The Impact of the Enterprise Act 2002 on Realisations and Costs in Corporate Rescue Proceedings

1
The Impact of the Enterprise Act 2002 on
Realisations and Costs in Corporate Rescue
Proceedings

• John Armour
• (Cambridge University)
• Audrey Hsu
• (National University of Taiwan)
• Adrian Walters
• (Nottingham Trent University)
• Insolvency Service Seminar
• 24 May 2007

2
Outline

• Motivation
• Background
• Hypotheses
• Data
• Results
• Conclusions Implications

3
Motivation
4
Motivation

• Enterprise Act changes
• Pre-Act secured creditors controlled formal
  insolvency through ability to appoint admin
  receiver
• From 15/09/03 Enterprise Act 2002 shifted power
  -gt unsecds prospective abolition of admin
  receivership (RE) revamping of admin (AD)
• Academic international context secured
  creditor control is topical
• Growing in US in recent yrs
• Some argue firms should be permitted to contract
  with creditors for more control over bky
• Debate about desirability of secured creditor
  control in context of DIP financing etc
• IS evaluation
• Encouraged us to test empirically whether the RE
  gt AD control shift has materially impacted on
  net returns to creditors

5
Background
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UK corporate rescue

• Formal rescues (as distinct from informal
  workouts, turnarounds etc) are a small company
  phenomenon
• Formal insolvencies of listed companies are rare
  1996-2005 79 8 p.a. (Carapeto and Stuflesser,
  2006)
• Administration, receivership are rescue
  procedures capable of preserving going concern
  surplus in contrast to liquidation

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Incidence of UK insolvency procedures, 2001-2007
Source Insolvency Service
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Administrative receivership

• Control rights in insolvency given to holder of
  floating charge FCH
• Appointee (receiver) owed fiduciary duties only
  to FCH
• Unsecured creditors had limited info rights but
  no voting rights
• Incidence
• Pre-15/9/03, FCH had free choice whether to use
  receivership or not
• Criticism gt to prospective abolition
• Limited incentive to maximise recoveries and/or
  minimise costs where oversecured ( 50 of cases)
• Bias against continuation rescue of viable cos?

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Administration

• Appointment still controlled by FCH
• Out of court entry routes etc
• But accountability now to unsecureds (residual
  claimants) where they are in the money
• Fiduciary duties to all creditors to maximise
  value
• Unsecured creditors get to vote on exit (unless
  clearly out of the money)
• Enterprise Act 2002 (from 15/09/2003)
• FCH no longer permitted to appoint receiver
• Unless security created pre-15/09/2003
  (grandfathered)

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Administration replacing receivership
Source Insolvency Service
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Hypotheses

• Formulated following 13 open-ended interviews
  with professionals

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Hypotheses (1)

• Realisations
• RE to AD shift in control from secured creditor
  to residual claimant may enhance incentives to
  maximise realisations
• Increase gross recoveries?
• More going concern sales?
• Interviewees observations
• Likely to be most pronounced for oversecured FCH
  as administrator now owes duty to residual
  claimant
• Expect realisations generally to be increasing in
  size of firm, duration of proceedings also to be
  affected by outcome (eg going concern v.
  piecemeal sale)

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Hypotheses (2)

• Direct Costs
• RE to AD shift in control from secured creditor
  to residual claimant may enhance incentives to
  control costs
• But may also decrease ability to control costs
  (if we assume that unsecureds are typically
  dispersed)
• Interviewees observations
• Likely to be most pronounced for oversecured FCH
• Expect costs generally to be increasing in size
  of firm, duration of proceedings (Citron et al,
  2004 LoPucki and Doherty, 2004 Bris et al,
  2006) also to be affected by outcome (eg going
  concern v. piecemeal sale)

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Hypotheses (3)

• Net recoveries to creditors
• H1 realisations likely to increase
• H2 costs likely to increase
• gt Effect on net recoveries hard to predict a
  priori but possibly neutral?

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Data
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Data description

• Hand-constructed dataset of random sample of 500
  cases from the index in London Gazette
• 250 RE, pre 09/03 250 AD, post 09/03
• Excluded if not completed by 01/02/06 (leaving
  348 cases)
• Data hand-collected from reports submitted to
  Companies House by insolvency practitioners
• Supplemented with financial and accounting data
  from FAME database
• Cases with missing values in variables of
  interest excluded.
• Result 284 cases
• 102 receiverships (pre 09/03)
• 182 administrations (post 09/03)

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Sample composition
Before 102 RE cases
After 182 AD cases
Source Insolvency Service
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Sample composition
Before 102 RE cases
After 182 AD cases
(Robustness) 31 RE cases
Source Insolvency Service
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Sample composition
Before 102 RE cases
After 182 AD cases
(Robustness) 31 RE cases
(A different procedure)
Source Insolvency Service
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Descriptive statistics
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Firm SIC Industry Classifications
Receiverships
Administrations
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Results
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Preview of results

• Shift in control of formal rescue proceedings
  from secured (senior, concentrated) to unsecured
  (junior, dispersed) creditors via greater legal
  accountability.
• Increases gross realisations
• Most pronounced where senior creditor oversecured
  (ie value of security lt debt owed)
• Also increases direct costs
• Costs are greater under the new regime
• No significant change in outcomes or net
  recoveries

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Outcomes
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Determinants of realizations
Three measures of realizations A1 Total asset
realisations A2 A1 gross trading
receipts A3 A1 net trading receipts
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Determinants of realisations (A1)
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Determinants of realisations (A1)
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Determinants of realisations (A2)
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Determinants of realisations (A3)
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Determinants of remuneration and total direct
costs
Two measures of costs Remuneration fees paid
to insolvency practitioners Total direct
costs remuneration other costs associated
with realising assets
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Determinants of costs (remuneration)
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Determinants of costs (total direct costs)
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Net recovery rates
No significant (at 5 level) differences between
administration and receivership.
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Robustness checks
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Possible confounding factors

• Omitted variable/time effect?
• E.g. Practitioners complain of increased
  professional regulation as a burden
• Compare post EA receiverships with (post EA)
  administrations
• Selection bias?
• Secured creditors now have choice over use of
  procedure owing to grandfathering
• Compare (administrations and post EA
  receiverships) with pre EA receiverships

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Robustness Determinants of realisations (A1)
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Robustness Determinants of realisations (A3)
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Robustness Determinants of costs (remuneration)
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Robustness Determinants of costs (total direct
costs)
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Conclusions Implications
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Conclusions

• Impact of shift from RE to AD
• H1 supported gross recoveries increase in cases
  where FCH over-secured (however the result is not
  robust to checks regarding time/selection bias).
• H2 supported costs increase (result is robust).
• No significant impact on net recoveries.
• No clear superiority for unsecured creditor
  (dispersed) vs. secured creditor (concentrated)
  governance of corporate rescue.

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Implications

• Emphasises importance of optimal accountability
• Legal duties are no panacea
• Secured creditor control may be nothing to be
  afraid of
• ..But also nothing to write home about