With more corporate failures likely, the publication of the UK government’s white paper on insolvency seems timely. The government has listened to the views of those who believe that the present regime is too pro-creditor and has suggested initiatives designed to move the UK regime towards a more debtor-friendly slant.
One of the main changes proposed in the policy document is that administrative receivership be replaced by a revised administration procedure in which the interests of all creditors (including unsecured creditors) will be considered. This procedure would be subject to the overview of the courts in a more public and transparent process. Neil Cooper, an insolvency and business recovery specialist with law firm Kroll Buchler Phillips, says: “The abolition of the right of a debenture holder to appoint an administrative receiver because occasionally a few banks may have misused this right is rather like banning cars because some people may have driven them recklessly. One of the important aspects of this right is that it gives banks an incentive to monitor a company. If they don’t have a vested interest in doing that, then they won’t do it.”
The right of secured creditors to enforce their security by appointing a receiver goes back to the mid-19th century when the floating charge was created. The 1986 Insolvency Act introduced the concept of an administrative receiver – a receiver appointed over all of the assets of the chargor by the holder of security which includes a floating charge in order to enforce that security. The appointment of an administrative receivership does not require court approval and the primary duty of the administrative receiver is to his or her appointor, with limited duties to other creditors.
Largely as a result of the administrative receivership procedure, the insolvency laws in England and Wales are often described as being pro-creditor, in contrast to the US and certain continental European regimes that are considered to be more pro-debtor. According to trade&industry minister Patricia Hewitt, the new system is more likely to “ensure that that all interest groups get a fair say and have an opportunity to influence the outcome”.
The government, though, has made one important concession to the proposed abolition of the secured creditor’s right to appoint an administrative receiver. In the case of a floating charge granted in the context of certain capital markets transactions (which means securitizations, though that is not specifically stated) the charge-holder will remain entitled to appoint an administrative receiver.
In doing this, the government recognizes the growing importance to the economy of securitization. Ian Field, a partner specialising in insolvency at Allen&Overy, says: “Though this recognition of the importance of these transactions is to be welcomed, the carve-out that is suggested may ironically, in the short term at least, generate greater uncertainty – never a good thing in the capital markets – than it does deliver peace of mind. The concern is that, given the complexity of the transactions and the ingenuity of those putting them together, it may be very difficult to provide an adequate definition of the range of capital market transactions that should be covered by the exception.”
Conventional securitizations are known as true-sale. Broadly speaking, these are transactions in which a portfolio of financial receivables – typically mortgages or credit card debts – are sold by the originator to a special purpose vehicle (SPV) that issues bonds in order to raise finance for the originator. The SPV is often described as being bankruptcy-remote, engages in no activities other than bond issue and has no creditors other than the bondholders. Without this status, the rating agencies would not be able to give a high credit rating to the securities it issues. Although the SPV will grant security over its assets, the structure relies on a true sale of the assets by the originator, so in these transactions the ability to enforce security offers an additional level of comfort, but is somewhat superfluous.
But, it is in the growing use of securitization techniques in other contexts that the ability to enforce security is essential.
These techniques are suitable for a great many businesses that can show stable and predictable cashflows. Often known as whole business securitizations, these transactions use a secured loan from the SPV to the originator rather than a true sale of assets. In these circumstances, the right of the security trustee, on behalf of the bondholders, to appoint an administrative receiver over the assets of the originator in order to enforce the security provides the basis for the rating agencies’ ability to give a favourable rating for these deals.
The UK, ahead of other financial centres, has been pioneering the use of securitization techniques that benefit businesses that do not have more traditional portfolios of income-producing assets such as financial receivables. The UK’s insolvency rules are uniquely well suited to provide the security that the rating agencies require in order to rate these deals. Beneficiaries of such transactions to date have included such diverse businesses as London City Airport (with securitization of airport revenues), the Really Useful Theatre Group (theatre ticket revenues) and Welcome Break (revenue from motorway service areas).
To date, it has not generally been possible to use the same type of whole business securitization techniques in the US and other jurisdictions where the insolvency laws are seen to be more pro-debtor. “It is essential to know whether the capital markets exception will cover this type of securitization structure, which may be difficult to separate from other forms of syndicated secured lending which ought not to be caught by the exception,” says Field.
A further question that has been raised by the market is whether there are to be any grandfathering provisions for existing deals structured using the present rights of secured creditors. The white paper makes no mention of this, but the Insolvency Service has indicated that there will be a transitional period although no details have yet appeared.
There are arguments for and against such transitional provisions. Lenders and rating agencies that have assessed a company’s credit on the basis of the existing set of remedies available may find, in the absence of any grandfathering provisions, that their initial assessment needs to be revised. In extreme cases, this could lead to a reassessment of the credit that the lender has extended or a rating downgrade. On the other hand, the existence of separate regimes for existing and new transactions could create confusion and the prolonged existence of parallel systems. Given that some transactions envisage the security granted remaining in place for over 30 years, such a parallel system could be in place for a long time.
“Above all, what is needed from the legislation is clarification of these points,” argues Allen&Overy’s Field.
The use of securitization techniques is an increasingly important part of the financial landscape so this is not simply an issue that concerns the professional advisers in the securitization market. These techniques are increasingly employed in support of acquisition finance, allowing both lenders and borrowers to benefit from cheaper financing. The absence of clarity and certainty is not, therefore, a theoretical irritation. It is a genuine concern that may have a direct and tangible impact on the wider economy.
It may be that over the course of time, the revised administration procedure proves to be as effective as the present system of administrative receivership. In the longer term, therefore, no capital markets exception would be necessary. But until this time, clarification is needed as to the scope of the exception. This will serve to reassure the rating agencies, banks and investors so that the use of such valuable financial techniques as whole business securitizations may continue unhindered.
