In a series of articles prepared for our “Talk to the International Experts” program we take a look at “Undoing Business in the UK” highlighting the options available to corporates wishing to restructure, wind up or close their UK business.
Click here to read our guide.
Following our 2016 article, the Court of Appeal has upheld the decision of the High Court that dividends are liable to challenge as transactions defrauding creditors under section 423 of the Insolvency Act 1986 (the “IA”).
The case of BTI 2014 LLC v Sequana S.A. & Others  EWCA Civ 112 should serve as a warning to directors to consider fully the reasoning behind the declaration of dividends to avoid committing an offence.
What are the limits of a bankruptcy court’s authority to issue final orders and judgments? Does a bankruptcy court have authority under Article III of the U.S. Constitution to enter final orders in quintessential bankruptcy matters such as fraudulent transfer claims, or are the court’s powers more constrained? While the Supreme Court’s rulings in Stern v. Marshall, 546 U.S. 462 (2011), Executive Benefits Ins. Agency v. Arkison, 573 U.S. 25 (2014) and Wellness International Network, Ltd. v. Sharif, 135 S. Ct. 1932 (2015) laid a framework for answering these questions, confusion still exists.
With the gradual opening of energy supply markets allowing new energy providers to challenge the established providers and bring increased competition to the market, the last two decades have seen an increase in smaller energy providers entering the market and sharing a growing customer base. But what happens to the customers when an energy provider becomes insolvent?
Section 363 of the Bankruptcy Code provides a debtor with the power to sell its assets during the bankruptcy case free and clear of all interests. This permits the debtor to maximize the value of its assets and hence the recovery for creditors. But that is not always the end of the story. In Trinity 83 Development, LLC v. ColFin Midwest Funding, LLC, the Seventh Circuit Court of Appeals faced the issue of whether a debtor can attempt to claw back the proceeds from a section 363 sale even though the sale had already been consummated. In its March 1, 2019, opinion, the Seventh Circuit held that the debtor’s appeal presented live issues and that section 363(m) of the Bankruptcy Code did not bar the debtor’s claims.
It was a painful outcome for the administrator of ARY Digital UK Limited (“ARY”) when he was found in breach of duty and liable to pay £743,750.
The case of Brewer and another (as joint liquidators of ARY Digital UK Ltd) v Iqbal  EWHC 182 (Ch) reminds office holders of the importance of understanding what assets they are selling, ensuring that correct marketing processes are employed and obtaining proper valuations.
It also highlights the importance of administrators exercising their own judgment and independence and of the duty to act in the best interest of creditors. Whilst this might sound obvious to an experienced office holder; the case does highlight the financial consequences of failing do this. Simply going through the motions with a marketing and sales process without proper consideration of the nature of the asset being sold, could have serious monetary consequences, as the administrator of ARY discovered.
When dealing with a debtor or a tenant that has fallen behind with its payment obligations, one of the most cost effective ways of a creditor/landlord reducing its exposure against that entity will be to take advantage of a “self-help” remedy, such as taking possession of the entity’s assets and selling them in repayment of the sums owed.
However, when the entity is the subject of insolvency proceedings, the availability of the various self-help remedies varies depending on:
- Which enforcement method the creditor intends to take;
- Which specific insolvency procedure the debtor is in; and
- At what point during that insolvency process the creditor seeks to take that step.
We have prepared a table summarising each of the variables identified above, which can be accessed here.
Depending on the type of “self help” remedy exercised and when it is exercised will determine whether the landlord can retain the benefit of it. For example, monies received following the sale of goods may have to be paid over to the insolvent estate for the benefit or all creditors if the sale occurs post insolvency.
In most cases, the earlier the decision to take advantage of and exercise the “self help” remedy the better the outcome for the landlord.
Crown prerogative dates back to the Magna Carta entitling the monarch to absolute priority for revenue related debt. Come 6 April 2020 will we really be heading back to feudal times and 1215?
The proposal to reinstate Crown preference was announced as part of the Autumn Budget last year and came as a surprise to many. The expected consultation paper published by HMRC this week seeks the views of individuals, shareholders, directors, lenders, companies and insolvency practitioners on the proposal to reinstate Crown preference in part.
However whilst this is a consultation, one might conclude from the language of the paper that the decision to introduce this change is a foregone conclusion. The paper glosses over several important considerations: the impact on funders, the culture of business rescue and the impact on unsecured creditors which we consider further below.
What is proposed?
Presently, when a company enters into an insolvency process, HMRC’s claim for unpaid taxes is an unsecured claim meaning HMRC stand alongside other unsecured creditors and its claim is dealt with on an equal footing. In simple terms, unsecured creditor claims rank behind fixed charge holders, insolvency practitioner fees and expenses, other preferential creditors and floating charge holders. The order of payment is prescribed by statute.
It is proposed that the statutory order of payments will be altered so that HMRC’s claim will rank ahead of floating charge holders in respect of tax payments due to it for VAT, PAYE, NIC (employee contributions) and CIS being taxes paid by third parties to the insolvent company. In respect of the tax liabilities of the company (income tax, CGT, corporation tax and employer NIC) those unpaid taxes will still rank and be dealt with as unsecured claims.
Therefore, HMRC will become a preferred creditor, although only in part. The preferred element of HMRC’s claim will however include any penalties and interest due and include historic debt “irrespective of how old” that might be.
HMRC’s primary justification for this change is loss of revenue, but the impact on the Exchequer’s pocket was a consideration when Crown preference was abolished. The conclusion reached then was that the benefit to creditors and business rescue outweighed that loss of revenue. So what has changed?
When will the law change?
The change will apply to insolvencies commencing after 6 April 2020 HMRC.
Why was Crown preference abolished in the first place?
Crown preference was abolished in 2003 following the Enterprise Act because it was considered unfair to other creditors. Abolition was widely welcomed by industry: insolvency professionals, funders, professional organisations, creditors – the list goes on.
The change, driven by a desire to encourage enterprise and business rescue, came alongside other changes to the insolvency process including the introduction of an out of court process to appoint administrators and the introduction of the prescribed part with the intention that the package of measures would help support the rescue of viable businesses.
What is the impact of the proposal to reinstate Crown preference?
Lenders and business rescue
At the same time as HMRC’s preferential status was abolished, the prescribed part was introduced. This was to avoid floating charge holders receiving a windfall payment and ring fenced a pot of money for unsecured creditors out of floating charge realisations. The ring-fenced amount currently stands at a maximum sum of £600,000 with proposals to increase this to £800,000 at some point this year.
If HMRC return to preferential status, floating charge holders face a double whammy. Not only will they rank behind HMRC as preferred creditor, the balance of floating charge assets is further reduced by the increase in the prescribed part.
HMRC seem to discount the effect of preferential status on lenders commenting in the paper that the government does not expect this to have “a material impact”. It cites the fact that the loss to lenders will be a very small fraction of total lending compared to the financial benefits to HMRC. This is a very narrow view and ignores why Crown preference was abolished in the first instance and the wider impact that this would have on businesses in general.
To address additional losses, financiers are already considering whether they ought to make increased provision. If they do, this could have the effect of increasing lending costs, reducing finance options and making it more difficult and costly for businesses to leverage funds on floating charge assets to fund working capital. The abolition of Crown preference was premised on encouraging enterprise, its return is likely to have the opposite effect.
It has been a hard fight over the past few years to overcome creditor apathy.
Changes have been made to address this with the Insolvency Rules 2016 (making it easier for unsecured creditors to engage in the insolvency process and for clearer lines of communication), the introduction of the pre-pack pool (to dispel concerns about the pre-pack process and provide greater transparency) and the introduction of the prescribed part (to enable a return to unsecured creditors).
If Crown preference is reintroduced whilst any return to unsecured creditors may currently only be small (the consultation quotes that unsecured creditors recover on average 4% of their debt), reducing that recovery in many cases to nil removes any interest that unsecured creditors have in the process – why would they then engage at all?
Is there justification for the change?
HMRC say that this change is necessary because since 2003 losses to the Exchequer have increased and taxes paid to businesses (by third parties) should, instead of paying creditors of the insolvent business, be paid to HMRC to fund public services. Whilst that may be true and additional spending on public services is always welcome how much difference would this actually make? We come back to the point we made earlier that this was considered at the time of abolition and the benefits of enterprise and business rescue were thought to outweigh this. Why should HMRC be placed back in a better position than other unsecured creditors now?
Monies paid to a business are paid into the company’s bank account and are available to the company without restriction. It is not uncommon to find that monies representing VAT payments or PAYE are used to fund the day to day trading of the company and providing HMRC receives a payment equivalent to the tax received and taxes are paid, then surely it is up to the company to decide how monies it receives are applied. We don’t think anyone would argue with this provided all creditors are paid.
With an intervening insolvency the landscape changes, but it changes for all: lenders, creditors, shareholders, everyone. Most lose out because it is rare that unsecured creditors are paid in full, but the pari passu principle ensures all unsecured creditors are treated fairly. Secured creditors are only treated differently because they hold security for monies lent to the company.
HMRC is not a secured creditor and yes, the business may have received a payment from a customer representing tax due to HMRC i.e VAT, but that payment is not impressed with a trust in favour of HMRC nor does HMRC have any proprietary right to that money.
There are many other third parties who are in a similar position where a payment made in “good faith” to the now insolvent business would ordinarily have flowed down the supply chain to them, for example sub-contractors. HMRC may argue that it is an involuntary creditor, but other creditors are effectively in the same position when they have no control over credit control processes and no real say in when they are actually paid. Should HMRC be able to jump the queue and put itself in a better position by changing legislation when other unsecured creditors cannot exercise the same parliamentary clout?
In real terms, any additional returns to the Government through these measures are unlikely to be significant when compared to the Exchequers’ total receipts but the impact on business rescue and enterprise could be seriously undermined.
Is the proposal really creating a level playing field as suggested in the consultation paper or are we just taking a step back in time and progress?
The retail sky is falling. At least that is how it appears from recent and unprecedented number of retailers filing for bankruptcy. From iconic stores such as Sears and Toys ‘R’ Us, to department stores such as Bon Ton, to mall stores including Brookstone, The Rockport Company, Nine West, among others. The reasons given for such filings vary as much as their products but one theme seems to be constant — the inability of retailers to maintain “brick and mortar” operating expenses in the era of online shopping. Accordingly, it appears that what some retailers actually have is a real estate problem.
Another troubling theme of many retail filings is the use of bankruptcy courts to achieve a quick liquidation of the company, rather than a reorganization. Chapter 11 filings over the past several years have shown a dramatic shift away from a process originally focused on giving a company a “fresh start” to one where bankruptcy courts are used for business liquidation. The significant increase in retail Chapter 11 cases and the speed at which assets are sold in such cases is disturbing and provides a cautionary tale for developers and landlords alike. Indeed, such parties need to be extremely diligent in protecting their rights during initial negotiations as well as when these cases are filed, starting from day one, lest they discover that their rights have been extinguished by the lightning speed of the sale process.
Recent statistics suggest that the average time to complete a bankruptcy sale is only 45 days from the petition date. Moreover, under the Bankruptcy Code, and arguably, best practices, the sale will close shortly after court approval thereby rendering any appeal likely moot. This leaves little time for parties to protect their rights.
Bankruptcy Code Section 363(f) permits a debtor to sell property free and clear of interests in the property if certain conditions are met. Unlike a traditional reorganization, which requires a more engaging process, including a disclosure statement containing “adequate information,” a sale under Section 363 is achieved by mere motion, even though it results in property interests being entirely wiped out. Not only are property rights altered by motion, rather than by an adversary proceeding or a plan process, but these sale motions are being filed in retail cases as “first day motions” and concluded in as short as a month and half.
Even more alarming is that the notice accompanying such motions can be ambiguous as to how it will impact parties such as developers who have multiple interests in retail/multi-use properties. Often, the reference to the developer and its property is buried in a 20+ page attachment in 8 point font, listed in an order only the debtor (or its professionals) understands. If that was not concerning enough, these notices are being served by a third-party agent who may not have access to the most updated contact information necessary to ensure that non-debtors are actually receiving the notices in time to properly protect their rights. It is not uncommon for these notices to be inaccurately addressed and not be received until after an order is entered; an order which will undoubtedly contain a provision that notice was proper.
Notably, despite Section 363(f)’s reference solely to “interests” (the group of things that an asset may be sold free and clear of), these sales are commonly referred to as sales free and clear of “claims and interests.” Lacking an actual definition, courts have expansively interpreted “interests” to include “claims.” Indeed, it is now the norm for bankruptcy courts to enter extensive findings of fact and conclusions of law supporting 363 sales that extinguish every imaginable potential claim (rather than merely “interests”). While consistent with the overall spirit of the Bankruptcy Code to promote maximization of value through the alienability of property, it comes at the expense of those holding an interest in that property, such as a mall or shopping center developer.
Fortunately, there are certain well-accepted exceptions to the courts’ expansive application of “interest.” Courts generally limit a debtor’s attempt to use Section 363 to strip off traditional in rem interests that run with the land. When faced with such attempts, courts routinely constrain the interpretation of the statute to block the sale free and clear of an in rem interest.
The majority of state laws have long treated covenants, easements, and other in rem interests that are said to “run with the land” as property interests. Although clearly falling within the common definition of “interests,” courts routinely hold them not to be strippable interests for purposes of a Section 363(f), as being so ingrained in the property itself that they cannot be severed from it, or, alternatively, that the in rem interests are not included in Section 363(f)’s use of the term “interests.”
The protection afforded to in rem interests should provide forward-thinking transactional attorneys with a valuable opportunity to insulate many rights and remedies for their developer clients. A hypothetical real estate transaction is illustrative — consider a transaction in which a developer sells two parcels to a large retailer as part of a retail/mixed use shopping center and takes back a long-term ground lease for one of the parcels. There are a number of methods available to document this deal: a sale-leaseback agreement; a separate contract to convey in the future secured by a lien; entry into a partnership, joint venture, or similar agreement. When analyzed with respect to the risk of a potential retailer bankruptcy, these mechanisms are inferior to the use of a reciprocal easement agreement (“REA”) or similar devise that creates an in rem property interest that runs with the land in favor of the developer.
If traditional contractual methods are used, the documents run the risk of being construed as executory contracts in the retailer’s subsequent bankruptcy case, subject to rejection, leaving the developer with only a prepetition claim. A lien in favor of the developer would only marginally improve its position, as any lien will likely be subordinated to the retailer’s development financing and therefore of little value. But, based on the current state of the law, a non-severable REA or similar document recorded against the retailer’s property will not be stripped off the property absent consent or a bona fide dispute. Thus, rights incorporated into a properly drafted and recorded REA provide the developer with a level of “bankruptcy-proofing” against a potential future retailer bankruptcy. Further, as REAs in mixed-use developments are the norm in the industry, they are likely to be accepted, if not embraced, by the retailer’s construction lender, making their adoption that much more likely.
The lesson is be forward thinking and be diligent.
For those already making European holiday plans for summer 2019, or for those hesitantly waiting to see the results of ‘B’ day on 29 March there are still questions about what might happen to travel plans after this date. The Association of British Travel Agents (ABTA) has issued practical guidance to reassure travellers at this time of uncertainty.
If a Brexit deal is agreed, the UK will enter a transition period meaning travel laws and regulations will stay largely the same until 2020. However, deal or no deal we have been assured that flights will still operate between the UK and EU and a visa should not be required.
ABTA has identified actions that travellers may wish to take in advance to help avoid unnecessary future disruption in the event of no-deal: https://www.abta.com/tips-and-advice/brexit-advice-for-travellers. The advice also features practical guidance on the expiry of passports, recognition of driving licences, EHIC’s and data roaming charges should there be a hard Brexit.
Despite this, there is a lot speculation about the effect on travel in a no deal scenario because if flights will still operate and a visa is not required then what actually is the problem? The concern for consumers is that in order to avoid severe disruption in a no deal scenario, the EU has proposed a regulation that proposes to cap flight numbers between the UK and EU at 2018 levels.
The Airports Council International reported to The Financial Times that the cap could lead to the loss of 140,000 flights affecting nearly 20 million passengers travelling between the UK and EU. For the consumer this could mean flight cancellations and disruption to travel plans.
Customers who book a package holiday will have the most comprehensive protection, as their holiday will be protected under the Package Travel and Linked Travel Arrangements Regulations 2018. This means that it is the travel provider’s responsibility to offer an alternative holiday / refund if a package holiday can no longer go ahead. Travel insurance may also help but it is important to check the policy at the time of booking to see if it covers travel disruption, cancellations and also any consequential loss.
Despite this guidance and these reassurances, the uncertainty and lack of confidence stemming from Brexit is causing difficulties in the market for travel providers with Director General Alexandre de Juniac of The International Air Transport Association reporting that ‘airlines still do not know exactly what kind of Brexit they should be planning for’. Flybmi is an example of this, announcing at the weekend that it has ceased trading and intended to file for administration.
A press release published on the airline’s website confirmed: “Current trading and future prospects have also been seriously affected by the uncertainty created by the Brexit process, which has led to our inability to secure valuable flying contracts in European and lack of confidence around bmi’s ability to continue flying between destinations in Europe”. For further discussion on airline collapse and insolvency please see our previous blog: Lets Fly away…..
As detailed in this blog there are a number of ways to protect holiday bookings including through purchasing ‘package’ deals and arranging travel insurance down to how you pay for your holiday. For instance if a holiday is booked on a credit card in the UK usually the card company is jointly liable for the provision of services.
ABTA’s guidance should help to provide some confidence to consumers and with the right protection in place from the time of booking there should be no need to wait until after B day to book.
Although a reassuring message, it seems consumers are still lacking in confidence and tour operators understandably remain faced with a tough market. In addition to the collapse of Flybmi at the weekend it was announced last week that Thomas Cook are conducting a ‘strategic review’ of its airline and would consider ‘all options’ including a sale. Ryanair posted a net loss of £17.2 million last week and shares in TUI sank 20%, it seems there is a repeated blame on too many airlines and too fewer passengers coupled with last year’s extraordinary hot summer making consumers reluctant to part with their (weak) pound for European holidays.