UK: BANKS V BANKRUPTS.

UK: BANKS V BANKRUPTS. - Should UK law on insolvency be changed to protect small firms - and make the banks more responsible?

by Tom Pullar-Strecker.
Last Updated: 31 Aug 2010

Should UK law on insolvency be changed to protect small firms - and make the banks more responsible?

Until now, managers of ailing firms in Britain have only been able to dream of the protection afforded by Chapter 11 in the US. There, company directors can announce a moratorium on repayments and stay in day-to-day control of their business while they search for an agreement with their creditors.

But if the proposals set out in the DTI's April 1995 consultative document on reforming Company Voluntary Agreements (CVA) go onto the statute books, small businesses in the UK could receive a measure of the same protection afforded by Chapter 11 in the US - and, indeed, by insolvency laws in most of the rest of the developed world. The debate looks set to force the banks to justify the level of receiverships they initiated in the early '90s and may question the whole rationale of their relatively 'hands-off', strictly contractual relationship with their clients.

At the heart of the DTI consultative document is the proposal that any company in difficulties - or which has received five days' notice of a bank's intention to put it into administrative receivership - could win a stay of execution by applying for what would be virtually an automatic 28-day moratorium from any action by both secured and unsecured creditors. During the moratorium (which could be extended by a further two months with the agreement of creditors), company directors would be allowed to continue to manage their business under the supervision of a 'nominee' - probably a licensed insolvency practitioner - whom the company itself would appoint and whose primary task would be to ensure that assets were not dispersed to the detriment of creditors. At the end of the moratorium period the directors would have to set out proposals for reorganising the company's debts. These would need to be acceptable to 75% of its creditors (by value of their claims) in order to carry the day.

The DTI's proposals have a few less teeth than Chapter 11, it's true. For a start, new debts incurred by a company in the course of trading during a moratorium period in the US are given 'statutory super priority' ranking them above debts previously incurred, making it easier to find finance. But they nevertheless represent a frightening enough visage to British banks which naturally resent any dilution of creditors' rights.

In a hawkish 20-page response to the consultative document, the British Bankers' Association (BBA) stated, 'We cannot accept the proposal that there should be a five-day period of notice before a receiver could be appointed. This is wrong in practice because it would invite abuse from desperate or unscrupulous businessmen. It is also wrong in principle since it rides rough-shod over freedom of contract.' Assistant director Andrew Mason explains, 'We genuinely do not think a notice period could serve any useful purpose. It could certainly be put to bad use. Can you imagine what Robert Maxwell would have done with this? He would have loved this procedure.' Colin Bird, president of the Society of Practitioners of Insolvency (SPI) and a senior partner at Price Waterhouse, is equally belligerent. 'If the Government is going to play with the rights of a secure creditor then it should have a Royal Commission to look at it,' he argues. 'It is not the place of insolvency law reform to play with the balance of power between lenders and borrowers because it's a much bigger issue than making the CVA process work; we are talking about the financing of industry.

'I think the Government needs to be careful about this,' he continues. 'I'm not saying that it's wrong to change, just that you should be bloody sure that you are doing it for very good reasons - and I don't regard the ministerial post-bag as a good reason. The only postbag they get is from directors who say "If only I could have had another day, another few bob, I would have been all right". The answer is "No, they wouldn't have been, actually" because they are largely incompetent and didn't deserve to be banked in the first place. Bleating and bitching from directors that didn't make it isn't a good basis for changing policy.' Barclays' outgoing lending services director, Eddie Theobald, successfully argued that the proposals might undermine the tentative efforts of some in the banking industry to codify the 'London approach' of reorganising large firms outside insolvency law. He suggested that large firms, at least, should be excluded from the new proposed CVA procedure.

The DTI took this argument on board on 27 November last year when the minister for company affairs, Phillip Oppenheim, climbed down on this aspect of the consultative document, revealing that the new CVA procedure would only apply to small firms as defined by Section 247 of the Companies Act. This represents a major concession to the banks, but Oppenheim also raised the possibility of further back-tracking on the crucial principle of whether small firms could apply for a moratorium after the banks had announced their intention to put in a receiver.

In response to a parliamentary question, he stated, 'I intend to introduce legislation to effect a scheme broadly as described in the consultative document when parliamentary time allows,' but added, 'I am still reflecting on what was said regarding the requirement to give five days' notice of the intention of putting in an administrative receiver. I have yet to decide whether it is necessary to have a mandatory provision, or whether in response to the invitation I have issued to the British Bankers' Association, the banks can come up with a binding code of practice which obviates that need.' If the principle is indeed watered down, the April consultative document will have been all but gutted and the victory of the banking industry will be almost complete. But it's still a big 'if'.

One of the reasons that the banks and their agents have a fight on their hands centres on the fact that even though they argue (plausibly) that it is in their own interests only to put in administrative receivers as a last resort, this concern wasn't obvious in the last recession when the number of receiverships rose from 1,000 to 8,000 in the space of four short years.

Clem Rodgers, spokesman on insolvency for the Federation of Small Business, argues, 'There has been a bean feast in the past five years of insolvency practitioners doing an easy job. In the early days I think what the banks believed they were doing by putting a company into administrative receivership was beefing up the management of the company and I think it came as much of a surprise to them as anyone that the people they were appointing were just acting as liquidators.' He blames the tendency of the banks to turn automatically to the big six accountancy firms, along with the sheer workload of the early 1990s, for 'wholesale slaughter' at the smaller end of the business market. 'The last thing a bank wants to do is lose a business, but it's invariably the result as the receiver finds it easier to liquidate than to manage. The banks have no confidence in themselves and they do not know how to use the market.' Pointing to the explosion in the number of small businesses in the 1970s and 1980s, he adds, 'I side with the insolvency practitioners on a lot of things. In many cases businesses don't have people running them with a sufficient level of skill. But you don't treat those people in a derisory fashion, you don't call them the scum of the earth and say they shouldn't be in business in the first place. What you do is the proactive thing and teach them to be solvent. There is a certain amount of arrogance within the profession.' Where the banking industry and the SPI clearly do have a point is that if the security of loans was compromised by a more liberal insolvency law without a corresponding change in banking culture, the effect might simply be to restrict the finance options offered to businesses. This prospect is stressed by the BBA which stated in its response to the DTI's original proposals, 'There is bound to be an increase in the cost of borrowing if lenders see the new procedure as increasing the risk of lending. Companies - small companies especially - will hardly be helped in the way envisaged by the proposals if their net effect is to make it more expensive for such companies to borrow.' Bird points out that the majority of the banks' combined £6 billion write-off in the recession was accounted for by small businesses. 'The Government needs to realise that lending to small businesses is uneconomic from a bank's point of view and what you have got to do is asset-finance small businesses and not over-draft-finance small businesses. It is all very well for the Government to say "The banks will carry on lending because they've got to lend". The answer is "No, they haven't actually", not at too high a cost and not at too high a risk.' To its critics, this message amounts to 'stop the world we want to get off'; it's an indictment of the banks' refusal to accept that they are - and have to be - equity providers, and a sad reflection of an industry reduced to seeing its future in pawn-broking.

Nevertheless, Professor Roger Gregory, an expert in insolvency law at Touche Ross, cites the positive experience of the banks with the 'London approach' as evidence that cultures are changing. Gregory comments, 'The banks have built up a reservoir of experience of getting companies to survive and there's no reason why that kind of thinking won't filter or can't filter down to smaller companies. There is every reason to believe it should.' He continues, 'Modern banking is not what it was 50 years ago when bank managers tended to keep very close to their customers and be senior figures in the community. Nowadays,' he jokes, 'bank managers are expected to be experts in selling insurance and everything in fact, except banking. If you have somebody local on the ground who knows all his customers and plays golf or has a pint of beer with them, you get a nose for when trouble is starting and you can do something about it. In my view, if we are going to get a rescue culture, that is where we are going to get it from.' Reversing its policy of centralising business banking expertise in specialist regional units, Midland has put senior managers back into local branches. Small business services manager Mike Conroy explains, 'Twenty years ago branch managers were king of all they surveyed. Then there was a tendency to say, "Let's keep all that expertise in one place and then the process should be more efficient". The disadvantage is the distance it creates from the very people whose business you are trying to look after.

'What we have done by putting them back is to have a manager in situ who can deal with on average say 90% of the business that comes through their door. They are seeking to be "Mr Midland" in the local community. They've got some knowledge of what is going on in the local chamber and so on, and I think that also makes for better credit decisions. Two years ago branches would have been lending £10,000 to £20,000 on overdraft arrangements. Now figures of up to £500,000 would not be untypical.' It is perhaps a moot point whether the best interface between the banker and businessman is the golf course or (as in Germany) the boardroom. It is also debatable whether the goal of ensuring banks are closer to customers in the 1990s means reinstating Captain Mainwaring-type figures or reorganising lending departments into units of specific vertical industry expertise.

What can be said with a degree of certainty is that the high street banks have tended to see the challenge raised by the explosion in the sheer number of private businesses in the 1970s and 1980s primarily as one of lending to more companies while maintaining their own cost structures, rather than one of meeting a new more urgent need to get involved in backing winners and avoiding lending to losers.Theobald comments, 'I spent three years as a lending manager and I saw my responsibility was to consider a business plan, assess its viability and its risks - and lend or not. I didn't see it as my job to be responsible for the success or failure of the business. Frankly, if I did I wouldn't be working for the bank, I'd be in business myself.' And here, it seems, is the heart of the matter.

The DTI proposals as originally set out in April would, above anything else, increase the penalties for poor and ill-informed banking decisions by making it harder for banks to make a business merely out of lending against security on the basis of a reading of a business plan. And that's precisely why, despite the banks' legitimate and sincerely-held concerns, they might just prove to be a boot in the right direction.

Administrative Receverships by Turnover*

Less than £0.1m 5%

£0.1-£0.25m 9%

£0.25-£0.5m 12%

£0.5-£1m 25%

£1-£5m 32%

£5-£15m 12%

Greater than £15m 4%

Source: SPI survey * July 1993-June1994.

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