With customers, suppliers, borrowers and even lenders entering administration in the credit crunch, it is important to understand the purpose of an administration, the duties of the administrator and what remedies you may have as a creditor of the insolvent company against the administrator. This article provides an outline of each of these issues. Purpose of an administration (the three-tier statutory purpose)
The administrator is required by paragraph 3 of Schedule B1 to the Insolvency Act 1986 (the 1986 Act) to perform their functions with the objective of achieving the three-tier statutory purpose of the administration. The statutory purpose is important for creditors to bear in mind as an administrator will be acting with a view to achieving it. Whether it is achieved therefore provides an indicator of whether the administrator is doing a good job – although in some cases it may not be possible to achieve it, no matter what steps and actions an administrator takes.
The administrator must initially perform their functions with a view to achieving the first tier, which is to rescue the company as a going concern. Potential purchasers are often unwilling to buy the shares of a company in administration as this would involve them taking on the liabilities of the insolvent company. Consequently, in practice, this first limb is rarely achieved.
If it is not reasonably practicable to achieve the first limb, an administrator may perform their functions with a view to achieving the second purpose. That is, to get a better result for the company’s creditors as a whole than would be likely were the company being wound up without there being an administration first. This limb can often be achieved by the administrator selling the business as a going concern, where a higher purchase price is paid than if the assets were sold on a break-up basis, which often happens in a liquidation scenario.
If the second limb is not reasonably practicable, and only if the interests of the unsecured creditors as a whole will not be unfairly harmed as a result, the administrator may perform their functions with a view to realising the property, in order to make a distribution to one or more secured or preferential creditors. Even if this is the only limb of the statutory purpose that can be achieved, the administrator must still act in the best interests of all of the creditors of the company.
As discussed below, the administrator will set out in their proposals (which are circulated to all known creditors of the company) how they intend to achieve the statutory purpose.
Duties of an administrator
An administrator must be qualified to act as a licensed insolvency practitioner and be eligible to act in relation to the particular company. When consenting to act as an administrator, they must consider whether there is any conflict of interest or other reason why they should not act as administrator and also declare any prior professional relationship with the company. A prior relationship may include advising the company and its directors prior to the administration, even where that advice is in relation to the administration (see Coyne and Hardy v DRC Distribution Ltd [2008]).
Whether the administrator is appointed by the court or by the directors, the company or the holder of a qualifying floating charge (using the out-of-court route), that administrator will be an officer of the court (paragraph 5, Schedule B1 to the 1986 Act) and therefore must act honourably and fairly (see Ex parte James (1874)). The administrator cannot prefer a particular creditor because they were appointed by that creditor.
The 1986 Act states that the administrator is required to manage the affairs, business and property of the company in accordance with the proposals, which have been circulated and approved by the creditors at the initial meeting of creditors. The proposals must include all prescribed matters stipulated in the Insolvency Rules 1986, including how the administrator intends to achieve the statutory purpose, the expected dividend to creditors, what fees and expenses have been incurred and the basis upon which the administrator will be paid.
An administrator can only deviate from their proposals if they consider the change not to be ‘substantial’ or the court directs how they must act. Consequently, it is important for creditors to give careful consideration to the proposals and whether they wish to approve or vote against them. Under paragraph 68 of Schedule B1 to the 1986 Act, in certain circumstances, administrators are permitted to sell the business and assets of the company prior to the proposals being approved. There are also circumstances where the administrator is not obliged to hold an initial meeting of creditors. However, these topics are beyond the scope of this article.
If a creditor votes in favour of the proposals at the initial meeting and the administrator abides by their proposals, it will be difficult for a creditor to subsequently criticise the steps being taken.
An administrator must also act in accordance with any court directions. The courts are, however, generally reluctant to give directions on commercial matters and so directions will generally only be sought where there is an issue of law to be determined. The courts have stated that it would be contrary to the nature and purpose of an administration if the court were to interfere with the day-to-day management of the administration, which has been entrusted to the administrators. It is for an administrator to determine where the balance lies in responding to creditors’ enquiries, acting in the interests of the creditors and making commercial decisions.
Challenges to administrators’ conduct
Administrators are qualified professionals who have specialist knowledge and skills and therefore, in practice, the courts are slow to interfere in the way in which they conduct an administration and there are few challenges by creditors that make it to the courts.
A creditor does, however, have remedies available to them. The main remedies are as follows:
- An application to the court claiming:
i) an administrator is acting, has acted or proposes to act in a way so as to ‘unfairly harm’ the interests of the applicant, whether alone or in common with other members or creditors; or
ii) an administrator is not performing its functions as quickly or as efficiently as is reasonably practicable (paragraph 74, Schedule B1). - A claim against the administrator that they have misapplied or retained money or other property of the company, have become accountable for money or other property, they have breached a fiduciary or other duty or they have been guilty of misfeasance (paragraph 75, Schedule B1).
- An application to remove or replace the administrator from office (paragraph 88, Schedule B1).
- A claim to challenge the amount of the administrator’s fees on the ground that they are excessive (Rule 2.109 of the Insolvency Rules 1986).
In the recent case of Re Lehman Brothers International (Europe) Ltd (In Administration): four private investment funds v Lomas, Pearson, Schwarzman and Jervis [2008], the court considered an application by creditors of Lehman Brothers International (Europe) Ltd that the administrators were acting in a manner that unfairly harmed their interests.
The applicants, four private investment funds, sought an order that the administrators provide a written statement setting out better and further information in respect of the state of the applicants’ securities. It was argued that, if they did not receive the information, then they would be unable to give assurances to clients as to the likelihood of any funds being recovered and the funds would have to be wound down forthwith.
The administrators argued that they were content to provide information that was readily available, and had already done so, but to provide further information would involve a significant amount of time and resources. Further, any information supplied would have to be subject to a number of qualifications as to accuracy and completeness. While the latter point can often be frustrating for creditors, it is usual for information to be provided without any warranties or representations, as the administrator has not had any previous dealings with the company. An administrator can only provide such information as is available to it, which will depend on the accuracy and completeness of the documents maintained by the company.
The court considered whether the actions of the administrators could be said to be causing ‘unfair harm’ to the applicants and concluded that where:
‘… there was no suggestion that the administrators were acting other than in accordance with their obligations under Schedule B1 of the 1986 Act and [any order of the court] it is exceedingly difficult to see how the unwillingness of the administrators to devote more time and resources than they have already to answering questions put to them by a particular group of creditors… can be said to be unfair even if it can be said to be causative or likely to be causative of harm’.
Consequently, where the administrators were seeking to carry out their functions in good faith, in the interests of all creditors, and prevent themselves being deflected from this course of action by spending a disproportionate amount of time and resources on the requests of particular creditors, this would not be unfair harm.
There is no general right for individual creditors to sue administrators for breach of duty as administrators do not, absent special circumstances, owe duties to individual creditors. A creditor may, however, bring a claim against an administrator where it is guilty of misfeasance. It should be borne in mind, however, that any compensation paid upon a finding of misfeasance will be paid to the company for the benefit of all creditors, not to the creditor making the application. Such an application may therefore be of limited benefit to a creditor depending upon the number of creditors and the proportion of the creditor’s debt.
A creditor should commence any claim asserting misfeasance prior to the administrator obtaining its discharge, otherwise the creditor will need the permission of the court to commence the claim (paragraph 75(6) of Schedule B1).
The court may order the removal of an administrator from office whether they have has been appointed by the court or by the directors, company, or the holder of a qualifying floating charge (paragraph 88 of Schedule B1). The courts have held that, while the court has a wide discretion pursuant to the 1986 Act, an applicant would have to show ‘cause’ as to why an administrator should be removed (Sisu Capital Fund Ltd v Tucker [2005]). The courts have held that the test applied should be the same as that applied when the court is considering the removal of a liquidator, namely that:
‘… due cause is to be measured by reference to the real, substantial interests of the liquidation, and to purpose for which the liquidator is appointed’. (Re Adam Eyton Ltd ex parte Charlesworth (1887))
It is not, however, necessary to go as far as proving misfeasance or negligence. Where the conduct of an administrator is slightly short of ideal, the court will generally be reluctant to order the removal of an administrator as it is recognised that this will cause additional delay and cost, which is often not in the best interests of the creditors.
The court can and will, however, scrutinise and criticise the conduct of administrators were it is appropriate. In Coyne, the Court of Appeal upheld the lower court’s decision that the administrators in that case had ‘not acted expeditiously and with the robustness of purpose expected of them’. Prior to the administration, the director had caused the company to enter into a number of transactions whereby assets were transferred to a new company set up by the director for little or no consideration.
The Court held that the administrators should not have proceeded with the administration and attempted to sell the assets of the company without these transactions being unravelled. The administrators’ actions in negotiating with the director to sell the business were criticised as inappropriate in the circumstances of the case. Both the lower court and Court of Appeal concluded that, if they had been required to, they would have made an order pursuant to paragraph 88 of Schedule B1 to remove the administrators. The need for such an order fell away in this case as a result of the administrators petitioning for the company to enter compulsory liquidation. The Court of Appeal did, however, uphold a costs order against the administrators.
Where a creditor is of the view that the administrator’s fees are excessive, an application may be commenced to challenge the level of fees. To make an application a creditor will need the concurrence of at least 25% in value of the creditors, including itslef (Rule 2.109 of the Insolvency Rules 1986). This is a topic in itself, but readers are referred to the case of Re Cabletel Installations Ltd [2005] and the practice statement The Fixing and Approval of the Remuneration of Appointees (2004), which set out the guiding principles that the court will consider.
Conclusion
A creditor should scrutinise the actions of an administrator and give careful thought to the administrator’s proposals and how it wishes to vote, as this may have an impact on what action may subsequently be taken. Administrators, however, have a wide discretion as to how to conduct the administration and, provided they are acting in accordance with their statutory duties, the courts will be reluctant to interfere. If action is to be taken, careful consideration should be given as to whether replacing the administrator will actually improve the position. A new administrator will need to get up to speed with the issues and this will involve further costs and delay. Will a new administrator be able to do anything different that will actually result in a greater return to creditors? Often, the outcome of an administration can be disappointing to a creditor, but this may be the outcome regardless of who the administrator is and you need to make sure you don’t throw good money after bad.
By Claire Martin-Royle, solicitor, Jones Day. E-mail: cmartin-royle@jonesday.com.
