More secured lenders' issues

In part 3 of this mini-series we looked at the secured lender's choice between administrative receivership and administration now that the insolvency reforms in the Enterprise Act 2002 (the "Act") are in force. In this part we look at some of the other issues which the new regime raises for secured lenders.

Changes to documentation

• A number of changes to a secured lender's post-Act documentation will be required to take account of the new terminology and provisions. Instead of referring to "administration petitions" and "administration orders", documentation should instead refer to "administration applications" and "entering administration", the latter to take account of the out of court entry routes. This terminology will be particularly relevant to the insolvency events of default.
• A floating charge over the whole or substantially the whole of a company's assets which purports to empower the holder to appoint a receiver already satisfies (without amendment) the definition of "qualifying floating charge" ("QFC") in the new schedule B1(which is inserted into the Insolvency Act 1986 by the Act). This is important because only the holder of a QFC (a "QFCH") is entitled to appoint an administrator under the new regime. So there is no particular need to change the powers in "old" debentures to include a power to appoint an administrator because the nature of the debenture itself should be sufficient. However, with the abolition of administrative receivership (subject to the exceptions referred to in earlier parts of this mini-series), standard debentures should include a power to appoint an administrator.
• A QFCH is entitled to five business days' notice from a company (or its directors) intending to appoint an administrator. This gives the QFCH a chance to make its own appointment should it so wish. However, if the secured lender is not a QFCH (perhaps because its security does not cover the whole or substantially the whole of the borrower's assets), it does not have any statutory right to be notified in advance of the borrower's intention to appoint. Such a secured lender may wish to oblige the borrower to notify the lender of any steps it takes to appoint an administrator in the loan or security documentation. In practice, however, there would be little redress if such an obligation was ignored by the borrower.

Deeds of priority

• It is important that new deeds of priority make it clear which debenture is to be treated as the prior ranking QFC for the purpose of the new schedule B1 to the Insolvency Act 1986. The holder of a prior ranking QFC is entitled to two business days' notice from the holder of any lower-ranking QFC who intends to appoint an administrator. In most cases it will be clear that the prior ranking QFC is the one which was either created first or is to be treated as having priority under a deed of priority. However, some priority arrangements provide for different priorities in respect of different assets, or do not expressly rank one debenture ahead of another for these purposes. In such cases, the priority deed should contain a specific provision stating which debenture should be treated as having priority for the purposes of schedule B1 to the Insolvency Act 1986.
• Another priority issue under the new regime is where two lenders wish to enter into a priority arrangement and one lender has a pre-Act QFC and the other a post-Act QFC. The relevance of this is that the prescribed part for unsecured creditors (described below) will only apply in respect of the post-Act QFC. So a proportion of the post-Act QFC assets will have to be made available for unsecured creditors, whereas no such deduction must be made in respect of the pre-Act QFC. However, if the post-Act QFC is given priority to the pre-Act QFC, then the pre-Act QFC will lose its windfall advantage and will also be subject to the prescribed part.[1] Avoiding this potential outcome may require some creative thinking.

Administrators' proposals and voting

Within 8 weeks of his appointment, the administrator must produce and circulate his proposals to creditors. Within 10 weeks of his appointment, he must call a meeting of creditors to consider, and if thought appropriate, approve his proposals. At this meeting, a secured lender can only vote in respect of any unsecured shortfall in his security, notwithstanding the funds available for unsecured creditors may be very small and the creditor with the biggest financial interest in how the administration is run is probably the secured lender.

There are provisions allowing the administrator to dispense with the initial creditors' meeting where the administrator thinks that the company has insufficient property to enable a distribution to be made to unsecured creditors except for the prescribed part. If, nevertheless, the requisite value of unsecured creditors ask for a meeting then there is a provision allowing a secured creditor to vote for his entire secured debt.

Prescribed part windfall

We mentioned in part 1 of this mini-series that the legislation abolishes Crown preference. In order that at least some of the benefit of this abolition can be enjoyed by unsecured creditors rather than floating charge holders, the Act provides for a prescribed part of floating charge realisations to be made available to unsecured creditors.

The actual figures are 50% of the first £10,000 of net floating charge realisations and 20% of additional net floating charge realisations, subject to an overall maximum prescribed part of £600,000.

The good news for holders of floating charges which were created before the Act came into force, is that if your borrower does have the misfortune to enter administration, liquidation or receivership on or after 15 September 2003, Crown preference will have gone, but the prescribed part will not apply. In other words pre-Act floating charge holders gain the entire benefit of the abolition of Crown preference.

The decline in value of the floating charge – a continuing trend

• First there was Brumark[2], which called into question the validity of fixed charges on book debts (the debate rumbles on). Then there was Re Leyland Daf[3],which confirmed that liquidation expenses were payable out of floating charge realisations in priority to the holder of the floating charge. New with the Act comes the abolition of administrative receivership and with it an element of the floating charge holder's control of the floating charge assets and how they are spent.
• At the same time, there is the new administration regime, with the new primary objective of rescuing the company as a going concern (as opposed to the (usually cheaper) administrative receivership purpose of realising the assets for the benefit of the secured creditor). The new administrator also has access to the floating charge funds (including, potentially, book debts) to fund the administration to achieve the rescue purpose if it is reasonably practicable.
• Further nails in the coffin are the inclusion of corporation tax and capital gains tax as new administration expenses under Rule 2.67 of the amended Insolvency Rules 1986 and the Finance Act 2003 which changes the accounting rules, so that administration triggers a new accounting period. There will be more on this in the next, and final, part of the mini-series, but for now it suffices to say that these tax changes will generally swell the administration expenses which are payable out of floating charge realisations ahead of the floating charge holder.
• Small wonder we are seeing an increase in asset-based lending and invoice discounting or factoring deals and less reliance on the floating charge for value. The floating charge will however still remain important for as long as it empowers the holder to appoint an administrator.

[1] See Re Portbase Clothing Limited [1993] Ch 388 by analogy

[2] [2001] 3WLR 454

[3] [2002] EWCA Civ 228