Liquidating Companies

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‘It is best if insolvent companies are liquidated as soon as possible and creditors paid out. Doing anything else with such companies is just not efficient.’ Introduction From the sole perspective of a corporate creditor, the logic inherent in the title question is impeccable. The orderly breakup or winding up of a corporation that permits creditors to realize on their debts within a reasonable period, whether achieved by voluntary or compulsory means, is a central element in a properly constituted insolvency regime. However, the title proposition is only a single element in any consideration of the forces at play in a corporate insolvency. Not only does insolvency typically engage issues amongst creditors in terms of both quantum and priority, a profound public interest is present in many corporate insolvency proceedings that drives the agenda concerning the preservation or reorganization of an insolvent corporation. The satisfaction of these legitimate interests often requires time and effort that is at odds with the simple and expeditious pay out of debts. The current global financial crisis and its incipient threat posed to numerous UK and international corporate entities provide a contemporary illustration of the numerous potential public interest dimensions to the title question. This paper seeks to identify the principles that operate in this sphere. Particular attention is directed to the scope and application of the pari passu principles and their impact upon the desired efficiency in insolvency proceedings contemplated in the title statement. The factors that provide support for the stated object of procedural efficiency and those that militate against it are examined and contrasted. Practical examples are applied to the analytical framework to support the conclusion that insolvency issues cannot be resolved entirely in the unilateral fashion contended in the title. Insolvency – first principles The broad definition of insolvency is a straightforward proposition. Insolvency is the inability to meet a debt or other financial obligation, either by virtue of insufficient cash flow, or where the total liabilities exceed the value of the assets available to meet them.[1]At this early stage of the analysis, it is important to ensure that this general insolvency definition is understood from two critical philosophical perspectives. The first is that insolvency as an outcome of debt is a part of the triad of interests that drives all corporate and commercial activity, that of debtor / creditor / society at large. Described variously in the academic literature as a “compact” of interests that is essential to an effective marketplace[2], broadly stated the extension of credit to corporations is an essential feature of virtually every corporate existence that serves to benefit society as a whole[3]. This benefit derived from the ability of corporations to obtain ready access to credit to facilitate business and to generate both employment and trade, there will necessarily be risk of failure by such firms that utilise credit[4]. The Cork Committee in 1982 identified a number of factors that continue to operate below the surface of every insolvency consideration; these factors continue to be relevant and must be borne in mind as the present analysis moves forward, including[5]:

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  1. The ability to diagnose corporate financial problems at an early stage
  2. Prevention of conflict amongst creditor claims
  3. Preservation of corporate assets
  4. Reduction of delay in insolvency proceedings
  5. Recognition of the broader societal interests; preservation of some corporations is vital to national interests

This bare schematic review of the relationship of creditors’ interests to the entire insolvency picture reveals the operation of other interests that are not necessarily consistent with the efficient resolution of debtor claims. The precise determinations of the various forces that may compel insolvency are beyond the scope of this paper. It is important to appreciate however that the broader economic influences that may impair the finances or creditworthiness of any corporate venture include such macroeconomic factors as interest rates; economic recession or contraction; government policy[6]. Individual enterprises may be susceptible to internal inefficiencies and poor planning, especially with respect to cash flow and the orderly meeting of their obligations[7]. Armour notes that there is also an important societal interest in the encouragement of innovation that must be driven by the availability of venture capital that is more likely to be exposed to a corporate default that ultimately leads to insolvency.[8] As UK business becomes ever-increasingly integrated into a globalised financial environment, “… one of the most important determinants of (success will be) venture capital investment”.[9] Entrepreneurship as an outcome of a robust and vigorous economy may only be fostered through access to capital.[10]In this sense, the encouragement of risk is the recognition that there will inevitably be failures in the pursuit of innovation and corporate success. Legislative framework Given the philosophical underpinning that is suggested as the primary issue to be extracted from the title question and subjected to examination, this paper does not provide an in-depth review of the relevant UK and European statutory frameworks or the procedural rules within which insolvency matters are conducted, except as is necessary to ensure how the question of efficiency is defined or otherwise encouraged within the legislative frameworks. The UK Insolvency Act provides two separate mechanisms for the winding up of corporations, voluntary and compulsory. A voluntary winding up pursuant to s.84 of the Act provides two mechanisms for the passing of special and extraordinary resolutions for winding up; a compulsory winding up and the supervision of the process by means of liquidator appointment and court supervision is also mandated.[11] The legislation also provides for the conversion of a voluntary winding up into a compulsory proceeding, especially where the orderly dissolution of the subject company is questioned.[12] Where there is evidence of sharp practice or concerns that preference is improperly being extended to one creditor over another, the power of independent investigation and greater transparency of a court supervised proceeding is preferable.[13] The preservation of the principles of “fairness and commercial morality” through a compulsory court order will usually involve a delay and additional expense to the debtor / litigants that is contrary to the sentiments underlying the title question.[14] The appropriate EC regulation is not intended to harmonise insolvency practices in the European Union. The regulation is a recognition that all member nations will continue to employ their own insolvency practices. The regulation has been described as being amenable to a “purposive and liberal interpretation”.[15]It is not a device primarily directed at how the quantum or extent of corporate debts are resolved; the regulation is instead “… a piece of subordinate Community legislation which forms part of English Law. It was introduced in order to lay down mandatory rules for choice of law, jurisdiction, recognition, enforcement and co-operation applicable to cross-border insolvencies within the European Union.”[16] Certain industries are also subject to specific statutory regimes to govern insolvency; the UK insurance industry is a notable example.[17] It is contended that the most important consideration to be taken from the applicable legislation in the present context is that it collectively reflects a broader philosophical stance than the simple orderly and expeditious settling of all corporate debts in insolvency proceedings. As with the analysis of the pari passu principle set out below, insolvency legislation represents two different sets of intersections between legal theory and pragmatic action. Carruthers described the first as the meeting of the law, organizations, and professional interests associated with insolvency matters – the essential “industries” that propel insolvency proceedings forward.[18]The elevation of bankruptcy or its threatened occurrence has been a constant feature in the daily business news so as to heighten their appreciation as a corporate survival tactic, as opposed to a natural and sometimes unavoidable part of the business cycle.[19] The legislative framework also represents an appreciation that insolvency is an intersection of the variety of contractual relationships that exist both within and beyond the corporate structure.[20] The satisfaction of debt claims must occur against a backdrop of these various interests. The inter-relationship between public policy and insolvency proceedings Public policy considerations in the larger question of insolvency proceedings will include the proper treatment of creditors. The term ‘stakeholder’ is often applied in any assessment of multiple interests potentially at play in a given analysis; in many insolvency proceedings the stakeholders with legitimate interests in the outcome of a winding up, either voluntary or compulsory, will extend far beyond the boundaries established by the number of entities that extended credit to an enterprise. In all corporate insolvencies, there will some consideration given to the impact that the prospective winding up will have upon the employees of the company and its relative importance to the economy of a region or nation as a whole. These are transcendent questions that taken alone might trump a creditor’s interest in the expeditious resolution of its debts. Employment and job security are dormant but ever present insolvency issues that become activated when a company strikes the financial reef that is its inability to meet its obligations.[21]There are a multitude of examples from UK and international insolvency case law that stand for the proposition that in some circumstances, the orderly and expeditious resolution of creditor claims will be secondary to the national interests perceived to be at issue when major employers or key members of an industry sector face insolvency.[22]The extended public debate concerning the fate of British Rover MG and how the UK government might have intervened to assist the auto manufacturer is an example of how a larger public interest can dominate an insolvency question.[23] From the perspective of organised labour, and apart from the issues of how debts ought to be satisfied in insolvency proceedings, there are often significant questions raised by employees as to how a company can be maintained as a going concern to preserve both their ongoing employment and future pension and other health benefit interests. Strategies such as employee buyouts, either initiated by the employees alone or facilitated by the extension of public funds are a solution to insolvency that does not necessarily advance the immediate interests of a corporate creditor in their debt and its optimal satisfaction.[24] The pari passu principle and its relationship to efficient insolvency proceedings The pari passu principle is well entrenched in UK insolvency proceedings, to the extent that it is routinely described in the case law as the foundation of insolvency law[25]. From the 1978 House of Lords decision in British Eagle[26], its primacy as a governing doctrine and its true utility as a device for the proper resolution of insolvency claims has been endorsed in various proceedings and challenged by numerous academics and it has served as the subject of significant commentary[27]. Pari passu is the expression applied to any circumstance where debts or other types of obligations attract equal rights of payment. The expression is also used to describe clauses contained in various instruments to provide for rate able treatment of particular debts. Expressed another way, the pari passu principle requires that all creditors (in positions of relative equality as determined by pre-insolvency law) should be paid back the same proportion of their debt in their debtor’s liquidation.[28] As is discussed below, pari passu is a legal term of art whose true meaning and importance is not cast in stone but must be assessed in the circumstances of individual cases. It is noted that the rule in British Eagle arose in circumstances where “…a legitimate clearing house scheme, entered into for good business reasons was declared to be void as contrary to public policy in an insolvency situation, because it would, if effective, have deprived the general body of creditors of the insolvent company of assets which should have been available for distribution pari passu, whilst favouring a limited body of creditors within the clearing house scheme…”.[29] British Eagle as a proceeding that concerned a national UK airline carrier was a circumstance that engaged arguably broader public policy considerations that a conventional business insolvency. From a preliminary inspection, pari passu would seem to be in accord with the essence of the title question. The notion that creditors will be paid out in strict accordance with their status within the structure of the corporate indebtedness at the time that insolvency is determined has an inherent fairness. As this type of equality represents fairness, the argument is frequently advanced that the pari passu rule ensures all creditors are treated fairly. Some commentators have described the pari passu principle as the “normal rule” of UK insolvency.[30]Goode describes the relationship between the equality of treatment underlying the principle and the desire for orderly insolvency proceedings as equivalent concepts.[31] One of the most articulate challenges to the pari passu convention as one of myth and not substantive legal doctrine is advanced by Mokal in his 2001 analysis[32]. Mokal founds the argument that pari passu is inoperative in most insolvency circumstances on a contention that there must exist in all cases of insolvency an inherent tension between the ability of parties to pursue freedom of contract and the limitations of the pari passu doctrine[33]. The imposition of pari passu serves to distort the priorities between debtors as only those in relative positions of equality in insolvency as treated pari passu.[34] The central distinction between pre-insolvency law (i.e. the contractual position of the parties) and insolvency law underscores this point. Prior to either a voluntary or compulsory winding up each creditor is free to pursue whatever enforcement measures are open to them. The rule is sometimes expressed as, in the absence of insolvency proceedings, is that the race goes to the swiftest… Liquidation puts an end to the race.”[35] It is further contended that true rateability amongst corporate debtors can never be achieved due to the combined effect of contractual terms that may explicitly govern how debts are resolved and the welter of statutory exceptions to the pari passu principle. These exceptions include:

  1. The rights of set off at insolvency such as credits obtained pre-insolvency[36]; trade credit is estimated as twice as important as bank credit in the orderly flow of business[37]
  2. Claims arising after a winding up order is made (e.g. utility suppliers to a business); these are treated as an expense of the winding up proceeding and therefore will likely be afforded more favourable treatment than other corporate debts
  3. Pre-litigation creditors who can wield influence over the status of the insolvency proceedings, such as a landlord who possesses rights of distress[38]
  4. Preferred claims, such as VAT, customs and excise duties and obligations to employees by way of outstanding wages or holiday pay
  5. Deferred debts protected by statute (e.g. classes of shareholder claims)
  6. Solicitor and accounting fees[39]
  7. Liens on goods sold to the insolvent company

The power of a court to vary the pari passu rule is undoubted: “Thus strict priorities and pari passu distribution may be varied by the court, for example, in sanctioning payment of a class of creditor in full under Schedule 4 para 1 Insolvency Act 1986, sanctioning a scheme or compromise to that effect under s. 167(1) and s.425 of the Companies Act 1985 and in a number of other varied circumstances…”[40] The conclusion to be drawn from the weight of the exceptions permitted the application of pari passu is that the conventional belief in the usefulness of the doctrine to promote fair and orderly insolvency proceedings is that this position is rendered paradoxical, as the treatment of preferred claims is both an exception to, and yet an application of the pari passu rule at the same time (emphasis added).[41]This paradox is borne out by empirical evidence of how debt claims are actually satisfied in a majority of UK insolvency proceedings. General unsecured creditors (the only category of claimant truly subject to the pari passu rule)[42]obtain an estimated zero returns in 88% of administrative receiverships, 75% of creditors’ voluntary liquidations, and 78% of compulsory liquidations. On average, such creditors only receive 7% of what they are owed in total.[43] As noted above, the circumstances of each insolvency must necessarily play a significant role as to the course of subsequent proceedings initiated or maintained by a debtor. The statistical data relied upon by Mozal suggests that most types of insolvency claims “… either are or can be exempted from the application of the pari passu principle”, where it is very likely that in most if not all liquidations, hardly any claimants will be paid on a pari passu basis”.[44] This data also serves to undermine the contention that a pari passu distribution is the ‘… normal rule in a corporate insolvency”.[45] The difference highlighted here between the statement of the pari passu principle and the criticism leveled against it may be distilled to a single point. The rule does not speak so much to the distribution of assets in insolvency proceedings as it reinforces the different priorities of claims protected by the rule.[46] Even in those circumstances where unsecured claims other than preferential claims (created by either contract or statutory operation) form the bulk of the insolvency claims made, in most liquidations the available assets will not (and cannot) be distributed equally[47]. Where the pari passu rule is intended to govern distributions, the statistical data suggests that actual distribution in accordance with pari passu is almost never takes place.[48] The Insolvency Act provides that all unsecured or otherwise specially defined shall be paid pari passu, but this provision is triggered only after the winding up has commenced. The legislation does not encourage a Court to examine the past transactions of the company that relate to the debts owed and proceed to equalise the positions of all creditors. In such proceedings, the Court is compelled to take “… them exactly as it finds them”.[49] Keay and Walton contend for a contrary position. They assert that “…the underlying aim behind the use of the equality principle is to produce fairness, so that every creditor is treated in the same way”.[50] This argument advances the proposition that to abolish or restrict the operation of the pari passu principle would be to return to the “mediaeval policy” of allowing those with the greatest resources and access to legal remedies to deprive poorer and weaker creditors of anything in their debtor’s insolvency.[51]Finch describes the prospects of a “chaotic race” where huge costs are expended in the competitive pursuit of remedies amongst creditors, where expert creditors have an insurmountable advantage over the nave or unsophisticated challenger.[52] Conclusion   It is submitted that no sensible person can take issue with the proposition that the pursuit of justice is best undertaken in an orderly and cost effective fashion. The cases and the academic commentaries, when taken together, illustrate that equality of treatment exists in principle only. Pari passu principles have more to do with exceptions to equal treatment and the wholesale defeat of unsecured creditor interests by statutory and common law exceptions, than they do with the promotion of insolvency proceeding order and cost effectiveness. If the premise contained in the title question is to be regarded as a legitimate and overarching goal of insolvency proceedings, the pragmatic appeal of its sentiment to a corporate debtor must not be masked by the forest of exceptions apparent from the combined effect of its exceptions.                             Bibliography Table of Statutes Insolvency Act, 1986 Council Regulation (EC), 1346/2000 (in force May, 2002) Insurers (Reorganisation and Winding-up) Regulations 2004 SI 2004/353 Table of Cases Associated Travel Leisure Ltd, Re [1978] 2 AER 273 British Eagle International Ltd –v- Compagnie Nationale Air France [1978] 1 WLR 758 Gordon Beach Science [1995] BCC 261 HIH Casualty & General Insurance Ltd & Ors v McMahon & Ors [2006] EWCA Civ 732 (09 June 2006) Toshuku Finance UK plc, Re [2002] 1 WLR 671 National Westminster Bank Ltd. v Halesowen Presswork and Assemblies Ltd. [1972] A.C. 785 (HL) North Atlantic Insurance Co Ltd. v Nationwide General Insurance Co Ltd. & Ors [2003] EWHC 449 (Comm) (13 March 2003) Re Tain Construction [2005] BCC 88 Re Zirceman [2000] BCC 1048 Syska v Vivendi Universal SA & Ors [2008] EWHC 2155 (Comm) (02 October 2008) Table of Authorities Armour, John (2008) ‘Financing Innovation: The Role of Insolvency Law’ https://www.law.yale.edu/documents/pdf/armour.pdf (Accessed November 12, 2008) Armour, John, Simon Deakin and Suzanne J. Konzelmann (2003) ‘Beyond shareholder primacy? Reflections on the trajectory of UK corporate governance’ British Journal of Industrial Relations 41(3) 531-555 Charitou, Andreas, Evi Neophytou and Chris Charalambous (2004) ‘Predicting Corporate Failure: Empirical Evidence for the UK’ European Accounting Association at https://www.pba.ucy.ac.cy/courses/2004_EAR_publications_final_published_REAR1001111.pdf (Accessed November 12, 2008) Carruthers, Bruce and Terence Halliday (1998) Rescuing Business: The Making of Corporate Bankruptcy Law in England and the United States (Oxford: OUP) Cork Committee (Review Committee on Insolvency Law and Practice) Finch, Vanessa (2002) Corporate Insolvency Law: Perspectives and Principles (Cambridge: CUP) Finch, Vanessa ‘Security, insolvency and risk’ (1999) 62 M.L.R. 633, 634 Fletcher, I.F (2006) The Law of Insolvency (4th Ed.) Goode, R.M. (2005) Principles of Corporate Insolvency Law (London: Sweet & Maxwell) Keay, Andrew and Peter Walton (2003) Insolvency Law: Corporate and Personal (2nd ed.) (UK: Jordan) Hansard, (2004) Select Committee on Trade & industry (Minutes of evidence), Q260-276 Ho, Look Chan (2005) Pari Passu Distribution and Post-Petition Disposition: A rationalization of Re Tain Construction Social Science Research Network at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=852804 (Accessed November 14, 2008) Jensen, Anthony (2006) Insolvency, Employee Rights & Employee Buyouts: A Strategy for Restructuring (Ithaca Consulting) at https://www.efesonline.org/LIBRARY/2006/Insolvency, Employee Rights & Employee Buyouts.pdf (Accessed November 15, 2008) Kaufman, Aaron M. (2007) ‘The European Union Goes Comi-Tose: Hazards of Harmonizing Corporate Insolvency Laws in the Global Economy’ Houston Journal of International Law, 29, 3: 625 Keay, Andrew and Peter Walton (2003) Insolvency: Corporate and Personal (UK: Longman) Loose, P. and Michael Griffiths (2005) Loose on Liquidators: The role of a liquidator in a voluntary winding up (UK: Jordan) Milman D. and Charles Durrant (1999) Corporate Insolvency: law and practice (2nd Ed.) (London: Sweet & Maxwell) Mokal, Rizwaan Jameel (2001) ‘Priority as Pathology: The Pari Passu Myth’ [2001] Cambridge Law Journal 581-621 (November), also at https://law.bepress.com/cgi/viewcontent.cgi?article=6417&context=expresso (Accessed November 13, 2008) Pennington, Robert (1997) Pennington’s Corporate Insolvency Law (2nd ed.) Tolmie, Fiona (2003) Corporate and Personal Insolvency Law (London: Routledge) 1


Footnotes

[1] Tolmie (2003) 2, 3 [2] Ibid, 4 [3] Finch (2002), 4; see also Armour (2008) 2, 5 [4] ‘Credit’ is this context may be bank, private equity or trade credit [5] Summary of 1982 Cork Committee (Review Committee on Insolvency Law and Practice); see also Finch (2002), 25, 26; Tolmie (2003), 5 [6] Charitou (2004), 4 [7] ibid [8] Armour (2008), 5 [9]Ibid, 4 [10] Ibid, 6 [11] Insolvency Act, ss.84, 86 [12] See e.g. Gordon Beach Science [1995] BCC 261 [13] Loose & Griffiths (2005), 21 [14] Ibid, 22; see also Re Zirceman [2000] BCC 1048 regarding the ‘compelling reasons’ necessary to overcome the majority of creditors by value to obtain such an order [15] Ibid; see also Kaufman (2007), 625, and the analysis of the Parmalat proceedings in Italy and Ireland in 2003 and subsequent proceedings before the European Court of Justice [16] Syska v Vivendi Universal SA & Ors [2008] EWHC 2155 (Comm) (02 October 2008), para 10 [17] Insurers (Reorganisation and Winding-up) Regulations 2004 SI 2004/353 is an example [18] Carruthers (1998), 6 [19] Ibid [20] Ibid, 7 [21] Armour, Deakin & Konzelmann (2003), s.3.1, p.9 [22] British Coal and British Rail are notable UK examples from the later 20th century; the recent developments in a variety of national sectors in terms of the contemplated “bail outs”, such as the North American automotive industry, is another [23] Hansard, (2004) Select Committee on Trade & industry (Minutes of Evidence), Q260-276; [24] Jensen, Anthony (2006) Insolvency, Employee Rights & Employee Buyouts: A Strategy for Restructuring, 6,7; this particular document is written from a pro-labour perspective, but it effectively identifies the public issue at play [25] Re Tain [26] British Eagle International Ltd –v- Compagnie Nationale Air France [1978] 1 WLR 758 [27] See Finch (2002), c.13 [28] Mokal, (2001), 25 [29] As the rule was stated and applied in North Atlantic Insurance, n40 [30] Finch, ibid [31] Goode (2005) [32] Mokal, Rizwaan Jameel (2001) ‘Priority as Pathology: The Pari Passu Myth’ [2001] Cambridge Law Journal 581-621 [33] Ibid, 583 [34] Ibid, 585 [35] Goode, ibid, 142; Mokal, 13 [36] See also National Westminster Bank Ltd. v Halesowen Presswork and Assemblies Ltd. [1972] A.C. 785 (HL), where the Court held that the administration of insolvent estates embodies important elements of public policy, and since the rights of insolvency set-off form part of that regime, the creditor given such set-off rights cannot contract out of them [37] Armour, ibid [38] Re Toshuku Finance UK plc [2002] 1 WLR 671 [39] Re Associated Travel Leisure Ltd [1978] 2 AER 273 [40] HIH Casualty & General Insurance Ltd & Ors v McMahon & Ors [2006] EWCA Civ 732, para 26, 51 [41] Mokal, 7 [42] Ibid, 13 [43] ibid [44] Ibid, 25 [45] See also North Atlantic Insurance Co Ltd. v Nationwide General Insurance Co Ltd. & Ors [2003] EWHC 449, para 26 [46] ibid [47] Mokal, 585 [48] Ibid, 600 [49] Mozak, ibid; see also Carruthers, 8 [50] Keay & Walton (2003) [51] Finch, ibid, c.13 [52] Finch (2003), 25

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