The Impact of the Enterprise Act 2002 on Realisations and Costs in Corporate Rescue Proceedings

1. The Impact of the Enterprise Act 2002 on Realisations and Costs in Corporate Rescue Proceedings John Armour (Cambridge University) Audrey Hsu (National University of Taiwan) Adrian Walters (Nottingham Trent University) Insolvency Service Seminar 24 May 2007 Armour Hsu Walters

2. Outline • Motivation • Background • Hypotheses • Data • Results • Conclusions & Implications Armour Hsu Walters

3. Motivation Armour Hsu Walters

4. Motivation • Enterprise Act changes • Pre-Act secured creditors controlled formal insolvency through ability to appoint admin receiver • From 15/09/03 Enterprise Act 2002 shifted power -> unsec’ds: prospective abolition of admin receivership (‘RE’) + revamping of admin (‘AD’) • Academic + international context: secured creditor control is topical • Growing in US in recent yrs • Some argue firms should be permitted to contract with creditors for more control over bky • Debate about desirability of secured creditor control in context of DIP financing etc • IS evaluation • Encouraged us to test empirically whether the RE => AD ‘control’ shift has materially impacted on net returns to creditors Armour Hsu Walters

5. Background Armour Hsu Walters

6. UK corporate rescue • Formal“rescues” (as distinct from informal workouts, turnarounds etc) are a small company phenomenon • Formal insolvencies of listed companies are rare: 1996-2005: 79 = 8 p.a. (Carapeto and Stuflesser, 2006) • Administration, receivership are “rescue procedures”: capable of preserving going concern surplus in contrast to liquidation Armour Hsu Walters

7. Administrative receivership • Control rights in insolvency given to holder of floating charge: ‘FCH’ • Appointee (receiver) owed fiduciary duties only to FCH • Unsecured creditors had limited info rights but no voting rights • Incidence • Pre-15/9/03, FCH had free choice whether to use receivership or not • Criticism => to prospective abolition: • Limited incentive to maximise recoveries and/or minimise costs where oversecured (~ 50% of cases) • Bias against continuation + rescue of viable cos? Armour Hsu Walters

8. Administration • Appointment still controlled by FCH • Out of court entry routes etc • But accountability now to unsecureds (residual claimants) where they are ‘in the money’ • Fiduciary duties to all creditors to maximise value • Unsecured creditors get to vote on exit (unless clearly out of the money) • Enterprise Act 2002 (from 15/09/2003) • FCH no longer permitted to appoint receiver • Unless security created pre-15/09/2003 (‘grandfathered’) Armour Hsu Walters

9. Administration replacing receivership Armour Hsu Walters Source: Insolvency Service

10. Hypotheses Formulated following 13 open-ended interviews with professionals Armour Hsu Walters

11. Hypotheses (1) • Realisations: • RE to AD: shift in control from secured creditor to residual claimant may enhance incentives to maximise realisations • Increase gross recoveries? • More going concern sales? • Interviewees observations’ • Likely to be most pronounced for oversecured FCH as administrator now owes duty to residual claimant • Expect realisations generally to be increasing in size of firm, duration of proceedings; also to be affected by outcome (eg going concern v. piecemeal sale) Armour Hsu Walters

12. Hypotheses (2) • Direct Costs: • RE to AD: shift in control from secured creditor to residual claimant may enhance incentives to control costs • But may also decrease ability to control costs (if we assume that unsecureds are typically dispersed) • Interviewees observations’ • Likely to be most pronounced for oversecured FCH • Expect costs generally to be increasing in size of firm, duration of proceedings (Citron et al, 2004; LoPucki and Doherty, 2004; Bris et al, 2006); also to be affected by outcome (eg going concern v. piecemeal sale) Armour Hsu Walters

13. Hypotheses (3) Net recoveries to creditors • H1: realisations likely to increase • H2: costs likely to increase => Effect on net recoveries hard to predict a priori but possibly neutral? Armour Hsu Walters

14. Data Armour Hsu Walters

15. Data description • Hand-constructed dataset of random sample of 500 cases from the index in London Gazette • 250 RE, pre 09/03; 250 AD, post 09/03 • Excluded if not completed by 01/02/06 (leaving 348 cases) • Data hand-collected from reports submitted to Companies House by insolvency practitioners • Supplemented with financial and accounting data from FAME database • Cases with missing values in variables of interest excluded. • Result: 284 cases • 102 receiverships (pre 09/03) • 182 administrations (post 09/03) Armour Hsu Walters

16. Sample composition ‘Before’: 102 RE cases ‘After’: 182 AD cases Armour Hsu Walters Source: Insolvency Service

17. Sample composition ‘Before’: 102 RE cases ‘After’: 182 AD cases (Robustness): 31 RE cases Armour Hsu Walters Source: Insolvency Service

18. Sample composition ‘Before’: 102 RE cases ‘After’: 182 AD cases (Robustness): 31 RE cases (A different procedure) Armour Hsu Walters Source: Insolvency Service

19. Descriptive statistics Armour Hsu Walters

20. Firm SIC Industry Classifications Receiverships Administrations Armour Hsu Walters

21. Results Armour Hsu Walters

22. Preview of results • Shift in control of formal rescue proceedings from secured (senior, concentrated) to unsecured (junior, dispersed) creditors via greater legal accountability…. • Increases gross realisations • Most pronounced where senior creditor oversecured (ie value of security < debt owed) • Also increases direct costs • Costs are greater under the new regime • No significant change in outcomes or net recoveries Armour Hsu Walters

23. Outcomes Armour Hsu Walters

24. Determinants of realizations Three measures of realizations: A1: Total asset realisations A2: A1 + gross trading receipts A3: A1 + net trading receipts Armour Hsu Walters

25. Determinants of realisations (A1) Armour Hsu Walters

26. Determinants of realisations (A1) Armour Hsu Walters

27. Determinants of realisations (A2) Armour Hsu Walters

28. Determinants of realisations (A3) Armour Hsu Walters

29. Determinants of remuneration and total direct costs Two measures of costs: Remuneration: fees paid to insolvency practitioners Total direct costs: remuneration + other costs associated with realising assets Armour Hsu Walters

30. Determinants of costs (remuneration) Armour Hsu Walters

31. Determinants of costs (total direct costs) Armour Hsu Walters

32. Net recovery rates No significant (at 5% level) differences between administration and receivership. Armour Hsu Walters

33. Robustness checks Armour Hsu Walters

34. Possible confounding factors • Omitted variable/time effect? E.g. Practitioners complain of increased professional regulation as a burden • Compare post EA receiverships with (post EA) administrations • Selection bias? Secured creditors now have choice over use of procedure owing to ‘grandfathering’ • Compare (administrations and postEA receiverships) with pre EA receiverships Armour Hsu Walters

35. Robustness: Determinants of realisations (A1) Armour Hsu Walters

36. Robustness: Determinants of realisations (A3) Armour Hsu Walters

37. Robustness: Determinants of costs (remuneration) Armour Hsu Walters

38. Robustness: Determinants of costs (total direct costs) Armour Hsu Walters

39. Conclusions & Implications Armour Hsu Walters

40. Conclusions Impact of shift from RE to AD: H1 supported: gross recoveries increase in cases where FCH over-secured (however the result is not robust to checks regarding time/selection bias). H2 supported: costs increase (result is robust). No significant impact on net recoveries. No clear superiority for unsecured creditor (dispersed) vs. secured creditor (concentrated) governance of corporate rescue. Armour Hsu Walters

41. Implications • Emphasises importance of optimal accountability Legal duties are no panacea • Secured creditor control may be nothing to be afraid of … ..But also nothing to write home about Armour Hsu Walters