Chapter 11 style insolvency rules

Insolvency experts and turnaround specialists are gearing up for a surge in corporate debt problems which they expect will generate the biggest wave of company restructurings in decades. In spite of the tightening credit crunch, banks have largely held off calling in loans, focusing instead on dealing with write-offs from the subprime crisis. But they have been looking through their books to identify businesses in danger of breaching their loan covenants, and unless credit conditions improve in the next few months, these companies may well find themselves vulnerable to the banks' desire to balance their books.

With the potential for a serious downturn questions are being asked as to whether European insolvency regimes are in a position to deal with the consequences.

Capital structures have become very much more complex and the current Enterprise Act does not allow for a venue to conduct a valuation fight. Nor does it provide for a stay or freezing of past debts to allow a company breathing room to prepare a turnaround plan or address core issues.

It is these aspects of the current system that prompted David Cameron to raise the issue at the CBI employers' group recently.

The answer, he suggested, was to borrow some of the best aspects of the US Chapter 11 bankruptcy regime - to save such companies from liquidation. He pointed out that many of the likely casualties would be "fundamentally sound" companies, he said, but they would not have the "breathing space" to restructure and keep their businesses alive.

However, his advisers have focused on three areas: an "automatic stay of enforcement" of debt by creditors, granted for a renewable period of a few months, while management stays and tries to negotiate a restructuring; priority funding for distressed companies, to whom lenders could give money in exchange for "super priority" over other unsecured creditors; and binding measures agreed by court and a majority of creditors to stop "unscrupulous" creditors from vetoing desirable restructuring.

His comments have sparked a fierce debate between supporters of the US approach and defenders of the English system, introduced in the Enterprise Act 2002. The Enterprise Act works if more than 75 per cent of the creditors agree and do a scheme or pre-packaged restructuring but in the absence of full agreement problems can arise.

When it works well, it can be cheaper and faster than the adversarial Chapter 11 approach, which is under the direct control of the courts.

Advocates of change, however, argue that the 2002 regime has not been fully tested in the sort of market conditions now seen across the advanced economies. Some predict it will buckle when the pressure builds and that a more formal legal framework is needed to provide stability, predictability and efficiency.

To many in Europe, the US system is seen as one that protects inefficient companies by allowing them to offload their commitments under court protection and emerge as stronger competitors who can undermine more efficient businesses that have not been able to do the same. The most obvious example of this is in the airline industry where large US airlines have been allowed to go into chapter 11 when perhaps they should have really been left to wither.

In conclusion, it is paramount that any system works well. Chaotic attempts at restructuring large UK corporates could do untold damage to UK plc as a place to do business.

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