How the Enterprise Act affects entrepreneurs
We assess the Act that brought us pre-packers, phoenix companies and ransom creditors
The Enterprise Act received Royal Assent in 2002, introducing softer rules for business insolvency. As administrators enjoy their busiest period in years, we assess whether the government got it right and how the law affects entrepreneurs
There’s a lot of talk about the UK becoming an ‘entrepreneurial society’, but for many business owners that’s all it is. Politicians provide a lot of hot air, they say, but in practice they fall short of making the big decisions. The Enterprise Act was one of those occasions when Parliamentarians had a chance to make a difference to the way businesses operate, and perhaps to change perceptions and culture too. The act had a number of purposes, such as formalising the Office of Fair Trading, but for entrepreneurs it was changes to the laws on insolvency that are the most significant. Previously, a debtor business unable to pay its dues would end up in court, placed into administration, often leading to liquidation – a sale of assets and the business would cease to be. The tax authorities, often responsible for the court hearing in the first place, would invoke ‘Crown Preference’ and take what it could from the money produced by the sale. However, this rarely amounted to much and the Official Receiver’s office was often more like a graveyard than a place to sell a business. Secured creditors, like the banks, took their share from the securities, while the rest of the creditors were left to fight over the scraps, if there were any. Bankruptcy was hated, the bankrupts stigmatised and, it was felt, that a fear of failure dissuaded some from starting up in the first place. This was hardly a climate for entrepreneurs, it was argued. RIGHTING WRONGS The Enterprise Act was meant to change this and there’s little doubt that the law has made a difference. For a start, Crown Preference was abolished and the private sector can deal with the failing company’s assets, maximising value. Secondly, administrators are obliged, if possible, to save the company, avoid liquidations and so preserve jobs. If the company is liquidated and the assets are sold off, administrators are obliged to act in the interests of the creditors and get the most they can for them. Also, unsecured creditors are much more likely to get some of their money back, as a pot is now put aside specifically for them. So at first glance the new act appears to have righted several wrongs. However, as the country’s economy retracts, there is concern that administration is just too easy. One consequence of the law, which has drawn a lot of attention, is the rise in pre-pack (PP) administrations, where a business rapidly goes in and out of administration and emerges free of debt – in some cases with the same owner. Asher Miller, an insolvency practitioner (IP) at David Rubin & Partners, explains: “The ability to do a PP has always been there, but the process has become easier. Before, you needed a hearing. Now you simply lodge some forms at the court and the business is in administration.” PHOENIX COMPANIES So a director could, in theory, lodge his papers at the court and then buy back the business on the same day, leaving his creditors high and dry. Miller says this isn’t the norm and that IPs have an obligation to the creditors to get value for the business. He’s also sceptical of the idea that businesses would look upon administration as anything but a dreadful situation: “It’s far fetched to say a director drives businesses into the ground so they can come to an insolvency practitioner,” he says. “When you see them, they’re distraught, often have their houses on the line and are frequently ill-advised to buy back their own businesses.” Michael Tinling, a commercial lawyer at Barlow Robbins, agrees that ‘phoenix companies’ aren’t the norm, but admits that there are likely to be occasional cases of abuse. “My overall view of PPs is that they are a good thing, but they contain certain problems,” he says. “In practice I think they work well, particularly when you have the directors saying: ‘We have to do something or we will go under’.” However, for the creditor to see a debtor business go in and out of insolvency is a galling prospect if they aren’t going to get paid. Also, for most, they know nothing until a letter arrives from an IP telling them the business has collapsed. “I think there’s frustration at the lack of transparency,” says Tinling. “The first they know is when the administrator tells them and then they have little choice but to rubber stamp the decision.” There is a tendency towards secrecy and sensitivity to avoid the business becoming tainted and its goodwill evaporating. This places IPs in a tricky situation as they must try to sell the distressed company. “Marketing the business properly doesn’t necessarily entail telling the creditors. The most likely buyers for the business are the competitors and we need to be very discrete when doing this,” Miller says. Fears over transparency and allegations of abuse have led to new rules (SIP 16) being introduced to ensure administrators provide more information to creditors when they do a deal (for more details visit www.insolvency.gov.uk). These rules mean that you will know who the new owner is and how much money exchanged hands, making it clear that the IP’s job is to get value for the creditors. RANSOM CREDITORS In reality, it’s unlikely that you are going to challenge an IP unless you are very sure that they have done something dodgy. So if you find yourself in the position where you are owed money, what should you do? Richard Horsman, chief executive of telematics business Cybit, has purchased businesses from administrators and has met disgruntled suppliers as a result. “We bought a technology company and one of its suppliers said that unless we paid them what was owed they wouldn’t trade with us,” he explains. “It was too difficult to stop trading with them so we agreed.” Horsman adds that if you are acquiring a business, it’s something you must factor in to your calculations. However, if you are considering being a ‘ransom creditor’, make sure you have enough leverage. In Horsman’s example, the supplier company had hosting technology which they couldn’t do without. But if you aren’t irreplaceable, you will need to tread more softly or just accept your loss. HAS THE ENTERPRISE ACT BEEN GOOD FOR BUSINESS? Critics argue that by softening the rules on insolvency we could be in danger of creating a cascade effect, with one insolvency leading to another. Indeed, by virtue of the fact that the rules on administration were tightened up, this was a concern. However, on the whole, some sensible changes have been made – the abolition of Crown Preference being one. Doubtless there have been and will be some abusers of the law. How many is difficult to predict, but whenever a business collapses, creditors will always be annoyed, regardless of the surrounding legislation. But has it created an entrepreneurial society? Certainly it will take more than one piece of legislation to do that. But we are now in a unique period when perfectly good businesses are going to the wall due to the lack of bank finance. Overall, the Enterprise Act enables more of them to be saved than would have been previously.