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Constrained Choices in Corporate Insolvency?

15 August, 2017Keith Pond

The UK system of corporate insolvency law and practice has been slowly moving in the direction of emphasising company rescue rather than enforcing the priority of secured creditors as the primary consideration.  Change has been driven by government policy makers (Cork Report, 1982), insolvency practitioners, financially troubled companies and creditors who have less senior rights.  Of note, however, is the low take up rate of rescue procedures in the UK since legislative changes in 1986 and 2002 (Pond, 2017).

Corporates entering insolvency appear to have a variety of choices regarding formal procedures.  Administration and Company Voluntary Arrangement schemes are focused on rescue of the whole or part of the enterprise, whilst Liquidation and Law of Property Act Receivership are focused on realisation and maximisation of asset values for creditors.

The Downward Spiral 


But is there a real choice?  The evidence suggests that too many companies leave it too late to have a choice as they attempt to stay afloat.  Activities “below the waterline” are often private and difficult to see but where they are effective they can avoid terminal problems.

Once a company and its directors have left it too late the choice becomes less open – and it becomes public, with the fallout in the markets and amongst creditors fuelling a downward spiral.  Lenders’ policies and Insolvency Practitioner advice influences the choice much more that directors’ wishes in “above the waterline” choices.

Weakening the power of the floating charge (Enterprise Act 2002) by making a portion of the proceeds of floating assets available to unsecured creditors and outlawing Administrative Receivership (where the IP is responsible only to the bank, rather than to the creditors as a whole) have attempted to swing the pendulum in favour of rescue attempts.

The Sad Truth

Revealed by insolvency statistics, many more companies in the UK are liquidated than are rescued.  David Milman, in his excellent and comprehensive book “Governance of Distressed Firms” (2013) describes governance in what he calls “the twilight zone” between the recognition of distress and the onset of formal insolvency.  Shareholder rights (which directors of SMEs, in particular, are motivated to maintain) disappear with the firm’s evaporating solvency.  This shifts the duty of a director away from the primary aim of shareholder benefit to that of preservation of value for creditors.  This is not a transition that many directors are either motivated or equipped to perform.

So, a choice, but, at best, a constrained one…

References: 

The Cork Report: Insolvency Law and Practice – Report of the Review Committee, 1982, Cmnd 8558. HMSO, London.

Insolvency Statistics (on-line): https://www.gov.uk/government/collections/insolvency-service-official-statistics

Milman D, (2013), Governance of Distressed Firms, Edward Elgar,

Pond K, (2017), Recession-what recession? LIBF Insights blog, available at: http://www.libf.ac.uk/news-and-insights/insights/detail/2017/01/26/recession-what-recession-corporate-insolvency-numbers-herald-a-recession-in-insolvency-markets

To read the other instalments in the Insolvency Series, please click here.