Journal of International Banking & Financial Law/2007 Volume 22/Issue 4, April/Articles/The Companies Act 2006 - (2007) 4 JIBFL 192
Journal of International Banking and Financial Law
(2007) 4 JIBFL 192
1 April 2007
The Companies Act 2006
Feature
Ken Baird
is head of the Restructuring and Insolvency Group at Freshfields Bruckhaus Deringer. Email: ken.baird@freshfields.com
Paul Sidle
is the knowledge management lawyer for the Restructuring and Insolvency Group at Freshfields Bruckhaus Deringer. Email: paul.sidle@freshfields.com
© Reed Elsevier (UK) Ltd 2007
This article raises awareness of some of the changes introduced by the Companies Act 2006 (the 'Act') which are of relevance to the restructuring and insolvency sector.
KEY POINTS
· The statutory statement of duties, with its express inclusion of various matters to be taken into account beyond shareholders' interests, may lead to confusion for directors of financially troubled companies as to whom their duties are owed at any one time.
· Liquidation expenses will be payable out of assets subject to a floating charge, but disputes are likely to arise.
· The changes on the dissolution and restoration of companies may have an impact on the use of members' voluntary liquidations.
· The need for so-called Slavenburg registrations has been abolished (albeit there is scope in the Act for the (re)introduction of some form of requirement on overseas companies to register charges over property in England and Wales in certain circumstances).
INTRODUCTION
When the Act received Royal Assent on 8 November 2006, it represented the culmination of many years of corporate law review, the aim of which had been to establish a company law that was fair, modern and effective. The majority of the Act is expected to come into force by October 2008, although some parts are already in force,1 with others due later this year.2 Further consultation has recently been issued on how the Act should apply to existing companies.3 Secondary legislation will be required to support some of the Act's provisions.
The Act spans an impressive 1,300 sections and 16 schedules. Of course, the success of the Act in achieving its aim will be tested only once in practice. As with any legislative reform (especially one of this size), there will inevitably be a period of uncertainty faced by companies, directors and other interested parties. The legal community, therefore, has a role to play in offering clarity where at all possible and indicating ways to work with the changes rather than engaging in a scaremongering exercise.
It is with this spirit in mind that this article attempts to raise awareness of some of the changes introduced by the Act which are of relevance to the restructuring and insolvency sector. In particular, the article addresses the following:
· The provisions relating to directors' duties which are of critical importance;
· The self-standing issue of the statutory reversal of Leyland Daf (payment of liquidation expenses);
and
· A miscellany of smaller items which may have gone unnoticed but which are of interest.
DIRECTORS' DUTIES
Statutory statement
The aim of the Act is to make the law in the area of directors' duties more consistent, certain, accessible and comprehensible. In view of this, the Act introduces a statutory statement of directors' general duties which, subject to the conditions below, replaces existing common law and equitable rules.
Included in the statement is a duty to act in the way a director considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (s 172(1)). This duty is to be carried out with regard to a series of matters, including the interests of employees, the impact of the company's operations on the community and the environment or the desirability of maintaining a reputation for high standards of business conduct (s 172(1)(a) to (f)).
While the introduction of these additional factors has provoked much debate, the government's expressed intention is not to impose additional bureaucratic burdens on companies. Rather, consideration of the matters listed in s 172 (while not exhaustive) is supposed to reflect current best practice. Directors should, therefore, continue to exercise their business judgment when taking decisions and should resist the temptation in the board minutes to repeat by rote the factors listed in s 172 as part of a box-ticking exercise.
Companies in trouble
The duty to promote the success of the company for the benefit of its members is expressed to have effect 'subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company' (s 172(3)). Under the existing common law, when a company's financial position has deteriorated to the point where its solvency is in question, the focus of the directors' attention must shift away from the shareholders towards protecting the interests of creditors. This is the position classically set out in West Mercia Safetywear Ltd (in liquidation) v Dodd4 and it would seem that the expressed intention is not to change this.
The decision to stop trading
When a company is in trouble, should the directors, in considering the interests of creditors, also have regard to the various factors set out in s 172(1), or are they only relevant when the directors are looking to promote the success of the company for the benefit of its members?
If directors determine that they should be taking into account the other interest groups, then they may determine (rightly or wrongly) that they should delay filing for insolvency where to do so would impact adversely on the company's employees, the community, the environment or any of the other interests to which they believe they are to have regard. Perversely, this could expose them to claims for wrongful trading where the company was clearly insolvent at the time.
Alternatively, the directors of a company may decide to continue trading for a period in order to improve returns for creditors but, ultimately, with a view to filing for insolvency. In so doing, they would be minimising the potential loss to creditors and, at the same time, reducing the likelihood of a wrongful trading action. However, what if, in continuing to trade, it is harder for the employees to find alternative work when the company eventually files for insolvency -- for example, if the directors decide to trade up until Christmas (as they might well do in a retail example)? Is this something the directors should be having regard to in considering the interests of creditors?
It is suggested that the factors relevant to promoting the company's success under s 172(1) are not relevant at a time when the directors need to take the interests of creditors into account. Such factors are only required to be considered in relation to the exercise of the duty in that sub-section. There appears to have been no intention to change the existing law governing how directors should exercise their duties when a company approaches insolvency.
However, under the common law, it is difficult for directors to know precisely when creditors' interests are to be preferred over the interests of shareholders in any given situation, as there is no neat dividing line. Directors are not, currently, expressly required to take into account the procedures that they must perform under s 172(1) (even though it may be best practice to do so). There is, then, clearly scope for future conflict where it is unclear to the directors whether they fall within s 172(1) or (3) territory -- a consequence of the express inclusion in s 172(1) of those relevant matters is that concerns might be raised that the directors took them too much into account at a time when they should have been protecting the creditors' interests. Directors may find it more difficult to navigate the so-called 'twilight zone' as a result.
The proposed statutory statement of directors' general duties will, initially, probably cause some confusion and concern for directors as a company is nearing insolvency. Directors are likely to require substantial advice as to whom their duties are owed in such circumstances and how to discharge them. There might also be an impact on director and officer liability insurance if it leads to increased litigation.
LIQUIDATION EXPENSES
Leyland Daf reversed
The House of Lords in Buchler v Talbot (Re Leyland Daf)5 held that general liquidation expenses were not payable out of assets subject to a floating charge security. The decision in Re Barleycorn Enterprises,6 which had stood for over 30 years, was thereby overturned.
In a reform which provoked considerable debate and highlighted the difficult policy considerations inherent in insolvency law, the Act will reverse the decision of the House of Lords.
Section 1282 of the Act inserts a new s 176ZA into the Insolvency Act 1986 (the 'IA') on the payment of expenses of winding up and restores the Barleycorn position. Section 176ZA(1) provides that:
'The expenses of winding up in England and Wales, so far as the assets of the company available for payment of general creditors are insufficient to meet them, have priority over any claims to property comprised in, or subject to, any floating charge created by the company and shall be paid out of any such property accordingly.'
Prescribed part
The prescribed part in s 176A of the IA, which sets aside a special ring-fenced fund out of the floating charge assets for the payment of unsecured creditors, will not be available to meet liquidation expenses.
The reference to 'assets of the company available for payment of general creditors' does not include the prescribed part (s 176ZA(2)(a)). In addition, s 176ZA(2)(b) clarifies that the reference to 'claims to property comprised in or subject to a floating charge' is a reference to the claims of the debenture holders and preferential creditors only -- ie not to claims of the unsecured creditors for the prescribed part. Had the Act enabled liquidation expenses to be taken out of the prescribed part, then the impact of one of the major policy reforms introduced by the Enterprise Act 2002 would have been significantly weakened. The wording ensures that the burden of paying winding up expenses is shared among all creditor groups.
Approval of liquidation expenses
Section 176ZA(3) provides that rules may be made restricting the application of the new provision to those expenses authorised by the floating charge holder, preferential creditors or the court. It is as yet unclear whether such rules would come into force at the same time as s 176ZA.
It is likely that any such rules would govern, for example, situations where the liquidator wishes to bring litigation claims. Presumably, the liquidator will not require floating charge approval to bring a claim to avoid the floating charge under s 245 of the IA, although the liquidator could always seek court consent in the event such consent was not forthcoming. Even so, there will be real tension between liquidators and floating charge holders as to precisely what expenses will require approval and this is likely to be an area ripe for litigation of disputes. Clarification will also be necessary in respect of the inter-relationship between the current provisions requiring creditor consent for the exercise of certain powers (eg by the liquidation committee under ss 165 and 167 of the IA) and the authorisation or approval under any rules.
In making provision for approval of the winding-up expenses, the position prior to Leyland Daf has not been entirely restored. Rather, the statutory approval regime attempts to provide for a greater balance between the interests of the liquidator and the floating charge holder (and preferential creditors) in getting paid.
Liquidation and admin expenses
The new law will now ensure that the regimes for the payment of liquidation and administration expenses are brought closer into line. Administration expenses were not affected by the decision in Leyland Daf and so have continued to be payable out of floating charge assets. To the extent that, following Leyland Daf, secured creditors had an incentive to push for liquidation rather than administration (so that their recoveries were not reduced by liquidation expenses) the new law can be regarded as shoring up the UK's rescue culture (a major factor behind the introduction of s 176ZA).
Legislation generally changes the law prospectively. So, the Act will not affect distributions that have already been made on the basis of Leyland Daf. There were arguments that any reversal of Leyland Daf should not affect debentures entered into in reliance upon it, but these were rejected. The legislative changes will, in future liquidations, affect realisations of floating charges under debentures whether or not granted in reliance upon Leyland Daf.
DISSOLUTION AND RESTORATION
Where a company has been dissolved, the liquidator, or any other person appearing to be interested, currently has two years to apply to court for a declaration that the dissolution was void (s 651 Companies Act 1985 (the 1985 Act)). Outside of insolvency proceedings, the English registrar of companies has power to strike-off a defunct company from the register of companies. In such circumstances, the company, the members or creditors currently have 20 years to apply to court for restoration (s 653(3)).
Under the new law,7 the distinction between ss 651 and 653 will no longer exist. Instead, an application may be made to court for restoration to the register where a company has been struck off voluntarily, for being defunct or where it has been dissolved under the IA. The Act lists possible applicants which include the Secretary of State. The Secretary of State may wish to apply, for example, in order that director disqualification proceedings can be instigated and the company's affairs investigated. Any application under the new provisions may only be made, however, within six years from the date of dissolution.
Impact on members' voluntary liquidations ('MVL')
One of the reasons a MVL is currently seen as more attractive than simply allowing a company to become defunct and struck off by the registrar is that a 'hidden' creditor would have only two years to apply to court to declare the dissolution void, rather than 20 years if the company had become defunct and struck off . This distinction will, under the Act, no longer exist. In some circumstances, therefore, in order to save costs it may be more appropriate for companies to be allowed to become defunct rather than be put into MVL.
Liquidators' indemnities
Prior to Pt 31 of the Act coming into force, liquidators will need to consider their indemnities carefully. The term for liquidators' indemnities is usually restricted to two years (the current period during which an objection to dissolution may be made). However, once the Act comes into force, a creditor will have six years from dissolution to apply for restoration. Accordingly, a liquidator's indemnity will need to reflect this. Moreover, until it is clear what the transitional provisions will be, liquidators may need to seek even longer indemnities to cover the period from now until the Act comes into force and then a further six years.
The changes introduced by the Act are particularly relevant in group re-organisations. The tool of a MVL is frequently used to remove unwanted companies from a group structure or facilitate intra-group asset transfers, for example.
ARRANGEMENTS AND RECONSTRUCTIONS
As part of the exercise of restating the 1985 Act, the Act restates the regime currently provided by Part XIII of the 1985 Act (arrangements and reconstructions). The relevant provisions in the Act are ss 895 to 901. An attempt has been made to ensure that, under the new law, the drafting is more in line with plain English principles. There is no intention to make substantive changes.
There is an unfortunate error in the drafting of the Act, however, since an administrator is permitted to make an application for a scheme meeting only if 'an administration order is in force' in relation to the company. There are no indications that this is anything other than an oversight, since there is no logical or policy reason why an administrator appointed out-of-court should also not be able to apply for the sanctioning of a scheme. Indeed, the existing s 425 of the 1985 Act was amended by the Enterprise Act 2002 to reflect the changes made to the administration regime. In order to avoid confusion this drafting error should be corrected.
REGISTRATION OF CHARGES
Slavenburg registrations
If a company incorporated outside Great Britain but having an established place of business in England and Wales grants a charge over property and that property is located in England and Wales, then s 409 of the 1985 Act extends the requirement under s 395 to register that charge. This requirement applies whether or not the overseas company has actually registered its place of business with the Registrar of Companies.
A chargee may not always know whether a chargor has, in fact, an established place of business in England and Wales and it may be difficult to determine if the charged property is located in England and Wales. Accordingly, there can be some confusion as to whether to register the charge or not. If it turns out that the overseas company does have an established place of business in England and Wales and the charge was not registered, then the sanction of invalidity will be applied -- ie, the charge will be void as against a liquidator, administrator or creditor by virtue of s 395 of the 1985 Act.
It was established in NV Slavenburg's Bank v Intercontinental Natural Resources Ltd8 that s 395 does not require registration of a charge to render it valid, but instead particulars of the charge have to be delivered to the Registrar. It has, therefore, been common practice for chargees, as a precautionary measure, to deliver particulars of the charge for registration at Companies House, notwithstanding that the overseas company has not registered its place of business in England and Wales. This protective filing has, of course, led to increased administration pressures and costs (for chargees and the Registrar).
Under the Act,9 there is no equivalent to s 409. The need for so-called Slavenburg registrations would seem to have been abolished. This will avoid the unnecessary and defensive filing of documents where it is unclear whether an overseas company has an established place of business in England and Wales. It will also remove the need to register charges over property in England and Wales created by foreign companies which have registered a place of business in England. This should simplify registration and save costs, not only for borrowers and lenders but also for the Registrar. It is worth noting, however, that under s 1052, there is a regulation-making power for the Secretary of State to make provision about the registration of charges over property in the United Kingdom of an overseas company that has registered its particulars with the registrar under s 1046. Section 1046 enables the Secretary of State to make provision by regulations requiring overseas companies to register particulars in certain circumstances. Accordingly, it is conceivable that there may be some requirement on overseas companies to register charges over property in England and Wales which may bring with it some of the difficulties referred to above under the existing regime.
SHARE CAPITAL
Reductions of capital
At present, a private company wishing to reduce its share capital must obtain court approval under Chapter IV of the 1985 Act (ss 135 to 141), principally to ensure that creditors are not prejudiced by the reduction. The involvement of the court obviously has time and cost implications.
Under ss 642 to 644 of the Act, the procedure for a private company to reduce its share capital is made less onerous. For public companies, it will still be necessary to seek court approval. However, rather than a court application, a private company may reduce its capital by passing a special resolution, provided it is supported by a directors' solvency statement made not more than 15 days before the date on which the resolution is passed. Directors must take into account both contingent and prospective liabilities of the company.
If the directors make a solvency statement without having reasonable grounds they commit a criminal offence. The Act does not require the directors to have their solvency statement verified by the auditors, although their involvement may assist. Directors will likely need to engage in a similar process to that involved when swearing a statutory declaration of solvency for the purposes of a MVL.10 In considering actual, contingent and prospective liabilities, the directors may wish to consider, for example, whether the company is a party to any agreements containing early termination provisions -- what liabilities might be triggered? Does the company have any other financial commitments -- has it issued any guarantees or comfort letters? Does it have liabilities under contractual warranties in commercial contracts, commitments or leasing arrangements? Is there any exposure to foreign exchange positions or contractual liabilities for deferred consideration?
Capital reductions, often seen in combination with schemes of arrangement, may be relevant where a company is seeking to eliminate accumulated losses on its accounts, returning value to shareholders or distributing assets to shareholders (ie in return for the reduction). In particular, they might be used following on from a restructuring which involved a debt-for-equity swap.
Financial assistance
The restriction on private companies from giving financial assistance for the acquisition of their own shares (s 151 of the 1985 Act) will no longer apply. The regime will continue to apply to public companies or its UK11 subsidiaries -- ss 677 to 683 of the Act.
The relaxation of the financial assistance rules for private companies will clearly be relevant in distressed M&A and refinancing situations or internal reorganisations where the issue can increase costs and cause delays. Private companies will no longer need to go through the 'whitewash' procedure in order to grant security, make loans or give guarantees to assist in its acquisition. Of course, directors will still need to consider such action in the context of their general duties (under the statutory statement) and other statutory rules.
Common law rules on maintenance of capital will continue to operate after the statutory prohibition is removed, in particular the rule in Trevor v Whitworth.12 It is clearly the desire of the legislature to ensure that, following the repeal, transactions involving financial assistance will be simplified. Some commentators have raised a question over the interplay of the old financial assistance regime and the rules on capital maintenance. In order to avoid any potential for uncertainty, the government has indicated that it intends to make a savings provision to clarify the position and confirm that the repeal of the prohibition on financial assistance for private companies will not make unlawful anything that could have been done under the whitewash procedure.13 Companies will not be required to go through a whitewash procedure in future and in many cases it should be easier for companies to give guarantees and security in connection with an acquisition of their shares.
LOOKING FORWARD
It is hoped that this article has made one thing clear -- the Act contains more of interest to the restructuring and insolvency community than perhaps initially expected. Potential insolvency officeholders and creditors will need to keep an eye out on the timing of implementation of the various provisions of the Act and begin to consider how the changes will affect them. The consultations on how the Act should be applied to existing companies and the various pieces of secondary legislation that will be needed to put some flesh onto the raw bones of the Act will be eagerly awaited. In an area of law and practice which has already fuelled much judicial comment and clarification, the new Act will inevitably stoke the fire.
1 See s 1300 of the Act for further details; and The Companies Act 2006 (Commencement No 1, Transitional Provisions and Savings) Order 2006 listing those provisions of the Act effective (and the provisions of the 1985 Act to be repealed) on 1 January, 20 January and 6 April 2007.
2 See Margaret Hodge's statement available on the DTI website, dated Wednesday 28 February, in which she announces the Companies Act Implementation timetable.
3 See http://www.dti.gov.uk/consultations/page37980.html for a copy of the DTI's Implementation of Companies Act 2006 Consultative Document February 2007.
4 [1988] BCLC 250.
5 [2004] UKHL 9.
6 [1970] Ch 465.
7 See Part 31, ss 1000 to 1034 of the Act.
8 [1980] 1 All ER 955.
9 Part 25, ss 860 to 894.
10 Section 89 of the IA.
11 Section 678 of the Act gives statutory effect to the decision in Arab Bank Plc v Mercantile Holdings Ltd [1994] 2 All ER 74 that the prohibition on financial assistance does not apply to the giving of such assistance by a subsidiary incorporated overseas. This is achieved by the definition of 'company' in s 1 of the Act making it clear that, unless the context otherwise requires, 'company' means a company which is formed and registered under the Act or a former UK Companies Act. This contrasts with the current definition in s 736 of the 1985 Act which includes foreign companies.
12 (1887) 12 App Cas 409 -- the rule provides that no part of a company's capital may be returned to members to reduce the funds out of which creditors have a right to be paid.
13 Per Lord Sainsbury of Turville, Hansard col. 443, 2 November 2006.
Journal of International Banking and Financial Law
(2007) 4 JIBFL 192
1 April 2007
The Companies Act 2006
Feature
Ken Baird
is head of the Restructuring and Insolvency Group at Freshfields Bruckhaus Deringer. Email: ken.baird@freshfields.com
Paul Sidle
is the knowledge management lawyer for the Restructuring and Insolvency Group at Freshfields Bruckhaus Deringer. Email: paul.sidle@freshfields.com
© Reed Elsevier (UK) Ltd 2007
This article raises awareness of some of the changes introduced by the Companies Act 2006 (the 'Act') which are of relevance to the restructuring and insolvency sector.
KEY POINTS
· The statutory statement of duties, with its express inclusion of various matters to be taken into account beyond shareholders' interests, may lead to confusion for directors of financially troubled companies as to whom their duties are owed at any one time.
· Liquidation expenses will be payable out of assets subject to a floating charge, but disputes are likely to arise.
· The changes on the dissolution and restoration of companies may have an impact on the use of members' voluntary liquidations.
· The need for so-called Slavenburg registrations has been abolished (albeit there is scope in the Act for the (re)introduction of some form of requirement on overseas companies to register charges over property in England and Wales in certain circumstances).
INTRODUCTION
When the Act received Royal Assent on 8 November 2006, it represented the culmination of many years of corporate law review, the aim of which had been to establish a company law that was fair, modern and effective. The majority of the Act is expected to come into force by October 2008, although some parts are already in force,1 with others due later this year.2 Further consultation has recently been issued on how the Act should apply to existing companies.3 Secondary legislation will be required to support some of the Act's provisions.
The Act spans an impressive 1,300 sections and 16 schedules. Of course, the success of the Act in achieving its aim will be tested only once in practice. As with any legislative reform (especially one of this size), there will inevitably be a period of uncertainty faced by companies, directors and other interested parties. The legal community, therefore, has a role to play in offering clarity where at all possible and indicating ways to work with the changes rather than engaging in a scaremongering exercise.
It is with this spirit in mind that this article attempts to raise awareness of some of the changes introduced by the Act which are of relevance to the restructuring and insolvency sector. In particular, the article addresses the following:
· The provisions relating to directors' duties which are of critical importance;
· The self-standing issue of the statutory reversal of Leyland Daf (payment of liquidation expenses);
and
· A miscellany of smaller items which may have gone unnoticed but which are of interest.
DIRECTORS' DUTIES
Statutory statement
The aim of the Act is to make the law in the area of directors' duties more consistent, certain, accessible and comprehensible. In view of this, the Act introduces a statutory statement of directors' general duties which, subject to the conditions below, replaces existing common law and equitable rules.
Included in the statement is a duty to act in the way a director considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole (s 172(1)). This duty is to be carried out with regard to a series of matters, including the interests of employees, the impact of the company's operations on the community and the environment or the desirability of maintaining a reputation for high standards of business conduct (s 172(1)(a) to (f)).
While the introduction of these additional factors has provoked much debate, the government's expressed intention is not to impose additional bureaucratic burdens on companies. Rather, consideration of the matters listed in s 172 (while not exhaustive) is supposed to reflect current best practice. Directors should, therefore, continue to exercise their business judgment when taking decisions and should resist the temptation in the board minutes to repeat by rote the factors listed in s 172 as part of a box-ticking exercise.
Companies in trouble
The duty to promote the success of the company for the benefit of its members is expressed to have effect 'subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company' (s 172(3)). Under the existing common law, when a company's financial position has deteriorated to the point where its solvency is in question, the focus of the directors' attention must shift away from the shareholders towards protecting the interests of creditors. This is the position classically set out in West Mercia Safetywear Ltd (in liquidation) v Dodd4 and it would seem that the expressed intention is not to change this.
The decision to stop trading
When a company is in trouble, should the directors, in considering the interests of creditors, also have regard to the various factors set out in s 172(1), or are they only relevant when the directors are looking to promote the success of the company for the benefit of its members?
If directors determine that they should be taking into account the other interest groups, then they may determine (rightly or wrongly) that they should delay filing for insolvency where to do so would impact adversely on the company's employees, the community, the environment or any of the other interests to which they believe they are to have regard. Perversely, this could expose them to claims for wrongful trading where the company was clearly insolvent at the time.
Alternatively, the directors of a company may decide to continue trading for a period in order to improve returns for creditors but, ultimately, with a view to filing for insolvency. In so doing, they would be minimising the potential loss to creditors and, at the same time, reducing the likelihood of a wrongful trading action. However, what if, in continuing to trade, it is harder for the employees to find alternative work when the company eventually files for insolvency -- for example, if the directors decide to trade up until Christmas (as they might well do in a retail example)? Is this something the directors should be having regard to in considering the interests of creditors?
It is suggested that the factors relevant to promoting the company's success under s 172(1) are not relevant at a time when the directors need to take the interests of creditors into account. Such factors are only required to be considered in relation to the exercise of the duty in that sub-section. There appears to have been no intention to change the existing law governing how directors should exercise their duties when a company approaches insolvency.
However, under the common law, it is difficult for directors to know precisely when creditors' interests are to be preferred over the interests of shareholders in any given situation, as there is no neat dividing line. Directors are not, currently, expressly required to take into account the procedures that they must perform under s 172(1) (even though it may be best practice to do so). There is, then, clearly scope for future conflict where it is unclear to the directors whether they fall within s 172(1) or (3) territory -- a consequence of the express inclusion in s 172(1) of those relevant matters is that concerns might be raised that the directors took them too much into account at a time when they should have been protecting the creditors' interests. Directors may find it more difficult to navigate the so-called 'twilight zone' as a result.
The proposed statutory statement of directors' general duties will, initially, probably cause some confusion and concern for directors as a company is nearing insolvency. Directors are likely to require substantial advice as to whom their duties are owed in such circumstances and how to discharge them. There might also be an impact on director and officer liability insurance if it leads to increased litigation.
LIQUIDATION EXPENSES
Leyland Daf reversed
The House of Lords in Buchler v Talbot (Re Leyland Daf)5 held that general liquidation expenses were not payable out of assets subject to a floating charge security. The decision in Re Barleycorn Enterprises,6 which had stood for over 30 years, was thereby overturned.
In a reform which provoked considerable debate and highlighted the difficult policy considerations inherent in insolvency law, the Act will reverse the decision of the House of Lords.
Section 1282 of the Act inserts a new s 176ZA into the Insolvency Act 1986 (the 'IA') on the payment of expenses of winding up and restores the Barleycorn position. Section 176ZA(1) provides that:
'The expenses of winding up in England and Wales, so far as the assets of the company available for payment of general creditors are insufficient to meet them, have priority over any claims to property comprised in, or subject to, any floating charge created by the company and shall be paid out of any such property accordingly.'
Prescribed part
The prescribed part in s 176A of the IA, which sets aside a special ring-fenced fund out of the floating charge assets for the payment of unsecured creditors, will not be available to meet liquidation expenses.
The reference to 'assets of the company available for payment of general creditors' does not include the prescribed part (s 176ZA(2)(a)). In addition, s 176ZA(2)(b) clarifies that the reference to 'claims to property comprised in or subject to a floating charge' is a reference to the claims of the debenture holders and preferential creditors only -- ie not to claims of the unsecured creditors for the prescribed part. Had the Act enabled liquidation expenses to be taken out of the prescribed part, then the impact of one of the major policy reforms introduced by the Enterprise Act 2002 would have been significantly weakened. The wording ensures that the burden of paying winding up expenses is shared among all creditor groups.
Approval of liquidation expenses
Section 176ZA(3) provides that rules may be made restricting the application of the new provision to those expenses authorised by the floating charge holder, preferential creditors or the court. It is as yet unclear whether such rules would come into force at the same time as s 176ZA.
It is likely that any such rules would govern, for example, situations where the liquidator wishes to bring litigation claims. Presumably, the liquidator will not require floating charge approval to bring a claim to avoid the floating charge under s 245 of the IA, although the liquidator could always seek court consent in the event such consent was not forthcoming. Even so, there will be real tension between liquidators and floating charge holders as to precisely what expenses will require approval and this is likely to be an area ripe for litigation of disputes. Clarification will also be necessary in respect of the inter-relationship between the current provisions requiring creditor consent for the exercise of certain powers (eg by the liquidation committee under ss 165 and 167 of the IA) and the authorisation or approval under any rules.
In making provision for approval of the winding-up expenses, the position prior to Leyland Daf has not been entirely restored. Rather, the statutory approval regime attempts to provide for a greater balance between the interests of the liquidator and the floating charge holder (and preferential creditors) in getting paid.
Liquidation and admin expenses
The new law will now ensure that the regimes for the payment of liquidation and administration expenses are brought closer into line. Administration expenses were not affected by the decision in Leyland Daf and so have continued to be payable out of floating charge assets. To the extent that, following Leyland Daf, secured creditors had an incentive to push for liquidation rather than administration (so that their recoveries were not reduced by liquidation expenses) the new law can be regarded as shoring up the UK's rescue culture (a major factor behind the introduction of s 176ZA).
Legislation generally changes the law prospectively. So, the Act will not affect distributions that have already been made on the basis of Leyland Daf. There were arguments that any reversal of Leyland Daf should not affect debentures entered into in reliance upon it, but these were rejected. The legislative changes will, in future liquidations, affect realisations of floating charges under debentures whether or not granted in reliance upon Leyland Daf.
DISSOLUTION AND RESTORATION
Where a company has been dissolved, the liquidator, or any other person appearing to be interested, currently has two years to apply to court for a declaration that the dissolution was void (s 651 Companies Act 1985 (the 1985 Act)). Outside of insolvency proceedings, the English registrar of companies has power to strike-off a defunct company from the register of companies. In such circumstances, the company, the members or creditors currently have 20 years to apply to court for restoration (s 653(3)).
Under the new law,7 the distinction between ss 651 and 653 will no longer exist. Instead, an application may be made to court for restoration to the register where a company has been struck off voluntarily, for being defunct or where it has been dissolved under the IA. The Act lists possible applicants which include the Secretary of State. The Secretary of State may wish to apply, for example, in order that director disqualification proceedings can be instigated and the company's affairs investigated. Any application under the new provisions may only be made, however, within six years from the date of dissolution.
Impact on members' voluntary liquidations ('MVL')
One of the reasons a MVL is currently seen as more attractive than simply allowing a company to become defunct and struck off by the registrar is that a 'hidden' creditor would have only two years to apply to court to declare the dissolution void, rather than 20 years if the company had become defunct and struck off . This distinction will, under the Act, no longer exist. In some circumstances, therefore, in order to save costs it may be more appropriate for companies to be allowed to become defunct rather than be put into MVL.
Liquidators' indemnities
Prior to Pt 31 of the Act coming into force, liquidators will need to consider their indemnities carefully. The term for liquidators' indemnities is usually restricted to two years (the current period during which an objection to dissolution may be made). However, once the Act comes into force, a creditor will have six years from dissolution to apply for restoration. Accordingly, a liquidator's indemnity will need to reflect this. Moreover, until it is clear what the transitional provisions will be, liquidators may need to seek even longer indemnities to cover the period from now until the Act comes into force and then a further six years.
The changes introduced by the Act are particularly relevant in group re-organisations. The tool of a MVL is frequently used to remove unwanted companies from a group structure or facilitate intra-group asset transfers, for example.
ARRANGEMENTS AND RECONSTRUCTIONS
As part of the exercise of restating the 1985 Act, the Act restates the regime currently provided by Part XIII of the 1985 Act (arrangements and reconstructions). The relevant provisions in the Act are ss 895 to 901. An attempt has been made to ensure that, under the new law, the drafting is more in line with plain English principles. There is no intention to make substantive changes.
There is an unfortunate error in the drafting of the Act, however, since an administrator is permitted to make an application for a scheme meeting only if 'an administration order is in force' in relation to the company. There are no indications that this is anything other than an oversight, since there is no logical or policy reason why an administrator appointed out-of-court should also not be able to apply for the sanctioning of a scheme. Indeed, the existing s 425 of the 1985 Act was amended by the Enterprise Act 2002 to reflect the changes made to the administration regime. In order to avoid confusion this drafting error should be corrected.
REGISTRATION OF CHARGES
Slavenburg registrations
If a company incorporated outside Great Britain but having an established place of business in England and Wales grants a charge over property and that property is located in England and Wales, then s 409 of the 1985 Act extends the requirement under s 395 to register that charge. This requirement applies whether or not the overseas company has actually registered its place of business with the Registrar of Companies.
A chargee may not always know whether a chargor has, in fact, an established place of business in England and Wales and it may be difficult to determine if the charged property is located in England and Wales. Accordingly, there can be some confusion as to whether to register the charge or not. If it turns out that the overseas company does have an established place of business in England and Wales and the charge was not registered, then the sanction of invalidity will be applied -- ie, the charge will be void as against a liquidator, administrator or creditor by virtue of s 395 of the 1985 Act.
It was established in NV Slavenburg's Bank v Intercontinental Natural Resources Ltd8 that s 395 does not require registration of a charge to render it valid, but instead particulars of the charge have to be delivered to the Registrar. It has, therefore, been common practice for chargees, as a precautionary measure, to deliver particulars of the charge for registration at Companies House, notwithstanding that the overseas company has not registered its place of business in England and Wales. This protective filing has, of course, led to increased administration pressures and costs (for chargees and the Registrar).
Under the Act,9 there is no equivalent to s 409. The need for so-called Slavenburg registrations would seem to have been abolished. This will avoid the unnecessary and defensive filing of documents where it is unclear whether an overseas company has an established place of business in England and Wales. It will also remove the need to register charges over property in England and Wales created by foreign companies which have registered a place of business in England. This should simplify registration and save costs, not only for borrowers and lenders but also for the Registrar. It is worth noting, however, that under s 1052, there is a regulation-making power for the Secretary of State to make provision about the registration of charges over property in the United Kingdom of an overseas company that has registered its particulars with the registrar under s 1046. Section 1046 enables the Secretary of State to make provision by regulations requiring overseas companies to register particulars in certain circumstances. Accordingly, it is conceivable that there may be some requirement on overseas companies to register charges over property in England and Wales which may bring with it some of the difficulties referred to above under the existing regime.
SHARE CAPITAL
Reductions of capital
At present, a private company wishing to reduce its share capital must obtain court approval under Chapter IV of the 1985 Act (ss 135 to 141), principally to ensure that creditors are not prejudiced by the reduction. The involvement of the court obviously has time and cost implications.
Under ss 642 to 644 of the Act, the procedure for a private company to reduce its share capital is made less onerous. For public companies, it will still be necessary to seek court approval. However, rather than a court application, a private company may reduce its capital by passing a special resolution, provided it is supported by a directors' solvency statement made not more than 15 days before the date on which the resolution is passed. Directors must take into account both contingent and prospective liabilities of the company.
If the directors make a solvency statement without having reasonable grounds they commit a criminal offence. The Act does not require the directors to have their solvency statement verified by the auditors, although their involvement may assist. Directors will likely need to engage in a similar process to that involved when swearing a statutory declaration of solvency for the purposes of a MVL.10 In considering actual, contingent and prospective liabilities, the directors may wish to consider, for example, whether the company is a party to any agreements containing early termination provisions -- what liabilities might be triggered? Does the company have any other financial commitments -- has it issued any guarantees or comfort letters? Does it have liabilities under contractual warranties in commercial contracts, commitments or leasing arrangements? Is there any exposure to foreign exchange positions or contractual liabilities for deferred consideration?
Capital reductions, often seen in combination with schemes of arrangement, may be relevant where a company is seeking to eliminate accumulated losses on its accounts, returning value to shareholders or distributing assets to shareholders (ie in return for the reduction). In particular, they might be used following on from a restructuring which involved a debt-for-equity swap.
Financial assistance
The restriction on private companies from giving financial assistance for the acquisition of their own shares (s 151 of the 1985 Act) will no longer apply. The regime will continue to apply to public companies or its UK11 subsidiaries -- ss 677 to 683 of the Act.
The relaxation of the financial assistance rules for private companies will clearly be relevant in distressed M&A and refinancing situations or internal reorganisations where the issue can increase costs and cause delays. Private companies will no longer need to go through the 'whitewash' procedure in order to grant security, make loans or give guarantees to assist in its acquisition. Of course, directors will still need to consider such action in the context of their general duties (under the statutory statement) and other statutory rules.
Common law rules on maintenance of capital will continue to operate after the statutory prohibition is removed, in particular the rule in Trevor v Whitworth.12 It is clearly the desire of the legislature to ensure that, following the repeal, transactions involving financial assistance will be simplified. Some commentators have raised a question over the interplay of the old financial assistance regime and the rules on capital maintenance. In order to avoid any potential for uncertainty, the government has indicated that it intends to make a savings provision to clarify the position and confirm that the repeal of the prohibition on financial assistance for private companies will not make unlawful anything that could have been done under the whitewash procedure.13 Companies will not be required to go through a whitewash procedure in future and in many cases it should be easier for companies to give guarantees and security in connection with an acquisition of their shares.
LOOKING FORWARD
It is hoped that this article has made one thing clear -- the Act contains more of interest to the restructuring and insolvency community than perhaps initially expected. Potential insolvency officeholders and creditors will need to keep an eye out on the timing of implementation of the various provisions of the Act and begin to consider how the changes will affect them. The consultations on how the Act should be applied to existing companies and the various pieces of secondary legislation that will be needed to put some flesh onto the raw bones of the Act will be eagerly awaited. In an area of law and practice which has already fuelled much judicial comment and clarification, the new Act will inevitably stoke the fire.
1 See s 1300 of the Act for further details; and The Companies Act 2006 (Commencement No 1, Transitional Provisions and Savings) Order 2006 listing those provisions of the Act effective (and the provisions of the 1985 Act to be repealed) on 1 January, 20 January and 6 April 2007.
2 See Margaret Hodge's statement available on the DTI website, dated Wednesday 28 February, in which she announces the Companies Act Implementation timetable.
3 See http://www.dti.gov.uk/consultations/page37980.html for a copy of the DTI's Implementation of Companies Act 2006 Consultative Document February 2007.
4 [1988] BCLC 250.
5 [2004] UKHL 9.
6 [1970] Ch 465.
7 See Part 31, ss 1000 to 1034 of the Act.
8 [1980] 1 All ER 955.
9 Part 25, ss 860 to 894.
10 Section 89 of the IA.
11 Section 678 of the Act gives statutory effect to the decision in Arab Bank Plc v Mercantile Holdings Ltd [1994] 2 All ER 74 that the prohibition on financial assistance does not apply to the giving of such assistance by a subsidiary incorporated overseas. This is achieved by the definition of 'company' in s 1 of the Act making it clear that, unless the context otherwise requires, 'company' means a company which is formed and registered under the Act or a former UK Companies Act. This contrasts with the current definition in s 736 of the 1985 Act which includes foreign companies.
12 (1887) 12 App Cas 409 -- the rule provides that no part of a company's capital may be returned to members to reduce the funds out of which creditors have a right to be paid.
13 Per Lord Sainsbury of Turville, Hansard col. 443, 2 November 2006.
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