Contradictions abound around insolvency exemption

Restructuring & Insolvency analysis: Frances Coulson of Moon Beever, and former president of R3, considers the recent confirmation that the insolvency litigation exemption will end in April 2015.

Original news: Jackson reforms and insolvency

The current exemption for insolvency proceedings will come to an end in April 2015. The confirmation for this arose out of a written question put to the Secretary of State for Justice, Shailesh Vara.

What is the current position in terms of lobbying the government on the exemption?

While the lobbying to retain the exemption from the Legal Aid, Sentencing and Punishment of Offenders Act 2012 (LASPO 2012) for insolvency litigation is currently hitting a brick wall, there is no reason to give up the fight. Shailesh Vara recently responded to a question from the Shadow Justice Minister, Andy Slaughter, to the effect that the exemption will end in April 2015. In response to several MPs letters, Mr Vara has responded that they will rely on their 'existing impact assessment'. They do not seem to realise that they simply have not had one. While impact assessments were indeed carried out, if the Ministry of Justice were to revisit them, they would see that, in fact, there was no mention of insolvency litigation at all. The impact assessments deal with general tort claims. There is a glaring omission in their impact assessments in relation to insolvency litigation and no follow up impact assessment on the intention to take positive steps to remove the current insolvency exemption. The only assessment of evidence as to the effects of loss of the carve-out come in the form of the Walton Report commissioned by R3 (see: R3 report on the impact of the Jackson Reforms on insolvency litigation from April 2015)

How does this fit in with the broader reform programme?

From my perspective, the whole insolvency reform programme seems to be inherently contradictory. The massive Small Business, Enterprise and Employment Bill (Small Business Bill)--which is being rushed through with virtually no parliamentary scrutiny despite the huge changes it proposes--states in the accompanying human rights statement that :

'The ..... Bill will open up new opportunities for small businesses to:

o           compete

o           get finance to create jobs

o           grow

o           innovate

o           export

It will ensure that the UK continues to be recognised globally as a trusted and fair place to do business; it will strengthen the current system and deliver the UK's G8 commitments to introduce new rules requiring companies to obtain, and hold, information on who owns and controls them, increasing trust and encouraging investment and growth within the UK.

It will also introduce tougher rules to make sure public sector workers do not get high pay outs if they get re-employed in the public sector; tackle misconduct by directors and unfair employment practices; provide reforms to increase the efficiency of the Employment Tribunals system and further reduce its burden on small businesses; and ensure a strong regulatory regime for those that administer insolvencies.

All of this will mean that small businesses will have access to finance and reduced red tape to grow and thrive, and that honest, hardworking businesses can be confident in the rule of the law and are not disadvantaged by those that don't play by the rules.'

This is a Bill which had its first reading on 25 June 2014, its second reading in July 2014 and is up for Committee stage on 14 October 2014. It's all over bar the shouting--so I believe people should start shouting.

Take the various strands of reform which are currently in play in the Small Business Bill and LASPO 2012, among other things:

Regulatory reform

There are huge challenges to insolvency practitioner fees coming. The original proposal was that time costs not be allowed at all--(see our news analysis piece from 17 February 2014: New consultation--strengthening the regulatory regime and fee structure for insolvency practitioners) that would discourage proper investigations and actions to recover money for creditors. This proposal seems to have been dropped from the forefront of government thinking, but a cap on fees at the start is a possible threat. If you are taking on a nil asset case, with the investigations that need to be undertaken to establish the wrongdoing/wrongdoers, how can you give a cradle-to-grave estimate? Anyway, how can you do that without tipping off the targets? Of course, some fee estimates in stages can be given--however, there is a capacity to benefit the crooks and damage the competition in the frenzy to beat up insolvency practitioners over fees, which last year I gather only founded 13 (not 13%, actually only 13) of the complaints to regulators.

Creditors having a say

One might think that creditors can have their say in insolvency--they can approve fees, authorise litigation and generally control things. Professor Elaine Kempson recommended encouraging creditor engagement to control fees--particularly by HMRC. There has been a lot of talk about creditor engagement but HMRC don't have the resource and most creditors don't want to spend the time. The one time creditors are engaged is often at an Insolvency Act 1986, s 98 (IA 1986) meeting. Their loss is recent, they have lots of direct knowledge, and they want to ask questions of the director. However, physical meetings are to be banned.

Furthermore upon the Official Receiver being automatically appointed as Trustee on the making of a bankruptcy order, creditors will not be able to appoint a private Trustee by SOS request, but will be able to seek to requisition a creditors' meeting to seek to replace the Official Receiver (if they can persuade the Official Receiver to call the meeting and their clients to pay the meeting costs). Not encouraging creditor engagement at all, but it does seem to smack of unfair competition by the Insolvency Service.

The power to ban pre packs

The Small Business Bill gives the power to ban pre-packs, and ban sales to connected parties. So a useful swathe of rescue will be cut out. There seems to be a fundamental lack of understanding of their own legislation. Rescue the business, let an entrepreneur or inventor have another go, but if he was culpable in the first failure, let insolvency practitioners pursue him personally for IA 1986 offences committed and make a return to creditors. The way to encourage trade is to allow people to try and fail, but the way to make competition fair in an active market is to ensure the wherewithal to pursue the wrongdoer isn't removed from the profession.

Compensation orders

The Small Business Bill suggests that the Insolvency Service will be getting compensation orders in disqualifications, so victims will be fine. However, who judges which victims should be compensated?

Given that disqualifications have declined by half over the last decade, and that so many are simply the easy meat (trading at the expense of the crown, failing to keep proper books and records etc), will this really have any impact on the criminal or reckless directors who have real human and small trade victims? This could also mean that those directors who might have previously rolled over for an undertaking because it was cheaper (and rarely enforced) will have to fight if there's a chance they will have to pay compensation. How will the more complex forensics be taken forward? How will the funds be distributed? How will the compensation of a few affect the pari passu in any concurrent liquidation.

I could say much more if my fingers weren't worn down through my despair at the court and insolvency reforms which promise to do the very opposite of their stated aim in many cases.

The government is still batting firm against making the exemption permanent, citing reliance on its 'existing impact assessment'. However, as I mentioned at the beginning of this piece, no such impact assessment exists. I have spoken to many parliamentarians, peers and creditor groups over the last year following the gaining of the temporary exemption (and I know that many of my fellow lobbyists in R3 have done the same) and the response which is almost invariably given when the need for the permanent carve out is explained is 'well, it's a no brainer'. It really is a no brainer. The recoverability of success fees and after-the-event (ATE) premiums recovers money for government--it enables actions to be taken against non-compliant businesses and crooks who fleece victims (which can only be good for fair competition and human rights). It puts money in the hands of actual creditors, not fraudulent or reckless directors and not in the hands of offshore litigation funders (though of course they have their place).

The increase in take up of this litigation is because the economics work under the present system. The expansion of the investigations (often speculative but encouraged by potential) and of litigation in this vital field deter poor corporate behaviour and deliver redress where other legislation fails to deliver (eg tax avoidance legislation). A clever structure might avoid tax without fear, but an insolvent part of a group dumped can be the springboard to recovery for creditors and can perhaps give the directing minds pause for thought before doing it again.

While the Small Business Bill seeks to encourage fair competition and Dr Cable's 'Transparency & Trust' consultation fed into the thought processes, the loss of the insolvency exemption goes the very opposite way.

The recent Supreme Court case of Coventry v Lawrence [2014] UKSC 46, [2014] All ER (D) 226 (Jul) may throw a spanner in the governmental works if, as many commentators suggest, the challenge to recoverability of ATE and success fees, as a breach of the payer's human rights, leads to the government's access to justice legislation being declared incompatible with the European Convention on Human Rights. This could open up the floodgates for claims against the government from those who have paid ATE premiums and uplifts--especially in personal injury cases. The government has been invited to make submissions to the Supreme Court on this issue.

So when the Minister says the Small Business Bill will ensure that 'hardworking businesses can be confident in the rule of the law and are not disadvantaged by those that don't play by the rules' why does government remove the tools which help make that true? Watch this space, but have your say. It will all affect the insolvency and related legal profession as well as the general business of UK plc.

Find out more

For another viewpoint on the implications of the Small Businesses Bill on insolvency practitioners, see our news analysis piece: Are more changes afoot for insolvency practitioners? with Ian Defty, a director in the niche London insolvency firm of DDJ Insolvency Limited.

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First published on LexisPSL Restructuring and Insolvency

Interviewed by Eleanor Stephens

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