Theory, Principles and Processes of Insolvency Law

Question 1

What are the 2 kinds of distressed firm?

Answer 1

“economic” distress = operating costs are higher than its income and “financial” distress, =income isn’t enough to pay debts

Question 2

Can a firm have both kinds of distress?

Answer 2

Yes, many firms face financial distress because they are in economic distress.

Question 3

What is the anti-deprivation principle?

Answer 3

A common law rule that an arrangement is void if: (a) it removes an asset that could otherwise be realised for creditor’s benefit (b) The parties to the arrangement intend to deprive creditors of the asset (c) The asset is removed as a direct consequence of the insolvency.

Question 4

Should we allow the “New value exception”?

Answer 4

Traditionalists think bankruptcy law should allow the judge to confirm such a plan even when the firm’s senior creditors want to liquidate the firm as employees keep their jobs, the community keeps its anchor, and the owner-managers keep their dignity. Proceduralists think that courts should think twice before overriding the wishes of the senior creditor who bears the entire costs of the decision.

Question 5

Difference between economic distress and financial distress?

Answer 5

“economic” distress exists regardless of capital structure and it’s when a firm cannot succeed in the marketplace. “financial” distress, meaning the firm’s income is not enough to pay back what it has borrowed.
Financial distress exists only if a firm has creditors. If the creditors disappeared, the problem would disappear and the firm would thrive. Not so for a firm in economic distress: Its assets fail to bring in sufficient revenue, relative to the costs of operating the firm and the alternative ways in which they could be used.

Question 6

What is the pari passu principle?

Answer 6

The pari passu principle means that all unsecured creditors in insolvency processes, such as administration, liquidation and bankruptcy must share equally any available assets of the company or individual, or any proceeds from the sale of any of those assets, in proportion to the debts due to each creditor. Companies can contract out of this principle in advance as it can be varied by agreement.

Question 7

Exceptions to pari pass principle?

Answer 7

Firms can opt out of it as it can be varied by agreement.

Question 8

Do proceduralists allow assets to be removed?

Answer 8

No, proceduralism concentrates on removing bias- creditor should not be able to seize assets and remove them from the firm if doing so will reduce the value of the remaining assets.

Question 9

Proceduralists/traditionalists on who pays for rehabilitation attempt?

Answer 9

Traditionalists think exactly how the costs are being borne is less important than giving the firm a chance to stay alive.
Proceduralists think forces those who make decisions and enjoy the benefits should bear their costs.

Question 10

Do firms in economic distress belong in bankruptcy?

Answer 10

For the proceduralist, if a firm is in economic distress it does not belong in bankruptcy. Traditionalists do not distinguish sharply between economic and financial distress.

Question 11

What is the “New value exception” ?

Answer 11

“New value exception” to the absolute priority rule- should the law allow the contribution of new value to be sufficient to overcome the objection of the creditors.

Question 12

When can a company be wound up by a court?

Answer 12

S122 of The Insolvency Act 1986
(I have a statute book)
A company may be wound up by the court if—
(a) the company has by special resolution resolved that the company be wound up by the court,
(b) being a public company which was registered as such on its original incorporation, the company has not been issued with [a trading certificate under section 761 of the Companies Act 2006 (requirement as to minimum share capital)] 1 and more than a year has expired since it was so registered,
(c) it is an old public company, within the meaning of [Schedule 3 to the Companies Act 2006 (Consequential Amendments, Transitional Provisions and Savings) Order 2009] 2 ,
(d) the company does not commence its business within a year from its incorporation or suspends its business for a whole year,
(f) the company is unable to pay its debts, (fa) at the time at which a moratorium for the company under section 1A comes to an end, no voluntary arrangement approved under Part I has effect in relation to the company.
(g) the court is of the opinion that it is just and equitable that the company should be wound up.
(2) In Scotland, a company which the Court of Session has jurisdiction to wind up may be wound up by the Court if there is subsisting a floating charge over property comprised in the company’s property and undertaking, and the court is satisfied that the security of the creditor entitled to the benefit of the floating charge is in jeopardy.
For this purpose a creditor’s security is deemed to be in jeopardy if the Court is satisfied that events have occurred or are about to occur which render it unreasonable in the creditor’s interests that the company should retain power to dispose of the property which is subject to the floating charge.

Question 13

Should we distinguish between firms in economic distress and financial distress?

Answer 13

Yes, I think it should because a firm that’s financially distressed can be rescued as a going concern.

Question 14

Why do we have the pari passu principle?

Answer 14

It prevents an individual creditor from obtaining an unfair advantage over the general body of creditors

Question 15

Full name of BNY Case

Answer 15

Belmont Park Investments v BNY Corporate Trustee Services

Question 16

What consequences does insolvency have for a company?

Answer 16

• Rescue package / new funding
• CVA / an arrangement with creditors
• Liquidation
• Admiistratio

Question 17

Why do we need insolvency procedures? Why not just make do with a law of individual debt enforcement (i.e. diligence)?

Answer 17

If we didn’t have insolvency procedures, we’d have no ranking system, and debts would be enforced on a first-come-first-served basis. Insolvency procedures ensure that the interests of one creditor are not enforced to the detriment of other creditors. Furthermore, if debts were enforced on a first-come-first-served basis, it would encourage creditors to enforce debts earlier, when the company would otherwise survive.

Question 18

What functions are performed by insolvency law?

Answer 18

distribution, conflict resolution and prevention (Gessner et al)

Question 19

Does insolvency law make sure creditors are treated equally?

Answer 19

The pari passu principle doesn’t ensure equality between creditors, but rather equality between those in the same class.
It doesn’t ensure fairness- a large institutional investor with a small secured debt is more protected than a sole trader with a large, unsecured debt, although the institutional investor would likely be unaffected by the loss, while it could destroy the business of the sole investor. There’s an argument that we owe a moral duty to protect the vulnerable (Goodin).

Question 20

Can a firm in economic distress be saved?

Answer 20

No, its assets fail to bring in sufficient revenue, relative to the costs of operating the firm and the alternative ways in which they could be used. A firm in financial distress’s problems would disappear if its creditors did.

Question 21

What are the exceptions to the anti-depravation principle?

Answer 21

• Where there was no intention to defraud

Question 22

Function of distribution in bankruptcy law?

Answer 22

Gessner et al- allowing “equal satisfaction” of all creditors.

Question 23

Belmont Park Investments PTY Limited v BNY Corporate Trustee Services Limited on anti-depravation rule?

Answer 23

where sophisticated commercial parties had entered into an arrangement in good faith, the courts should be slow to invalidate the bargain which had been struck and should consider the application of the Rule on a case by case basis. (as it only applies to deliberate intentional attempts)

Question 24

My comment on Belmont Park Investments PTY Limited v BNY Corporate Trustee Services Limited on anti-depravation rule

Answer 24

The approach of the Supreme Court in this appeal reflects the desire of the courts, as far as possible, to give effect to contractual terms agreed between parties. In particular, the terms of Lord Collins’ judgment rests heavily on the commercial context and sophistication of the parties to the Programme. In this regard, there remains scope for argument that the application of the Rule may have a different outcome where the parties in question are not sophisticated financial investors or institutions.

Question 25

Goode on pari passu

Answer 25

Describes it as a ‘theory’

Question 26

How do traditionalists see rehabilitation?

Answer 26

Rehabilitation is a good thing in itself, but must be balanced against other interests, including creditors rights. Giving a debtor additional time to create a plan of reorganization is a good idea if there is a reasonable chance that a confirmable plan can be created.How the costs are being borne is less important than giving the firm a chance to stay alive.