Pragmatic approach to voluntary arrangements

Much publicity attended the publication on 31 July of the Department of Trade and Industry’s White Paper entitled “Insolvency – A Second Chance” particularly directed to proposals for discharge of bankrupts after a period of twelve months instead of the current three years.

What escaped most commentators, at least in Scotland, was that personal insolvency is effectively a devolved matter and that buried in the White Paper was a paragraph (para. 1.49) which stated that the Scottish Executive had indicated that it would study carefully the extension of the proposed provisions on personal bankruptcy to Scotland. The paper contained no proposals on the timetable for reform and there was little attention in the press to the proposals on corporate insolvency (largely not a devolved matter) which would effectively abolish receivership as we know it on both sides of the border.

The personal insolvency reforms are relatively simply stated. They are a reduction in the discharge period for most bankrupts to a maximum of twelve months; there are proposals for discharge even earlier than twelve months. Consideration is given to reducing what the White Paper describes as “the stigma of failure” by reviewing the relevance of statutory restrictions on undischarged bankrupts which are unnecessary or outdated. Such restrictions include acting as a director of a limited company; obtaining credit above a prescribed limit (currently £250) without disclosing bankruptcy, acting as a Justice of the Peace, carrying on business as an Estate Agent, acting as a Charity Trustee, being a Member of Parliament as well as less common tasks such as being a member of a Valuation and Community Charge Tribunal or of the National Board for Nursing, Midwifery and Health Visiting for England. The third leg of the personal reforms is a proposal for the introduction of a Bankruptcy Restriction Order which would be fairly similar in scope and effect to the current Company Director’s disqualification provisions (including the recent amendments to allow restriction orders by agreement).

The package of corporate insolvency reform is designed, according to the White Paper, to create a fairer system in which there is a duty of care to all creditors and in which all creditors are able to participate.  Using the jargon of the times another aim of the reform is “to maximise economic value by aligning incentives properly”. This involves restricting the right to appoint a receiver to holders of floating charges granted in connection with very limited circumstances in the capital markets largely based around the transaction and settlement systems. As a corollary, the White Paper contains a commitment to streamline administration to make it fully effective in all circumstances. The principal stated objection to receivership is the ability of the floating charge holder to appoint a receiver whose duty lies essentially to the floating charge holder and where there are effectively no responsibilities of either information or payment to other creditors and no general accountability. The Government’s view is that on grounds of both equity and efficiency the balance of insolvency proceedings should be tipped firmly in favour of collective proceedings in which all creditors participate; under which a duty is owed to all creditors;  and under which all creditors may look to an office holder for an account of his stewardship of the company’s assets.

Finally, the White Paper proposes the abolition of Crown preference in all insolvencies and in relation to receivership proposes that a certain proportion of the funds generated by a floating charge is ring-fenced for the benefit of unsecured creditors. The preferential status of certain claims by employees for wages and holiday pay, for example, are to remain.

Meanwhile, elsewhere, the Partnership (Unrestricted Size) Number 17 Regulations 2001 (SI 2001/2422) remove with effect from 9 August 2001 the limit of 20 members for partnerships carrying on business as insolvency practitioners and consisting of a majority of partners authorised to act as insolvency practitioners under the Insolvency Act 1986 or equivalent law in the European Economic Area.

Two commencement orders have been made under the Insolvency Act 2000. The Commencement Number 1 and Transitional Provisions Order (SI 2001/766) introduced from 2 April 2001 company director disqualification formal undertakings in lieu of disqualification orders together with a series of miscellaneous amendments. The Commencement Number 2 Order (SI 2001/1751) introduced rule making powers in relation to the moratorium for company voluntary arrangements, with effect from 4 May, but did not implement the substantive provisions themselves. Implementation of these which were originally scheduled for “the summer” have been put back and are not now expected to be brought into force until the end of this year. 

Disqualification undertakings

The new powers for disqualification undertakings have already been considered by the Courts. In Re Blackspur Group plc on 23 May 2001 the Chancery Division had an opportunity to consider the new powers. The director in question has already been involved in Court proceedings as his offer to grant a voluntary undertaking not to act as a Director had been held by the Court of Appeal (Re Blackspur Group plc (No.2) 1998 [BCC] 11) not to be allowable without statutory authority. The Secretary of State then invited the Director to agree to the disposal of the disqualification proceedings by means of the informal procedure approved in Re Carecraft Construction Co Ltd (1993 4 ALLER 499). In September 1999 the director gave an undertaking to sign the draft Carecraft statement on the condition precedent that his then pending application for judicial review of the Secretary of State’s decision to continue disqualification proceedings was unsuccessful. The application was unsuccessful. The new provision in the Insolvency Act 2000 came into force on 2 April 2001 and this allowed the Secretary of State to accept disqualification undertakings without need for a Court hearing. The Secretary of State sought to require the director to attach a statement of grounds for the undertaking in the terms of those of the agreed draft Carecraft statement. A question arose as to whether the Secretary of State had power to require such a statement. The director argued that the purpose of the new provision was to eliminate the need for and expense of “proceedings”, which included the cost involved in agreeing the Carecraft statement and in those circumstances to allow the Secretary of State to require a statement of grounds would be to permit the mischief that the amended legislation was designed to counter. It was held that the Secretary of State did have such power. The Judge examined the statements made in Parliament within the principles in Pepper v Hart (1993 AC593) and concluded that whilst Ministers wished to leave the Secretary of State free to implement the undertaking procedure without a statement where it was expedient to do so in the public interest, the possibility of requiring a statement where desirable and appropriate was not excluded. It was a precondition to acceptance of an undertaking that the Secretary of State had to form a view on the evidence that the conduct of the director rendered him unfit. It would be odd if Parliament had intended that the Secretary of State should have no power to require a statement of the grounds on which that finding of unfitness had been made. The 1986 Act as amended by the 2000 Act disclosed nothing to suggest that Parliament had not intended the undertakings to have the same effect as the disqualification orders. It was also possible for an application to be made to reduce the period of an undertaking or to obtain leave to act in certain circumstances. The first question to be asked on such occasions was likely to be why the director in question came to be disqualified and it would be absurd if, in the absence of any statement, a Court on such applications was required to decide disputed issues of fitness years after the event. 

The Chancery Division has also recently been asked whether director disqualifications proceedings were an abuse of process of the Court where they followed a criminal trial for fraudulent trading in which the criminal court, aware that it had jurisdiction to disqualify the defendant company director in the criminal proceedings, had not made a disqualification order. It  was held that civil proceedings were not an abuse of process. Section 4 of the 1986 Act specifically envisaged that civil disqualification proceedings could follow criminal proceedings.  (Judgment on 3 May 2001 in Re D Hilton Limited).

Company voluntary arrangements

Company voluntary arrangements continue to create problems which only reinforce the difficulty of drafting the CVA to account for possible future circumstances. In Re N T Gallagher & Son Limited the company entered into a CVA where monthly payments and the potential proceeds of prospective litigation against another company were held in trust for the CVA creditors. Because of post CVA debts the company was put into liquidation. The CVA supervisor held over £571,000 realised for the benefit of the CVA creditors. The liquidators applied to the Chancery Division to determine whether those assets remained for the benefit of the CVA creditors or whether the trusts ended on the commencement of the winding up. The judge decided that the assets held by the supervisor, including the potential proceeds of the litigation, remained on trust for the CVA creditors only. There was nothing in principle nor in the statutory regime which prevented the trust of a CVA continuing following a winding up and in the absence of an express provision to contrary effect in the CVA the trust survived the winding up for the benefit of CVA creditors.  Once again everything is in the drafting!

Another CVA provided that the supervisor should petition for the winding up of the company subject to the CVA immediately it failed to comply with its obligations under the CVA or failed to co-operate with the supervisor. The supervisor was directed to set aside sufficient funds for this purpose. There were also other provisions which stated that the supervisor “shall petition for liquidation” and a provision that a meeting called to consider either varying the monthly contributions or to consider revised proposals would require a 75% majority in value of creditors voting at the meeting to make those amendments. The company fell into arrears and the supervisor called a meeting of creditors to ascertain their wishes as to the future of the CVA at which creditors voted by over 88% that the CVA should continue; that the supervisor was not obliged to petition for the winding up of the company; and that any existing breaches of the CVA should be waived.  A small CVA creditor objected and contended in Court that the CVA had automatically failed; that failure meant automatic termination of the CVA; that the supervisor was obliged to petition for winding up; and as a result the supervisor had no power to convene a creditors’ meeting or seek creditors’ approval to a variation of the terms. The judge held that a pragmatic approach should be taken to construction of the CVA. Whilst he was of the view that the supervisor’s obligation to issue a winding up petition was mandatory, he made the point strongly that a flexible approach to construction must be taken bearing in mind the commercial purpose of the CVA. He held that the petitioning creditor’s intentions were “unlikely to be a construction considered by creditors” and accordingly concluded that whilst the supervisor was under an obligation to issue a petition, the CVA continued in full force until he did so and an order was made on the petition; that the supervisor had power to call a creditors’ meeting in accordance with the terms of the proposal; and that having done so the CVA was validly varied by the requisite majority. Judicial activism or not?  (D & S Plumbing, Mechanical & Electrical Services Limited v Appleton & Marpaul Southern (1996) Limited).

Alistair Burrow is a partner in Tods Murray, a licensed insolvency practitioner and accredited as a specialist in insolvency law.