Where lenders rely on floating charge security to make recoveries from companies in administration, some recent cases have massively increased the potential for administration expenses to swallow up those recoveries. The more well-known cases could just be the start. So, what are the potential risks? What can lenders do in the face of the law as it currently stands? What is going to happen next?

The Nortel decisions

 Administration expenses have super-priority in an administration. They are payable out of floating charge realisations ahead of the administrators’ own remuneration (amongst other things). The potential for unforeseen administration expenses to slash the expected returns for a lender under its floating charge is obvious. Two important judicial rulings on administration expenses delivered in the past year, both arising from the Nortel administration, have increased their scope.

Firstly, in Goldacre (Offices) Ltd v. Nortel Networks UK Ltd (in administration) [2009] EWHC 3389 (Ch), the High Court held that, if the administrator causes the company to use leasehold property, the rent that falls due under the lease is an administration expense. The administrator must pay the full rent, even if the company in administration only uses part of the leasehold property.

The Scottish Court of Session (which although not binding on English courts is of highly persuasive value) extended the scope of the ruling in Goldacre in Cheshire West and another, in the administration of Springfield Retail Ltd [2010] CSOH 115. It now covers the situation where an administrator grants a licence over a leasehold property to the buyer of the company's business and assets, awaiting a formal assignment of the lease (a standard arrangement). If the buyer fails to meet the rental payments, the landlord can claim the unpaid rent as an expense of the administration.

Secondly, in Bloom & Ors v. The Pensions Regulator (Nortel, Re) [2010] EWHC 3010 (Ch), in December 2010 the High Court held that the cost of complying with a financial support direction issued by the Pensions Regulator against a company after it had entered administration was an expense. The court reached that conclusion by analogy with the position of corporation tax. Corporation tax arising from post-administration disposals has long been an administration expense following the House of Lords decision in Re Toshoku Finance (UK) plc (in liquidation) [2002] 1 WLR 671. The financial support direction issued in respect of the deficit in the UK pension plan of Nortel amounts to an administration expense of more than £2.1 billion.

Potential contagion

The decision in the second Nortel case as it stands means that every statutory liability ranks as a potential administration expense. So administration expenses could include penalties under health and safety legislation, environmental liabilities, EU competition fines and employment compensation liabilities. It is unlikely that contingency planning for any administration started before December 2010 would have assessed such liabilities as a potential drain on floating charge realisations.

The present

What can lenders do in the face of the current uncertainty? Where an administration is already in progress, the short answer is “very little”. An administrator would be unlikely to distribute any floating charge realisations to a lender without a promise to hand back the money should an expense claim wipe out those realisations. In relation to financial support directions in particular, the Pensions Regulator has pledged to be “reasonable” when imposing a potential administration expense, but floating charge creditors can draw little practical comfort from this.

Nortel might simply mean that lenders shy away from lending to groups which have a defined benefit pension scheme. More generally, the decision could lead to a concerted effort by lenders to ensure that their standard debenture security captures as many assets of the company as possible under the fixed charge.

The future Is this the end of the floating charge as a tool to recover value for a lender? After all, irrespective of Nortel, in many current administration cases the floating charge is merely a gateway to the appointment of administrators, rather than being key to a recovery strategy. This is particularly relevant in cases involving portfolios of real estate but little in the way of book debts or stock turning over.

If Nortel remains good law and its scope continues to expand to include further statutory liabilities as an expense, perhaps so. However, the Court of Appeal will consider Nortel this spring and it is likely to visit the Supreme Court after that. Meanwhile, the Insolvency Service is considering an approach to the Government to clarify the current legislation. It intends to consult on the following changes:

  • Liabilities imposed by the Pensions Regulator would (under pensions legislation) be deemed to be ordinary unsecured debts and not administration expenses (with retrospective effect).
  • Amendment of the Insolvency Rules to clarify and limit the scope of administration expenses (effectively reversing Toshoku, although without retrospective effect).

However, either change could take the best part of a year to take effect. The Government is likely to allow Nortel to progress through the courts first to avoid influencing the outcome. So, for some time yet, the true value of the floating charge to lenders will remain uncertain at best.

Law stated as at 22 February 2011.