More calls for US-style Chapter 11 insolvency procedures

In light of the recent freeze on credit and the effect this has had on UK business and consumer spending, some have begun to suggest we take lessons from the US on how they deal with insolvency. So, would adopting US practices offer advantages to struggling business in the UK?

The UK Enterprise Act 2002 works well if more than 75% of the creditors agree and do a scheme or a prepackaged restructuring but in the absence of agreement problems can arise. With increasingly complex corporate structures there can also be difficulties in deciding true valuations of businesses and their assets.
In the US there are two ways of dealing with insolvent businesses, Chapter 7 and Chapter 11 of the Bankruptcy Code. Chapter 7 involves firms applying to be wound up through the courts, and having their remaining assets sold off and distributed to creditors, much like liquidation in the UK.

However, Chapter 11, like Chapter 7, protects struggling companies from creditor taking action to enforce their debt. However, it also enables businesses to consider re-organising their affairs in order to stay in business, or sell off their assets. This procedure has proved extremely popular - half of all airline seats in 2006 belonged to airlines operating under Chapter 11.

Chapter 11 is similar to the UK's administration laws in that measures are taken to try to keep the business from collapsing. Companies also have the opportunity, under both systems, to eventually emerge from their protected status and continue trading independently.

The major difference then, between Chapter 11 and administration, is that when a US firm falls into the court's protection, its management is allowed to stay in place. Therefore, the people who were essentially responsible for the failure of the firm are charged with the responsibility to make it a success again. Although managers who are considered particularly inept or unethical can be jettisoned.

There are also several extra measures in place under the UK administration procedures, which are mainly intended to protect the creditors, rather than the debtors. These include actions to protect creditors who unwittingly did business with a sinking company just before it fell into administration.

These safeguards for creditors that have been worked into the UK administration procedure add to a perception that UK administration is much harder on the debtor and is rather kind to the creditor. John Davies, ACCA's head of business law, says that point of view on this matter is down to business culture, "This perception may have a lot to do with the feeling that entrepreneurialism is a more deeply ingrained tradition in the US, where risk-taking in business has always been encouraged and occasional failures seen as an unavoidable feature of the capitalist system."

Davies claims that the UK and European regulations can stigmatise business failures. He suggests that the success of an insolvency system should be judged on whether it achieves what it intends to achieve, which will undoubtedly be viewed in terms of the country's business culture.

However, it is unwise to make assumptions about UK and US insolvency rules as recent changes have been made in both countries, says Davies. UK law has been changed in the last few years to make it easier for firms and consumers with smaller debts to declare themselves bankrupt and start afresh. Alongside these changes, insolvency procedures in the UK have also been streamlined to cut unnecessary costs and allow action to be taken more quickly. In turn, US rules have needed to be tightened in order to protect smaller creditors.

So, in conclusion, can we learn anything from the US in terms of insolvency? Davies says "better protection for trade creditors must be high on the list." He adds that this is vital in times of recession as deliberate late payment can occur, threatening the future of SMEs. However, Davies does not consider the allowance of managers to continue to run a Chapter 11 firm to be an aspect of the US system that we should adopt. He says "while the success of any corporate rescue model can only ultimately be judged by its ability to help viable companies survive, what is essential is that the business community as a whole is satisfied that insolvency procedures are expeditious, cost-effective and transparent for all interested parties."

Moving closer to chapter 11 would be neither useful nor necessary, but any gaps in our current insolvency system are likely to be exposed as more businesses inevitable pass into administration.

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