Insolvency update

The cases of Key2Law (Surrey) LLP v De'Antiquis [2011] EWCA Civ 1567 and Spaceright Europe Ltd v Baillavoine [2011] EWCA Civ 1565 have provided further clarification as to the protection afforded to employees under TUPE in the case of a transfer of an employer's business and assets in an administration. The position had been unclear following the decision of the Employment Appeal Tribunal in Oakland v Wellswood (Yorkshore) Ltd [2009] EWCA Civ 1094.

The Transfer of Undertakings (Protection of Employment) Regulations 1981 and 2006 (TUPE) confer on employees certain rights in the event of a transfer of an employer's business. TUPE provides that employees will automatically transfer to the transferee on their existing terms of employment and the transferee will then inherit employment liabilities and obligations in relation to them. Further, a dismissal that was connected to the transfer will be automatically unfair, unless the reason is economic, technical or organisational (referred to as an ETO reason), entailing changes in the workforce.

Clearly, the potential adoption of liability under employment contracts would discourage purchasers of insolvent businesses and so the government introduced provisions to assist by adding some flexibility.

TUPE provides that, where the employer is subject to 'bankruptcy proceedings or any analogous insolvency proceedings which were instituted with a view to the liquidation of the assets of the transferor', employees would not automatically transfer to the transferee and a dismissal for reasons connected with the transfer would not be automatically unfair.

TUPE also provides that, where there are 'relevant insolvency proceedings' (being 'insolvency proceedings which have been opened in relation to the transferor not with a view to the liquidation of the assets of the transferor and which are under the supervision of an insolvency practitioner') there would be greater scope to vary the terms of employment, where the variation is designed to safeguard employment by ensuring the survival of the business or part of it.

There have been a number of decisions in the employment tribunal and above that have demonstrated the shortcomings in TUPE, and more particularly the definitions of 'relevant insolvency proceedings' and 'bankruptcy proceedings or any analogous insolvency proceedings' when it comes to be applied to an administration.

It is important to understand the difference between an administration and a liquidation.

The statutory purpose of an administration is to achieve one of the following objectives:

• The rescue of the company as a going concern; and only if that cannot be achieved.
• The achievement of a better result for the company's creditors as a whole than would be likely if the company were wound up; and if that cannot be achieved.
• The realisation of some or all of the company's property to make a distribution to one or more secured or preferential creditor.

Often, the administrator, once appointed, will trade the company either with a view to rescuing it and returning it to its directors (albeit this is rare) or to preserve goodwill and avoid termination or breach of contracts while the business is marketed for sale.

Conversely, the purpose of a liquidation is to sell assets and distribute them to creditors. A company can only trade in liquidation in so far as it is necessary for the beneficial winding up of the company and even then the permission of the court may be required. A liquidation procedure therefore fits squarely into the definition of a process 'with a view to the liquidation of the assets', whereas an administration process does not.

Administrator objectives

It is not always clear, at the outset of an administration, what the objective of the administrator may be and it may change as the possibility of achieving the primary and/or secondary objective disappears.

There is no obligation upon the administrator to state his objectives until he makes his proposal to the company's creditors, which may be up to eight weeks after the administration. His only obligation is to consider each of the objectives and either perform the administration so as to achieve the primary objective or dismiss it and move onto the secondary and possibly the tertiary objective. To that extent an administration should always be commenced with a view to rescuing the company as a going concern. Does that mean that an administration can never be considered to have been carried out with a view to liquidation of assets, regardless of the actual outcome, such that it would never be possible to avoid the consequences of TUPE and that a dismissal connected to a transfer of the business would be automatically unfair?

In practice, very often the second or third objective is achieved by selling the assets of the business in one go so that the business is sold as a going concern. Effectively the insolvent company's assets will have been liquidated albeit the business will have been preserved through the sale. Sometimes this will happen after a period of trading while in administration. Sometimes the buyer is found before the company goes into administration and the sale effected upon administration to preserve the goodwill and trade of the business (a 'pre-pack' sale). Often, once the business has been sold the company quickly moves into a liquidation. Does that mean that such administrations were commenced with a view to liquidation of assets or does it depend upon whether there was a post-administration period of trading?

In Oakland the insolvent company had been sold back to its director and shareholder on the day that it went into administration. The Employment Appeal Tribunal decided that, in circumstances where the company would not trade in administration and would shortly enter into liquidation, this was 'bankruptcy proceedings or any analogous insolvency proceedings... instituted with a view to the liquidation of the assets of the transferor' such that the employees did not automatically transfer to the transferee. The EAT did not say that this would always be the case but considered that it would be a question of fact to be determined by the court. This would mean that a court would have to reconstitute the circumstances existing at the time of the start of the process and the objective of the administration in the mind of the administrators at that time.

Not only would this decision mean a great degree of uncertainty as to the rights of employees against transferees and the risk of a transferee adopting employee liabilities, but it would encourage the use of pre-pack administration where the purchaser would, on this view, be able to take the business free of employee liabilities.

Seeing clearly

A contrary view was adopted by the EAT in OTG v Barke (16 February 2011). However, the Court of Appeal has recently considered the issue in two cases which now provide much-needed guidance on the position.

In 2011, in Key2Law, the Court of Appeal considered the effect of an administration on employees. In this case a company went into administration in the hope that a buyer could be found but it wasn't. Instead, firms of solicitors were engaged by the administrators to carry out the work of the company as its agent.

The EAT had considered that the aim of an administration was not a question of fact but was absolute, depending upon the procedure adopted, and that, since the primary aim of an administration is to rescue a company as a going concern, it would not be a process analogous to bankruptcy. The Court of Appeal agreed, and accordingly employees of companies in administration would automatically transfer to a transferee and be protected from dismissals by reason of the transfer of the business.

In Spaceright, the business and assets of the company were sold one month after the company went into administration. At the time of the administration a buyer of the business had not been identified. The Court of Appeal had to decide whether the dismissal of the managing director of the company was connected with the transfer of the business. It decided that it was, notwithstanding that the actual buyer was not in contemplation at the time of the dismissal. This is an important clarification. Further, the court considered that the dismissal did not relate to the ongoing business, for example, a general reduction in the number of employees to assist trading as a going concern; accordingly the dismissal was not for an ETO reason and was unfair.

Purchasers of the business of companies in administration, and other transferees, need to be aware that they are likely to adopt liabilities in relation to employees. Purchasers should be advised that employment liabilities cannot be avoided by reaching an agreement with the administrators of the seller that they will procure the dismissal of employees before the sale of a business and assets. This is an important consideration for purchasers in any purchase, but, where there is a sale by an administrator, a purchaser cannot expect an indemnity from the seller or the administrator in relation to any liabilities that the purchaser may find that they have adopted. Indeed, administrators will often insist on the purchaser providing an indemnity in favour of the seller and invariably in respect of himself, in respect of any claims subsequently made by employees against them.

All too often purchasers are unaware of this risk and the question of employment liabilities becomes a 'deal breaker'.

Either the sale will fall away, potentially damaging the value of the business, or the purchaser will negotiate a reduction in the purchase price, reducing the return to creditors, or the purchaser will have to take the risk that it may have to take on employees that it does not need and/or risk employment claims from employees that are or have been involved in the business. The claims that may be made against a purchaser may be substantial, including claims for failure to consult employees in relation to a transfer. Liability for such failure may amount to up to 13 weeks pay per employee.

Policy decisions

Pre-pack sales of businesses out of an administration have received a great deal of bad publicity in the press fuelled by unpaid creditors left high and dry. However, it is well established that the advantage of a 'pre-pack' sale in an administration is that jobs are usually saved. The government has considered whether pre-pack sales should be outlawed or further regulated. While more stringent reporting requirements and duties have been imposed upon administrators, in an attempt to avoid sales back to directors of an insolvent business, for the purpose of avoiding having to pay creditors, proposals that creditors should receive notice of an intended sale have been dropped.

Ultimately the government has a policy decision to make as to whether legislation protects creditors or employees. Particularly in the current economic environment, the interests of employees must be considered to be paramount. However, in general a sale of a business as a going concern is likely to result in a higher return to creditors (albeit it is usually secured creditors that benefit) than a break-up sale of assets, in a liquidation, would achieve. Further, where employee liabilities transfer to a buyer of the business, the level of liabilities in the insolvent company is reduced, thereby potentially increasing the level of any distribution of funds in the administration to unsecured creditors.

At its best, Oakland created a period of uncertainty when many purchasers may have been comforted by the decision and held the view that employment liabilities for dismissed employees would rest with the insolvent company.

At its worst, the decision potentially meant that the transfer of employment rights could be avoided when a business was sold out of an administration process. This is entirely contrary to the understanding of insolvency professionals and the basis upon which policy upon administrations has been formed. The decisions in Key2Law and Spaceright must therefore be welcomed.