Exiting administration and the role of liquidation after the Enterprise Act

The Enterprise Act 2002 (the "Act") comes into force today. It rewrites the rule book on exiting

administrations.

• The Insolvency Act 1986 is virtually silent on exit routes, even though administration has always been seen as a transitional regime, given the inability of administrators to make distributions to creditors.
• The Enterprise Act prescribes no less than 9 exit routes, but still leaves many unanswered questions.
• It introduces the concept of a new streamlined creditors' voluntary liquidation ("CVL") process but does not make it clear when the administrator should use this process, rather than the new powers given to him to make distributions to unsecured creditors.

Initially exit is likely to be an area of uncertainty. It will no longer be possible to leave it until the rest of the administration business is concluded. Under the new regime, administrators are required to specify the proposed exit route in their initial proposals which have to be sent to creditors within the first 8 weeks of administration. If the administrator proposes to exit administration using a CVL, then his proposals must specify the identity of the liquidator. The timetable is ambitious to say the least.

Exiting administration under the old regime

Getting out of administration under the old regime has been a vexed issue. The Insolvency Act does not say much at all about it, but a quirk in the drafting gives preferential creditors a better return in a compulsory liquidation than in a CVL. CVL is generally preferred as an exit mode, however, not least because it involves lower government levies on the company's assets.

The objectives of the new administration regime

The four purposes of administration are replaced by one purpose, comprising three distinct objectives (see Part 1 of the mini-series for further explanation on this):

• rescuing the company as a going concern, or
• achieving a better result for the company's creditors as a whole than would be likely if the company were wound up (without first being in administration), or
• realising property in order to make a distribution to one or more secured or preferential creditors.

The better view is that at the time when the company enters administration, there is no need to be too precise about which of the three objectives will form the purpose. As time goes by, however, (and within the first 8 weeks of administration when the administrator has to put together his proposals) the administrator must give much more detailed thought as to which of the three objectives is achievable. However, the administrator is under a duty to achieve the rescue objective unless it is not reasonably practicable, or the second objective would achieve a better result for the creditors as a whole.

The administrator's interpretation as to which of the three objectives forms the purpose impacts upon his choice of exit routes.

Exit modes and the new administration model

There are no less than nine exit possibilities to consider:

• Automatic termination

All administrations will now automatically end after one year, unless extended by the consent of the creditors, or the Court. Don't be caught out – make a careful diary note.

• By Court order on the application of the administrator

This exit route applies in all cases where the administrator concludes that administration was inappropriate or that its purpose cannot be achieved.

In the case of a Court appointment only, the administrator must also make an application if he thinks that the purpose has been sufficiently achieved. Potential problems may arise where it is not clear which of the three specific objectives forms the purpose. In practice, the administration is likely to stay open whilst at least one of the three objectives remains achievable. The decision as to whether or not the administration purpose has been achieved rests with the administrator, and the Court is unlikely to interfere with his commercial judgment, although he will need to be clear in his own mind what the purpose is and have evidence to support that.

• Out of Court appointments where the objective has been achieved

The out of Court administrator can (but is not obliged to) proceed to exit using this route simply by filing a notice.

• Dissolution

The administrator can file a notice of dissolution of the Company where he thinks that there is nothing to distribute to creditors.

• CVL

There is a mechanism for proceeding straight into CVL simply by filing documents, but only where the total amount which each secured creditor of the company is likely to receive has been paid or set aside for him, and a distribution will be made to unsecured creditors. This is likely to be the most favoured distribution route given the streamlined procedure – it is not necessary to hold the usual shareholders' and creditors' meetings.

The overlap between this exit mechanism, and the Court-appointed administrator's obligation to apply to Court for discharge where the purpose has been achieved (see the second exit option above) is currently unclear, and may have to be resolved by an application for directions, or proceeding cautiously in applying under both sections, until the position has been clarified.

The administrator does not necessarily have to use any kind of liquidation route or CVA to distribute funds to unsecured creditors, given his new power under the Act to make distributions to creditors (subject, in the case of ordinary unsecured creditors, to Court approval). So, in what circumstances will a liquidation process be used? Some suggestions:

• where the distribution process cannot be completed within the shorter timeframe contemplated for new administrations;
• where there is no obvious advantage to creditors in distributing within administration as opposed to a CVL;
• where the security under which the administrator was appointed needs investigation by an independent liquidator; and
• where the liquidator would want to disclaim some onerous property, or bring wrongful or fraudulent trading proceedings.

• If creditors fail to approve the proposals

• Where the administration involves unfair harm to creditors or shareholders

There is a new ground for complaint by disgruntled creditors or shareholders where the administrator has not been performing his functions as quickly or as efficiently as is reasonably practicable. This is consistent with the aim of the Act to make administration quicker and more effective as a rescue tool.

• Application by a creditor to challenge administration

A creditor can apply to end the administration on the basis of an improper motive on the part of the applicant for the administration order, or the appointor (but not on the part of the administrator). It is submitted that this is unlikely to be much used in practice, particularly as there is no guidance as to what is meant by an "improper motive".

• Public interest winding-up

The Act has gone some way towards achieving flexibility on exiting administration which was lacking under the old law. However, there are several areas of uncertainty, some of which can only be resolved by directions applications, unless clarification, in the form of practice directions, is issued. The question of mode of exit is not the only issue causing uncertainty within the new administration regime.

For more information please contact Sophie Elboz at [email protected] or on +44 (0) 20 7367 2958 or Ashley Smith at [email protected] or on +44 (0) 20 7367 2154.