Has MF Global changed the insolvency landscape?

THE WORLD’S FIRST special administration sees KPMG administrators appointed to the UK arm of MF Global – but has this new regime changed the fundamental principle that ensures all creditors are treated equally?

The special administration regime (SAR) was brought about to help creditors caught up in complex insolvencies receive their funds quicker. The collapse of investment bank Lehman Brothers at the back end of 2008 saw the administrators tied up in heavy litigation resulting in some creditors waiting years before they received any payment.

To prevent this from happening again, the Financial Services Authority created the SAR to ensure creditors receive their returns faster.

Usually, administrators pool creditor returns and pay secured creditors first, usually the lender, then the unsecured creditors, such as the taxman. Secured creditors are likely to be paid in full and unsecured creditors a substantially lower amount.

SAR works differently – most notably, in that it is only applicable to financial services businesses such as investment organisations like MF Global and Lehman Brothers. In a SAR there is no collective pot, which is distributed among creditors.

The key aim is to return customers’ assets quickly and efficiently. Administrators trace and retrieve funds that creditors handed over to MF Global to invest on their behalf. Straightforward and easy – in theory.

But what if there are two creditors with differing circumstances? One’s fund was ringfenced by MF Global for investment and is handed back. Another creditor’s is not traceable, wasn’t ringfenced and is not returned. These two creditors, which have acted in the same way, could end up with one paid in full and the other receiving nothing. With creditors not treated equally and no collective pot to evenly distribute among them, some will be paid and some won’t.

“If you were the creditor with no ringfenced funds you’d be pretty gutted,” says Christoph von Wilken, a cross-border insolvency expert at Schultze & Braun.

“In an administration there are statutory objectives: rescue the business as a going concern and achieve a better outcome,” he says.

“SAR is bolted onto that, but has different objectives: to hand back assets to creditors.”

Creditors could argue that the new regime is working outside of normal case law-set insolvency principles – that all creditors be treated equally in an administration.

But it is not all doom and gloom. The SAR could allow for quicker and, sometimes, more substantial return to creditors, argues KPMG partner Richard Fleming.

Fleming was appointed joint administrator to MF Global UK in November, along with Richard Heiss and Mike Pink.

The SAR mitigates the effect of prolonged legal actions. Lehmans was shrouded in so much litigation that, although cash was raised for creditors, the funds sat in an account while court action took place.

Because of all the fighting and litigation in the Lehmans’ administration it has taken a long time for funds to be repaid to clients, Fleming explained.

“Previously the funds would sit in an account, while other things were done first,” he says.

With a SAR, the administrator is given clear guidelines: any money handed over for investment, should be traced and returned to its owner, mitigating (in theory) any legal claims on ownership of money.

“Our job now is to cut through the litigation so money ends up in client hands as soon as possible,” said Fleming.

Although he and the team hope the administration won’t be controversial, he explains that the real work of trying to understand and trace all the complex transactions has only just begun.

From 8 December, anyone can make a claim to the administrators, although a closing date of 30 March 2012 has been set. The KPMG team has also managed to sell parts of the business to JP Morgan.

The Financial Services Authority, the government and even the insolvency profession are now focused on the success of the SAR to see if it is a viable alternative for investment corporate administrations, or if the UK should continue to use the regular process.