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When regulators become supercreditors

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.

Posted on 17th September 2015 by Fred Crawley

 

 

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