How big a slice should administrators take?

THE LARGEST PRE-PACK administration to hit the UK in recent times raised some important questions. Should a company be allowed to move to the UK to take advantage of the our insolvency tools? And can practitioners ringfence funds for future possible legal action or are challenges a personal liability insolvency practitioners (IP) have to bear?

The second question was answered in a recent High Court judgement concerning the collapse of Greek communications company Hellas II in November 2009, to which Ernst & Young administrators were appointed.

The controversy started when Hellas II decided to change its centre of main interest, where its main function and head office is based, from Luxembourg to the UK. Once basing itself in the UK, it entered into a pre-pack administration – where a sale is organised prior to entering into an insolvency process and sold immediately after the IP is appointed – selling its main subsidiary, Wind Hellas, to Weather.

Weather paid around €10m (£8.5m) to E&Y to fund the administration and take the asset.

The High Court case centred around money. Usually after a company collapses in a pre-pack the profitable parts are sold and funds distributed to creditors. The IP will then dissolve the business.

However, Ernst & Young administrators Margaret Mills and Alan Hudson suggested part of the fund (€2m) should be retained to pay for dissolving the business and any costs they could incur from possible future legal proceedings brought against them.

Asking for future liability funds might seem quite brash, but it is a question many IPs need answering.

The law around ringfencing funds for future legal challenges has always been murky at best. An IP has professional indemnity insurance to pay for any possible court action, and the insurance premium is usually paid out of the cost of an administration or as a premium when a legal is mounted.

Ringfencing these funds might seem like a step too far. But if an IP is taking on a controversial case, where they know the creditors are likely to be angry, should they be allowed to do this?

Hellas II’s creditors argued that once the administrators had finished their role in the demise of the business, any legal costs incurred were their own problem.

However, presiding judge Mr Justice Sales found in favour of the administrators.

He explained that failing to allow the IPs to ringfence funds or claim future legal challenges as a cost of the administration could have unintended consequences.

Sales ruled: “If someone happened to sue the administrators during the course of the administration they [IPs] would be protected, but if by chance the action were commenced the day after the administration ended they would not be”. This was not fair, he concluded.

A huge sigh of relief could be heard from the insolvency profession that indemnity insurance wasn’t about to go through the ceiling as IPs become totally exposed to legal challenges as soon as they cease to be administrator.

Although the IPs may now feel vindicated, it was very obvious to see that all funds were going to be argued over.

The majority of the creditors were left completely out of pocket in the Hellas collapse. Secured creditors such as lenders were owed about €1.8bn and unsecured creditors such as suppliers €1.24bn at the time of its collapse.

The creditors’ disgruntlement didn’t stop there. They also argued that the appointed IPs were conflicted because Ernst & Young already had a relationship with Hellas. These complaints were taken to the ICAEW, which has since launched an investigation.

In 2006, Ernst & Young Greece had been auditor of Hellas II’s operating arm, Wind Hellas, and E&Y Luxembourg were the auditors of Hellas II.

The creditors also felt that the money given by Weather should be used towards liquidating the business. Dissolving the business, which was the preferred approach for Ernst & Young, would mean there are no assets, no investigation and the case is closed. However, with a liquidation, an IP is granted more investigative powers. It will trace any fraudulent activity and chase any possible money owed by the former directors.

On this point the judge ruled that the creditors can use the remaining funds to pay for a liquidator if that is what they want. However, no details have yet been given as to who the liquidator will be.

Although the E&Y administrators in this case were largely defended by the judge, this case raises the question that IPs have a responsibility to explain properly the procedures of an administration. They have a difficult road to navigate in making creditors understand the process and what they are likely to receive while also protecting themselves from future legal challenges and adhering to the many regulations associated with corporate collapses.

As insolvency cases are likely to increase in 2012, practitioners might want to brush up on their own communication skills so that cases do not end up in court in the first place.

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