Should UK Adopt a Version of US Chapter 11 Bankruptcy Process?

Insolvency Reform
A 21-day moratorium for failing businesses is among suggestions for reforming the UK’s corporate insolvency regime.

A 21-day moratorium for failing businesses is among suggestions for reforming the UK’s corporate insolvency regime. Will a version similar to America’s Chapter 11 bankruptcy process give firms much-needed breathing space or just allow the less scrupulous to fritter away assets?

There’s much to admire in the UK’s insolvency system. It returns more money to creditors and is faster and cheaper than those in the United States, Germany and France, according to rankings published by the World Bank.

Insolvency trade body R3 also points out that in 2013-14 two out of every five businesses its members worked with were able to continue in some way — equivalent to almost 7,000 business rescues and 235,000 saved jobs.

So why is R3 keen to overhaul the system and introduce a 21-day period free from creditor pressure? Its contribution to the debate on insolvency reform comes as the Government considers whether to copy the Chapter 11 system in the United States, where companies are allowed 90 days’ grace.

R3’s thinking addresses a common complaint among struggling firms that when the threat of formal insolvency looms, the time for decision-making is too short.

It believes firms need a period of time to consider their options and take difficult decisions without jeopardising the company’s supply chain and increasing pressure on cash flow, both of which could hasten the onset of formal insolvency.

Too expensive

There are parallels with Chapter 11 of the Bankruptcy Code in the United States, where management can continue to run day-to-day operations but significant business decisions are approved by a bankruptcy court.

America’s 90-day moratorium allows for a plan that can be accepted by creditors, bondholders, and stockholders, and ultimately the bankruptcy court. This is one of the options ministers have been looking at with the UK regime.

Even though the Chapter 11 process is open to all, it is expensive and more likely to be used by larger companies rather than the SMEs that account for most of UK insolvencies. One of the major concerns with the US system is the lengthy amount of time that many companies spend in the insolvency process.

Replicating this in the UK would require greater involvement in the courts system, whether the process is for three months or three weeks.

Simon Renshaw, a director at corporate and personal insolvency specialist AABRS, said: “We don’t rely on the courts as much for insolvencies in the UK, so I’m not sure how our legal system would be able to deal with it.

“We are supposed to be getting rid of red tape, but by using the court system in this way we will be creating more.”

Mediation role

R3’s alternative to the substantial use of court time is to fill the role of third-party oversight with a licensed insolvency practitioner. However, Mr Renshaw has concerns about whether this Moratorium Supervisor, or meditator, will always be able to act in a creditor’s best interests.

Only recently the government ended the insolvency litigation Legal Aid exemption, even though it helped insolvency practitioners to recover an estimated £480 million a year from rogue directors and others.

Mike Smith, managing director of Company Debt, said the: “This latest proposal gives a 21 days moratorium, a breathing space for directors who think they are on the brink, or are insolvent. In theory this will allow the director to contact an insolvency practitioner who will act as “supervisor” for the 21 day period.

“Suppliers must maintain supplies and HMRC are pulled into check. In theory anyway this may improve the chances of a company voluntary arrangement.

“Unfortunately the same ‘breathing space’ allows’ unscrupulous or, incompetent directors, to create more debts.”

Open to abuse

This is also the concern of Philip King, chief executive of the Chartered Institute of Credit Management, who has said the proposals are “fraught with dangers” with consequences for creditors, cashflow and thousands of small businesses within the supply chain.

He believes the ability to distinguish the ‘good’ from the ‘bad’ would be almost impossible to determine and the system open to abuse.

Mr King said: “It is naïve to think that the system will not be open to further abuse by unscrupulous directors without adequate or appropriate oversight. The challenge will be in ensuring that such oversight is rigorously monitored and the process sufficiently transparent.”

Other issues raised by the industry concern how struggling firms can prove that debts accrued during the 21 day moratorium period can be repaid.

Lending to a company in a moratorium could be risky and lenders will be understandably cautious when it comes to extending credit to such companies.

In addition, Mr Smith points out other concerns:

  • What are the penalties for a false declaration or delaying tactic?
  • What is the legal process for objecting to the moratorium by an angry or, even malicious creditor?
  • What will be the banking response to a possible adverse effect on holding security on company assets? Will this effect on security push up costs elsewhere, affecting more profitable companies unfairly?
  • Whose interests are the insolvency practitioners acting in? I imagine the creditors’ interests, so how will this play out in practical terms?
  • What will be the impact on professional indemnity premiums?

Long-term gains

R3 insists that protection for creditors is built in to its proposals. It adds that they should get a better deal in the longer term as the chances of a rescue are increased by having more time to put together a business rescue plan. This, in turn, would lead to creditors seeing more of their debts repaid.

We should hear more on the merits of a moratorium when the government reports back on its consultation in the coming weeks. To remain at the forefront of insolvency best practice requires looking at what works well and what doesn’t, and asking whether the system remains fit for purpose.

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