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The last few months have seen a number of well-known companies going into formal insolvency procedures, while others have been saved from insolvency only by government intervention, for fear of the systemic impact that their collapse might have. In difficult times it is inevitable that attention turns to the regime for dealing with corporate insolvency and questions are asked about its effectiveness, fairness and value for money.

The modern regime for dealing with corporate insolvency in England has been in place for over 20 years and is to be found in the Insolvency Act 1986. Under that act, there are four different types of insolvency process applicable to companies – liquidation, administration, receivership and company voluntary arrangement (CVA). Schemes of arrangement are also sometimes used as a tool for dealing with insolvency situations. Most of these processes involve the use of a licensed insolvency practitioner, who either takes over the running of the company or supervises its existing management.

In recent years, the Insolvency Act has received a couple of legislative make-overs to address certain perceived shortcomings. So, for example, the effectiveness of CVAs has been improved, and administrative receivership has largely been abolished in favour of the more collective process of administration. The policy throughout the period since 1986 has been to provide the tools by which companies can be preserved if possible – the rescue culture.

Constructive steps have also been taken to streamline the system for dealing with cross-border insolvencies. In 2002, a European-wide regulation came into force governing the jurisdiction in which an insolvency process should be opened and conducted, and in 2006 the UK implemented a United Nations model law governing the recognition of, and co-operation with, foreign insolvency office-holders. The same law has also been implemented in, amongst others, the United States and Japan. Both the European regulation and the UN model law use the concept of centre of main interests (COMI) to determine the basis for jurisdiction and recognition and
as a result, this concept has become of
primary importance to companies and creditors alike when assessing insolvency risk or restructuring possibilities.

Despite these domestic and international refinements, it was inevitable that a global financial crisis of the kind currently being experienced would test the existing insolvency regime and reveal the need for further changes. Reform to insolvency law within the financial services sector has, not unsurprisingly, been the focus of government activity over the last 12 months.

Following the run on Northern Rock in September 2007, the government did not feel that the tripartite authorities; HM Treasury, the Bank of England and the Financial Services Authority, had sufficient powers to deal with a failing bank and it began a consultation process that culminated in the Banking Act 2009.

The key objective of the new act is to provide the tripartite authorities with the tools to deal pro-actively with a distressed or failing UK deposit-taking institution, in order to strengthen the stability of, and confidence in, the UK banking sector, and to ensure that depositors are adequately protected. At the time of writing, just weeks after coming into force, the new act has been called into action to deal with the situation at the Dunfermline Building Society, resulting in a transfer of depositors to Nationwide and the commencement of a bank administration process.

The centrepiece of the new powers contained in the Banking Act is the special resolution regime (SRR). Under the SRR, if certain conditions are met, the authorities will be able to transfer all or part of the shares or assets and liabilities of a distressed bank to (i) another institution in the private sector, (ii) a bridge bank or (iii) temporary public sector ownership.

The precise conditions depend on the particular power(s) being exercised, but in all cases the authorities must be satisfied that the bank is failing, or is likely to fail, to satisfy the threshold conditions for permission to carry on regulated activities and, taking into account timing and other relevant circumstances, it is not reasonably likely that action will be taken by or in respect of the bank that will enable the bank to satisfy the threshold conditions, absent the use of the stabilisation powers or financial assistance by the Treasury or the Bank of England.

In addition, when using any of the stabilisation powers described above, or considering their use, the authorities must have regard to the following objectives, which are to be balanced as against each other in the circumstances of each case:

A code of practice has been issued by the Treasury to provide guidance on how to judge whether the various criteria and objectives have been met, and to provide the market with a transparent explanation as to how the authorities should use their powers in practice.

Alongside the SRR, the Banking Act provides for a special bank insolvency order, akin to liquidation, but with the repayment or transfer of depositors as the liquidator’s top priority, and a special administration process, to deal with the rump of a bank if a partial transfer of business has taken place.

The impact of the Banking Act is to be kept under review by a specially appointed panel of experts, the banking liaison panel, made up of members of the banking industry, the legal community and the tripartite authorities.

Given the depth of the credit crisis, the Banking Act is unlikely to be the end of the story in terms of the development of the UK’s insolvency regime. Other reforms are being proposed and, in concluding, I would mention two to watch.

The first is trailed in the Banking Act itself, which provides that the Treasury may bring in regulations dealing with the insolvency of investment banks. Investment banks are not covered by the powers described above and, as in the case of Lehman Brothers, will utilise ordinary insolvency procedures if they fail. The question for the Treasury is whether these institutions need specialist insolvency rules to address the type of complex, high-value, international trading arrangements in which
they engage.

The second area of possible reform concerns the way in which large companies are restructured. Currently, debt restructurings in the UK take place outside of any formal process and are not regulated by the courts. For several years, the European High Yield Association (EYHA) has been lobbying for a new court-led restructuring process, similar in some ways to Chapter 11 in the US, which it believes could facilitate successful rescues by giving companies the benefit of a moratorium and access to streamlined judicial resolution of valuation disputes, while attempts are made to agree a re-organisation plan.