Two weeks ago, we looked at how reforms to the law of arrestment might impact on the concept of "effectually executed diligence" under sections 60 and 61 of the Insolvency Act 1986.  In this bulletin, we consider the reforms proposed for inhibitions and land attachment and effectually executed diligence under those provisions. 

Section 61 relates to the ability of a Receiver to deal with secured property and property subject to effectually executed diligence.  In our bulletin on arrestments, we explained that a new section 61(1B) was proposed in the Bankruptcy & Diligence (Scotland) Bill.  This provides that an arrestment will only be regarded as effectually executed if it was executed prior to crystallisation of the floating charge.  The position on inhibitions is quite different.  The Bill envisages a new section 61(1)(A) providing that:-

            "an inhibition which takes effect after the creation of the floating charge… is not an effectual diligence."

This provision harks back to the proposals in the Bill to reform the law on floating charges; these include the proposal that floating charges will only be created once registered in a new Register of Floating Charges.  The Bill also proposes that floating charges should rank with other floating charges and with other fixed securities by date of registration.  In other words, a floating charge will prevail over a fixed security that was registered after the charge was registered, regardless of the fact that the charge has not at that point in time crystallised. 

Clearly, it would make a nonsense of the proposed reforms to floating charges if an inhibition, which ranked behind a particular fixed security, ranked in front of a floating charge (as "effectually executed diligence") which itself prevailed over the fixed security.  This explains the apparent inconsistency of treatment between arrestments and inhibitions in sections 61(1A) and 61(1B).

The process of land attachment will be commenced by registering a notice of land attachment in the Registers and serving that notice on the debtor.  The Bill states that the land attachment will be created 28 days after registration of the notice.  After the expiry of the 28 day period the attaching creditor will get a right in security over the property (or, as it is expressed in the Bill, "a subordinate real right over the land").  During the 28 day period, the notice is to have effect as if it were an inhibition registered in the Register of Inhibitions but restricted to the property mentioned in the notice of attachment.  In view of the fact that until 28 days have elapsed the notice of attachment is to be treated like an inhibition, it cannot at that stage be regarded as "effectually executed diligence" in relation to any pre-existing floating charge, given the terms of the proposed section 61(1A).  Similarly, once it obtains the status of a subordinate real right in security after 28 days, it would rank behind the charge in line with the general rule that heritable securities are to rank by date of creation. 

The position therefore appears to be straightforward in relation to land attachment: if it is registered before a floating charge it prevails over the charge and if it is registered after the floating charge it does not.  However, that is not the whole story.  The Bill also proposes a change to the striking down of diligence provisions in section 37 of the Bankruptcy (Scotland) Act 1985 (as applied to winding up by section 185 of the 1986 Act) to deal with land attachment.  The proposed new section 37(5B) of the Bankruptcy (Scotland) Act 1985 will provide that no land attachment created within 6 months of sequestration or winding up shall be effectual to create any preference in favour of the attaching creditor.

The Bill also proposes a new section 37(8A) which sets out what a trustee or liquidator will require to do where a sale of attached land is already underway.  This will depend upon whether or not missives have been concluded.  If they have not, the creditor cannot insist in the land attachment.  If they have, the trustee or liquidator will require to concur in or ratify the disposition, in return for which, any net free proceeds are to be sent to him.

In next week's bulletin we will look at residual attachment and money attachment as "effectually executed diligence".  

Approval of Fees in Administration

New rules, which came into force on 6 April 2006, have made significant amendments to the procedure to be followed by administrators wishing to have their remuneration and outlays fixed. These rules apply with immediate effect and apply to all assignments where the company went into administration on or after 15 September 2003 i.e. to all post Enterprise Act administration cases. 

The new rules

Under the previous rules, the legislators, in typical fashion, adopted the rules applying to liquidations and applied these to administrations. This meant that in the absence of a creditors' committee, it was necessary to apply to the court to have remuneration fixed and outlays approved. 

The Insolvency (Scotland) Amendment Rules 2006, have introduced new Rules 2.39 and 2.39A and streamlined the procedure, leaving the decision for approval with a creditors meeting, in the absence of a creditors' committee.

The procedure for approving remuneration is now as follows: 

• Within 2 weeks of the end of the accounting period an account of intromissions and a claim for outlays and remuneration must be submitted to the creditors' committee for audit. This must be accompanied by a scheme of division where there are funds available to permit a distribution.
• If there is no creditors' committee these documents must be submitted to a meeting of the creditors
• The committee or the creditors have a period of 6 weeks to audit the accounts and issue a determination fixing the outlays and remuneration payable to the administrator
• It is competent to make a claim for interim remuneration prior to the expiry of the accounting period
• If the administrator is dissatisfied with the amount fixed by the committee he can request that it be increased by a resolution of the creditors at a meeting
• If the committee fails to issue a determination within the 6 week period, the claim can be submitted to a meeting of the creditors
• If the meeting of the creditors fails to issue a determination, the claim can then be submitted to the court
• In the absence of a creditors' committee and in cases where there is not going to be any distribution to the unsecured creditors, except via the prescribed part, the remuneration and outlays will have to be approved by each secured creditor and 50% of the preferential creditors where a dividend is to be paid to preferential creditors
• An appeal against the remuneration fixed by the committee or by the creditors' meeting will then lie to the court.

Conclusions

The new rules, although over two years overdue, are better late than never! Given the stated aim of reducing court involvement and taking administrations out of the courts, it was surprising that the court had been left with such a critical role in fixing remuneration in the absence of a creditors' committee. In order for practitioners to gain the benefit of the cost savings of lesser court involvement it will be necessary to ensure that a committee of creditors is appointed in each case wherever possible, although practitioners are reminded of the provisions in paragraph 58 of Schedule B1, which permit meetings of creditors to be held by correspondence.

Introduction

Section 60(1)(b) of the Insolvency Act 1986 provides that any person who has "effectually executed diligence" over any part of the company's property subject to a floating charge shall be paid in priority to the floating charge holder.  The exact meaning of "effectually executed diligence" has been the subject of some controversial case law, especially in relation to arrestments.

The Bankruptcy and Diligence (Scotland) Bill proposes a number of reforms to the law  of arrestments which will inform the correct interpretation of section 60(1)(b) going forward.

The case of Lord Advocate v Royal Bank of Scotland in 1977 seemed to provide a straightforward answer to the question of when an arrestment would be regarded as effectually executed diligence.  The Court reasoned that there were two stages to arrestment, service of the schedule of arrestment and action of furthcoming.  An action of furthcoming required to be raised in cases where the debtor was not prepared to agree to the funds being released to the arresting creditor.  The Court reasoned that where an arrestment had been served but not "completed" by an action of furthcoming it could not be regarded as an effectually executed diligence.  This decision was helpful for Receivers who would otherwise have had to consider winding the company up within 60 days of the arrestment having been executed in order for it to be cut down under section 185 of the 1986 Act.

The issue was further refined in the case of Iona Hotels in 1991 when the Court was asked to consider a situation in which the floating charge was granted after the arrestment had been served.  In that case the Court held that the arrestment prevailed over the floating charge, not because it was effectually executed diligence, but because the arrestment had rendered the property in question litigious and had restricted the debtor's power to grant a security over that asset.  To add to the mix, a number of leading academics criticised both decisions, arguing that an arrestment which is served prior to crystallisation of a floating charge should be regarded as effectually executed diligence and that to focus instead on the date of registration of the charge was illogical.

The Bill proposes a number of reforms to the law on arrestment, including provision for arrested funds to be released automatically 14 weeks after service of the arrestment i.e. without the need to raise an action of furthcoming.  The automatic release provisions will only apply where the arrestment is in execution of a decree or document of debt.  They will not apply in relation to arrestments on the dependence.  Moreover, if the debtor gives notice of objection to the funds being released or if the arrestment is recalled or if the funds become the subject of an action of multiplepoinding, automatic release will not occur.

The implication of this reform is that an arrestment is effectually executed once the schedule of arrestment has been served.  The automatic release provisions mean that in many cases no further step need be taken by the creditor to "complete" the diligence.  This challenges the rationale of Lord Advocate v Royal Bank of Scotland, which has long been doubted by academics.  However, it will not be until another case comes before the court that any pronouncement to the contrary will be made. These reforms may encourage arresting creditors to litigate this issue afresh.

The story doesn't end there.  Section 61 of the 1986 Act deals with the Receiver's power to sell property subject to, amongst other things, "effectual diligence executed".  The Bill inserts a new section 61(1)(B) which provides:-

            "For the purposes of sub-section (1) above, an arrestment is an effectual diligence only where it is executed before the floating charge… attaches to the property…"

With this provision, the Bill makes clear that the key event determining priority between a floating charge and an arrestment should be the date of crystallisation and not the date of registration of the floating charge.

It should, however, be noted that the position in relation to inhibitions is different and we will look at that in the next bulletin.

The proposed reforms make for a persuasive case that arrestments should in future prevail over floating charges where the arrestments have been served pre-crystallisation.  However, to obtain an authoritive pronouncement to the contrary would require parties to got to the expense of raising a court action.  Receivership has largely been abolished for post-Enterprise Act charges but there remain many floating charges in existence which pre-date the Enterprise Act and there are of course, the various carve-outs set out at sections 72B-72G of 1986 Act.  It is therefore entirely possible that the point will arise in the future.  Rather than deal with some of these difficult issues before the Courts, where the arrestment has been executed within 60 days, it may be prudent to simply proceed to wind the company up to enable the arrestment to be struck down by section 185.

Reforms

On 6 April 2006, the Transfer of Undertakings (Protection of Employment)(“TUPE”) Regulations 2006 come into force, replacing the TUPE Regulations 1981 wholesale.

• Codifying the existing case law rule that TUPE will not apply to an insolvency sale where the purpose is to liquidate the assets of the insolvent entity
  
  The phrase used in the new regulations is “bankruptcy proceedings or any analogous insolvency proceedings which have been instituted with a view to the liquidation of the assets of the transferor” rather than a listing of particular regimes. Regard will have to be had to the substance and reality of the sale in interpreting this. Where the insolvency has as its purpose rescue of the entity or part of it, TUPE will apply.

• Reducing the burden on purchasers of certain insolvent businesses by providing that certain TUPE liabilities shall to be met by the National Insurance Fund
  
  Many insolvent businesses are simply wound up and there is no prospect of saving jobs. The claims of such employees are against the insolvent entity, however, the Government underwrites some of these claims under the Employment Rights Act 1996.
  
  Prior to 6 April 2006, where there was a relevant transfer of an insolvent business, the employment contracts transferred with the business to the transferee and the employees had no preserved claims against the insolvent entity. Similarly, any employees who had been unfairly dismissed before the transfer would look to the transferee to meet their claims. If the level of these TUPE liabilities was substantial, this could be a disincentive to purchase an insolvent business.
  
  The 2006 Regulations provide that any claims which employees would have been able to make against the National Insurance fund under the 1996 Act but for the transfer, can nevertheless be made on that fund, thereby lifting that burden from the transferee. The DTI calculate that additional liabilities will amount to around £6.6million per year. They also calculate that the preservation rate of all insolvencies will increase by 2-3%, affecting around 4,900-7,300 employees, of whom they expect half will retain their jobs with concomitant savings for the taxpayer both in relation to redundancy payments and unemployment.

• Allowing insolvency practitioners to agree changes to the terms of the employees’ contracts of employment in the context of a transfer
  
  Previously, it was not possible to re-negotiate employment contracts to any extent in the context of a transfer, even with the employees’ consent. However, this inflexibility has been changed in the 2006 Regulations, which provide that an IP (or the transferor or transferee) may agree certain permitted variations in the employees’ contracts with employee representatives for the purposes of survival of the business.
  
  The regulations set out procedures which must be followed in entering into such negotiations. These changes should operate in practice to give IPs and those advising in restructuring situations greater flexibility to re-negotiate contractual terms where the business is being prepared for a transfer. There will be time and cost involved in seeking to vary contracts and, in some cases that may present difficulties. However, in other cases, these provisions may make the difference between rescue and failure. In such a case, it is important to ensure that the prescribed procedures are followed, for example arranging for the appointment of specially elected employee representatives where the business has no such representatives in place.

• Introducing a new obligation for the transferor to provide certain information to the transferee regarding the employees
  
  The Regulations provide that a transferor must disclose certain information to the transferee, including the name, age and statutory employment terms of the employees being transferred; details of any statutory grievances and disciplinary action taken in the last two years; and details of any future potential employee claims.
  
  There is a financial penalty for failing to meet this requirement. The penalty will be a minimum of £500 per employee affected. In some cases, IPs will have difficulty in complying with this obligation, however, attempts will have to be made to try to keep down the potential penalties to maximise any potential dividend in the insolvency and avoid criticism.

• Providing that the transferor and transferee shall be jointly and severally liable for any failure to inform and consult with transferring employees
  
  It will be open to the Employment Tribunal to make an award of joint and several liability between the transferor and transferee in respect of any protective awards for failing to inform and consult under TUPE. Such sums could amount to up to 13 weeks pay per employee subject to mitigation. This may be a preferential debt (up to the £800 maximum with the balance being unsecured). If such a liability was imposed it could significantly affect the outcome of insolvency and should thus be borne in mind when negotiating any sale agreement.

Conclusion

The new Regulations introduce some measures which are designed to promote the Rescue Culture. However, these measures are somewhat offset by the prospect of new liabilities for failure to disclose and failure to inform and consult. IPs should be alive both to the greater flexibility which the new Regulations will provide and the need to take prospective liabilities into account in negotiating any sale agreement.

If you require any further information, please contact Gillian Carty on 0131 473 5138 or Joanna Clark on 0131 473 5242.