Arms of U.K. Administration Embrace U.S. Companies

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May 2003

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For the first time, a U.S. company has been put into administration in the United
Kingdom. This is the result of recent European legislation that gave birth to a
greatly extended jurisdiction for the U.K. administration regime. It also means
that U.K. administration orders are now automatically recognized throughout
Europe. Combined with forthcoming U.K. legislative amendments that will make
the process quicker and cheaper, U.K. administration is an increasingly powerful
and important tool in cross-border restructurings. This article outlines these
U.K. and European changes and considers their impact.

<h3>Changes to Administration Under the EU Insolvency Regulation</h3>

Historically,
administration orders could only be made over U.K. incorporated companies.<a href="#2" name="2a">2</a> A
limited exception arose through a regime of cooperation under §426 of the
U.K. Insolvency Act of 1986, but this only extended administration to a list of
designated countries (essentially Commonwealth countries such as Australia,
Canada and Bermuda). Importantly, the list
did not include the United States or any European countries, so administration
was not an option for a company incorporated in the United States or Europe.

This
has changed with the introduction of the EU Insolvency Regulation in May 2002.
The EU Regulation was primarily aimed at coordinating insolvency proceedings
throughout Europe and it has a direct effect in the local courts.<a href="#3" name="3a">3</a> The test for
opening U.K. administration proceedings is now whether a company's
"center of main interests" (COMI) is located in the United
Kingdom.<a href="#4" name="4a">4</a> While the starting point is that the COMI is where the
company's registered office is located, that presumption is rebuttable.
The recitals to the regulation say that COMI should correspond to "the
place where the debtor conducts the administration of his interests on a
regular basis and is therefore ascertainable by third parties." If that
is in the United Kingdom, then irrespective of where the company is incorporated,
an administration order can be made.

This means that a U.S.
company with a U.K. COMI can be put into administration, which is precisely
what happened in the case of BRAC Rent-A-Car International Inc., [2003] EWHC (Ch) 128, in January (BRACII). Before
the BRACII case, it was open to
debate whether the EU Regulation gave the U.K. court jurisdiction to make an
administration order over a U.S. company. At the BRACII hearing, a creditor argued that the EU Regulation
should only apply to European companies. However, the judge rejected that
argument and put BRACII into administration, even though it was incorporated
in Delaware.

Pausing
for a moment on the COMI test, it is immediately apparent that the legal hurdle
under the EU Regulation is significantly higher than the chapter 11
jurisdiction test. A mere bank account in the United Kingdom would fall a long
way short of proving that a company's COMI was in the United Kingdom, and
even having an office in the United Kingdom with employees and assets would not
necessarily suffice. The court must be satisfied that the United Kingdom is the
COMI, over and above any other country. Legally speaking, a company can have
only one COMI, so the court has to decide between any competing jurisdictions.

<h3>Lowering the Legal Hurdle</h3>

While
the COMI hurdle looks high, in practice it is significantly lower than might be
expected, especially for the debtor. There are two reasons for this. First, the
hearing to open administration proceedings is generally unopposed, largely
because very few people need to be notified in advance. On a debtor's
administration petition,<a href="#5" name="5a">5</a> the company only needs to notify any creditors that
hold floating-charge security, which is unlikely to be anyone other than a
bank. Floating-charge creditors are often involved in restructuring
negotiations, and their support is generally needed in any event. At the
hearing, the debtor will address the court as to where its COMI is located.
While the debtor should put "points against" as well as
"points for," it is always easier to win a match if the other team
does not show up. A debtor's COMI is said normally to correspond to the
debtor's head office,<a href="#6" name="6a">6</a> and if the debtor goes on oath saying that its
COMI is in the United Kingdom, a judge is unlikely to second-guess the company—especially
if no one is arguing the contrary. Importantly, once administration
proceedings are opened in the United Kingdom, that decision can only be
challenged in the U.K. court itself. For many creditors, especially those
outside the United Kingdom (who are likely to feel more aggrieved than U.K.
creditors), this operates as a major disincentive to a challenge.

Second,
the COMI test is easier in practice because it is not clear what factors
determine a company's COMI. Unlike §304, there is no list of points
to be considered by the court. This opens the door to creative arguments, as
was shown by the U.K. administration of Enron Directo SA (unreported). Enron Directo was a Spanish company
with Spanish operations and Spanish employees, and most of its day-to-day
operations were performed in Spain. However, some of its strategic decisions
were made in London at Enron's European headquarters, and certain board
meetings were held in London. Accordingly, the argument was that the
debtor's head office functions took place in London. At the unopposed
hearing, the U.K. court accepted that as being the test for COMI and opened
U.K. administration proceedings.

The
Enron Directo approach is of particular
significance given that many U.S. groups base their European headquarters in
London, and so that is where the high-level strategic decisions are taken. This
creates the potential to coordinate a group restructuring by obtaining U.K.
administration orders over all the subsidiaries operating in Europe. Provided
their COMIs are in the United Kingdom, it does not matter that they may be
incorporated in different European countries, or even in the United States.

<h3>Why Have Administration if You Can Have Chapter 11?</h3>

While the scope for U.K. administration has greatly expanded, why would a company
want to go into administration if chapter 11 is available? Doesn't
chapter 11 automatically have extra-territorial worldwide effect? The simple
answer is "yes" if you are in America, but not necessarily if you are
not. The long-arm jurisdiction of the U.S. courts is problematic in European
courts, especially in continental European courts and if based on what are seen
as manufactured jurisdictional links. This means that, absent local ancillary
proceedings, a creditor may not be prevented from pursuing its debt in Europe
even though the company is in chapter 11. (However, it would run the risk of
incurring the wrath of the U.S. court for breaching the chapter 11 moratorium.)
The striking recent U.K. and U.S. proceedings concerning Cenargo International
plc have clearly highlighted this potential.

It
comes as a surprise to many U.S. lawyers that chapter 11 proceedings are not
automatically legally recognized in Europe. This surprise is understandable, as
chapter 11 proceedings are often recognized as a matter of practice by European
creditors. Creditors do so because they are reluctant to act in contempt of the
U.S. court, particularly if they have assets or operations in the United
States. In light of the dominance of the U.S. economy, this practical point
means that many creditors act as if chapter 11 proceedings are enforceable in
Europe.

Given
that chapter 11 proceedings are not by themselves legally effective in Europe,
a major advantage of administration is that it does have effect throughout
Europe. A key part of the EU Regulation is that proceedings such as
administration have direct and automatic effect and govern the restructuring in
all the member states of the European Union.<a href="#7" name="7a">7</a> There are specified carve-outs,
but as a general rule the administration order with its moratorium bites on all
assets and creditors in Europe.<a href="#8" name="8a">8</a> The U.K. administrators are automatically
recognized by all the European courts and, subject to any carve-outs, have
power to control the debtor's assets throughout Europe.

Administration
can also be quicker and cheaper than chapter 11. In administration, the power
to run the company is taken from the directors and given to the administrators,
who are licensed by a professional body and are typically partners in an
accountancy firm. Some of the existing management will be retained to assist in
the day-to-day operations, but this is in marked contrast to the
debtor-in-possession (DIP) approach. Because administrators are independent
professionals and their duty is to act in the best interests of creditors,
commercial decisions are taken by the administrators, and the requirements for
court and creditor approval to be obtained in advance are minimal compared to
the U.S. model. Therefore, the sale of assets, for example, is primarily a
matter for the administrators' commercial judgment. This means that
administration sales can be much quicker than §363 sales or reorganization
plans. As a result, the costs of administration tend to be lower than those of
chapter 11, particularly because in administration, the creditors'
committee plays a much smaller role, and it is rare for the committee to have
separate legal representation.

Having
said that, chapter 11 has some powerful features that can facilitate a
restructuring and that are not present in administration. For example, there is
no parallel in administration to the §365 process of curing, adopting and
assigning executory contracts, so contractual termination or non-assignment
clauses remain valid. Further, while technically administrators can borrow
funds and give the lender priority status, that cannot trump existing security,
and the administration lending market is undeveloped compared to DIP lending
in the United States.

<h3>Enterprise Act</h3>

Returning
to current developments that are making administration more attractive, the
U.K. Enterprise Act is due to come into force this June or July. This will
simplify and reduce the costs of administration because, for example, it will
be possible for directors to appoint an administrator without a court hearing
at all. The Enterprise Act changes in respect of administration are primarily
procedural but nevertheless will make the process more streamlined and should
result in an increase of administrations.

<h3>Administration and Chapter 11 or §304</h3>

Ultimately,
it seems likely that U.K. administration will become more common in
cross-border restructurings. In particular, debtors might look to take the
European benefit of opening administration proceedings as well as opening
chapter 11 proceedings. This benefit can outweigh the cost implications, and
has happened in restructurings such as Federal-Mogul, BRACII and Maxwell, although protocols may be helpful to regulate the interplay between
the courts. Alternatively, administration alone may be favored for its speed,
cost and automatic effect around Europe, with protection in the United States
being obtained through a §304 order. What is best for a given
restructuring will be determined primarily by the structure of the company or
group, the location of the assets and where the creditors are based.

<h3>Conclusion</h3>

With
its expanded jurisdiction, automatic recognition around Europe and lower costs,
administration seems destined to become an increasing feature of international
restructurings involving European operations. It certainly should be added to
the list of options.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Ken Baird is a partner and Richard
Tett is a senior associate in Freshfields Bruckhaus Deringer's
Restructuring and Insolvency Group, and they are based in London. Freshfields
Bruckhaus Deringer has a network of 28 offices worldwide with 18 in Europe. <a href="#1a">Return to article</a>

<a name="2">2</a> The U.K. courts always had much
wider jurisdiction to grant winding-up orders. However, as a winding-up order
envisaged the company being liquidated, it was unattractive in the context of a
restructuring. Lawyers had sought to "fill the gap" by using
provisional liquidation. While this was successful to an extent, it brought
with it various complications; a more detailed discussion of this topic is
outside the scope of this article. <a href="#2a">Return to article</a>

<a name="3">3</a> The EU Insolvency Regulation covers
all collective insolvency proceedings, but the focus of this article is on U.K.
administration rather than proceedings generally. <a href="#3a">Return to article</a>

<a name="4">4</a> Interestingly, these are the same
words as are used in the UNCITRAL Model Law. <a href="#4a">Return to article</a>

<a name="5">5</a> On a creditor's
administration petition, as would be expected, the debtor must be given advance
notice of the hearing of the petition so that it can attend. <a href="#5a">Return to article</a>

<a name="6">6</a> See the Virgos-Schmidt report, ¶75, which, while not binding, is very influential. <a href="#6a">Return to article</a>

<a name="7">7</a> Denmark has opted out of the EU
Regulation, but is expected to implement it in due course. <a href="#7a">Return to article</a>

<a name="8">8</a> Under the EU Regulation, the
starting point is that U.K. administration proceedings, as "main
proceedings," govern all aspects of the debtor's insolvency around
Europe. However, there are local law carve-outs including for security, set-off,
real estate and employment contracts and for member states where local
"secondary proceedings" are opened. <a href="#8a">Return to article</a>

Journal Authors

Ken Baird

Richard Tett

Journal Date

Thursday, May 1, 2003 - 12:00

Bankruptcy Rule

2003