Following 20 years of change, Vernon Dennis finds that creditors and debtors face a lot more choice when insolvency situations arise

With bankruptcy levels at a historically high level, personal debt now exceeding £1 trillion, a slowdown of sales in the high street and some high profile retail insolvencies, one would have thought the British economy were in the grip of a recession. However, while it is true that some commentators consider the UK is slowing down and could face more difficult times ahead, the economy appears to be some way from experiencing the recessionary spiral that was evident in the early 1980s and 1990s. Why is this?


A change in approach to financial difficulty by insolvency practitioners, lenders and creditors has caused less formal insolvency and more business rescue. As a result, despite financial difficulties for individuals and across certain sectors of the economy, there are fewer 'fire sales', less fear of a property crash and accompanying problems of negative equity/ mortgage repossessions and less incentive for creditors to petition for company winding-up or personal bankruptcy orders.


Consequently, there is less recessionary pressure, and this has contributed to a move away from a boom-or-bust economy.


From the recessions of the early 1980s and 1990s lessons were learned and major statutory reform resulted, namely the Insolvency Act 1985, which was consolidated into the 1986 Act and the Enterprise Act 2002. The cumulative effect of these reforms has had a liberalising influence on the UK insolvency regime, introducing new procedures for business rescue and debtor rehabilitation.


The options and decisions to be faced by an insolvent debtor, and their creditors, are defined by whether the debtor is an individual or corporate entity. In the UK, corporate personal insolvency law has developed separately and unique practices, procedures and terminology apply. Insolvency is a factual condition that the debtor finds itself in when it cannot meet its financial commitments, on either a cash-flow basis (an inability to pay debts as they fall due) or a balance sheet basis (where liabilities exceed assets).


Insolvency should be distinguished from the technical and statutory procedures of bankruptcy, liquidation (winding-up), receivership or administration that may, but does not necessarily, result from the fact of insolvency. Both individuals and companies may be insolvent, yet they can come to an arrangement with their creditors, either formal, such as voluntary arrangements, deed or schemes of arrangement, or informal, such as compositions or agreements with creditors, which may stave off the statutory insolvency procedures.


Furthermore, both debtor and creditor may ignore the fact of insolvency, although the Insolvency Act provides a variety of offences that might be committed should an insolvency procedure eventually be commenced (for example, wrongful trading or entering into a transaction at an undervalue).


Where the statutory reforms over the past 20 years have altered fundamentally the corporate insolvency law landscape is in the field of business rescue. The 1986 Act introduced company voluntary arrangement and administration procedures, both of which have been modified and improved by reforms of the Insolvency Act 2000 and Enterprise Act 2002.


The cumulative effect of these reforms has been to put administration into the centre stage of business rescue, decreasing the role and inference of secured lenders by limiting the use of administrative receivership to especially statutory approved lending situations, or where the security was created prior to 15 September 2003.


The principal objective of administration is to affect the rescue of the company as a going concern. It does not matter by what means and by whom the administrator was appointed. In every case, the administrator must perform his functions with the objective of achieving the purpose of the administration in the interests of the creditors as a whole.


Speedy and efficient methods of administration have been introduced, including an ability by a company and/or its directors to appoint an administrator without the need for a slow and costly court application. The moves have made the UK administration procedure closer in style to the US chapter 11 process and introduced a system that is distinctly more debtor friendly than before.


The wider purpose of administration permits its use in a variety of circumstances that may not necessarily see the company exiting administration and continuing as a trading concern. Instead, administration can be used to effect business rescue, selling on a going-concern basis the assets, including the goodwill of the company.


In many instances, with appropriate planning and proper independent valuation, business rescue can be affected by a sale of the company's business almost immediately on the company entering into administration. A 'pre-pack sale' to the stakeholders of the insolvent company may be viewed by some as 'phoenix trading', but in reality it is often the only way of ensuring business and job survival.


A changing approach by lenders and creditors, who increasingly recognise the economic value of business rescue (in potential dividend return on their debt and for the practical reasons that there is a new trading partner) as opposed to the slower and possibly more expensive liquidation, has led to more business rescue and ensures that less loss is suffered to the economy as a whole by any incidence of insolvency.


In the area of personal insolvency law, the reforms of 1986 introduced automatic discharge, while the 2002 reforms are intended to alter the perception of bankruptcy, giving individuals a second chance and thereby encouraging entrepreneurial responsible risk-taking. The reforms introduced on 1 April 2004 have the effect of reducing the period of bankruptcy to a maximum of 12 months and the lifting of certain restrictions during the period of bankruptcy. The trustees' ability to recover certain assets (for example, principal private residence) has been limited, which means that bankruptcy provides less of an economic hindrance hanging over the debtor for years to come.


With greater debtor rehabilitation and less stigma caused by bankruptcy, the effect of a rise in bankruptcy levels may have had less detrimental effect on the economy than would otherwise be the case, as individual traders and consumers will quickly be re-integrated into the economy. The effects of bankruptcy have been deliberately decreased.


The insolvency law landscape has fundamentally changed over the past 20 years, and an insolvency practitioner's work is increasingly less concerned with the application of formal insolvency procedures and instead has developed in the areas of personal and corporate rescue. Lenders and other creditors are growing familiar with changing the insolvency landscape, are commercially realistic and are more willing to accept both formal and informal proposals from debtors.


Lenders will increasingly look to facilitate work-outs and assist in business turnarounds, and there has also been a boom in sub-prime lending, which has increased opportunities for (not always wise) re-financing. As a result, insolvency has increasingly less impact on the economy as a whole; it does not always result in the terminal procedures of liquidation and bankruptcy.


However, It means that the options and decisions to be faced by creditors and debtors are more numerous than ever before and careful strategic planning is often required when an insolvent situation arises.


Vernon Dennis is a insolvency specialist solicitor and a partner with international London-based law firm Edwin Coe. He is the author of Insolvency Law Handbook, published in February by Law Society Publishing. The book can be ordered direct from Marston Book Services, tel: 01235 465 656.