Comparative Insolvency Law - the British System - Case Study Example

Student’s name Course name Instructor’s name Date of submission Comparative Insolvency Law Q1 Although both fixed and floating charges must be filed in a public registry to be effectual; under British law the two charges are differentiated. The main difference between the two charges is that, while floating charges are would-be liens on nearly all if not all of the debtor’s possessions, fixed charges are liens on definite assets. The other key differences are that, clients who transact with the debtor in the normal course of trade take free of charge of the interest produced by a floating charge; the floating charge is exposed to a carve out in support of unsecured creditors; the floating charge possessor has a especially complimentary enforcement instrument in the shape of an administrative receiver. The receiver, who is typically a qualified liquidation practitioner and an accountant, is appointed by the protected party (Briscoe & Booth 16). The receiver usually acts in the best interests of the secured party, even though officially the receiver is the company’s representative. The use of collateral in the guaranteeing of transactions brings into question diverse issues as to what type of charge the collateral can be applied to. Some collateral are more suited to the fixed charge model, while others are more suited to the floating charge model. Issues that come into focus regard the ownership aspects of the item used as collateral. This item ceases being free of encumbrances and cannot be used by the debtor to secure further business transactions. In case of default the creditor takes the collateral into his full possession denying the debtor its use. Some systems allow for some types of collateral which are intangible such as intellectual property and account receivables which are impossible to possess. In this regard all systems have to find ways to streamline these issues. Systems are evolving to include non possessory mechanisms of collateral though the application is varied. The British system permits the coverage of future collateral and future credits. Future credits allows for the making of security arrangements at the beginning of a credit relationship of which collateral will be used for both current and future credit. It can be particularly important if the system of credit is maintained on an imprest system. This method enables any outstanding credit to be secured by all the property of a specified type owned by the debtor at any given time, including property acquired after the initial grant of security. It gives the creditor holding the charge maximum protection as even property acquired after the initial grant can be possessed as collateral. The security interest is also advantageous to the creditor as it can be implemented even in property which may be otherwise exempt. The creditor will have right to use to property which might not be accessed by a creditor who is unsecured. The floating charge permits the secured party to acquire an all all-encompassing security interest covering every single one of the debtor’s assets, despite the fact that it permits for free utilization of those possessions before default. In case of default by the debtor, the floating charge gives the creditor the power to engage the services of a professional receiver. The secured creditor is protected by a legal doctrine from any mistakes made by the receiver in the execution of receivership activities. A lien or fixed charge on specific assets also has its own advantages over the floating charge. For one, the fixed charge is not liable to claims of preferential creditors. The secured creditor is not therefore likely to lose part of the value of the collateral to such creditors. However, only a floating charge gives the secured creditor the power to appoint a receiver after default (Briscoe & Booth, 43). Thus it is always prudent for any businessman or creditor to always opt for both fixed and floating charges in order to have priority and control respectively. Priority in solvency law becomes important due to the necessity of the secured creditor having to have superior priority. The secured creditor has to have superior priority over the other creditors of the firm if he is not to incur losses when the collateral is sold due to encumbrances. In this regard there are several measures that the law provides in order that a secured creditor is protected. In the United Kingdom, an issue that has arisen over the last few years is the issue of whether security interests ought to take express predilection in the earnings of the sale above all supplementary parties. While other systems have a tendency to give more priority to other privileges and interests, the English system even though favoring secured credit, lets some privileges and interests to have priority over a secured party’s floating charge priority which may well consist of charges of bankruptcy. Holders of fixed charges nevertheless get extra supreme priority. This is what has led fixed creditors in the UK to construe their charges as fixed charges so as to have precedence above the preferential creditors. Q2 The principle of an official business rescue administration goes back to 1926 when it was pioneered in South Africa under the report of judicial administration. The American and British regulatory regimes developed systems of restructuring and reorganization of corporations in the form of receivership instruments. Receivership entails the appointment of a specialized administrator who is not necessarily statutorily or court appointed, to run a business on behalf of the creditors. The system of formal rescue which was intended to bring back businesses to profitability is used alongside other official government instruments of reorganization such as court appointed administrators (Briscoe and Booth, 66). Asset management companies (AMC’s0) are used in as a mechanism in many corporate and bank restructuring regimes. Corporate restructuring involves the restructuring of business model in order that the debtor business may be able to pay off its creditors. Restructuring is dedicated to keeping a major part or all of a business as a going concern. It may be geared towards saving the company or simply just saving the business in order to dispose of it to the highest bidder. The former was usually the objective in previous times but recent changes and enactments have made the latter objectives more common at present. Asset management companies are usually companies created by the regulatory regimes in order to administer institutions which are insolvent fro the sake of the creditors. The companies are usually formed as a separate independent administrator’s of insolvent business so as to dispose or otherwise liquidate the debtor’s non performing assets and settle the debts owed to the creditors (Briscoe & Booth 73). Asset management companies were first used in the United States of America after the Savings and Loan crisis of 1989. Asset management companies have come to be a common feature of restructuring and informal workout regimes. AMC’s served as the model after the 1997 Asian financial crisis which was as a result of a high number of non performing loans. Asset management companies were set up to aid with disposal and the restructuring of the non performing loans in an orderly manner. China is a particularly good example of the use of asset management companies. China established Asset management companies. The four asset management companies were linked to the four major Chinese banks and were used in the restructuring of banks and corporations which had high levels of toxic debt due to the Asian financial crisis. Q3 In s. 239 of the 1986 Insolvency Act of UK, voidable preferences are recognized. In the case of MC Bacon Ltd, the directors and the company were held to have not done anything wrong after granting an overdraft facility to National Westminster Bank to secure its debenture which was a condition for the government to continue its support. The directors argued that they did that at the best interest of the company and not necessarily the debtors. In the new law, it is not necessary to prove the intention to prefer. In addition, establishing an intention to prefer is almost impossible. However, there is a relevant desire to ensure than a given party is in a better position in case of insolvent liquidation. In this case, the drive to make the payment is that the director will be in a better position in the foreseen liquidation. BB will however depend on the judgment as winning the case is not assured. If the directors prove that their action was not driven by the desire to make SS stand in a better position but that he continues offering his services and for him as an employee to maintain his family, BB loses the case. The new law makes it very hard to prove that a requisite desire exists. The wording of the primary legislation makes difficult for BB to pursue unfair preferences in this case. B Under the HK Companies Ordinance BB is likely to win the case. In Hong Kong, most businesses are controlled by a very small group of People who in most cases are from the same family. Though the rule in Hong Kong is based on UK company adamancies, exemption of employees of whom directors are considered as part would result to a loophole in judging unfair preferences. As a result, the directors are not considered as employees due to the control they have on the company. BB is therefore likely to win if she represents the case to the court. FMC’s actions of paying SS his full loan before the due date were simply aimed at ensuring that SS does not loss when the company is declared bankrupt. According to the explanation, SS was a director of FMC and therefore in a position to understand the day to day operations of the company. The director realized that the company would collapse and ensured that his loan had been paid fully before the due date to avoid any losses. It is clear that BB had lent $10, 000 to FMC earlier than SS (January). In addition, the amount lent to FMC by BB was half of what it received from SS at a later date (February 2010). Logically thinking, FMC would have been expected to clear her loan with BB at an earlier date than SS since the amount was less and had been given earlier. This clearly proves that FMC acted in unfair preference of its director. BB has a right to apply to the court to invalidate the actions of FMC since its action was aimed at placing S at a better position in a foreseen insolvent liquidation. This can be said as unfair preference since the director is part of the decision makers in the company and therefore could have influenced the decision to pay him fully before the company is declared bankrupt. FMC was already insolvent at the time it cleared the payment of SS’s loan. According to s.266B (1) (b), the timing is considered relevant if at the time of preference the company was insolvent and the alleged preference was given within 2 years in a case where the parties are associates including directors (Briscoe & Booth, 108). In this case, the preference was given within seven months thus qualifying it as unfair preference. Since there is no any evidence that the director pressurized the company to pay his debt, BB is in a position to win the case. This is in reference to Sweetmart Garment Works Ltd case where the company granted one of its bank creditors a yacht prior to the presentation (Briscoe & Booth, 111). This mortgage was aimed at securing general credit facilities accounting for HK $6.8. Three days after this, the loan was used to repay an existing overdraft with the same company. After an analysis, the judge ruled that this was an unfair preference as the company did not receive any financial benefit from the loan. Its actions were therefore in favor of this particular bank. In the case of BB, the mortgage had been granted within the 6 stationary months thus the company was insolvent at the time it granted the mortgage. There was a strong evidence of preference and liquidators therefore proceeded with the sale of the Yacht. In this regard, BB is likely to win the case. Q4 concept of an automatic stay or moratorium on secured creditors is a question that has received a lot of attention from legal scholars and experts. The issue is usually whether secured creditors should be bound or not by an automatic stay in times of corporate insolvency and liquidation. There is a variety of opinion concerning this subject with both sides of the debate having valid points. In the discussion of whether a stay should be enforced on secured creditors or not, there are a variety of approaches which are usually employed in order to determine the question. There are three main liquidation procedures formal restructuring and out of court restructuring which are involved. These include receivership, pre packaged insolvency procedures and the London approach. Of all these, the London approach is the most prominent and dominant having been adopted the world over. It has in the recent past been used in the Asian financial crisis where the countries of Thailand, China and Indonesia gave out procedures for multi bank workouts that assume as a fundamental precept the need for a stay on secured creditors. In my opinion, secured creditors should be bound by the automatic stay in a corporate insolvency. If the secured creditors are free, they are likely to pursue enforcement actions which would see to it that they get their secured property or receive compensation from the debtor through his or her machines or equipment. Secured creditor hold rights to key machines or equipment without which the company or organization cannot run effectively. As a result, allowing them to be free means that the restructuring the company is next to impossible. Whenever there is a chance to rescue a company that is heading to bankruptcy, this chance should be maximized on. This should be the case especially for those secured creditors who own substantially all the assets the debtor has. Countries such as UK, Germany, Italy and France do no exempt secured creditors in rescue cases (Briscoe & Booth, 70). Reorganization is made easier when secured creditors are made to stay especially in rehabilitation process. The possibility of rescuing the company is raised and thus the chance to pay all creditors including the non- secured creditors. Allowing secured creditors to move out automatically makes it impossible for the unsecure creditors to be paid. In addition, though secured creditors may take the assets belonging to the debtor, their value may not be high enough to cater for all secured creditors. This means that they lose as well. Reorganization benefits all creditors in general. For instance, if a processing company is at the verge of collapsing and a creditor has a security interest in the processing machine, the creditor is likely to take the machine if free. In corporate insolvency, selling the machine would reduce the liability of the secured creditor while other creditors receive nothing. Consequently, all the process of the company would come to halt making it impossible to rescue the company. However, if the secured creditor is made to stay by being subject to a moratorium and all efforts focused on rescuing the company, the possibility is that profit would be generated to pay every creditor including the secured ones. Secured creditors must in this case be protected by the insolvency law for any diminution in value of the machine for the entire time she is prevented by the virtue or staying from asserting its preexisting rights (i.e. the right to selling the machine to reduce its liability) on the processing machine (Briscoe & Booth, 71). The moratorium is not meant to deny secured creditors of their right but rather delaying the assertion of the rights for the good of all. Unless granted “adequate protection” for interest incurred by the security assets, a secured creditor in UK has a right to apply for a relief from the automatic stay. The protection may include insurance cover, periodic payment, and other assets belonging to the debtor or a combination of all. In Germany, the creditors have a right to interest. The London Approach is very useful in out-of –court restructuring. For instance, guidelines for multi-bank workouts issues by HKAB (Hong Kong Association of Banks) and HKMA (Hong Kong Monetary Authority) jointly focusing on the need for a standstill (Briscoe & Booth, 72). Such guidelines have been developed elsewhere following the London Approach that has made standstills in out-of-court restructuring possible. Banks are made to stay by a moratorium in a formal insolvency proceeding. Proposed corporate rescue in Hong Kong make it even easier to conduct the rescue process effectively (Briscoe & Booth, 72). Enacting this will mean a burn in the actions of secured creditors aimed at reducing their liability. This however required support from the banking community thus it had to be in place for a short time to achieve its purpose and the proposed time is one month. Protection for creditors especially those with floating or/ and fixed charge of almost all assets of the company. Non-major secured contractors are bound by the moratorium while the major creditors have a choice and can only be exempted where facts apply. This is all aimed at smoothening the rehabilitation and recovery process. If these groups are allowed to move out and be free to exercise their rights at will, the possibility of rehabilitating a company is minute. This clearly indicates the importance of secured creditors staying in case of insolvency. UK focuses on rehabilitation with the interest of all creditors at heart by subjecting secured creditors to a moratorium though with elaborate protection provisions (Briscoe & Booth, 73). A formal legal environment is necessary in conducting informal restructuring and rescue. The most important part of this is that, if successful, it eliminates the cost that would have incurred if court procedures were followed. This cost may now be transferred to paying the creditors. Holding secured creditors ensures that they are involved in selection of unbiased professionals to handle the case and ensure total recovery or efficiency in the insolvency process. A formal insolvency is opted if the informal one fails. All stakeholders in the bankrupt company including secured creditors believe is some form of reorganization and that such rescue process would not benefit the minority but as many as possible. If anyone is to loss everything, it is the unsecured creditors. This would be termed as favoring the minority at the cost of the majority. Setting secured creditors free would mean that the other creditors will end up losing in the battle and this justifies the statement that secured creditors should made to stay in case of insolvency. Q5. Two students from our class were overheard discussing the appropriate treatment of workers in corporate insolvencies. Student A said: “Workers deserve special protection in insolvency cases in the form of priority ahead of secured creditors.” Student B said: “I disagree. Workers should be treated no better or worse than other unsecured creditors.” I do agree with student A. In my opinion workers deserve a special protection in insolvency cases as compared to unsecured creditors. This is because employees in most cases solely depend on their salary to cater for all their needs (Briscoe & Booth, 187). If these needs are not being met, business productivity goes down or collapses. This is as a result of the devastating effects of unpaid employee entitlement. When the employee is stressed, he or she is not the only one that suffers. The business suffers losses as well. This calls for employees to focus on building mutual and lasting relationships with the employees. Poor performance resulting to losses being incurred ultimately affects the financial power of the business to be able to pay other creditors. This means that the ability of the business to pay its creditors basically depends on employee productivity. As a result, any creditors’ claims secured by a floating charge though entitled to benefit after the company’s assets are realized, this can only happen after preferential claims such as employee’s claims have been met. Often, employers leave unpaid arrears in employee’ contractual benefits including wages/salaries. When this happens, the employee is barely in a position to support him/her self and the dependant family members bearing in mind that this is usually the sole source of income. These claims include pension claims, claims for wages or salaries, abrupt dismissal from work without warning and other contractual benefits as stated in the employment terms and conditions. In UK pensions are protected by a state-backed guarantee and vigilant authority (Briscoe & Booth, 187). Employees in any business have some rights in the management and the operation of the business with regard to collective bargaining agreements that have been made. While other creditors are often after recovering their losses, employees’ interest is not only to recover their contract benefit but also to ensure that the business performance is at its best. In the 2003 labor law in Columbia and Indonesia, the rights of employees come before those of secure and unsecured creditors. Adequate notice is given to an employee incase the business intends to lay off employees on the basis of redundancy, structural, technological or economical to reduce the effects of such actions on workers. This allows time for them to find an alternative employment or source of income thus minimizing the effects of job loss on their lives as well as those of their dependants. According to 1982 ILO’s Termination of Employment convection, the workers must be informed on time regarding any intention to terminate them due to structural, technical and economical reasons. Strong employee provisions are aimed at resulting to business rescue rather than liquidation a factor that is of great importance. Attempt to rescue bankrupt businesses has however been made impossible where the role of paying employee arrears is transferred to those that purchase a collapsing business (Briscoe & Booth, 192). The argument is that such a burden of paying incurred arrears makes it impossible for those willing to rescue the business do so. But in my view, the success of the business even though purchase by a well able person does not depend on the finances attached to it only. To a greater extent, the success of that business depends on the employees (Briscoe & Booth, 196). If they are well motivated, their hard work ultimately pays their salary and any other incurred debts. The most important asset for any business is human power. Employees cannot run a business without a source of motivation. The role of unsecured creditors in ensuring business maintenance and rescue is very minimal. Those in whom the survival of a business depends on in this case are the workers deserve a special treatment. Their role does not only determine the possibility of rescuing business but the ability of the business to pay other creditors as well. Since in normal circumstances workers do not have any share in the company’s profit and should not either share in its losses. Q6 It is important to note that there is a major difference between the reorganization regimes of Britain and the United States. In the US, the secured creditors are bound by moratoriums and stays and it is prerequisite for them to file in court in order to obtain protection of the collateral whereas the administrator has official power over the property all through the process of restructuring. The English system on the other hand allows the secured creditors to operate independently of restructuring procedures. Under the American system, an administrator is usually appointed to take the company through the process of restructuring. Under the British system however, prior corporate management is allowed to remain in control an approach referred to as debtor in possession. One of the disadvantages of a debtor in possession is that, the debtor may take advantage of it to defraud the creditors as the prior management remains in control of the business. Through its 1986 Insolvency Act, the United Kingdom set up two regimes, Administration and the corporate Voluntary Arrangement. The CVA was intended partially as a establishment to facilitate the setting up of an arrangement to mark the concluding phase of a successful administration nevertheless it also functioned as a stand alone regime to effect a business salvage in situation where there was no considerable risk of the creditor taking possible terminal enforcement procedures not in favor of the debtor (Briscoe & Booth, 139). The original administration, contrasting the CVA, necessitated considerable prudence and court participation. The main advantage of this approach was that, the management of the business having been in charge of the business for a lo0ng period is more in tune with the objectives of the business, its weaknesses and its strengths. The management will therefore be able to manage the business in relation to the above said objectives and purposes. The new provisions of the United Kingdom concerning liquidation offer something akin to a third way connecting discretionary entry and automatic entry business regimes. Fundamentally the provisions provide for an automatic employment of administration which immediately activates stays and moratoriums on the creditors’ enforcement processes and claims. Concurrently, the provisions have restricted the entry into administration by making it subject to a court petition. Creditors would therefore find it harder to enforce liquidation procedures or put claims on the business. The main advantage with this type of ruling is that it gives the debtor in possession enough time to restructure his business back into profitability or a chance to wind up the business in the interest of all creditors. This is because; the debtor in possession can have leeway of payment of creditors without threat of the secured creditors enforcing liquidation proceedings. Another advantage of the debtor in possession legislation is that, it allows the prior management of the company to remain in control and run its own reorganization and rescue. In doing this, it significantly reduces the discouragement that loss of control of the business offers to the administration. The management of the business is more likely to seek liquidation protection if it has a hope of continuing its employ and its control of the venture. A great disadvantage of the system though is that, the management of the company may be incompetent and hence the cause of the dwindling fortunes of the company. Administration allows prior management to retain control which would mean that this would be more detrimental to the company and its creditors. The US system employs an independent administrator who is usually a lawyer or an accountant to run the business on behalf of the creditors and the business owners. This approach differs from the British approach in that it shifts the management responsibilities from the prior management of the company to new administrators while the United Kingdom regime retains the control of prior management. With regard to liquidation, the majority of scholars are in agreement on the need for independent administrators to be appointed to run the business in liquidation. The new management usually administers the property on behalf of the creditors so that they may recoup the debts owed to them (Briscoe & Booth, 122). After appointment the new officials are allowed to take control of all the company’s assets and in addition, third parties are required to surrender property to him. The appointed official usually has the authority to delegate authority to the prior officials of the company who would be required to report to him. Of great importance in insolvency proceeding is whether the administrator should be made liable for any losses that occur during his tenure as administrator of the company. The American system makes the administrator liable to all such losses as a result of mismanagement of the business. The advantage of this system is that it guarantees the creditors of being paid back as the administrator is required to pay off any losses incurred out of his own pocket. The new administration also has to ensure that the creditors will be paid even if the assets of the company are not enough to pay all debts after insolvency. The administrator will thus be more careful, diligent and cautious in running the affairs of the business in order to prevent personal costs to himself in the event of the business not having enough to satisfy the creditors’ claims. The disadvantage with this approach however is that the administrator may be too cautious which may prevent him from taking necessary risks which may be in the interests of the business. The independent administrator in previous times used to be anybody but in recent times it is increasingly a qualified practitioner who is either a lawyer or an accountant. The practitioner must belong to a body of qualified liquidation practitioners licensed by the government. The advantage with this approach is that it offers the business a new lease of life. New management usually comes in with new ideas which can be incorporated into the business to salvage it. The administrator in addition has the advantage of having experience in handling insolvencies which he brings into the business. The downside with new managers in insolvencies though is that, they may not have enough information about the business such as weaknesses, strengths, objectives and trajectories (Briscoe & Booth, 70). New management may not be interested in ideas of the previous management or their plans which may lead to misplaced decisions and priorities which could have been avoided. It will also take much time before the administrator gets to understand the whole business perspective of the company as previous management will not be around to help. The US system of administration has the advantage that its administrators are appointed by the courts. This is as opposed to the United Kingdom system which allows secured creditors to appoint administrators. Secured creditors may not have the interests of the business at heart; they may also not care for the interests of the unsecured creditors and may enforce their claims at the expense of the other creditors and the business. The appointment of the administrator though is also a disadvantage as the administrator does not owe the creditors any allegiance. The wishes of the creditors may thus be ignore by the administrator. The appointment though of an administrator prevents the enforcement of claims of the creditors which could sabotage a business which can be salvaged. Work Cited Briscoe, Stephen and Booth, Charles, Hong Kong corporate insolvency manual 2nd Ed. Hong Kong institute of certified public accountants Read More