Update: insolvency

In the February 2010 update, reference was made to the data published by the Insolvency Service, which stated that 'corporate insolvencies in the third quarter of 2009 showed an increase of just over nine per cent compared with the same period a year ago'. With the sharp decline in GDP between 2008 and 2009, we expected 2010 to see a further rise in corporate insolvencies.

Instead we have seen a fall in both liquidations and administrations during the year. The recent figures from the Insolvency Service show that company insolvencies decreased by 2.2 per cent on the previous quarter and by 13.9 per cent on the same period a year ago, while individual insolvencies also saw a decrease of 3.7 per cent on the same period a year ago.

Despite certain signs of economic recovery in the UK there still remain many problems. Business confidence is low because of the lack of available funding, resulting in fewer investors willing to buy business assets following administration or restructuring. The government spending cuts are also just beginning to effect corporate insolvencies among businesses directly concerned. A recent example is the maintenance services contractor Connaught PLC going into administration.

Connaught has partially blamed its demise on the fact that the availability of additional funds from its lenders was not forthcoming. However, Connaught cannot deny that it was affected by the drastic cost cutting in public spending because of its almost complete reliance upon contracts from the public and social housing sectors.

The balance sheet test

The case of BNY Corporate Trustee Limited v Eurosail [2010] EWHC 2005 (Ch) offered some help with the issue of when exactlya company is insolvent under section 123(3) of the Insolvency Act 1986, aka 'the balance sheet test'.

BNY was the trustee for the holders of notes and certain other secured creditors under a structure involving residential mortgage backed securitisation pursuant to which notes were issued by Eurosail. The notes were issued in multiple classes of denomination and in turn entered into a number of currency and interest swaps with the Lehman Brothers group. The transaction also included a post-enforcement call option (PECO). Following the collapse of the Lehman Brothers group, the swaps were terminated, resulting in a substantial net liability close out position which was highlighted in Eurosail's latest audited accounts.

The English court decided that a company was not insolvent within the meaning of section 123(2) of the Insolvency Act 1986 (more commonly known as the balance sheet test) even though the company's management and financial records indicated that there were substantial net liabilities. The court held that the PECO was a contingent liability which did not have to be reckoned in the balance sheet at its full risk value.

The chancellor held that the exercise which section 123(2) IA 1986 calls for is not the creation of a balance sheet to provide a snapshot of the company's financial affairs at a certain point in time. Instead, what is required to ascertain solvency is to make a comparison between the value of a company's actual assets and its actual liabilities.

Consideration had to be made to the relevant facts of the case, including: when the prospective liability falls due; whether it is payable in sterling or some other currency; what assets will be available to meet it; and what if any provision is made for the allocation of losses in relation to those assets.

The three main points that can be taken from the decision are:

• Only present assets should be taken into account when considering thebalance sheet test and those assets may include items not on the company's balance sheet.
• Contingent and potential liabilities should not necessarily be taken into account at face value.
• The balance sheet test is a legal assessment, not an accounting exercise, and generally accepted accounting principles do not necessarily apply.

In an area where most court decisions have focused on the cash flow test, Eurosail helps to provide some clarification on how the balance sheet test will be applied in practice. The decision emphasis is that the test which determines whether a company is balance sheet insolvent or not differs in the legal context from the test applied for accounting purposes.

Thin ice

The moratorium afforded by administration provides that no legal process can be initiated against a company or its property without the permission of the court or the consent of the administrators.

The case of Re Frankice (Golders Green) Limited v The Gambling Commission [2010] concerned three companies that were members of the Agora Group. The group entered into administration in December 2009, with an estimated shortfall to its creditors of £84m. The companies were required to hold operating licences under the Gambling Act 2005, while licences were also needed for key individuals and the premises at which the licensed activities were conducted.

The administrators entered into a contract for a going concern sale to be completed.

However, before the administration the Gambling Commission had started an investigation into suspected breaches of licence conditions. The commission felt these matters should be reviewed by a regulatory panel.

This could have resulted in the revocation or suspension of the licences which in turn would lead to the companies trading unlawfully, therefore suspending the sale as a going concern. Thus, the administrators applied for directions as to whether or not the review hearing was subject to the administration moratorium and, if it was, whether permission to continue should be given.

The court held that the review of the licence was a legal process, so as to fall within the moratorium, and required permission to continue. This decision is significant for administrators of regulated businesses faced with a hearing of this sort which, depending on the result, could adversely impact on the completion of a sale and the return to creditors.

This decision has clearly altered the balance of power between regulators and administrators by restricting the exercise by regulators of the powers that they have to perform their public duties in the regulation of businesses. We may, therefore, see some regulators looking to change their licensing conditions to ensure that the regulatory regime is not undermined by companies going into administration. In the meantime some companies may try to use administration as a device to stymie regulatory sanction. That by itself would not be a proper use of administration. Also, it is unclear whether this decision will stand, with Norris J underscored within his judgment that he found the decision difficult.

Relocation, relocation

The last insolvency update considered the decision in Goldacre (Offices) Limited v Nortel Networks UK Limited (in administration) [2009] EWHC 3389 (Ch).

It is interesting to note that the Scottish courts have followed the English decision in Goldacre in ordering that rent was an expense of the administration of the tenant for the period from the grant of a license to a buyer of the tenant's business until the contractual expiry of the license. This decision helps in harmonising the English and Scottish positions on this issue.

In Rubin v EuroFinance [2010] EWCA Civ 895, the Court of Appeal considered the question of whether a default and summary judgment given by the Bankruptcy Court for the southern district of New York in the course of bankruptcy proceedings taking place under chapter 11 of the United States Code should be recognised and enforced in England. This case builds on the relatively recent House of Lords cases of Cambridge Gas Transport Corp v Official Committee of Unsecured Creditors of Navigator Holdings PLC [2006] UKPC 26 and Re HIH Casualty & General Insurance Ltd [2008] UKHL 21.

The bankruptcy proceedings under chapter 11 were in relation to a trust (the Consumers Trust) which was running a scheme in the United States. In the course of those proceedings, claims were made against the respondents to recover amounts paid from the trust to the appellants before the trust entered into bankruptcy proceedings. The respondents failed to challenge the proceedings with the result that a default judgment was entered against them.

The respondents contested the recognition of the judgments in England on the ground that the New York Bankruptcy Court had not had jurisdiction in personam over them.

Lord Ward held that the ordinary rules for enforcing foreign judgements in personam did not apply to bankruptcy proceedings. He held that the default judgement in the present case fell within the category of bankruptcy judgments and, therefore, could be recognised in England under the common law principles which enable the recognition of a foreign insolvency proceeding.

However, as the Court of Appeal ordered that the judgment should be enforced under the common law, it did not proceed to decide whether the judgement could have been enforced under the Cross Border Insolvency Regulations 2006.

The Court of Appeal's decision has indicated that there are some special features of insolvency law that should be recognised and assisted by the English courts, wherever the insolvency proceedings originated. This may now result in more foreign representatives seeking the assistance of English courts in the future.