Old lessons hold good

It is now difficult to open a newspaper without seeing the words “credit crunch” somewhere. We have even had the Chancellor of the Exchequer saying that we are facing the worst economic conditions for 60 years. Hopefully that is an exaggeration and what we are experiencing is a relatively short lived downturn. It appears clear however that for the immediate future anyway we are likely to see an increase in the number of both personal and corporate insolvencies.

Quite frequently the largest assets of a company or individual will be its land and buildings, and conveyancers will be called upon to act for the insolvency practitioners in selling and for proposed purchasers in buying these assets from insolvency practitioners. What lessons can we learn from previous experience, and what is likely to be different this time around?

Lessons of the past

1. Personal liability

The position here is very straightforward. No insolvency practitioner will willingly accept personal liability, therefore if you are acting for an insolvency practitioner you absolutely must ensure that personal liability is excluded in the contract in very clear terms. Even though certain insolvency regimes do not automatically result in personal liability of the relevant insolvency practitioner with regard to any contract entered into, it is to be expected, and it has grown to be standard practice, to incorporate specific exclusions of personal liability regardless of which insolvency regime has been adopted.

Acting for a purchaser, there is no point in wasting time and effort demanding that the insolvency practitioner accepts personal liability. Unless there are very unusual circumstances indeed, it is just not going to happen.

2. Warrandice

The personal liability point leads logically into warrandice. Many standard styles state that the insolvency practitioner gives warrandice from fact and deed only and grants full warrandice on behalf of the insolvent entity. Granting warrandice from fact and deed only would however be something that would impose personal liability on the insolvency practitioner. If acting for the insolvency practitioner in the sale, a solicitor must be very clear on their instructions. Before committing the insolvency practitioner to granting warrandice from fact and deed only, the solicitor must be careful to obtain specific instructions from the insolvency practitioner on the point.

Some insolvency practitioners are willing to grant fact and deed warrandice. Others are clear that they will not accept any form of personal liability whatsoever and accordingly will not give warrandice from fact and deed only. If you are acting for a purchaser then bear in mind that if a contract is concluded which clearly states that the insolvency practitioner will not incur any personal liability whatsoever, the purchaser has no right to demand warrandice from fact and deed from the insolvency practitioner. The issue should be bottomed out and agreed before the contract is concluded.

3. Warranties

Conveyancing offers are normally full of warranties. In normal solvent transactions a large number of these warranties are deleted, modified and watered down, but a substantial number do remain. As a general rule, insolvency practitioners and the corporate entities to which they are appointed will not warrant anything. The knowledge of insolvency practitioners is generally limited given the fact that in many cases they have had no prior involvement with the company to which they have been appointed. Their instinct is also to refuse to warrant even the things they do (or it is assumed would) know, although if pressed and the circumstances of a particular case dictate, there may be an ability for the insolvency practitioner to “confirm” certain aspects. There will, however, require to be special circumstances before an insolvency practitioner will concede to even this.

There is therefore little point in a solicitor expending time and effort in drafting and then trying to negotiate warranties if acting for a purchaser from an insolvent entity. You are very unlikely to receive any warranties, and any “confirmations” which may be given will be of a very restricted nature. Even if you are successful in obtaining some very limited warranties, what is the point in having them if you are contracting with an insolvent entity and the insolvency practitioner has excluded personal liability? By the time you come forward with a warranty claim will there be any source of cash against which you can make that claim?

4. Importance of due diligence

All of the foregoing therefore makes the due diligence process vital. The actual facts (including title to and ownership of property) need to be checked very fully, since no reliance can be placed on any warranties as would be the case in a normal solvent sale. The purchaser should also ensure that the correct price is being paid. If no warranties are being given and risks (whether perceived or actual) are being assumed, the purchase price should reflect that, always bearing in mind however that there may be a competitive bidding exercise undertaken to identify the purchaser and which offer the insolvency practitioner will select to pursue.

5. Checking the validity of appointments

When purchasing from an insolvency practitioner, the validity of their appointment should always be checked by the purchaser’s solicitor. That can involve reviewing interlocutors, instruments of appointment, resolutions of members (and possibly creditors), and the (now not so new) notices of appointment in relation to administration. The extent of “validity checks” may vary from case to case. If interlocutors or court-stamped notices of appointment are produced, the necessity to check behind the validity of those appointments may be more limited than, say, a receivership instrument of appointment where there is no court involvement at all. Regardless, the fundamental point is that a solicitor acting on behalf of a purchaser from an insolvency practitioner must carry out such checks as the solicitor deems necessary in order to ensure that the relevant insolvency practitioner has been properly appointed and has the necessary powers to enter into and implement the sale in hand.

What is likely to be different this time?

It is easier to list lessons from the past than to guess about the future. However, going forward, it is fair to say that the number of administrations which we will all come across (whether acting for insolvency practitioners or potential purchasers) is on the increase.

Since 15 September 2003, the granting of a floating charge (on or after that date) generally no longer entitles the holder to appoint receivers over the whole of the business and assets of the grantor. What the holder of a “qualifying floating charge” (as defined in sched B1 to the Insolvency Act 1986) can do is appoint an administrator. In addition, the streamlined “out of court” appointment of administrators by directors or companies makes administration a much more attractive regime to adopt (assuming that its objectives can be achieved).

This will therefore result in a significant change in the nature of corporate insolvencies since the last downturn, and if advising either insolvency practitioners or purchasers alike in such administrations, solicitors must be fully informed and aware of the new regime, introduced by the Enterprise Act 2002, including the modes of appointment (in order to be satisfied with the validity of appointment), the powers available to the administrators (in order to be satisfied that the administrator can enter into and complete the relevant sale), and the potential rights of purchasers in sale contracts if not drafted correctly (in order to protect the interests of the client being represented).

The administration regime also contains a provision of specific interest with respect to warrandice. It must be remembered that any claim arising under a disposition granted by a company in administration acting through its administrator(s) may obtain a ranking above that of a floating charge holder, in terms of para 99 of sched B1 to the Insolvency Act.

Be prepared

Like death and taxes, insolvency will always be with us, but for the sake of the economy in general let’s hope that our Chancellor of the Exchequer is wrong and that the wave of insolvency we believe is coming will not be “the largest for 60 years”. Whatever the size of this wave, however, those advising purchasers or insolvency practitioners must not only remember the lessons from the past but must also remember that there are new lessons to be learned, given that insolvency legislation has radically changed even since the last slowdown.

Professor Kenneth Ross is a partner in the Property Department of Brodies LLP and a member of Brodies’ Corporate Restructuring and Insolvency Teama