• Consultation ends September 7 2009
  • Likely to re-ignite controversy over 'pre-pack' administrations

New proposals by the Government to improve access to rescue finance for small companies would allow larger or complex businesses to make private applications to the courts for an "administration-type" regime without creditors necessarily knowing. Proposals in the same consultation on lending to insolvent companies could drive up the cost of borrowing, says Reynolds Porter Chamberlain LLP (RPC), the City law firm.

Under proposals put forward by the Insolvency Service the rights of existing lenders to security over borrowers' assets could be overridden to make it easy for distressed companies to obtain rescue finance from other lenders.[1]

The Insolvency service is also suggesting that companies should be able to make private applications to the court for a moratorium from their debts without the knowledge of existing creditors.

According to RPC, both of these proposals could leave creditors exposed to greater risk and could increase the cost of borrowing as a result.

Vivien Tyrell, Restructuring and Insolvency Partner at RPC, comments: "It is essential that all creditors are aware of attempts by debtors to enter administration or similar proceedings. Allowing larger and complex distressed businesses to apply in private for a moratorium of 42 days on their debts runs the risk of some creditors failing to come forward and participate in the distribution of a company's assets through a company voluntary arrangement."

"This is a surprising proposal given the controversy over 'pre-pack' sales. Under a 'pre-pack, the business of a distressed company can be sold to existing management while having some of their debts written off, sometimes leaving certain creditors isolated and unpaid while others get some of their money back and are involved in the ongoing business. Creditors are likely to regard any moves towards private court hearings as an unwelcome continuation of this trend."

Proposals to improve access to rescue finance could drive up the cost of lending to SMEs

Companies in a company voluntary arrangement (CVA) or administration often find it difficult to raise finance when they cannot use their assets as security because existing loans are already secured against those assets. The consultation proposes that the security of existing loans over assets could be overridden to make the provision of finance to insolvent companies more attractive to new lenders.

Vivien Tyrell, Restructuring and Insolvency Partner at RPC comments: "The Insolvency Service recognises that giving priority to post insolvency lenders may increase the cost of borrowing overall, but the proposed solution of letting the court hold the ring between competing interests of pre and post insolvency lenders looks doubtful. It seems inevitable that there will be increased borrowing costs as lenders try to offset the risk that their security will be diluted in the event a customer goes into a CVA or administration."

"The current difficulty accessing finance is already creating serious cashflow problems for many businesses. Any legislative changes that make banks more reluctant to lend to businesses or lend at a higher rate of interest could make the situation worse, which would be somewhat ironic considering the purpose of this exercise is to help businesses stay afloat."