Case Study: US-based unsecured creditor proactively protects its position and recoveries from the liquidation of its UK distributor
When a company enters into an insolvency process in the UK, the position of unsecured creditors is typically one of uncertainty. Ranking fifth1 in the insolvency payment waterfall, unsecured creditors frequently find themselves out of the money. Even in cases where there are sufficient realizations to make a distribution to unsecured creditors, they may receive only a minimal amount in respect of their outstanding debts.
Our specialist restructuring team in Manchester has recently advised a number of international corporate clients operating in the consumables sector, whose UK distributors have been challenged by the sharp depreciation of the pound which followed the UK's decision to leave the European Union, to such an extent, that they have entered creditors' voluntary liquidation (CVL). The clients, in all cases, were unsecured creditors with substantial debts owed to them.
This article presents a short case summary of one of the referrals, in which the client was able to leverage its position as the majority unsecured creditor and by using protective provisions under the new insolvency rules, to procure the appointment of its preferred liquidators and the swift return of goods which it continued to own.
The New Rules - deemed consent and the objections threshold
New insolvency rules came into force in England and Wales on April 6, 2017 (the New Rules). One of the changes brought about by the New Rules is the abolition of physical creditors' meetings as the default method for decision making in the context of insolvency procedures. This has, in turn, redefined the process by which the directors of a company are required to seek creditors' approval of the insolvency practitioners whom they propose should act as liquidators of the company.
The New Rules provide two methods by which a company may now seek creditors' views on the identity of the proposed liquidator. However, in practice, companies are more likely to use the so-called, "deemed consent" procedure. This provides that unless at least 10 percent of the relevant creditors by value2 object (the objections threshold), the creditors are deemed to have consented to the appointment of the directors' proposed nominee(s) to act as liquidator(s).
Client case study
The client, a leading US and Canadian manufacturer and marketer of consumer products sought advice in respect of its sole UK distributor, which had accrued substantial unsecured arrears and engaged a firm of insolvency practitioners to liquidate the company.
The client had three principal concerns. First, it wanted to know how the company had amassed such substantial arrears and sought to understand why it had not been alerted sooner to the company's deteriorating financial position. Importantly, the client had real concerns that, in addition to the impact of the current economic and political climate, the directors of the company may have been misappropriating the company's assets.
Second, before receipt of the notice, the client had been working with the company to agree a repayment plan. The receipt of notice of the liquidation was unexpected, and the client wanted to understand why the company had decided to enter into CVL notwithstanding that repayment negotiations had been progressing.
Finally, the client's biggest concern was retrieving branded stock which it had supplied and which remained in the company's possession. The client was keen to prevent the stock being marketed at a discount, thereby potentially damaging its brand.
At first blush, the client's position as an unsecured creditor did not appear to provide many solutions to address its concerns.
The notice of liquidation sought the creditors' decision in respect of the appointment of the company's preferred liquidators by way of the deemed consent procedure. Following review of the directors' statement of affairs, received shortly after the notice, the client's status as majority unsecured creditor became apparent (with the client's debt representing circa. 80 percent of the company's total debt). This provided the client with an opportunity to lodge a proof of debt and notice that it objected to appointment of the proposed liquidators and to request that a physical meeting of the company's creditors be convened.3 The opportunity to requisition and attend a physical meeting of creditors (removed as a matter of course under the New Rules), provided the client with the platform to put probing questions to the directors of the company in order to ascertain when and why the company fell into financial difficulties and why, given the previous repayment negotiations, the company felt that entering into CVL was its only option.
At the physical meeting, the client was also able to use its majority vote to procure the appointment of its preferred liquidators who, it was satisfied, would undertake an objective and rigorous review of the company's dealings to identify whether any assets had been misappropriated and to determine the extent to which poor management may have contributed to the company's financial deterioration. The client was also able to work quickly with the newly appointed liquidators to evidence its title to the unsold stock that remained in the company's possession and secure its swift return.
Faced with the initial prospect of receiving a minimal dividend for the substantial arrears owed, the loss of its sole UK distributor, a loss of stock and the potential of its brand being negatively impacted with no satisfactory explanation as to the circumstances surrounding the company's insolvency, the client's position had looked bleak. However, the client, as the majority unsecured creditor, was able to use the New Rules to its advantage so as to maximize its recovery in the liquidation by calling for a physical meeting with the directors of the company and influencing the appointment of its preferred liquidators. As a result, the client was able to remove some of the uncertainty it had initially faced.
As the UK continues to negotiate the terms on which it will exit the EU, the uncertainty of what this means for both UK domestic companies and international companies doing business in the UK is palpable. The fact that UK economic growth is lagging behind that of the Eurozone nations suggests that the worst is yet to come.
If the value of the pound relative to the US dollar and euro remains depressed, there is likely to be an increase in those UK companies that are part of global integrated supply chains entering into insolvency processes as they buckle under ever-tightening margins and increasing financial pressures.
A creditor faced with the potential failure of a key supplier or distributor will ideally seek advice at an early stage and take immediate steps to protect its position. However liquidation can come swiftly and unexpectedly. In order to maximize its recovery, an unsecured creditor should consider the following steps upon receipt of a notice to creditors of the proposed liquidation of a company:
- Seek immediate UK insolvency advice to understand the impact of the company's proposed insolvency on the unsecured creditor's business
- Analyze the insolvent company's financial profile, as soon as possible - in particular the likely overall unsecured debt position to the extent that this is known or can be ascertained
- Upon receipt, analyze the directors' statement of affairs to establish the percentage of total debt owed to the unsecured creditor and determine whether the objection threshold has been met
- Complete and deliver a timely proof of debt and, if desirable, a notice of objection seeking nomination of the unsecured creditor's proposed liquidators