The Coming Revolution in U.K. Insolvency Law Part II

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Jun 2003

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Editor's Note:Part I of this article appeared in the April 2003 issue, Vol. XXII, No. 3.

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The new U.K. Enterprise Act will shortly bring with it several unprecedented changes in U.K. insolvency practice.
Portions of the Enterprise Act have already become effective, and the major portions of the new legislation, apart
from some specific provisions relating to insolvency measures, will become effective this month.

The Act will effectively eliminate the private (i.e., out-of-court) receivership remedy. This is a seismic shift for the
country that invented and perfected the concept of privately appointed receivers. The U.K. government concluded
that receivership was no longer the preferred remedy in cases of insolvency because it tended to hand effective
control of insolvency proceedings to a single secured creditor. The elimination of private receiverships is intended to
favor the administration process. (Administration has no counterpart in U.S. or Canadian practice and involves the
court appointment of an insolvency practitioner to operate the business of a debtor company while restructuring
arrangements are negotiated.) The government viewed administration as a more balanced approach to insolvency
proceedings because it reflects the interest of a wider group of creditors.

The second revolutionary change involves no less than the elimination of government priority claims in bankruptcy
proceedings. This is, again, a most remarkable change for a nation that many consider to have perfected the concept
several centuries ago. Under the new legislation, governmental claims for taxes and social security contributions
will no longer have priority over other creditors. This change is intended to benefit unsecured creditors who often
receive little or nothing in a bankruptcy or receivership.

In another change in long-established U.K. practice, a carve-out will be created for the benefit of unsecured creditors
from realizations by secured creditors holding floating charge security. The amount of the carve-out will be fixed by
statutory regulation and is likely to be in the 10-15 percent range. It should be noted that secured creditors with
deficiency claims will not be able to participate in the carve-out for their deficiency claims.

These are very significant changes. In a sense, the new system has eliminated the priority of governmental claims so
that more assets can be made available for unsecured creditors. To ensure that secured creditors holding floating
charges do not intercept these benefits, the new Act creates the carve-out so that the benefit of the abolition of
governmental priority claims flows through to ordinary unsecured creditors. There may be some rough justice in all
of this, and only time will tell whether the economic impact of the changes is more "rough" or more "just." It will
probably depend on your point of view!

Authors' Note: Readers who are interested in the U.K. Enterprise Act can find it at <a href="http://www2.dti.gov.uk/enterpriseact/">http://www2.dti.gov.uk/enterpris…;.
(The Act is a major piece of legislation, and only some portions of it deal with insolvency matters: the insolvency
provisions are at Part 10 of the Act). The International Scene will keep readers of the Journal apprised of
developments under this remarkable new English legislation.

<h3>Court-to-court Communications: The ALI Guidelines Get Another Boost</h3>

Readers of The International Scene will be familiar with the Guidelines for Court-to-Court Communications in
Cross-border Cases that were developed by the American Law Institute's (ALI) Transnational Insolvency Project.
The guidelines have been recently adopted in yet another Canada-U.S. cross-border insolvency case, Re Systech
Retail Systems Corp.

As most readers will know, ALI is a prominent association of leading U.S. judges, lawyers and academics, and
includes a growing number of international members. The ALI is probably best known for its Restatement series of
analyses of U.S. law and practice, which are regarded as authoritative statements of the law and are widely cited and
relied upon in U.S. practice.

The ALI's Transnational Insolvency Project involved a study of the insolvency systems and procedures of the
United States, Canada and Mexico. Part of the Project's work was the development of the Guidelines for
Court-to-court Communications in Cross-border Cases, which were intended to facilitate communications between
administrations in cross-border cases. The Guidelines formed part of the statement of principles that was formally
approved by the ALI's membership at its 77th Annual Meeting in 2000. The Guidelines have now been translated
into French, Portuguese, German, Italian, Korean and Spanish (and these translations are available from either of the
authors for interested readers).

Systech involved a number of interrelated companies that provided "retail point-of-sale services" in North America.
The ultimate parent of all the companies was an Ontario corporation, but the companies' principal place of business
was in Raleigh, N.C. The Systech companies eventually filed for protection under U.S. chapter 11 in Raleigh on
Jan. 13, 2003, and a day later under the Companies' Creditors Arrangement Act in Toronto. The Guidelines were
incorporated into a cross-border insolvency protocol, which was approved by Mr. Justice J.D. Ground of the Ontario
Superior Court of Justice on Jan. 20, 2003, and by Hon. A. Thomas Small of the U.S. Bankruptcy Court for the
Eastern District of North Carolina on Jan. 30, 2003. The proceedings in Systech were also notable for featuring a
joint hearing between the U.S. Bankruptcy Court and the Canadian court (Mr. Justice J.M. Farley), held in
accordance with the Guidelines, which resolved and coordinated a number of cross-border issues in the case. The

Systech case is another valuable example of the growing use and acceptance of the Guidelines, and we anticipate that
this trend will continue. See In re Systech Retail Systems (USA) Inc., Case No. 03-00142-5 ATS (Bankr. E.D.N.C.)
(Hon. A. Thomas Small) and Re Systech Retail Systems Corp., Case No. 03-CL-4836 (Ontario Superior Court of
Justice, Toronto) (Mr. Justice James M. Farley).

<h3>A Call for International Cooperation from the Third Circuit</h3>

The Third Circuit has issued a remarkable judicial call for cooperation and coordination in international
bankruptcy cases. The decision emerged from the acrimonious litigation in the two-country reorganization
of Lernout & Hauspie Speech Products N.V. in the United States and Belgium. L&H had filed under
chapter 11 in Delaware, but had also filed a second plenary insolvency proceeding a day later in Belgium.
Conflicts inevitably arose as to the ranking of claims in the chapter 11 proceeding, including a contentious
issue as to whether stockholder claims should be subordinated (under §510(b) of the U.S. Bankruptcy Code)
or treated as ordinary claims (as under Belgian law). The Third Circuit ultimately remanded the case to the
bankruptcy court for further determination, but in the course of its decision issued a remarkable exhortation
to international cooperation in very strong terms:

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Situations such as this call out for coordination of the two plenary proceedings. The parties have alluded to,
and we are aware of, the ability of courts to discuss and ultimately agree upon an amicable resolution of
these types of issues by way of an understanding or "protocol" that becomes a governing instrument by
agreement. Maxwell was the "poster" case for how courts can work together when dual proceedings take
place, and other courts have followed suit... 
We strongly recommend, in a situation such as this, that an actual dialogue occur or be attempted between
the courts of the different jurisdictions in an effort to reach an agreement as to how to proceed or, at the very
least, an understanding as to the policy considerations underpinning salient aspects of the foreign laws... 
While we do not know whether the cooperation [in Maxwell] was initiated by the court or the parties, there
is no reason that a court cannot do so, especially if the parties (whose incentives for doing so may not
necessarily be as great) have not been able to make progress on their own. 
[W]e urge that, in a situation such as this, communication from one court to the other regarding cooperation or the
drafting of a protocol could be advantageous to the orderly administration of justice.
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The decision is a very strong recommendation from a very distinguished appeals court on the need for and
advantages of international cooperation and judicial communication in cross-border cases and is certain to set the
tone for more communications between administrations in different countries in the days ahead. See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=3…
Partners v. Lernout & Hauspie Speech Products N.V., 310 F. 3d 118 (3rd Cir. 2002)</a>.

Journal Authors

Bruce E. Leonard

Journal Date

Sunday, June 1, 2003 - 12:00

Bankruptcy Rule

2003