The latest trans-atlantic row between two of the world’s biggest economies has been sparked by the vastly different philosophies between the way the US and the UK deal with business failures.
On one side of the Atlantic, there is Chapter 11 bankruptcy protection.
This is a debtor-led operation where a troubled company’s management remains in possession of the company and continues to control the business. The endangered company’s board restructures the company and its debt, and remains protected from creditors.
On the other side, we have UK administration. Here, the creditor is in possession of the company and appoints an administrator to run the business and restructure or sell it. The company’s former management helps the administrator, but is not in control of the company, and can even get disqualified if found negligent.
The differences between the two processes are clear: one relies on the debtor, while the other relies on a third party to deal with the business in the best interests of the creditor. But with the greater globalisation of companies, America’s Chapter 11 and UK administration have been brought together, with sometimes surprising and often explosive consequences.
Insolvency practitioners are worried about the possible consequences of UK companies that opt for Chapter 11, particularly as some US law firms are championing it as the ‘new tool for M&A and restructuring European companies’.
Gibson Dunn & Crutcher LLP, which runs workshops on US bankruptcy protection, states that: ‘In the wake of numerous highly-publicised “mega-filings” for Chapter 11, it has become clear that (the procedure) is a powerful tool also available to European companies.’
Wayne McArdle, a London partner in the firm, admits the procedure only works ‘when there is sufficient nexus with the US jurisdiction, and it only helps when the creditors outside the US are concerned of the potential danger of breaching the US court order and being in contempt’.
‘It will not work if the lessor is here and has no presence in the US. The whole point of Chapter 11 is to make creditors comply with the restructuring plan,’ he says.
And this is where UK practitioners’ fears come in. Not only are they afraid of losing business to the US, but also the raft of problems created by the fundamental differences between a creditor-led and a debtor-led process.
Simon Freakley, global head of corporate restructuring at turnaround specialists Kroll, says a company teetering on the brink of insolvency could find itself in more difficulty if it fails to get consent from all creditors to restructure the American way.
‘By-and-large, it can be a spoiling tactic. Ultimately UK creditors will take remedial action to get their money back. The only way to take this action appropriately is when most creditors are American,’ he says.
Shipping company Cenargo offers an example of the problems UK companies could face that go down the Chapter 11 road. It set up a bank account in the US, and promptly filed for Chapter 11 without an agreement from its main creditor Lombard.
As a result, Lombard hired Ernst & Young to reclaim its investment, which, in the interest of its client, put Cenargo into administration. This breaks US Chapter 11 bankruptcy protection laws, and the Big Four firm and Lombard are now being sued for contempt by the US courts.
The Cenargo case is one that illustrates the prospective problems and the great tension Chapter 11 can cause across the channel. It has thrown up a wealth of complications, which E&Y’s lawyer, Mark Andrews of Denton Wilde Sapte, describes as a ‘mess’.
The procedure is not always in the best interest of the company either.
Andrews says Chapter 11 can be ‘slow and massively expensive. Every interest group has to have its own adviser to look after its interests and the company pays for all of them’. Andrews advises those companies considering the US route to be extremely cautious.
One industry where Chapter 11 could work is telecoms, as many of the companies are multi-jurisdictional and have creditors on both sides of the Atlantic. But there are fears among UK insolvency experts that specialise in this field, that troubled UK telecom companies will turn to Chapter 11 rather than administration.
Nitin Joshi, insolvency partner at PKF, says: ‘In the telecoms industry there is a lively debate about this because a lot of companies have interests in the US and have creditors there.’
The insolvencies of Federal Mogul and Budget Rent-a-Car International are examples of how both these processes can work well together. US company Federal Mogul went into Chapter 11 to help resolve asbestos-related lawsuits that threatened to bring the company down.
One of Federal Mogul’s largest subsidiaries, Turner and Newall, whose workers were also suing for compensation, went into administration in the UK. Although the case is not entirely resolved, Kroll recently won a victory after a UK court ordered insurance companies Royal & Sun Alliance and Lloyds to cover employees’ insurance claims for 1972 to 1995.
The Budget Rent-a-Car case is another example of how both procedures can work together, according to experts. The company’s international subsidiary was put into administration after its US parent went into Chapter 11.
The administration allowed Kroll to sell certain assets to competitor Avis, setting a legal precedent.
But in both cases, the companies were US-based and went into administration in the UK at the same time as they entered Chapter 11 in the US. Getting UK creditors to agree to restructuring its debtor under Chapter 11 might be more difficult.
As Joshi says, there is a ‘natural resistance to allow UK companies to go into Chapter 11. (The UK) has various tools that the US does not’.