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Covid-19 – Needs Must: Time to Use Administration to Rescue Companies?

15.05.2020 Business Recovery, Restructuring & Insolvency

Alex Rogan

Alex Rogan Partner

Julie Killip

Julie Killip Partner

Rescuing UK businesses in the COVID-19 economy: Light touch administration

The COVID-19 crisis presents UK businesses with serious challenges, and in many cases will test their continuing viability. The government has set out an unprecedented range of supporting measures in order to assist business through this challenging period. Lockdown measures have in many cases reduced revenue significantly if not to zero in some industry sectors. As the lockdown measures are slowly rolled back the shape of the economic recovery will become apparent. Predictions range from a V to a lazy U shaped recovery. What is clear is that a raft of previously viable businesses will need continued assistance in order to ensure that they are able to continue to trade as the recovery develops.   

What proposals have been made to protect UK businesses?

Widespread difficulties with solvency are anticipated. The government has announced a range of changes to corporate insolvency laws, including protections from certain creditor action, ensuring the continuance of supply for distressed businesses, a new restructuring tool and the suspension of wrongful trading to provide directors with more latitude in determining that they can continue to trade. Detail on these measures is still awaited as the government finalises the draft implementing legislation for the Corporate Insolvency and Governance Bill 2020. This article is primarily focused, however, on an existing restructuring tool, ‘light touch’ administration, which is currently available and may end up being a key cornerstone of the fight to rescue companies and relaunch the economy.

What is light touch administration?

Light touch administration is not a new tool available to insolvency practitioners. The primary objective of an administration process is the rescue of the company. However, particularly since the financial crisis of 2008, administration has increasingly been used as a precursor to liquidation and, as such, a significant stigma has been attached to it. A common theme of administration is for the management team behind the ailing company to be displaced. This historically has been viewed as an appropriate measure, where that management team can typically be considered to be responsible for the failure of the company.

With the unfolding COVID-19 pandemic, however, the context has shifted. Given the extraordinary circumstances, and the serious adverse effect on the economy, perceptions will likely change. The fact a company now faces a solvency crisis may no longer be viewed as a failure by management, but rather the inevitable result of a drop in revenue caused by unforeseeable challenges beyond their control. The essence of light touch administration is to allow a company the protections afforded by an administration process. This includes a moratorium on the payment of debts which pre-exist the company filing for administration, which helps enable continued trading. Furthermore, an administrator has the power to raise new funds through borrowing (although this is at his personal risk). In this scenario, any debt to the lender will rank higher in priority than existing liabilities in insolvency proceedings.

The key difference is that a light touch approach to administration proposes to keep the day to day running of a business in the hands of those who know it best, that being the existing management team. Light touch administration can therefore be seen to have elements in common with the ‘debtor in possession’ Chapter 11 bankruptcy regime employed in the United States of America. 

How and where can light touch administration be applied?

Proponents of light touch administration have now drafted a consent protocol which has been circulated by the City of London Law Society and the Insolvency Lawyers Association. The consent protocol can be entered into between directors and an administrator and gives directors powers to incur credit with suppliers, pay employee salaries and acquire and dispose of stock amongst other things. Importantly, directors should only use these powers in furtherance of the objective of rescuing the company as a going concern. Consequently, it is a condition of the protocol that directors inform the administrator if they receive information which would lead a reasonable person to conclude that rescue of the company is no longer feasible. Additionally, administrators should impose financial caps to keep spending in check and have a responsibility to closely monitor how directors exercise these powers.

What is the extent of an insolvency practitioner’s liability under a light touch administration?

As in a conventional administration, where an administrator exercises tight control over the subject company, insolvency practitioners will face personal liability for breaches of their duty to creditors of the company. Insolvency Practitioners have high regulatory obligations.

Administrators are normally given leeway to carry out their functions in such way as they see fit, provided they reasonably consider their actions fulfil the statutory purpose of the administration. This principle was confirmed in the recent case of Davey v Money [2018] EWHC 766 (Ch), Snowden J presiding. Snowden J made clear that administrators’ actions were not to be second-guessed lightly by the court with the benefit of hindsight. This is particularly the case where the administrator’s actions can be clearly seen to have been taken in good faith. It was held, consequently, that an administrator’s decisions should only be challenged by the court where they can be seen to have been made in bad faith or where they were clearly perverse.

It follows that this is likely the standard an administrator’s conduct must fall below for them to be held personally liable for the failures of a light touch administration. Generally, the courts are supportive of administrators, and the protection of insolvency practitioners’ scope to make commercial decisions is considered a key public policy point. This was indicated by Snowden J in Re Carluccio’s (In Administration) [2020] EWHC 886 (Ch) where he held that the “promotion of the rescue culture is an important consideration when interpreting the Insolvency Act”. Snowden J made clear this is particularly true in the economic climate brought on by the COVID-19 pandemic.

What other risks should an insolvency practitioner be aware of?

Insolvency practitioners considering the use of light touch administration will need to be wary of other principles of UK insolvency law which could prejudice their position. Administrators should bear in mind that any employment contracts continued after 14 days from when they assume their responsibilities will be deemed to have been adopted. The practical implication of such an adoption would be that the employees’ wages will rank ahead of the administrator’s fees in the ranking of priority, jeopardising that administrator’s full reimbursement, and the administrator is personally liable for any shortfall. Similarly, where money is borrowed after the administrator’s appointment, those creditors will also rank above the administrator and will see their loan repaid before the administrator collects his fees, and the administrator is personally liable for any shortfall.

A lack of control over such functions clearly poses financial risk to administrators. Consequently, where management power is devolved to a company’s directors, it is critical that their decisions are closely monitored in order to protect the insolvency practitioner’s own position. The ICAEW has warned insolvency practitioners who they regulate:

“The motives of some directors may be well founded, but it may be difficult for insolvency practitioners (IPs) at the present time to be able to make a reasoned judgement about the skills and motives of directors that they are approached by, particularly if the communication has largely been carried out remotely.

Responsibility for the conduct of any insolvency appointment falls to the officeholder and there is a significant potential risk to an IP if they commit to agreements [with directors] that allow the directors to enter into transactions on their behalf. While financial limits could limit any exposure, there’s also the risk that some directors may well take advantage of the current constraints and it will be left to the IP to pick up the pieces.

On future monitoring visits we will look carefully at cases where the ‘light touch’ approach has been used, to ascertain whether the IP has exerted an appropriate level of control and oversight.”

How has light touch administration been received by the insolvency industry?

One criticism of light touch administration, and in particular the consent protocol, is that it does not take into account important practical issues surrounding funding and access to bank accounts or an insolvency practitioner’s liability for health and safety or GDPR. Insolvency practitioners will need to be wary of challenges resulting from social distancing rules, as they will continue to be personally liable for the actions of directors to whom they have devolved power. The vetting and monitoring of such directors, in terms of their motives, competence and the actual decisions being made, will be more difficult when such evaluations must be carried out remotely via telephone or video-conferencing technology.

There is also the question of whether directors will want to continue to exercise their powers as they will remain liable for breaches of fiduciary or other duties as a director.  They will either accept these or resign.  Retaining directors will be at a cost to the Administration creditors and the expense will have to be factored into any decision.

Many have welcomed the protocol, which is still in the drafting phases and may appear different in final form. Regulators and the courts are generally receptive to concepts which make innovative use of UK insolvency law. This will be particularly true where they intend to produce more favourable results for businesses suffering as a result of the current health crisis. In any case, owing to the risks a less restricted administration may pose, insolvency practitioners seeking to use the protocol are urged to seek legal advice before doing so.

Article authors:

Alex Rogan Julie Killip