This post comes from Sarah Paterson, chair of Working Group C of the Secured Transactions Law Reform Project. It brings together two initiatives already explored on this blog: the Secured Transactions Law Reform Project, set up to examine the English law relating to secured transactions and to consider the need and shape for reform, and currently led by Professor Louise Gullifer, and the UK Insolvency Service's consultation entitled 'A Review of the Corporate Insolvency Framework: A Consultation on Options for Reform.'
In a post on 1 June, Professor Gullifer reported on the STLRP's draft policy paper, which has recently been released on the project's website and which identifies, as one of the core aspects and matters for debate, the priority on insolvency of persons who presently have priority over floating charges, currently being considered by Working Group C. The Insolvency Service consultation was the subject of two posts (Part 1 and Part 2) by Professor Jennifer Payne and, in the second of her posts on 15 June, Professor Payne identified that the consultation includes certain proposals for priority of rescue finance. As we shall see, this directly relates to Working Group C's work.
Although the consultation concentrates on post-filing financing arrangements, an equally important source of insolvency funding comes from assets within the business. In England, an administrator is free to use assets which are subject to a floating charge without the consent of the creditor or the consent of the court. Notably, following the decision of the House of Lords in Spectrum Plus, security over cash will often be floating rather than fixed. This contrasts with the position in the US, where secured cash can only be used with the consent of the creditor or the consent of the court, and the latter is only likely to be forthcoming if the court is satisfied that the creditor has received "adequate protection" (a relatively complex and widely litigated concept).
In reality the administrator is unlikely to use cash in a way which the floating charge holder wholly dislikes, but there is some anecdotal evidence that US lenders to UK corporates are nonetheless concerned by the English law position which is unfamiliar and apparently less creditor-friendly, and that they take little comfort in "soft" promises from a profession they do not know. At the same time, there is increasing focus on security law issues by UK banks in light of the changing regulatory capital environment. Working Group C has been told that lenders demand detailed advice as to whether charges will be fixed or floating, which may be difficult to give definitively because of the opacity of the tests. Lender counsel fear that at best this increases transaction costs in the finance market for healthy companies and, at worst, reduces the availability of finance. At the same time, particularly after various reforms in security law, US commentators fear that secured creditors are able to steer Chapter 11 cases in their own interests, in part as a result of their ability to control cash. There is no easy answer to the dilemma, and one vital aspect of Working Group C's work is to explore the case for the current English law position and for the various options for reform.
This, in turn, impacts directly on the proposals for priority for rescue finance in the consultation. As Professor Payne notes, one option put forward is to rank the rescue finance as an administration expense. This arguably reflects the status quo in English law, although the position is not clearly articulated anywhere in the legislation and has not been tested significantly in the courts. Working Group C also understands that so-called 'DIP loans' are often ranked as super-priority administrative expenses in US Chapter 11. However, crucially, the US does not draw a distinction between fixed and floating security, and a DIP loan which ranks as a super-priority administrative expense would still rank behind secured lenders. In contrast, in English law administration expenses rank ahead of the floating charge holder. Thus it can be seen that the rescue finance proposal is intrinsically related to the broader debate on the relative position of insolvency funding and the floating charge holder. This also comes into focus in proposals for rescue finance to enjoy a junior security interest, but still with the possibility of ranking ahead of a floating charge holder, and with proposals in another part of the consultation for expenses incurred in a preliminary moratorium to rank as administration expenses if restructuring attempts fail. In short, as Professor Payne notes, "The devil with such proposals is generally in the detail and not much detail is provided in the Consultation Paper." Working Group C is currently undertaking detailed research which, it is hoped, will help to flesh out the debate and the issues which need to be worked out in detail before any legislative reform. Its response to the consultation is available here.
Sarah Paterson is Assistant Professor of Corporate Insolvency at the London School of Economics and Political Science (LSE). Before joining LSE she was a partner in Slaughter and May in London, with whom she retains a consultancy.