A comparison: company rescue under UK

administration and US Chapter 11

Standard Note: SN/HA/5527
Last updated: 18 May 2010
Author: Lorraine Conway, Home Affairs Section
Section Home Affairs Section


In the UK, a company is insolvent if it cannot meet its debts as and when they fall due.
Broadly speaking, an insolvent company has two options: compulsory liquidation or company
rescue via administration. Under the Insolvency Act 1986 (IA 1986) and the Enterprise Act
2002 (EA 2002), compulsory liquidation (or winding up) involves the closing down of the
business and the realisation of company assets for the benefit of creditors. In contrast,
administration provides an opportunity to rescue the company or its business. The
administration procedure is designed to hold a business together while plans are formed
either to put in place a financial restructuring to rescue the company, or to sell the business
and assets to produce a better result for creditors than a liquidation. It is possible for a viable
business in financial difficulty to emerge in tact from administration.

In the US, an insolvent business also has two options under the US Bankruptcy Code: file
with a federal bankruptcy court for protection under either Chapter 7 or Chapter 11. Chapter
7 deals with liquidation; under Chapter 7 the business stops trading and all assets are sold
for the benefit of the creditors. In contrast, the aim of Chapter 11 is to restructure debts and
save the business. It is also possible for a viable business in financial difficulty to emerge in
tact from Chapter 11 proceedings.

Comparisons are often made between UK administration and US Chapter 11 proceedings.
They share the same purpose: to rescue a viable business in temporary financial difficulty.
The EA 2002, which came into force in September 2003, substantially reformed the
administration procedure. However, it has been argued variously that the Act could have
gone much further - it could have introduced in the UK new procedures more akin to Chapter
11 of the US Bankruptcy Code. Certainly, at the time of this insolvency law reform in the UK,
comparisons were made to Chapter 11.

This note has two aims. First, to outline the background to the reform of administration in the
UK in order to facilitate greater company rescue and second, to provide a comparison
between the UK administration insolvency procedure and US Chapter 11.

Separate Library note SN/HA/4915 provides an explanation of how administration works in
practice in the UK. Another Library note SN/HA/4798 provides an overview of Chapter 11
and an explanation of how this insolvency procedure works in the US.
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Contents
1 Introduction 2
2 Government consultations on Chapter 11 type reforms in the UK 2
3 Overview of administration under the EA 2002 3
4 Comparisons between the UK administration and US Chapter 11 4



1 Introduction
The Enterprise Act 2002 (EA 2002), which came into force in September 2003, substantially
reformed administration law in the UK. However, it has been argued variously that the EA
2002 could have gone further - it could have introduced US Chapter 11 type procedures in
the UK. Certainly, at the time of this insolvency law reform, comparisons were made to
Chapter 11 procedures under the US Bankruptcy Code.

2 Government consultations on Chapter 11 type reforms in the UK
Reform of the UK insolvency law regime was considered in December 1998 in the
Governments White Paper Our Competitive Future: Building the Knowledge Driven
Economy.
1
In this White Paper, the Government announced its intention to review
arrangements for business rescues and reassess the relative rights of creditors, including
possible changes to the Crowns preferential status. The Governments aim being to
encourage risk-taking and facilitate company rescue when things go wrong. It argued that
when fundamentally viable businesses are lost there are consequences for creditors,
employees and the wider economy.

A joint DTI and Treasury working party was set up in 1999 to review company rescue and
business reconstruction mechanisms. In September 1999, this working party published a
consultation document, A Review of Company Rescue and Business Reconstruction
Mechanisms.
2
A principal theme of the document was whether there was a need to shift the
balance of the UK insolvency regime from being creditor-friendly to being debtor-friendly.

In its report, which was published for consultation in November 2000, the Working Party
recommended certain legislative changes. These recommendations were considered in the
Governments White Paper, Insolvency A Second Chance, published in J uly 2001.
3
In the
foreword to this insolvency White Paper, Patricia Hewitt, Secretary of State for Trade and
Industry, explained the main aim of insolvency reform:

Promoting enterprise will boost UK business and improve productivity. Our Enterprise
Bill will strengthen competition and the power of consumers by radically reforming
competition law, transforming our approach to bankruptcy and corporate rescue and


1
Department of Trade and Industry (now Business Innovation and Skills) White Paper, Our Competitive Future:
Building the Knowledge Driven Economy, 1998
2
Department of Trade and Industry (now Business Innovation and Skills) and HM Treasury consultation
document, A Review of Company Rescue and Business Reconstruction Mechanisms, November 2000,
http://www.insolvency.gov.uk/insolvencyprofessionandlegislation/con_doc_register/con_doc_archive/consultati
on/condoc/condocreport.htm
3
Department of Trade and Industry (now Department of Business Innovation and Skills), Insolvency A
Second Chance, 2001, Cm 5234, http://www.insolvency.gov.uk/cwp/cm5234.pdfe
2
promoting new safeguards for consumers. We believe that promoting enterprise will
release the entrepreneurial skills of the British people.

In this White Paper I am setting out my proposals for the reform of insolvency law.
Companies in financial difficulties must not be allowed to go to the wall unnecessarily.
Administrative receivership, which places effective control of the direction and
outcome of the procedure in the hands of the secured creditor, is now seen by many
as outdated. There are many other important interests involved in the fate of such a
company, including unsecured creditors, shareholders and employees. We propose to
create a streamlined administration procedure, which will ensure that all interest
groups get a fair say and have an opportunity to influence the outcome.
4


At the time that these proposals were considered, a comparison was made between the UK
regime and the entrepreneurial regime in the US. It was argued that bankruptcy in the US
does not have the same stigma as it has in the UK. To some extent, it was this theme which
drove the reforms of the EA 2002.

3 Overview of administration under the EA 2002
In terms of reform of corporate insolvency and restructuring, the EA 2002 fell short of
implementing a full Chapter 11 style process. The main corporate insolvency measures
introduced by the Act were:

a streamlined administration procedure (making it more efficient and accessible in
order to facilitate the rescue of viable companies)
the out of court appointment of insolvency practitioners to act as administrators

the abolition of administrative receivership (with certain exceptions)

the introduction of new powers to extend certain insolvency proceedings, with
modifications, to foreign companies, Industrial and Provident Societies and Friendly
Societies

The EA 2002 promotes administration as an important vehicle for company rescue. The
original characteristics of administration, as introduced by the IA 1986, were retained: its
collective nature, its moratorium, and the opportunity to achieve different outcomes for
businesses. Other characteristics of administration introduced by the EA 2002 include:

without court order entry into the procedure;
the express power for the administrator to distribute realised assets;
new exit routes from administration into dissolution and voluntary liquidation; and
a faster and fairer procedure

Under the EA 2002 the primary aim of administration is to rescue the company as a going
concern (i.e. with as much as possible of its business) where it would provide the best result
for the company's creditors as a whole. If this is not possible, then the aim of the
administrator is to perform his functions with the objective of achieving a better return for
creditors than would be achieved in a winding-up. For example, a better return may result
from trading on for a period whilst seeking to sell off the business and/or assets.



4
Ibid
3
4
4 Comparisons between the UK administration and US Chapter 11
Some insolvency specialists have argued variously that the EA 2002 was a missed
opportunity for more radical reform of the UK administration procedure. In making their case,
they point out that the EA 2002 failed to introduce:

The US concept of the debtor stays in possession (DIP). Under the EA 2002, the
administration process does not leave directors in possession of a company with the
benefit of a statutory moratorium on creditor action and enforcement of security.
5

Instead, an insolvency practitioner is appointed administrator with responsibility for
the day-to-day running of the business and the goals of the administration.

The US concept of a DIP priority financing arrangement. In the US, there is an
established industry of DIP lenders who, because of the super-priority status granted
to them in a Chapter 11 process, will make funding available to support a company
through its restructuring. This is significant because it means that a US company in
financial difficulties is not dependent on attempting to persuade its existing banks to
lend more money.

Chapter 11 provisions as apply to so-called executory contracts and leases. Chapter
11 renders unenforceable any provision purportedly terminating a lease or executory
contract by reason of the debtors financial difficulties. Under the UK administration
process of the EA 2002, it is argued that administrators often struggle to hold together
and sell a business as a going concern without these powers.

However, other insolvency specialists have argued that the EA 2002, and the reformed
administration procedure it has introduced, has carefully avoided problems associated with
US Chapter 11 style proceedings. For example, it is argued that:

Chapter 11 imposes greater administrative burdens on the debtor business than the
EA 2002. The DIP is subject to substantial financial reporting requirements to
creditors and other interested parties. This imposes a significant administrative
burden on the DIP, not least because all parties have the right to be consulted during
the Chapter 11 process. In contrast, most of the provisions of the EA 2002, which
sought to give greater powers to creditors committees, were dropped by the time the
Act came into force.

Chapter 11 procedures is excessively lenient in giving an escape route to the
incompetent management of a failing company, damaging the efficiency of the
economy as a whole and allowing poor managers to continue managing. This is not
the case with administration.

It is worth pointing out that in the UK, it is the responsibility of the Insolvency Service to
keep under review the effectiveness of all insolvency legislation including the EA 2002.
6



5
It is correct that changes introduced by the Insolvency Act 2000 introduced a statutory moratorium to protect
companies seeking a Company Voluntary Arrangement, but this protection is only available to small
companies (a company that has a turnover of not more than 2.8m and/or a balance sheet total of not more
than 1.4m and no more than fifty employees)
6
The Insolvency Service is an executive agency of the Department of Business Innovation and Business (BIS)