Stuart Gardner, a Director at EY in Transaction Advisory Services, and David Jones, Counsel at Carey Olsen, writing on behalf of the Guernsey Investment Fund Association, look at Guernsey’s role as a centre for restructuring and insolvency.[I]
Importance of a robust insolvency regime
The World Bank’s Ease of doing Business Index1 quite simply measures the ease of doing business in 190 jurisdictions. It takes the mean of 10 subindices to benchmark those jurisdictions. Three of those indices measure the quality of the insolvency regime including protecting investors, enforcing contracts and resolving insolvency. Given that 30% of the index relates to enforcing stakeholder rights, it is clear that the World Bank attaches significant importance to this.
Just last year in November 2016, the EU proposed a new insolvency directive. Its reasons for so doing were stated in its press release2: “Many investors mention uncertainty over insolvency rules or the risk of lengthy or complex insolvency procedures in another country as a main reason for not investing or not entering into a business relationship outside their own country.” That same press release noted that there are 600 corporate bankruptcies every day in the EU.
It is clear from these two brief examples from the World Bank and the EU, that for those involved with structuring transactions and financing investment vehicles, insolvency regimes matter.
From a Guernsey perspective, as at 30 June 2017, there were over 800 Guernsey domiciled closed and open ended investment schemes, with a net asset value in excess of £211 billion3. The geographic location of assets held in these schemes spans the globe, from the UK and the US to Australia, South Africa and China4.
Given this geographical reach and its pre-eminence as an international finance centre, it is axiomatic that Guernsey has a well-developed and sophisticated insolvency regime. It does. This regime allows stakeholders to access the courts to maximise value in an efficient, orderly and controlled manner.
This article outlines market trends and some of the tools available to stakeholders in Guernsey in distressed situations.
The sale of non-performing loans (NPLs) has been a significant trend in recent years as Europe has deleveraged following the financial crisis. To 31 March 2017, UK Asset Resolution Limited has reduced its balance sheet by £81 billion since its formation in 2010.5
As at the end of September 2016, banks directly supervised by the European Central Bank (ECB) held €921 billion of NPLs.6 A keynote speech7 from the Vice-President of the ECB in February 2017 noted that ‘inefficient and uncertain debt enforcement frameworks’ were one of the impediments to Europe resolving these NPLs, and further noted that, ‘on the demand side, investors are also deterred by high uncertainty around recoveries and their timing.’ 8
Many NPLs are structured through Guernsey, via Guernsey companies or funds holding, for example, European real estate assets. Guernsey has proved itself as a robust jurisdiction for enforcing debt and lenders can take comfort that the considerations highlighted by the ECB should not be an impediment to enforcing in the Island.
Guernsey’s insolvency regime
The island has a well-established and tested insolvency regime contained in Parts XXI to XXIV of the Companies (Guernsey) Law, 2008 as amended (the Law), which set out Guernsey’s laws relating to corporate insolvency.
The Law includes the concept of the statutory ‘solvency test’ which is key to understanding the insolvency process. A company satisfies this solvency test if:
- it is able to pay its debts as they become due (known as the ‘cash flow test’); and
- the value of the company’s assets is greater than the value of its liabilities (known as the ‘balance sheet test’).
A company must pass both limbs of this solvency test to be deemed solvent.
Types of corporate insolvency proceedings
An administration order can be made by the Court for the purpose of achieving either:
- the survival of the company and the whole or any part of its undertaking as a going concern: or
- a more advantageous realisation of the company's assets than would occur in a winding up.
The Court also must be satisfied that the company does not satisfy, or is likely to become unable to satisfy, the solvency test as described above.
The main effect of an initial application for an administration order is the implementation of a court sanctioned moratorium against resolutions for the winding up of a company and the commencement (or continuance) of proceedings against it (without leave of the Court), during the period between the presentation of the application and the making of the actual administration order.
The granting of the administration order itself provides the company with the continued benefit of this moratorium. Fundamentally the rights of secured creditors are not affected by the administration moratorium in Guernsey. Moreover, secured creditors often make applications for an administration order.
The making of the administration order facilitates the appointment of an officeholder, proposed by the applicant and approved by the Court, who displaces the directors and manages the company’s affairs. The office holder has wide powers to inter alia trade the business to the benefit of the creditors.
If a stakeholder of a company, or the company itself, is looking to continue trading (or in the case of real estate assets continuing leasing arrangements or undertaking capital expenditure / development prior to sale), or to reach accommodations with the company’s creditors, an administration order is the most appropriate insolvency process as it affords the office holder flexibility to rescue the business or otherwise maximise value.
The Court may order a compulsory liquidation of a company and appoint a liquidator on application by, amongst others, a creditor. The liquidator's role is to collect and realise the company's assets and to distribute dividends according to a statutory order of priority. The Court also has the ability to appoint a provisional liquidator.
Liquidation can offer a more direct and efficient route to control of a company or its assets where, for example, the enforcement strategy focusses on realising underlying assets quickly.
Alternative enforcement methods
The Security Interest (Guernsey) Law, 1993 (the ‘Security Interests Law’) governs the taking and enforcement of security in Guernsey.
It is common for a security agreement to create security interests over shares and rights attaching to those shares by both ‘possessory security’ and ‘title security’. The security rights are normally held by a security agent. The rights will often include remedies for the agent beyond a mere power of sale and will include an attorney right in favour of the security agent. Those rights may, in certain circumstances, be used to displace the boards of asset owning vehicles or otherwise enforce security through taking possession of shares and / or the exercise of voting rights.
On 9 February 2017, indicative of Guernsey’s commitment to ensuring a modern and fully functioning insolvency framework and following an extensive consultation period, Guernsey's Committee for Economic Development recommended the enactment of amendments to Guernsey's existing insolvency laws.
At the end of March 2017, Guernsey's legislative body directed that legislation necessary to give effect to the reforms should be drafted. The draft is expected in late 2017. The reforms envisaged include:
- the creation of a basic set of insolvency rules covering those key procedural issues not currently legislated for;
- the ability to end an administration by dissolution. The current system requires liquidation if a company cannot be rescued;
- the expansion of office holders' investigatory powers; and
- the introduction of statutory provisions dealing with transactions at undervalue.
The combined effect of the revised legislation will be to increase the robustness and clarity in the current, well developed system.
Guernsey's insolvency regime has already been utilised in a number of significant enforcements of NPLs and other complex financing arrangements in respect of real estate assets. The laws are effective and the Court system nimble enough to deal with complexity but still reliable for creditors. The proposed reforms will build on Guernsey's existing reputation as a reliable insolvency jurisdiction.