Update: insolvency

The Insolvency Service shows a contrasting picture for the first quarter of 2010 between corporate and individual insolvencies. While compulsory and creditors' voluntary liquidations have decreased 8.4 per cent on the previous quarter, individual insolvencies have increased 17.9 per cent on the same period a year ago.

Bankruptcies, IVAs and debt relief orders added up to 35,862 individual insolvencies in England and Wales in the first quarter of 2010. This increase is mainly due to a 20.1 per cent increase in IVAs, against a 10.7 per cent decrease in bankruptcies.

HMRC's 'Time to pay' scheme has eased cash-flow problems and reduced the number of liquidations. This may be only a temporary reprieve for some companies. Already, HMRC is being stricter about both eligibility to join the scheme and the time allowed for deferral of payment. Looking ahead, this is likely to increase pressure on debtors. A rise in formal insolvencies is anticipated.

The plans announced by the chancellor George Osborne to cut government spending will clearly put greater financial pressure on those businesses in sectors that rely on government contracts as a source of revenue.

Aside from a brief review of the new Insolvency Rules below, this article looks at several recently reported decisions arising out of company administrations. This is mainly because the growing popularity of pre-packaged administration sales is also engendering court challenges, typically by unsecured creditors who have felt disenfranchised by the process.

New orders

The Insolvency (Amendment) Rules 2010, the Legislative Reform (Insolvency) (Miscellaneous Provisions) Order 2010, and the Insolvency (Amendment) (No 2) Rules 2010 came into force on 6 April 2010. They include important changes to the costs of pre-appointment administration, office-holders' remuneration and dealing with onerous property contracts.

The new rules set out the mechanism for approval of pre-appointment costs and expenses. Approval must be given by the creditors or the court (Insolvency Rule (IR) 2.67A). 'Pre-administration costs' are stated as 'fees charged and expenses incurred, by the administrator, or another person qualified to act as an insolvency practitioner, before the company entered into administration but with a view to its doing so' (IR 2.33(2A)). The nature of the work which can underlie these expenses is not explained.

A recent case decided under the old rules may cast some light on how the new rules will be interpreted. In Re Johnson Machine & Tool Co Ltd [2010] EWHC 582 (Ch), the administrators were refused the treatment of their pre-appointment costs as administration expenses. HHJ Purle QC held that such costs were only allowable where the administration was clearly for the benefit of creditors as a better alternative to a winding up. The directors were the prospective purchasers of the company business so the required 'clear benefit to the creditors' was not proven in that case.

The administrator will need to show that costs were incurred specifically with a view to the administration. Their case will be greatly assisted by incurring these costs, as far as possible, after a 'firm decision' has been taken to put the company into administration. The process should be thoroughly reviewed and documented to show the clear benefit sought for the creditors. Best practice to achieve this was codified in the Statement of Insolvency Practice (SIP) 16 on pre-packs, which has been effective since 1 January 2009. Detailed information must be provided to creditors showing it is the best commercial solution to the business's crisis. The disclosure requires the administrator to keep a detailed record of the reasoning and show the source of their initial introduction, any involvement before the appointment, the alternatives considered, valuations and the possible financial outcomes between the purchaser, directors, shareholders and secured creditors.

Relocation, relocation

In Goldacre (Offices) Limited v Nortel Networks UK Limited (in administration) [2009] EWHC 3389 (Ch), the court held that rent relating to the period of administration is an expense payable by the administrator under IR 2.67. Occupying only a part of the premises was no defence against liability for the rent of the whole premises. The judge dismissed the argument that the court had the discretion to decide the treatment of the rent. The decision appears to strengthen the landlord's position but may be at the expense of a better long-term solution worked out through negotiation between the parties.

The administrators were using part of the premises for which the company had been paying rent under two long leases obtained before the insolvency. Rent payable during an administration may fall into one of two categories of administration expense: 'Expenses properly incurred by the administrator in performing his functions in the administration of the company' (IR 2.67(1)(a)), and 'any necessary disbursements by the administrator in the course of the administration' (IR 2.67(1) (f)). HHJ Purle QC preferred heading 'a', without distinguishing between expenses incurred by the administrator for his own functions or on behalf of the company. He also held that the claim could have been founded under heading 'f'. Under either head, the expenses were ranked ahead of the remuneration of the administrator.

In reaching his decision on the application of IR 2.67, the judge drew an analogy with the treatment of liquidation expenses under the 'Lundy Granite principle' which dealt with the similarly worded IR 4.218. The analogy overlooks two important differences. First, there is the general difference that an administration is closer to a receivership than a liquidation; a point taken by the Court of Appeal in Atlantic Computer Systems Plc, Re [1992] 2 WLR 367 CA (Civ Div). Second, there is a specific difference concerning onerous property obligations, which can be disclaimed by a liquidator but not by an administrator.

In addition to rent, all other expenses under the terms of the lease may fall to be paid by the administrator if the Lundy Granite principle is followed through. These could include the costs of repairs and making good dilapidations. The net result appears to be a very favourable regime for landlords compared with other unsecured creditors, as a result of judicial interpretation rather than statutory provision.

Goldacre has a potentially significant impact on an insolvency practitioner considering taking on an administrative appointment with onerous leasehold terms.

Taking up office in the company's premises may be avoided easily for some businesses. The balance may tip towards the disadvantage of doing so, with some relocation of working assets, for more businesses now where carrying on in situ would be prohibitively expensive.

Where relocation is not possible, then timing and terms of occupation of the company's premises will have to be tackled. Selecting only the minimum necessary space to occupy from a portfolio of properties will be the first step. The timing of entry is then critical. Goldacre concerned rent paid on a quarter date and the judge held that the administrator should pay the whole of the rent then falling due.

The obvious planning point for the administrator is to enter into office after the rent due date for the period with a view to paying only for their actual time in occupation.

The reluctant and halting steps of an administrator to take up office may encourage the landlord to negotiate on the terms of occupation. If wholesale renegotiation is not possible, then piecemeal agreement may be reached to reduce or remove exposure to specific items, such as repairs, dilapidations and any rent review. The flexibility ofrenegotiation of all terms has been removed by Goldacre and may only be restored by further case law or statutory change.

Working around TUPE

The last insolvency update considered the application of the TUPE legislation to an administration (Solicitors Journal 154/4, 2 February 2010). In Oakland v Wellswood (Yorkshire) Ltd [2009] UKEAT/0395/08; [2009] EWCA Civ 1094, the Court of Appeal held that continuity of employment was preserved by section 218(2) of the Employment Rights Act 1996 when an employee of a company in administration was employed by the buyer following a sale. However, the question of whether and in what circumstances the buyer in a pre-pack administration can obtain the benefit of regulation 8(7) TUPE and avoid the automatic transfer of employees remained uncertain.

This issue was considered further by the Employment Appeals Tribunal in Olds v Late Editions Ltd on 17 March 2010. Many commentators are taking a prudent view on predicted costs in an administration by anticipating that TUPE will be held to apply.

The judgment should be issued soon and, once received, should hopefully provide some helpful clarification.

The admin factor

An out-of-court appointment of administrators is effected first by filing a notice of intention to appoint administrators and then, within a few days, a notice of appointment. The first notice imposes a moratorium on any creditor action against the company. Thus, some directors have been filing repeat notices of intention so as to maintain a creditor moratorium for more than ten days.

Where there is a genuine reason for an appointment not being made within the statutory time limit of ten days after an application, the court will consider making an appointment under a new application. HHJ Purle QC so held in Re Cornercare Limited [2010] EWHC 893 (Ch) in making the administrative order.

The case illustrates the practical difficulties which can complicate the appointment of an administrator. The directors had intended to make an out-of-court appointment within the prescribed ten days of the first application. Their original plan was delayed by difficulties in obtaining funding to purchase the new premises for the business. Circumstances changed during this delay period so that by the time of the hearing the directors requested an administration order for a pre-pack administration sale. Documents showing compliance with SIP 16 were included with the report to the court.

The judge decided that the ten-day time limit prescribed in paragraph 26 of schedule B1 of the Insolvency Act 1986, only applied to the particular application. He did not need to address further the issue of a repeat notice of intention.

However, doing so was in keeping with the statement of the court in Re Kayley Vending [2009] EWHC 904 (Ch) in making an administration order involving a pre-pack sale. In that case, the court issued a caution that in exercising its discretion the court must be on guard that the procedure is not being obviously abused.

Repeated filing of notices of intention would create a series of moratoria to the creditors' disadvantage. In the present case, the judge held that such abuse could be prevented by the court using its inherent jurisdiction to remove the abusive notice of intention from the court file.

The judge's comments on the subject of possible abuse are obiter, so little guidance is provided on what is a 'genuine reason' for repeated notices of intention outside the facts of this case.