to a creditor, usually a bank, often over the whole
or substantially all of the company's assets.(8)
Administration:
An
insolvent company, instead of going into liquidation, can also choose
the option of administration by an external manager. The administration
was primarily a procedure for the companies where no secure creditor
held as much a charge as amounted to cover the whole or nearly the whole
of the undertaking of the company. An external administrator was
appointed by the court of the relevant jurisdiction on the satisfaction
that a company is, or likely to be, unable to pay its debts. This, too,
was an arrangement to dispose off the assets of a company and pay off
the debts to the creditors, with the proceeds of the sale, through a
neutral person. But, "the primary purpose of the administration now is
to rescue the company."(9) While passing an order of administration, the
court takes into account: the possibility of survival of the company or
one or more of its components, probable voluntary arrangement between
the creditors and the company, prospective compromise of the creditors
on their claims, or at least, better prospects of realization of the
assets prior to going for liquidation. Administration, now, is in
essence, a temporary measure which either lays down the foundations for
the rescue of the company or for its winding up on a more favourable
basis.(10)
"It involves the appointment by the court of an
administrator to manage the company for the benefit of creditors
generally with a view to securing the survival of the company as a going
concern, the approval of a voluntary arrangement under Part I of the
Insolvency Act 1986, the sanctioning of a compromise under section 425
of the Companies Act 1985 or a more advantageous realization of the
company's assets than would be effected on a winding up."(11)
Administration
order brings about an automatic stay order: moratorium, dismissing any
winding up petition, removing any administrative receiver and placing an
administrator with the full authority and powers of the directors to
manage the company, and take all appropriate decisions about its future.
The moratorium provides the administrator with an opportunity to take
and execute the decisions about the fate of the company, whether for its
rescue or to make some other more beneficial arrangement for its
winding up, without any pressure or harassment by the creditors. An
administrator is usually an Insolvency Practitioner, officer of the
court, or representative of the Department of Trade and Industry; and an
administrator owed a duty to a company over which he was appointed to
take reasonable care to obtain the best price that the circumstances as
he reasonably perceived them to be permitted, including a duty to take
reasonable care in choosing the time at which to sell the property.(12)
Insolvency Act 1986 requires an administrator to act with the purpose of
(i) rescuing the company as a going concern, or (ii) achieving a better
result for the company's creditors as a whole than would be likely if
the company were wound up, or (iii) realizing property in order to make a
distribution to one or more secured or preferential creditors.(13)
Voluntary Arrangements:
In
most jurisdictions insolvent companies can enter into a voluntary
arrangement with the creditors. There are many different forms of
agreement and these possess a bewildering variety of names: composition,
compounding, compromise, arrangement, scheme of arrangement, voluntary
arrangement, moratorium, workout _ in the case of an individual
insolvent, an assignment (to trustees) for the benefit of his
creditors.(14) However, these are categorized in two types: Formal
Voluntary Arrangement, where an arrangement is made with the involvement
of the court, under the cover of law _ in UK, a company can opt for a
Company Voluntary Arrangement (CVA) _ and Informal Arrangement, where
the debtor reaches an agreement with the creditors outside the court,
without an appropriate shelter of law. In the event of any type of
arrangement, if a company seems to be unable to run as a going concern,
then a voluntary arrangement would usually require the creditors to
compromise over the quantity of amount due as debt (though, at a rate,
better than what would be expected in case of liquidation); and if it
has a potential of rehabilitation, then it would normally require
negotiation on time for repayment of the debt, for example, a break for a
certain period of time, or payment in installments spread over a longer
period. The purpose, again, is to save the company from liquidation, or
at least, liquidation with minimum loss.
Informal arrangements
could be more efficient, time saving and cost effective, if, however,
they can work. To persuade the creditors to come to a new agreement may
be a bit difficult, though in benefit of all the concerned. While it is
not too difficult to make the creditor understand that ultimately get
much more than is likely in case of winding up, it is nonetheless, not
easy to maintain such a deal with a relatively larger number of
creditors for a longer period of time.
Formal arrangements are
provided in the law, hence more workable, under the auspices of the
court after the company goes into administration, or even prior to that.
CVA is a significant feature of UK insolvency regime. A company in
administration can achieve the object of rescue by approval of CVA.(15)
Before order of administration, the directors, and after that the
administrator or receiver have to make a proposal for rehabilitation of
the company or rescheduling the debts of the company etc. The proposal,
after the approval of the court is to be put up before the creditors in a
meeting. If 75% of the creditors agree _ in some jurisdictions the
number may vary, like 66% in USA _ it becomes binding on everyone else.
The whole idea of pushing through a CVA is to prevent the creditors
putting the company into winding up.(16) CVA, once agreed, becomes
binding on all who had notice of and were entitled to vote at the
meeting.(17) Case law has described it as 'statutory binding,'(18)
'commercial agreement'(19) and a 'trust'(20) . This legal status makes a
CVA more workable than an informal arrangement.
All the above options are available prior to going for liquidation of an insolvent company.
CORPORATE RESCUE:
There
is increasing scope for business rescues through restructuring and
reorganization where the enterprise is fundamentally sound and has good
prospects of being restored to profitability. The so-called "rescue
culture" has developed significantly in recent years.(21) 'The purpose
of business rescue is not necessarily to prevent a company from being
wound up or liquidated,' says University of Pretoria associate professor
David Burdette. 'But even if the business cannot be restored to a
solvent and profitable status, business rescue has shown that the return
to creditors in the long run will be higher'.(22) It is very difficult
to argue against the concept.(23) Certain measures can be adopted to
attempt a rescue. In addition to negotiations with the creditors,
company's rescue may require some other measures to be adopted. A change
in management, sometimes along with other measures can help a company
survive. Turnarounds are often accompanied by management changes, asset
sales, and new finance or directors' guarantees. There is evidence that
these changes significantly influence the bank's response and the
likelihood of a successful outcome.(24) An insolvent company that wishes
to raise working capital urgently can opt, after careful analysis, for
issuance of shares at a discount, but it would require approval from its
shareholders and the relevant regulatory body.(25)
Transnational Legal Scene:
Currently,
companies facing difficulty in Hong Kong have little choice other than
liquidation or receivership. An effective rescue procedure exists in
other jurisdictions, such as the US (Chapter 11 of the Bankruptcy Act),
UK and Australia (the process of "Administration"). In the case of
Australia, the introduction of the corporate rescue regime has led to a
marked decrease in the number of receiverships (from 380 cases in the
year ended March 1997 to 240 the following year) and a rise in the
number of "administrations" (from 421 in 1997 to 503 in 1998).(26)
Although,
practically, in New Zealand liquidation is the primary ( and strictly
speaking the only) collective legislative procedure for dealing with
distribution and realization of assets of an insolvent company, yet
aspects of statutory management procedure could be preserved in any
rescue procedure, such as the moratorium and the powers of the
manager.(27)
While there is no developed practice regarding
informal corporate rescue processes in Pakistan, formal corporate rescue
processes that are available to corporate debtors and creditors are
almost similar to those of the UK. The Federal Government of Pakistan
has also set up a Task Force for Revival of Sick Industrial Units. The
issue in Pakistan is not the lack of an adequate and comprehensive
legislative framework, but rather the lack of a speedy and efficient
implementation process.(28)
South Africa is one of the most
competitive countries in which to do business, it has an unhealthy
number of liquidations. Though SA was one of the first countries to make
provision for business rescue - through the judicial management
provisions in the Companies Act - there hasn't been much success in
implementing it.(29)
UK insolvency procedures are highly creditor
oriented. Contractual rights are strictly enforced, and the courts have
no power to intervene in the way the bank exercises its rights, say, to
sell the business as a going concern, or sell the assets piece meal.
However, where there is a possibility of a rescue being implemented, the
courts will make a space, sometimes being most reluctant to help a
judgment creditor to obtain execution.(30)Still there exists an
elaborate rescue process outside formal procedures. About 75% of firms
emerge from rescue and avoid formal insolvency procedures altogether
(after 7.5 months, on average).(31)
Chapter 11 Regime:
It is
commonly acknowledged that no other jurisdiction currently has a
statutory procedure as effective as the US' chapter 11 in supporting
business restructuring.(32) Rescue procedures are available to
struggling companies immediately, at their instigation and timing, and
at a far earlier stage in the process than would be the case in many
other jurisdictions.(33) In many jurisdictions in Europe, including in
the UK, France and Germany, insolvency proceedings are usually only
capable of being implemented where the entity is, or is on the brink of
insolvency. From management's perspective, the main driver in
instigation insolvency proceedings in these jurisdictions is likely to
be (at least in part )defensive - the directors will be motivated in
starting proceedings by a desire to ensure that they are not personally
(and in some case criminally) liable in respect of the company's
indebtedness. In contrast, management in the US can plan for a chapter
11 restructuring, usually without the fear of personal liability and
preferably at a point when rescue and rehabilitation of the company has
good commercial prospects of succeeding .(34) It is no surprise to see
the influence of chapter 11 on recent or prospective reforms to
insolvency laws world wide as many jurisdictions move towards a more
debtor-friendly approach.(35) The debtor friendly nature of Chapter11
suggests that less distressed firms (or even profitable ones) may enter
Chapter 11 thereby increasing the incidence of going concerns compared
with the UK sample.(36)
Complete harmonization of insolvency laws
worldwide is not currently regarded as feasible.(37) However, most of
the jurisdictions are aiming at the Chapter 11 model of insolvency
regime.
CONCLUSION:
Liquidation of insolvent companies is
comparatively an easier phenomenon. Court, liquidator or administrator
has to assess the assets and liabilities of the company. Assets are sold
out. Preferences of the creditors are determined. After making payments
to the preferential and secured creditors, residual amount generated by
materialization of assets is distributed among the unsecured creditor,
and the company gets buried. An already dying company's affairs involve
no risks, as such. No challenges are to be faced. No big decisions are
to be made. Creditors, already prepared to face the consequence, get
pacifies without causing much trouble to the persons involved in the
process of administration. There are least uncertainties, actually,
about the time to come. No liabilities of future results are there on
the shoulders of the people responsible for the process, except for
performing the immediate duties. An attempt to rescue the company is
like one of treatment of a dying patient. If, despite putting all
possible efforts, life could not be brought to him, the relatives would
blame the doctor. Then, what is the need to get into such an exercise?
Why not to let the leaving souls leave?
Needless to say, rescue is
not always guaranteed under rescue processes, but there may be an
opportunity for companies to revive the business, for jobs to be
preserved, for debts to be satisfied, and in the event that liquidation
is inevitable, for a better return to be provided for creditors.(38)
The
resources used and the risks involved in an attempt to save a company
from liquidation might be a matter of concern, yet even only small
success rate would be desirable, as in the event of liquidation the
percentage of recovered money does not reach the double digit, for most
of the creditors.
From communitarian point of view, that attracts
me the most, a single instance of successful rescue would be more
beneficial to the society than tens of efficient liquidations.
REFERENCES
1-
Keay, A (1998) "Preferences in Liquidation Law: A Time for a Change"
Company Financial and Insolvency Law Review: Vol. 2 pp 216
2- Goode, R. M. (1997) Principles of corporate insolvency law 2nd ed London : Sweet & Maxwell p14
3-
Keay, A. R. & Walton Keay, A. R. & Walton P. (2003) Insolvency
Law: Corporate and Personal, Harlow: Pearson Longman pp 9
4-
Franks, Julian and Sussman Oren (2000) "The Cycle of Corporate Distress,
Rescue and Dissolution: A Study of Small and Medium Size UK Companies"
http://facultyresearch.london.edu/docs/306.pdf>
5- Ibid
6-
Ministry of Development , New Zealand (2004) "Current New Zealand Law
in Context of Rescue" p3 7- Armour, John and Frisby, Sandra (2001)
"Rethinking Receivership" Oxford Journal of Legal Studies: OJLS
2001.21(73)
8- Op. cit. Ministry of Development , New Zealand: p2
9- Op. cit. Keay, A. R. & Walton P. pp95
10- ibid
11- Op.cit.Goode pp 22-23
12- Re Charnley Davies Ltd (No 2) [1990] BCLC 760, [1990] BCC 605
13- Para 3(1)
14- Op. cit. Goode pp 20
15- Op. cit. Keay, A. R. & Walton P. pp 126
16- ibid pp 127
17- Section 5 of Insolvency Act 1986
18- RA Securities Ltd v Mercantile Credit Co Ltd ([1994] BCC 598)
19- Burford Midland Properties Let v Marley Extrusions Ltd ([1994] BCC 604)
20- Re Halson Packaging Ltd ([1997] BCC 993)
21- Op cit. Goode pp 15
22- Pile, Jacqui (2004) "Liquidation Industry: Overview" Financial Mail:
23- Milman, David, (2000) "Corporate Rescue: Principles and Pragmatism" Insolvency Lawyer Vol. Jan.
24- Op.cit. Franks et al.
25- Rizvi, Isa (2001) "Legal Issues: Pakistan"
26- Hong Kong Coalition of Service Industries (1998) "Position Paper on Corporate Rescue"
27- Op. cit. Ministry of Development, New Zealand
28- Op. cit. Rizvi
29- Op. cit. Pile
30- Op. cit. Milman pp 12
31- Op. cit. Franks et al
32- Mallon, Christopher (2004) "Chapter 11: Relevant Beyond the US"
33- Op. cit. Mallon
34- Op. cit. Mallon
35- ibid
36- Op. cit. Franks et al
37- Op. cit. Mallon
38- Op. cit Hong Kong Coalition of Service Industries
