Maxine Reid, leader of the Kreston Reeves restructuring and recovery team, unravels the aftermath of Kids Company’s insolvency.
| Maxine Reid |
Leader, Kreston Reeves restructuring and recovery team
One unusual aspect to the sudden collapse of Kids Company, shortly after receiving £3m from the government, has been calling in the official receiver.
It happens rarely with charities. But the decision signifies a case deemed to be of particular public interest, although sends no signal as to what is likely to be discovered.
What it certainly does mark out, in this case, is the complexity of unravelling an organisation where children are involved, taxpayers’ money has to be accounted for, and in the backdrop are press reports of a criminal investigation involving allegations of abuse.
Apart from the status of his office, at a practical level the official receiver has security clearances within government not given to commercial recovery companies.
It will still be a complex and politically delicate exercise for the person appointed, Matthew Stone, senior examiner and deputy official receiver. However, his basic task is clear.
He will try to realise assets, find out what went wrong, and decide if the trustees have fulfilled their duties.
At some point in the next few weeks he will also invite creditors to make a claim.
The role may involve attempting to transfer viable parts of Kids Company, which claimed to support 36,000 vulnerable young people, to others offering similar services.
As his investigation gets under way there will be a focus on what financial controls were in place, especially given claims in the media that regular audits failed to flag up its vulnerabilities.
So far, arguably, so familiar with a conventional liquidation. The law imposes duties on trustees similar to company directors, requiring the same fiduciary standards.
However, there are particular sensitivities when dealing with a failing charity.
Company directors, for example, are usually welded to a for-profit business. By contrast, charity trustees are generally part time, possibly from the ‘great and the good’, and often people with other roles elsewhere.
They may be in reality somewhat honorary, or there for the contacts they bring.
Anyone called in to restructure a charity must be aware of this distinction, although it does not absolve anyone from their responsibilities. They must also be particularly aware of the sector’s regulator, the Charity Commission.
The commission will want to know, for example, what plans are in place for any surplus after creditors can be paid. This generally must be for the balance to go to another charity.
There may also be issues around whether assets are ‘restricted’ or ‘unrestricted’ by covenant. If the former, it may be impossible to use them to repay creditors. The asset may have to be returned to the original donor. This can be a complex task, particularly if they were the result of a bequest.
It is not always easy to find fits with other organisations, either, however apparently similar. Charities often rely on good will to do their good work. Any restructuring that includes a merger must take into consideration whether it would damage reputation or diminish fund raising.
There are, therefore, particular challenges for recovery professionals in dealing with charities, and they can be onerous. Some commentators believe that the not-for-profit sector is heading for a big shake-up.
This gloomy view is based on clear indications from the Treasury of a reduction in government support upon which many of the UK’s 160,000 charities, including Kids Company, have come to rely. We have, perhaps, been warned.
Philippe Hameau, Paris-based partner at Norton Rose Fulbright, explains the effects of a new piece of French legislation on corporate insolvency.
| Philippe Hameau |
Partner, Norton Rose Fulbright
The recently adopted French Loi Macron, voted into law on July 10 in order to stimulate “growth, activity and equality of economic opportunity”, has been widely reported on for some of its more controversial features.
But it also has significant effects on French companies facing economic difficulties, notably by changing how the commercial courts deal with distressed companies, and reinforcing creditors’ rights.
The new Loi Macron provides that certain proceedings relating to distressed companies will be reserved to a limited number of French commercial courts (yet to be determined).
These specialised commercial courts will have sole jurisdiction for the relevant geographical area for judicial safeguard, reorganisation and liquidation proceedings concerning certain companies.
Criteria for such treatment include, for example, companies with at least 250 employees and total turnover of at least €20m, or firms subject to insolvency proceedings which require application of principles of international or EU law.
Ironically, though, this may mean that those companies that do not meet the qualifying criteria to be considered in a specialized court, could be handled by courts that may lack the depth of expertise necessary to judge complex cases.
The result is a “two-tiered” justice system, which may raise serious constitutional issues. Even though the principle of special jurisdiction already exists under French law for certain categories of disputes (for example with respect to disputes involving sudden termination of established commercial relations), no such distinction has previously existed based on the nature of the parties or the amount in issue. In this respect, the distinction created by the Loi Macron is open to criticism.
Since the Ordonnance of March 12, which attempted to reinforce the rights of creditors in judicial safeguard and judicial reorganisation procedures, creditors are entitled to present their own proposed reorganization plan to the court. This is undertaken in “competition” with the debtor’s proposals.
The creditors’ plan can incorporate a proposed increase in the share capital of the debtor by way of conversion of debts owed to the creditor, thereby diluting the holdings of existing shareholders.
The Loi Macron reinforces those rights, and enables creditors to have the final say on the issue and defines the circumstances in which the powers of shareholders can be limited, or even the expropriation of un-cooperative shareholders can occur.
If the plan proposed by the creditors includes a modification to the share capital of the debtor company, this will most often be by way of conversion of debts owed to the creditors, thereby enabling them to assume control of the debtor.
In such a case, if the existing shareholders of the debtor or some of them refuse to vote in favour of the modification to share capital, the court will have the ability, to intervene at the request of the insolvency administrator or the public prosecutor.
It is worth noting that the measures can be ordered only after the court has first considered the possibility of a total or partial transfer of the business in a transfer plan.
It is yet to be seen the level of impact that Loi Macron could have on future restructuring and insolvency proceedings. However there is currently uncertainty on how the provisions explained will be administered. We look forward to seeing the further detail on that.
Recent research by South Square & Grant Thornton UK has predicted a rise in cross-border insolvency work – Felicity Toube QC, of South Square, looks at what form that rise will take.
| Felicity Toube QC|
Co-authored with Steve Akers, Head of Complex and International Insolvency, Grant Thornton UK LLP
With recent high-profile decisions in mind, including the Privy Council in Saad Investments and Singularis, South Square and Grant Thornton UK LLP decided to commission joint research into the perceptions of leading UK and offshore insolvency lawyers and other professionals on undertaking cross-border insolvencies in major offshore jurisdictions.
Findings clearly suggest our respondents are anticipating an increase in cross-border insolvencies.
The full results are set out in a newly published report, From discord to harmony: the future of cross-border insolvency.
When asked about activity levels, 63% of respondents say the number of insolvencies involving offshore jurisdictions will increase over the next three years. This includes one in five respondents (19%) who say the level of activity will ‘increase considerably’ over this period, predominantly driven by an uplift in the financial services sector.
The majority of research respondents also want to see collaboration between offshore jurisdictions rise further up the agenda. 85% say that courts in different jurisdictions should collaborate more to make multi-jurisdictional insolvencies fairer and more efficient. Suggestions for fostering further collaboration range from formal mechanisms such as enacting the UNCITRAL Model Law through to informal channels for greater dialogue and information sharing between judges.
The top three factors when evaluating the attractiveness of a jurisdiction are: its legal process and infrastructure (84%), cross-border assistance provisions (63%) and enforceability of foreign court orders and judgments (40%).
The research points to the Cayman Islands as a preferred offshore jurisdiction for having the most effective insolvency laws. Almost two-thirds of respondents (63%) place the Cayman Islands among the three most effective offshore jurisdictions. It is followed by the British Virgin Islands (48%) and Hong Kong (37%).
Singapore emerged as a very effective location for cross-border insolvency for those with direct experience of multi-jurisdictional insolvency in the territory (75%). However, Singapore was not ranked very highly by respondents who provided feedback on the jurisdiction without direct experience there. This indicates a potential gap in perception and that Singapore might have a PR battle to wage.
With an anticipated uptick in cross-border insolvencies on the horizon, jurisdictions need to ensure their basic legal process and infrastructure is fit for purpose. Clearly, no single jurisdiction has got everything absolutely right, so we should be encouraging a wider debate about how all those involved in the legislative and judicial process might learn from each other and work more closely together to help ensure consistent and reliable standards are in place around the world.
The research was undertaken by an independent consultancy who gathered the views of 81 UK and offshore insolvency professionals, together representing views from 50 of the leading firms involved in cross-border insolvency. We are extremely grateful to everyone who took part in our research and look forward to discussing the findings with our clients and other colleagues in the international insolvency community.
For more information and a copy of the full report, contact Joanna Colton at email@example.com
Benjamin Wiles, managing director at Duff & Phelps, explains how regulators can gain controlling interests in regulated firms when they go bust.
| Benjamin Wiles |
managing director, Duff & Phelps
The emphasis on greater regulation as a legacy of the recession, coupled with a requirement for regulators to be self-funding, is impacting our clients in unintended ways, and this is increasingly true at times of distress and when companies enter administration.
Across administrations and distressed companies, we have seen a trend across regulators in their behaviour following the financial crisis. We’ve seen this from the Financial Conduct Authority (FCA) and Food Standards Agency, through to the Solicitors Regulation Authority and the Environment Agency.
In the aftermath of the recession their conduct was called into question. Since then, there has been a push towards hyper-regulation and enforcement, in no small part influenced by the decreased funding from central government as budgets have been slashed.
Regulators have had to source their funding from other means, either from their members in subscription fees, which some might point to as a conflict of interest, or through raising fines.
By way of example, the FCA has recently been actively enforcing fines. Through this change in behaviour, the FCA has taken on a larger role in some administration situations.
As a case in point, the FCA was involved in the administration of a London and Manchester-based company. This firm came within the definition of “investment bank” under the Investment Bank Special Administration Regulations 2011.
A special administration order in respect of the company was granted after the directors made an urgent application. The application was made following a suspension in trading of its AIM shares and a cessation of its regulated activities.
In effect, the “investment bank” was subject to the special administration regime, a process in which the FCA plays a key role.
The process entails the administrator completing three tasks: making a swift return of client assets; timely engagement with regulators; and to rescue the business as a going concern or wind it up in the best interests of creditors. A regular administration involves the latter, but not the first two objectives.
The special administration regime was introduced to help creditors caught up in complex insolvencies receive their funds faster. This is where the FCA comes into play.
Approval from the FCA must be sought before making the special administration order and the FCA must be served with any distribution plan proposed by the special administrators under the rules, (for the distribution of assets), prior to any court hearing for approval.
Although only a limited number of special administration orders have been made since the Investment Bank Special Administration Regulations 2011 came into force, there are advisors such as the law firm, DWF, which have growing experience acting for the special administrators.
This is true across other regulators. We had first-hand experience of this recently, when we were appointed as joint administrators for an abattoir, which before our involvement was fined more than £100,000 by the Food Standards Agency (FSA) for rule breaches.
The FSA regulates more than 822,000 food producers and establishments in the UK with more than 1,200 staff and a £70m budget, giving it considerable statutory powers. It has the power to impose fines or criminal convictions.
The insolvent abbatoir was unable to settle the judgment in full and instead had to negotiate deferred payment terms.
A Tomlin Order was subsequently entered into and the FSA’s original judgment was stayed to allow the company to make monthly repayments of arrears over a defined period.
A pre-packaged disposal of the business and assets was completed by the joint administrators following appointment. However, the approval granted by the FSA for the company to operate as an abattoir was not capable of being transferred to the purchaser.
Therefore, the purchaser was required to make a separate application to the FSA for a new approval to be issued to ensure no interruption in trading.
The joint administrators subsequently received correspondence from the FSA requesting for the statutory moratorium under the administration to be lifted. Due to the company’s failure to adhere to the terms of the Tomlin Order, the FSA required the administrators to sign a consent order to re-establish the remainder of the balance due under the original judgment. This was made to allow the FSA to rank as an unsecured creditor in the administration. The residual balance due under the judgment at this time was around £75,000 (the judgment debt).
The FSA, as a result of re-establishing the judgment debt, invoked its powers under the Meat (Official Controls Charges) Regulations 2009. Section 4 of the regulations states that where a judgment has been previously entered into, the FSA can refuse to exercise any further official controls at those premises, until the judgment is satisfied.
As a result, it required that the purchaser pay the judgment debt, otherwise it would not allow the firm to trade from the premises.
The FSA provided the purchaser with 14 days’ notice that it intended to withdraw all official controls from the premises. This would effectively cease operations and throw into doubt the viability of the business, as the delivery of meat for human consumption is illegal without FSA controls.
As a consequence, the FSA became a ‘super creditor’ with the ability to attach the judgment debt to the purchaser. In doing so, the FSA ensured it was paid ahead of anyone else.
The reality is that companies are increasingly under the burden of the regulators – particularly when they’re under stress.
The lesson here is to be aware when dealing with any regulated entities. Any fine imposed by the regulator may have a detrimental effect on a lender’s security, if the business needs to be sold as a going concern.
Christopher Russell, partner at Appleby Global, guides insolvency professionals in handling litigation involving failed offshore funds.
| Christopher Russell |
partner, Appleby Global
Co-authored with Rupert Coe, also partner at Appleby Global
Newly appointed liquidators will immediately seek to identify assets of the company. Usually, the company will be holding money: an important issue is whether money forms part of the liquidation estate or is held on trust and so falls outside the estate, and unavailable for payment of liquidation costs or distribution to stakeholders. Misuse of trust money would render the liquidators liable to the beneficiaries of the trust.
In the offshore funds industry, investors typically pay their subscription monies prior to the issue of their shares. It is common for a fund to have, at any one time, prospective investors who have paid for shares but are waiting for the next subscription date, when the fund’s NAV is calculated, before their shares can be issued. When a fund fails there will often be would-be shareholders in exactly that position. The question arises as to who owns the cash paid by those investors: the investors, or the fund? Are the would-be shareholders entitled to their money back, or can they only prove as unsecured creditors in the liquidation?
The issue is a topical one. In Bellis v Challinor (1) the English Court of Appeal (whose decisions are almost always followed in the British offshore world where the relevant legislation is materially similar) has considered the ownership of subscription monies paid to a firm of solicitors for onward investment into an ultimately unsuccessful property scheme. Although not a funds case, the principles are of wider relevance.
In Bellis investors advanced funds on the basis that loan notes would be issued in return, with the later possibility of acquiring equity. The property scheme failed before the loan notes were issued. The investors argued that their entire investment should be returned on the basis that the solicitors held the monies on a Quistclose-type trust (2). In other words the monies were provided to the solicitors on trust for the investors themselves, pending the satisfaction of certain conditions. The investors contended that those conditions went unfulfilled following the failure of the scheme, and the investment monies should be returned.
The Court of Appeal rejected the investors’ analysis due to the absence of an intention to create a trust. Bellis turned on its own facts, but the judgment clarifies and restates important principles. Briggs LJ, with whom the other judges agreed, noted that “A person creates a trust by his words or conduct, not by his innermost thoughts.” There must be evidence of an intention to enter into an arrangement which, as a matter of law, creates a Quistclose trust. This will typically mean that the transferor intended to restrict how the transferee could use the funds. On the facts of Bellis the investors made no attempt to place any restrictions on the solicitors as to how the monies were used. Accordingly the transfer of the investment monies was found to be an immediate loan to the solicitors’ client.
In the offshore funds context, there is typically a more formal process for subscription for shares than was the case for the investments in the Bellis case. Most commonly, investors will submit a subscription form with subscription monies to the fund’s administrator where they are held pending the next subscription day. Then, on the subscription day, shares will be issued and the investors entered onto the register of shareholders, at which point they legally become shareholders (this process might be delayed pending the calculation of the NAV for that subscription day). Usually this process will be clearly set out in the fund’s constitutional documents. Nevertheless, and unsurprisingly given the potential negative connotations such provisions might carry, it is rare to see provisions which detail who owns the subscription monies, and on what basis, in the event that the fund fails before a particular subscription day, leaving would-be subscribers in the unfortunate position of having paid for shares which cannot be issued.
As Bellis makes clear, should those would-be subscribers seek to assert that the subscription monies were held on trust, they must discharge the burden of proof that there was a trust. It is likely to be necessary to show evidence of an agreement that there was some special arrangement in place creating a trust, such that the monies were not at the fund’s free disposal (3).
From the perspective of liquidators of insolvent funds in the British offshore world, faced with prospective investors awaiting the issue of their shares at the start of the liquidation, regard should first be had to local legislation. Typically liquidators may not simply issue the shares. That being the case a careful factual analysis must be done to determine whether at law the subscription monies were paid on trust, such that they must be returned, or whether those monies fall into the liquidation estate, with the investors in no better a position than other creditors. As Bellis illustrates, the courts will be reluctant to find the existence of a trust absent clear evidence that a trust was intended.
(1)  EWCA Civ 59
(2) Barclays Bank v Quistclose Investments  AC 567: the so-called “purpose trusts”.
(3) For example in the case of Nanwa Gold Mines Ltd.  1 WLR 1080 a trust was found to exist because subscription monies were held in a separate account and never formed part of the company’s general assets. The Court of Appeal in Bellis considered Nanwa among other cases and simply concluded that it turned on its own facts.