some consequences of insolvency law reform
TRANSCRIPT
Some Consequences of Insolvency Law Reform
Steve Hill*
In 1985 and 1986, the United Kingdom introduced major substantive reform to its insolvency legislation. A number of jurisdictions are presently considering radical reform in this area, and the author sets out some of the lessons, both good and bad, which can be learnedfrom the British experience.
En 1985 et 1986. le Royawne-Uni modifia substantiellement se 1C;ggiSlation sur l’insolvabilitk. Actuellement. plusiers juridictiom envisagent des rC;formes radicales d m ce domaine. L’auteur prisente quelques-unes des lecon, positives et ne‘gatives, qui peuvenf itre tides de l’expirience britannique.
A number of jurisdictions are presently considering introdu- cing reformed insolvency laws, while others, including Britain, have done so. The advent of “Europe 1992” will increase the impetus towards harmonizing the procedures of the 12 European Community member states as cross-frontier insolvency becomes more wide- spread, at least within the European Community, and this is likely to bring further change in its wake. Radical reform can be a lengthy and painful process, and those countries presently undergoing that process may be interested in some of the lessons - good and bad - which can be learned from the English experiencc.
* Insolvency Technical Partner, Deloitte Haskins & Sells (U.K.).
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The Insolvency Act .!986* consolidated insolvency legislation for both individuals and corporate entities. Major substantive reforms were adopted the previous year in the Insolvency Act Z98j2 and the Companies Act 1985.3 Although many of these reforms were recom- mended in the Report of the Cork C~mrnittee,~ by no means all that Committee’s recommendations were incorporated. Indeed, if the Cork Committee’s proposals had about them all of the craftsmanship and technical precision of a Rolex watch, by the time the legislation emerged from the Parliamentary process it looked like a $20 Taiwan- ese copy.
Empirical evidence of the consequences of this insolvency legislation will be of particular interest to foreign legislators. This article analyzes a survey of creditors asking about respondents’ at- titudes to the legislation. In particular, the article examines the im- plications of the responses to questions about the creditors’ views of insolvency practitioners. In addition, the article draws upon pub- lished data to assess several responses that urge reform of costs.
1. SURVEY OF CREDITORS’ ATTITUDES
Two years after the legislation was passed, my firm camed out a survey of unsecured creditors’ views of the new law. Several respondents, without prompting, called for specific reforms, such as the reform of costs; others called for full implementation of the Cork Committee Report. It is not necessary to carry out a research survey to demonstrate that, given the chance, most unsecured creditors will vote in favour of receiving more money, from any source. What is of special concern about the results of our research, however, is how strongly creditors feel that the legislation has failed to improve mat- ters. Certainly many professionals thought that while the law might not give us everything, at least it addressed about 80 per cent of the key issues and therefore had to be a major improvement. Perhaps
1 (U.K.). 1986, c. 45. 2 (U.K.), 1985. c. 65. 3 (U.K.), 1985, c. 6. 4 Final Report of the Review Committee on Insolvency Law and Practice (Cmnd
8558) (1982).
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none of us really appreciated, in our enthusiasm for seeing as least some new law, that excising 20 per cent of the major proposals might also eliminate 80 per cent of the Act’s effectiveness. Figure 1 at the end of this article shows how creditors felt on a range of questions about their views of the legislation 2 years after its enactment. The results speak for themselves.
2. CREDITORS’ VIEWS OF INSOLVENCY PRACTITIONERS
Another area addressed by our research was creditors’ views of insolvency practitioners. We asked creditors what qualities they would be most likely to look for if they were choosing an insolvency practitioner. Unlike what happens in many countries, in England creditors generally hold the power of appointment. The results in Figure 2 show that the responses state that the key factors are profes- sionalism, efficiency, and, above all, being kept info~med.~
Having established the creditors’ priorities, we then asked them to rate the English insolvency profession as a whole on each of the five key qualities, using a scale of 1 (excellent) to 4 (poor). The results, shown in Figure 3, reveal that creditors are broadly satisfied only in relation to professionalism. This at least is comforting, as it supports the view that the licensing and ethical standards introduced in the wake of the new legislation are starting to take effect.
The generally even split of views on efficiency suggests, as might be expected, that some practitioners are better than others. Views on cost and value for money, although “bad” for the profes- sion, are perhaps predictable. Given a chance to express their opinion, creditors are not at all likely to give the profession a mandate for increasing its fees!
If that is accepted, the worst result for insolvency practitioners is the evidently below-par result on “Keeping you informed.” This is doubly concerning because, as revealed by Figure 2, it is the factor to which creditors attach most importance.
5 The relatively low concern about cost or value for money suggests either (i) creditors recognize that insolvency proceedings cost money and will tolerate realistic costs provided they receive good quality service; or (ii) creditors do not fully appreciate what proportion of assets can be absorbed by costs (another part of the survey provides some evidence to support this); or (iii) both of the above.
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3. COMMUNICATING WITH CREDITORS
The need for communication with creditors is a point which the Cork Committee addressed and, as a result, the Insolvency Act introduced for the first time new obligations upon practitioners to report to all creditors. For most procedures, however, the creditors are only entitled as of right to some information at the outset, prob- ably before all of the facts are known, and a final statement when the case is closed, with nothing in between. For a simple case which does not last too long this may well be adequate. However, the U.K. ex- perience seems to be that it is not enough for creditors in almost all other cases.
One of the objects of the new legislation was to increase the creditors’ sense of “involvement” in the proceedings. It is apparent that this has not been achieved, although it is to be hoped that now that practitioners are aware of the problem they can improve com- munication with creditors irrespective of any statutory provision.
It may be difficult to draft legislation which properly addresses the problem but also takes account of those cases where it might not be reasonable or cost-effective to do more in the way of reporting. It may not, however, be unrealistic to import into the ethical guidelines of professional bodies words to the effect that, where practicable, creditors should from time to time be given reasonable information as to the progress of the case. If insolvency practitioners have “clients” as such, they are surely not the debtors, but their creditors, who should be entitled to the quality of service we would all hope to give to any normal commercial clients of our firms.
Solving the communication problem may well improve cred- itors’ perceptions of us in other areas as well. How can they tell whether we are efficient or cost-effective if we never tell them any- thing?
4. COSTS
Several respondents to the survey analyzed above called, with- out prompting, for specific reforms. Reform of costs was one such area. Analysis of published data provides some support for this con- cern.
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Figure 4 shows that for bankruptcies dealt with by non-govem- ment trustees, dividends to unsecured creditors over a 30-year period fell in inverse proportion to the rising costs of proceedings. Divi- dends have halved, whereas costs have doubled. Since inflation would also affect the values realized for assets, the graph should show the position in real terms. Data is not available for more recent years, but as the government’s fees increased by around 50 per cent in 1988, it may not be unrealistic to say that left unchecked we will reach a point where all of the assets go to meet the costs of realizing them. In that eventuality we might as well cease paying lip service to the idea that insolvency proceedings have as one of their main objects the provision of compensation to creditors, and admit that we are simply confiscating a man’s land and chattels to teach him a lesson!
There are two main reasons why this unfortunate state of af- fairs came about. First, the government retains for its own use the interest eamed on undistributed funds in many cases. Second, the costs levied by the government - even before the 1988 fee increases - are far in excess of the sums needed to run the Insolvency Service. In the year to March 1986, for example, the government made a net profit of 16.5 million, up from less than 11 million 3 years earlier. This is nearly three times the total of 12.36 million paid out in dividends to all unsecured creditors in all bankruptcies in 1984, since which time the relevant statistics have not been produced.
The fees and costs levied by the government now usually ex- ceed those paid to the insolvency practitioner administering the case. Figure 5 compares, for a court liquidation, the fees payable to the government (the Department of Trade & Industry) with those payable to a liquidator charging an “official scale” realization fee, over a range of asset values. Only where assets exceed some 120 million does the liquidator finally overtake the government; i.e., in perhaps one case per decade. The Department of Trade & Industry obtain the greatest percentage “mark-up” at realization levels around 10.5 million.6
6 Ironically, Scotland, which obtains its own laws from the same Parliament, suffers none of these costs and never has done so. The same is true of Northern Ireland.
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It is hardly surprising that some 7 years ago the Cork Com- mittee recommended abolition of these fees. Equally, it is not dif- ficult to see why the government has been reluctant to abolish a com- fortable source of revenue. However, while most taxes are widely targeted, this particular levy falls specifically upon those creditors who have just learned that their customer has defaulted.
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Figure 1 Opinions on Insolvency Law & Practice
Question Yes % -
1. Do insolvency procedures benefit unsecured creditors? 22
2. Do insolvency procedures protect the public interest? 36
3. Are insolvency procedures flexible enough to rescue businesses in difficulties? 38
4. Do voluntary arrangements provide a better return to creditors than more formal procedures? 57
5 . Should creditors be represented at creditors’ meetings?
6. Are creditors’ rights ever changed in their absence?
97
40
7. Does your company usually arrange representation at creditor’s meetings? 81
8. Do your terms of trading incorporate retention of title (“ROT”) conditions?
9. Should there be a statutory public register of ROT agreements? 58
63
10. Should government departments have preferential rights? 5
11. Has the 1986 Insolvency Act made life
more difficult for unscrupulous directors?
12. Has the 1986 Insolvency Act improved your recovery prospects? 21
46
13. Do you think existing penalties are adequate for insolvents? 8
No Don’tknow % % -
73 5
51
43
22
1
11
17
22
27
92
33
60
81
13
19
21
2
49
2
15
15
3
21
19
11
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Figure 2 Qualities Most Desired of Insolvency Practitioners (Prompted)
Professionalism 59%
Efficiency 63%
cost 28%
Keeping you informed 64%
Value for money 30%
Figure 3 Insolvency Practitioners’ Ratings on Key Qualities
Rating Professionalism
%
1 (excellent) 19
2 57
3 21
4 (poor) 3
100 -
Efficiency
%
7
41
42
10
100 - -
cost
%
4
20
52
24
100
-
- -
Keeping Value you for
informed money
% %
8 4
22 23
38 50
32 23
100 100 - - - -
All factors
%
8
33
41
18
100 - -
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Figure 4 Bankruptcy - Costs and Dividends
% of assets realized
60
55
50
45
40
35
30
25
20
15
10
\ Administrative
- Unsecured creditors
Preferential creditors
1954 1959 1964 1969 1974 1979 1984
YEAR
1985 onwards - statistics no longer maintained
Note: Compiled from statistics presented to Parliament showing the disposition of funds in all bankruptcies closed in each year where a non-official trustee was appointed, i.e., those cases with most assets.
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Figure 5 Compulsory Liquidation Costs - DTI vs. Liquidator Fees
COO0
1000
700
400
zoo
100
60
25
10
5
2
1
0
% 120
110
100
90
80
70
60
50
40
30
20
10
0
5 10 20 50 100 ZOO 500 1000 2000 3JOO 5000 10000 20000
REALIZATIONS (€’OM)
Note: Right scale denotes percentage by which DTI fees exceed those payable to a liquidator who charges a fee on assets realized at the “official scale” rate. DTI fees are calculated at €500 fixed costs per case plus statutory fees and commissions earned by investing realiza- tions in government securities for 1 year.