Update: insolvency

Pensions legislation compels employers to ensure that pension schemes are properly funded. When an employer enters into insolvency proceedings, known in pensions legislation as an 'insolvent event', (including CVAs, administration and liquidation) any pension scheme funding deficit is recalculated on a 'full buy-out' basis. This requires the employer debt to be calculated on the assumption that the company has an obligation to purchase annuities in the commercial market place, in order to meet the unfunded pension cost in relation to all members of the scheme. As a result, buy-out debts are normally much higher than in solvent, ongoing, funding levels.

As soon as the employer suffers an insolvency event, all the rights of the pension trustee vest in the pension protection fund (PPF). The PPF will meet a basic level of scheme member compensation, up to about £29,000 per member per annum.

The Pensions Regulator has a statutory right to issue a financial support direction (FSD) against any company which has impaired the ability of the employer to meet its obligations to the pension scheme.

Contribution notices (CN) can also impose a financial liability payable by the associated company to the trustees of the employer's underfunded pension scheme. FSDs only apply to a final salary pension scheme if the following are satisfied:

1. the relevant company was connected to the employer in the period of two years before determination to issue FSD (the 'relevant period');

2. the regulator must be satisfied that the employer is insufficiently resourced within the relevant period. The value of company resources is less than 50 per cent of the estimate pension deficit owed by the company;

3. the value of resources of the target must not be less than the difference between the value of the company's resources and 50 per cent of employer debt; and

4. the Determinations Panel considers it reasonable. Factors to consider are: relationship between target and employer (is there control?); value of benefits received by the target from the employer; connection or involvement of target with the scheme; the target's financial circumstances; and the regulator has issued a warning notice setting out the grounds for the issue of FSD.

On 3 February 2011, the Insolvency Service (IS) wrote to stakeholders requesting evidence supporting the case for new legislation to counter the effect of the High Court's decision in Bloom and others v Pensions Regulator (Nortel, Re) [2010] EWHC 3010 (Ch). As a result of this decision, liabilities arising under an FSD or CN, issued to a company after it has gone into administration, rank as expenses of the administration.

The IS letter followed its meeting with stakeholders on 31 January 2011, at which it was suggested that the Nortel decision could make lenders more cautious about lending on the strength of floating-charge security. Certain statutory liabilities should be payable as expenses of the insolvency procedure during which they arise. Accordingly, lenders could not be sure whether a floating charge, which ranks behind administration expenses, was at risk of being subordinated to a wide range of environmental and other types of statutory liabilities in insolvency.

Corporate insolvency

In Re PAL SC Realisations 2007 Ltd (in liquidation) [2010] EWCH 2850 (Ch), the respondent creditors held floating charges over PAL and ranked second under a priority agreement for the repayment of debts to secured creditors. The floating charge assets were realised on administration of PAL and the amount owed to the first ranking secured creditor left nothing for the respondent creditors. The prescribed part was all that was available to the unsecured creditors.

The respondents surrendered their debenture and the debt was accordingly converted into a wholly unsecured claim. The liquidators applied for directions as to whether the respondents could participate in the prescribed part.

It was held that the debts due to the respondents were to be treated as unsecured debts for the purposes of section 176A (2) IA86. There was nothing in the provision to exclude a former floating charge holder from participating in the prescribed part. HHJ Kaye QC found that it was clear that a secured creditor who surrendered their security could prove for their whole debt as if it were unsecured '“ there was no reason to continue to treat them for the purposes of section 176 as a holder of a floating charge.

It had previously been held that a floating charge holder was barred from participating in the prescribed part for the shortfall under the meaning of section 176 (A)(2)(b) IA 86 (Re Permacell Finesse Ltd [2007] EWHC 3233 (Ch) and Re Airbase (UK) Ltd [2008] EWHC 124 (Ch)). This case will impact on secondary ranking floating charge holders: the relevant time for indentifying their creditor status is when the claim against the prescribed part is made; unsecured trade creditors will be disadvantaged as a result.

Personal insolvency

In Child Maintenance & Enforcement Commission v (1) Mark Beesley (2) Darren Richard Whyman [2010] EWCA Civ 1344, the appellant appealed against the first instance decision that it was a creditor capable of being bound by an individual voluntary arrangement (IVA) of the second respondent non-resident parent (W).

W had put forward a proposal jointly with his wife for an IVA which was approved by their creditors. W was then £25,610.90 in arrears with child support. His statement of affairs included those arrears and they represented some 94 per cent of his liabilities. The only creditor which voted at the meeting called to consider the proposed IVA was owed £381 and voted by proxy.

The commission did not attend because it considered that it was not a creditor capable of voting on or being bound by the IVA.

The commission applied, pursuant to the Insolvency Act 1986 section 263(3), for an order that the first respondent supervisor had incorrectly decided that the commission was entitled to vote at the meeting; and/or alternatively an order revoking the IVA on the ground that it was unfairly prejudicial to the interests of the commission.

It was held that the commission was a creditor capable of being bound by the IVA, within the meaning of section 260(2)(b) of the 1986 Act, but set aside the IVA on the ground that it unfairly prejudiced the commission under section 262(1). The commission appealed and the Court of Appeal held that the commission was not a creditor entitled to vote at the creditor's meeting called to consider W's IVA, and it was not capable of being bound by his IVA.

It is an implied requirement under part VIII IA86 that, for a creditor to be bound by an IVA, it must be capable of compromising the debtor's liability. As the commission was incapable of such a compromise according to the Child Support Act 1991, it couldn't be bound by the IVA. CSA maintenance arrears cannot be a creditor for the purposes of an IVA. The CSA must be notified of the meeting of the creditors but it cannot vote or participate in any IVA under existing rules. Instead, the CSA is free to pursue the debtor with potentially fatal consequences for the IVA.

Re Hargreaves in individual Voluntary Arrangement (Booth v Mond [2010] BPIR 1111) dealt with arrears of contributions under an income payments agreement (IPA).

Mr Hargreaves made an IPA with his trustee in bankruptcy under section 310A before he was discharged. He fell into arrears in the third year of the IPA and his trustee in bankruptcy claimed that the arrears should be included in the accepted IVA; the supervisor disagreed and both parties made applications to the court.

The wording of the new paragraph 9B in schedule 5 of the Act, effective from 6 April 2010, gives the trustee in bankruptcy 'power to make such compromise or other arrangement as may be thought expedient with respect to any claim arising out of the or incidental to the bankrupt's estate made or capable of being made by the trustee on any person'.

The judge concluded that if he had not found that the IPA arrears were an IVA debt the trustee in bankruptcy could have petitioned for the bankruptcy of the debtor, which would have resulted in the failure of the IVA.

Portsmouth FC 1 '“ HMRC 0

The High Court has dismissed a challenge by HMRC to the company voluntary arrangement (CVA) for Portsmouth City Football Club Limited that had been formally approved by its creditors.

HMRC had alleged there were material irregularities in the CVA documentation and the voting process. It also alleged it had been unfairly prejudiced because certain classes of unsecured creditors were to be paid in full by the Premier League, although other unsecured creditors (including HMRC) would only receive 20 per cent of the value of their claims from the club.

The High Court dismissed all five grounds of HMRC's challenge. In addition, this case highlighted the 'football creditor rules' of the Premier League and the Football League.

These rules require football players and other football clubs to be paid in full when a club becomes insolvent, notwithstanding that other types of creditors may receive nothing (HMRC v Portsmouth City Football Club Limited (in administration) and others [2010] EWHC 2013 (Ch) (5 August 2010)).

HMRC has a strict policy to vote against any CVA in which it is an unsecured creditor if the proposed CVA does not treat unsecured creditors equally. HMRC also opposes the football creditor rule and considers that it offends the principle of pari passu and what is known as the 'anti-deprivation principle'.

From the perspective of insolvency practitioners, this case provides a useful appraisal of the policy and approach of HMRC as a creditor in insolvencies and in particular CVAs. It seems that HMRC's policy of opposing CVAs that do not observe a strictly pari passu order of distribution, even where the alternative of liquidation will produce a worse outcome for HMRC itself, is likely to make the court more receptive to the debtor's commercial arguments as to the overall fairness of the CVA.

The question of whether unsecured creditors whose claims will be paid in full or otherwise discharged by third parties can vote in the CVA (without this constituting unfair prejudice or material irregularity) raises some interesting issues.

Although the votes of secured creditors or creditors whose claims are secured separately by bills of exchange or promissory notes are not taken into account in the CVA voting process, the insolvency legislation does not attempt to take into account the total commercial position of the creditor in deciding whether it has a real economic interest in the debtor's business. It is possible that it would be almost impossible to draft legislation that brought a creditor's full commercial position into account when deciding its entitlement to vote on a CVA.

This case shows that the debt owed to a creditor does not necessarily tell the full story of the creditor's real commercial interests: ''A debt, the value of which cannot be ascertained' means a debt the amount of which cannot be estimated until the happening of some future event' (Re Dummelow [1873] LR Ch App 997, judgment of Sir G Mellish LG).