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The Fair Business Banking APPG’s insolvency report: R3’s views

The Fair Business Banking APPG’s insolvency report: R3’s views

22 September 2021

Last week, the debate on insolvency regulation came back under the spotlight, as the All-Party Parliamentary Group (APPG) on Fair Business Banking published a report on the issue.

The report followed an inquiry, conducted by the group of cross-party parliamentarians earlier this year, which had aimed to identify and address any weaknesses in the current framework. The group, whose aim is to put forward policy recommendations “to help shape a level playing field between businesses and the banks that lend to them, while supporting a resilient business banking sector”, has long had an interest in insolvency policy issues – sparked in particular by the high-profile cases from around the time of the 2008 financial crash. R3’s response to the APPG’s insolvency inquiry can be read here.

The APPG’s report is well-timed, coming ahead of an expected Government review of insolvency regulation. The issues it raises are likely to attract a wide level of interest.

R3 has long made clear that, while the current framework is on the whole fair, proportionate, transparent and efficient, there are a range of improvements that can be made. The APPG has helped to restart an important debate about how some of these improvements can be made. 

However, as we set out in our press comments on the report, some areas of it suggested a lack of understanding of the insolvency framework, and the difficult circumstances in which the insolvency profession works.

This blog post sets out R3’s response to the APPG’s report and recommendations – including those that could help to make a positive difference to the current framework – while also highlighting some of the areas where we feel the report doesn’t get it right.

The APPG’s key recommendations

Along with a number of more minor suggestions, the report makes the following key recommendations:

  1. ‘A conflict of interests ban’ on insolvency practitioners (IPs) taking appointments where they have personally been involved in pre-appointment work for any party involved in the insolvency case in the two years before the appointment.
  2. ‘A single regulator with an ombudsman’. The APPG is recommending that the Government use the sunset clause contained within the Small Business, Enterprise and Employment (SBEE) Act 2015 to establish a single regulator of IPs. Currently, there are four Recognised Professional Bodies (RPBs) which regulate IPs in the UK. The APPG has also suggested that an independent ombudsman be set up to offer dispute resolu­tion to complainants and IPs, in respect of certain types of cases.
  3. ‘Placing the Code of Ethics on a statutory footing’ to formally make the Code part of law.
  4. ‘A centralised database recording the out­comes of administrations’ to record which of the three statutory objectives of administration, as specified by the Insolvency Act 1986, have been achieved in each administration case.

A conflict of interests ban

The APPG is recommending a ban on IPs taking appointments where they have personally been involved in pre-appointment work for any party who was involved in the insolvency case within two years before the appointment.

When a company becomes insolvent, an IP is usually appointed as an office holder (for example, as a liquidator, administrator, or trustee). The IP’s role is to maximise returns to creditors of the business. To help manage competing creditors’ claims, creditors are repaid in a strict hierarchy set out by legislation.

The APPG’s report raises concerns around conflicts of interest occurring, particularly in cases where a lender may seek to appoint an IP to handle the administration of a firm to whom they had provided funding on a secured basis, and where that lender has had a previous business relationship with the IP.

It is critical that the regulatory framework properly safeguards against conflicts of interest. IP firms and regulators do have strict rules on what appointments IPs can or can’t take to guard against conflicts of interest.

We can see the rationale for this recommendation from the perspective of dealing with the issue of perception, but there are some important considerations to make before such a policy could be introduced. Firstly, the insolvency Code of Ethics already specifies examples of circumstances that might create a conflict of interest and states that an IP must ensure their firm has policies in place to identify and safeguard against such conflicts. Most IPs take their requirement to comply with the profession’s regulatory framework very seriously, and to safeguard against conflicts of interest. If an IP is found to have broken the Code, and a secured creditor has exerted undue influence on the insolvency process, the IP can and should be reported through the Insolvency Service’s complaints gateway.

A ban as proposed by the APPG, for example, could end up being more costly to businesses, who would have to hire a separate advisor to offer pre-insolvency advice, before then having to appoint a different individual as the office holder in an insolvency procedure. The costs associated with the ‘independent’ office holder needing to get up to speed on the insolvent company may lead to lower returns to creditors. Meanwhile, the fees for an IP with prior knowledge of the case could be significantly lower, as the IP would have to spend less time learning about the company than a newly appointed office holder. An IP with prior knowledge of the company may also be able to begin trading the insolvent company more swiftly and efficiently, and may have already built trust over time with the insolvent company’s directors.

There are also instances where a secured lender and the director of the insolvent company might agree that the IP in question, who has provided pre-insolvency advice, should be appointed as the office holder in the subsequent insolvency procedure. It’s not clear why such a decision, where both parties are in agreement, should be prohibited.

A single regulator with an ombudsman “to assist in the swift, low-cost res­olution of certain disputes”

There are currently four RPBs which regulate IPs in the UK – two in England, one in Scotland and one in Northern Ireland. These are, in turn, regulated and regularly reviewed by the Insolvency Service, the Government’s executive agency which acts as the oversight regulator for insolvency.

The APPG is proposing that a single regulator be introduced to mitigate against what it considers to be an inherent conflict of interest with the RPBs, given their dual role as membership organisations that also regulate and censure the individuals they license. It is also proposing that an independent ombudsman be set up alongside the single regulator to offer dispute resolu­tion to complainants and IPs.

R3 believes that the current framework, while not perfect, is effective and helps the profession to navigate these difficult and sensitive situations in a way that protects creditors and the wider business community. Complaints about IP conduct occur in only a very small minority of cases. In 2020, out of almost 124,000 personal and corporate insolvency procedures (some of which were handled by the government’s Official Receiver), there were only 371 complaints against IPs referred to regulators – or one complaint in every 334 cases.

However, there is always room for improvement and the profession is not complacent about the efficacy of its current regulatory framework. R3 has identified a number of opportunities for potential reforms: speed, consistency in monitoring and enforcement, and the scope of regulation could all be improved.

While R3 is not opposed to a single regulator in principle, it would not be a silver bullet for concerns about insolvency regulation.

There is no guarantee that a single regulator would process disciplinary procedures more rapidly or effectively, while there are big questions about which organisation could take up the role. For example, the government assuming this role could lead to a conflict of interest as it would set insolvency legislation, regulate IPs and then, effectively, compete with those same IPs for work – while not being subject to the same regulation itself.

Placing the Code of Ethics on a statutory footing

The APPG’s report has recommended that the Code of Ethics be put on a statutory footing, asserting that the Code “has no force of law and no teeth without sanction which is currently effectively absent”.

While it is crucial that the Code is properly upheld by the insolvency regulators, the value in this recommendation is unclear given that currently, IPs do receive severe reprimands and sanctions for breaching the Code, and can lose their license for doing so. In 2020, five practitioners received regulatory penalties, reprimands or severe reprimands for breaching the Code, and were fined up to £925,000 for doing so. It’s not clear, looking at the complaints statistics, that the current footing of the Code of Ethics is anything other than robust.

There are also existing avenues through which creditors and others can take legal action against an IP, which may make this recommendation unnecessary. Section 212 of the Insolvency Act 1986 states that creditors can take legal action against an insolvency office holder if they have been found “guilty of any misfeasance or breach of any fiduciary or other duty in relation to the company”.

A centralised database recording the out­comes of administrations

Underpinning this recommendation is the report’s claim that “IPs have departed from the core principles of the Insolvency Act, that rescuing a business should be the primary goal of their work”.

This is a misreading of the legislation. Under statute, IPs have a duty to maximise returns to creditors. While this sometimes means rescuing the business, rescue is not always possible and efforts to pursue rescue may in some cases reduce returns to creditors.

Furthermore, the objective to rescue the business where possible is a feature of the specific administration procedure, rather than an overarching objective of the Insolvency Act 1986. The Act specifies that there are three possible statutory outcomes of administration:

  1. Rescuing the company as a going concern (rescuing the company with as much as of its business as possible);
  2. Or, achieving a better result for the company’s creditors as a whole than would be likely if the company were wound up without first being in administration (usually achieved by selling all or part of the company’s business);
  3. Or, realising company assets in order to make distribution to one or more secured or preferential creditors (organising the sale of property and other assets to repay as much as possible to secured lenders, employees and HMRC).

Rescuing a company (the first objective of administration) is often difficult to achieve. By definition, by entering an administration, the company is insolvent and is in a serious state of financial distress. There is likely to be little funding available for the company to continue to trade when in administration, and few prospective buyers willing to pick up the company’s liabilities. However, while it may not be possible to rescue the company, it may still be possible to save its ‘business’ (including its assets and goodwill). 

As R3’s Value of the Profession report shows, business rescue is an important part of the profession’s work – in 2019, for example, the insolvency and restructuring profession rescued 7,200 businesses, returned an estimated £1.82 billion to creditors, and saved an estimated 297,000 jobs.

The ability of an IP to rescue a business depends on the assets available in the case and inherent viability of the business in question – rather than the IP’s own inclinations. If the insolvent company’s asset base does not facilitate this, or the underlying business simply isn’t viable, the IP is unable to pursue this avenue.

Ultimately, whether a company or its business can be rescued depends on the stage at which directors have sought advice about their firm’s financial issues. The earlier advice is sought, the more options are available and the greater the likelihood of rescue.

Administrations accounted for just 9% of the total number corporate insolvencies from 2016 to 2020, a proportion that was significantly less than Creditors’ Voluntary Liquidations (73%), and compulsory liquidations (16%). This would suggest that most companies enter an insolvency procedure when in a virtually irreversible financial position.

Despite the APPG’s recommendation of a centralised database recording administration outcomes stemming from a misunderstanding of the legislation, such a database could actually be a helpful addition to the framework, and may help to underline the important role the profession plays in rescuing businesses.

The database could fit in to the already extensive reporting requirements IPs have to adhere to. These reports are currently publicly available on Companies House and must explain which objective is being sought in administration and – where rescue is not possible – why this is the case. Provided the database wouldn’t represent an additional administrative burden, it could potentially host these reports.

Technical inaccuracies

While some of the APPG’s proposals are worth further consideration, elements of the report showed a lack of understanding of the insolvency framework. These included the statements that:

  • There is a “failure” by IPs “to engage more broadly with the body of creditors [which] extends to the holding of a creditors’ meeting, which are often only held if interested creditors agree to pay for it”.

In light of changes brought in by the SBEE Act 2015 and the Insolvency (England and Wales) Rules 2016, IPs, are now unable to hold physical creditors meetings unless specifically requested by creditors. Some IPs will request a deposit from those creditors, but this is in an effort to prevent creditors from frustrating the process, which can happen in some cases.

  • It is “easy for an IP facing regulatory scruti­ny to avoid censorship by simply moving to a firm covered by a different RPB”.

While this historically was the case, this loophole has been removed in recent years. Any ongoing investigations are now effectively carried over from the old RPB to the new one.

Next steps

The coming months are likely to see insolvency regulation attract further interest, with insolvency cases on the rise, and the Government’s own consultation on the issue due to be published later this year. The APPG’s work has helped to kickstart the debate about the future of insolvency regulation at a timely moment, and we look forward to engaging constructively with all stakeholders to discuss the ways in which the framework can be improved.

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