Examination of Witnesses (Questions 40-59)
THE INSOLVENCY
SERVICE
27 JANUARY 2009
Q40 Mr Clapham: Given what we said
at the beginning of the questioning session about changes in structure,
have you put any measures in place that would, for example, mean
that there is going to be more regional engagement than there
has previously been, or is that something that is likely to develop
over the next two or three years?
Mr Speed: One of the things that
I think The Insolvency Service is very proud of is the fact that
it is not just a regionally but a very locally based organisation.
We have 36 buildings around the country, we have 42 official receivers
around the country. We have an office, as you may know, in Sheffield
and we have two offices in Leeds. The reason we are disposed that
way around the country is that some of the work that the official
receivers do, particularly the investigations work they do into
potential misconduct of bankruptcy company directors, requires
from time to time that we do face-to-face interviews with people,
so we think it is quite important to be present in the community
and we have specially designed offices to allow our customers
to come in and see us. In terms of other parts of our work, the
redundancy payments offices, for example, we have those in Watford,
Birmingham and Edinburgh, and they divide the country up according
to where the headquarters of companies whose ex-employees that
they are dealing with are, and, as I said earlier, in relation
to most of the rest of what we do, we have three concentrations
of staff. I think it would be helpful to point out that one of
the biggest concentrations of staff we have is in Birmingham and
there is also a pretty big group of people in Manchester. We have
bits of most parts of The Insolvency Service both in Birmingham
and in Manchester.
Q41 Mr Clapham: On the redundancies
issue, this is a very important one. Do you feel that your funding
is fit for purpose in the current situation? I will tell you why
I raise that. A little earlier today in the tea room, and all
the chaps go off in the tea room, I was talking to a colleague
about his particular situation in his constituency and he was
referring me to companies that went insolvent or shed labour rather
than going completely out of business and yet the people who were
waiting for their redundancy pay have been waiting since October
and some of them still had not received it. Given that situation,
does it not indicate that possibly your funding may not be fit
for purpose in a situation where the recession is increasing in
severity?
Mr Speed: I think we have got
a very good story to tell on that, and I would like just to make
the point that the only redundancies that we deal with are those
which arise from corporate insolvencies, so they may not include
the case that you are talking about, but Graham is very close
to this area and perhaps he would like to comment on it.
Mr Horne: We have seen a large
increase in the number of redundancy claims we have to process.
We processed less than 80,000 last year. This year we think it
will be over 160,000. Despite that we are still meeting our target
of processing 78% of claims within three weeks, so the case you
are referring to I am certain is not one that we are handling
because we are processing our claims very quickly. There are circumstances
where employees are made redundant and their employer does not
pay the redundancy they are due but they are not formally insolvent,
so therefore it is not in our system because the company is not
formally insolvent. What they can do, however, is go to an employment
tribunal and get an order that the company pay and then we will
pay out and seek to recover it from the company. There is this
state buffer that if the company either cannot pay because it
is insolvent or will not pay, provided a tribunal makes an order,
we will then be able to process the claim.
Q42 Mr Clapham: So you do not see
a situation arising where, for example, the Service is likely
to be out of pocket as a result of redundancy arrangements? I
mean out of pocket with, for example, the relationship with HMRC
in the funding that you receive?
Mr Horne: No. The HMRC, as you
say, fund us for administering the redundancy payment scheme.
We have had a large increase in the cases we have had to administer.
We have had discussions with them and they have said that they
have no difficulty in giving us more money so that we are able
to cope with the higher volume of claims, so we are confident
that next year we will be able to cope with the volume of claims
that we think we will have to deal with.
Q43 Mr Clapham: If things do get
worse, and the indication is that they are likely to get worse
before they get better, do you feel that you have sufficient resource
to be able to bring in the qualified people from the private sector
who are going to be able to assist in an appropriate way?
Mr Horne: On the redundancy payment
side it is processing work. It is done by comparatively junior
staff. How we have coped so far is by using our experienced staff
to manage groups of temporary staff, and that is what we would
expect to do in the following year, taking the dedicated and committed
workforce we have got who are there processing claims at the moment
and using them to lead teams of people we bring in. We have seen
a 100% increase and we are still hitting our targets. We could
easily cope with quite a large increase next year through this
use of our dedicated staff to manage temporary staff.
Q44 Mr Clapham: And that will generally
apply to, shall we say, the general case administration as well?
Mr Speed: Broadly speaking, yes,
it would. We have got, I think, a considerable way to go before
we would face serious difficulties in coping with an upturn in
demand in that sort of work.
Q45 Lembit Öpik: I understand
that you feel that you are covered. What happens if there is a
40,000 increase? I do not think that is going to happen, but what
do you do? What is the mechanism? Do you go to the Government
to get private practitioners out to try and deal with that backlog?
Mr Speed: One of the things the
Committee may want to note is that we will be putting our corporate
plan before Parliament in about two months' time, so if this inquiry
is still ongoing you will be able to have a look at what we have
concluded we should do. We are, obviously, in a position where
we are thinking about what we should do should there be an increase?
Should cases increase by 10% or 20% or 30%, or maybe even 35%
or 40%,—and I am talking now about the official receivers'
work, not the redundancy payments work that Graham was talking
about—we could cope. At the top end of that it would get
more and more difficult but we could cope. My own feeling is that
that is unlikely to happen despite the economic climate outside,
not least because the level of bankruptcy which we are dealing
with is already at a historic high. You might have seen our quarterly
statistics at the end of September, that on a seasonally adjusted
basis that was the highest level of bankruptcies on record. Beyond
that we have to start thinking quite differently, as your question
implies. We would certainly be wanting to have discussions with
the insolvency profession outside to see how we might cope.
Q46 Lembit Öpik: Is there a
mechanism through which you can ensure that Government and ministers
are cognisant of what you think are the trends as you see them?
Mr Speed: Oh, yes. Very simply,
I write a quarterly report about the state of play across the
whole of the Service to my minister and we talk pretty frequently.
He is pretty well appraised of what is going on.
Q47 Chairman: I just want to test
this question of director misconduct during the recession in a
bit more detail before we turn to pre-packs. One of the obvious
ways in which directors can misbehave during a recession is to
trade when knowingly insolvent, for example. They place large
orders with suppliers, knowing they are unlikely to be able to
afford them. There have not been very many prosecutions for trading
when knowingly insolvent over the last few years. This is an area
that is likely to increase, it seems, during a recession. It is
a natural defensive response. I think it is evil but the intention
quite often is probably to keep the business going. Sometimes
it is built on assets which can be sold in a pre-pack administration,
and we will come to that later, but this question of funding for
director misconduct does concern me. What are you asking for for
the financial year? It is £37.9 million this year, 0.5% higher
than the previous year. What increase are you looking for in the
New Year?
Mr Speed: I would rather wait
to see what the department says it is able to help us with. One
thing I have said to the department is that I think it would be
helpful for the confidence of the market generally if, instead
of investing all the money that we get into front-line activities,
we were to invest a very small top slice of that money in putting
more effort and more resource into publicising the work that we
do with a view to creating a better deterrent effect. We do do
some of that but my own feeling is that we do not do enough of
this and we do not do it well enough.
Q48 Chairman: Publicity?
Mr Speed: Publicity, yes. I think
knowledge of the types of sanctions which are available and of
the consequences of misconduct probably is not as good as it should
be, so, almost in a perverse way, you are suggesting we need more
money and I suggest what we need is a little bit of money to do
something different.
Q49 Chairman: That is in the evidence
and people in the profession have said to us that they think you
should. They take part of the responsibility for the low profile
of insolvency work and they say The Insolvency Service itself
could also do more.
Mr Speed: I agree with that. I
do not want to words in other people's mouths but I suspect the
department would be fairly comfortable with that.
Q50 Chairman: A truly well-functioning
capitalist economy demands the stiffest punishments for abuse.
Mr Speed: Yes. You talked about
a specific type of director misconduct. If I could give you a
flavour of what we do actually do, in terms of director misconduct?
On an average working day in this country round about five directors
will be disqualified as a result of work that we do around about
six or seven bankrupts will have bankruptcy restrictions placed
upon them as a result of what we do, and somewhere in the country,
again on average, one person per working day will be convicted
of committing an offence on the basis of evidence that we have
brought to a prosecuting authority. It is probably worth also
pointing out that, in relation to director disqualification, at
the moment we are achieving an average disqualification period
of round about six years. If you are somebody whose business is
running businesses that is a pretty serious sanction to have put
upon you.
Q51 Chairman: As long as Companies
House monitors it properly and makes sure that new companies are
not being formed with disqualified directors.
Mr Speed: I have read the transcripts
and we do talk to Gareth pretty frequently.
Q52 Chairman: I note and welcome
what you said about publicising your work more. Let us look at
this thorny question of pre-pack. I have had a copy of an email
to you yesterday which said, talking about the Radio 4 programme
File on Four, "Growing numbers of unsecured creditors
are being short-changed by chief executive officers who move liabilities
and debts to a beleaguered company within their organisation and
then call in the administrators to that company. This practice
is perfectly legal and is performed in the name of preserving
jobs, but at what cost?". I have a lengthy one here which
I received this morning just before I came to the Committee, and
I think this summarises the situation rather well. I will not
name the person; I will happily show it to you afterwards. "It
seems inconceivable that the law allows small companies to be
put into jeopardy whilst the administrators collect huge fees.
The banks and the Revenue"—the Inland Revenue—"are
preferred when they already have help from the Government and
the buyout teams can usually trade these invaluable assets and
goods which have been supplied, and supplied at no cost to them,
by the unsecured small businesses. We are currently suffering
as a result of a pre-pack administration which left us with a
considerable bad debt. As this was billed during the VAT quarter
ending November 2008 we have had to pay the VAT on this at 17
and a half % against no income and we will be unable to claim
against the bad debt until the end of the next VAT quarter."
That is a policy question that I had not previously considered.
"Of course it is good news that many jobs have been saved
but it seems to be at our expense. We are unable to borrow on
those bad debts so are facing grave difficulties in trading as
a direct result of the rescue of our client company. This is our
37th year of trading,"—so this is an established business—"so
we are old campaigners and have been through recessions before,
but this pirate's charter will surely make this particular downturn
even more painful for the small business". "Pirate's
charter" is the phrase that you and I heard on Radio 4 as
well. I could take you through the series of questions. Is there
anything you want to say first before I do that?
Mr Speed: I will just correct
one point in that, if I may, which is that it is no longer the
case that the Crown has preference in insolvency. That was removed
in the Enterprise Act. I could talk to you about our thoughts
about pre-packs and all that if you wish or I can answer your
questions.
Q53 Chairman: Let us see how we go
on the questions. I think it is fair to say that the balance of
evidence we have received about The Insolvency Service, and I
do not want to pre-judge our report, has been pretty favourable
to the Service. There are concerns of detail here and there but
we have not really heard a litany of complaints against the Insolvency
Service, so you can congratulate yourselves on that. We have got
quite a lot of complaints about insolvency practitioners and I
suppose that is inevitable because no-one likes insolvency practitioners
because they are doing an unpleasant job, but I think some of
those complaints might be legitimate. I want to move on to policy
work here. A good company can have a bad balance sheet; that is
possible, and a going concern is always preferable to liquidation
because that gives as much overall value to the company as possible.
Also, I am coming to the view that pre-pack is a problem for smaller
businesses and not the bigger businesses. Most big companies will
differentiate between financial and trade creditors and try to
look after trade creditors in administration. Is that fair comment?
Mr Speed: I do not think I can
answer that question. One of the interesting characteristics of
pre-packs is that we are still learning about them. You have,
I dare say, had information from Sandra Frisby, who is one of
the leading academics in this area, who indeed has been working
very closely with R3, and to some extent with us as well, so we
need more and better particulars on that sort of thing. One point
that struck me while you were reading out the email that you had
had—and you are right: we did have a copy of the other one
yesterday—is that it seems to me there is a considerable
amount of confusion in the quite extensive dialogue that has been
going on recently in the press and elsewhere about the position
of unsecured creditors. There seems to be an inference being drawn
by a great many people that somehow a pre-pack is uniquely prejudicial
to unsecured creditors when I think the real position is that
unsecured creditors are going to lose anyway, and therefore in
the round the sum of things is that the evidence suggests that
pre-packs do preserve jobs, economic value and goodwill in a business
that has become insolvent or got into difficulty, and therefore,
from a public policy perspective, there is an argument, I think,
that greater value can be preserved through that route.
Q54 Chairman: I have some sympathy
with that but I have got to drill down to the detail. Generalised
comments about all pre-packs being bad is not helpful. Let us
look at what formal insolvency actually does. It destroys all
value in the company effectively, does it not?
Mr Speed: Yes.
Q55 Chairman: And also—and
this is perhaps more controversial—when the big accountancy
companies like Deloittes and PWC get into a business, and I have
no particular cases in mind here, they make huge money in fees
for collection, and also the administrator takes on effectively
personal responsibility for getting cash for the business, so
actually there is direct pressure on the administrator to have
a fire sale of assets and get the thing off his books as quickly
as possible.
Mr Speed: I would argue that the
greater pressure on the administrator is to fulfil his statutory
objectives, which are set out very clearly in the Enterprise Act
and amendments to the Insolvency Act, and those are very clear
and the centrepiece of what the Government was trying to achieve
in the Enterprise Act, which was the better development of a culture
of rescue for businesses before they completely fail. An administrator
is bound by the Enterprise Act amendments to act first of all,
in the interests of all the creditors, whether they be secured
or unsecured, to try to rescue the company itself that is in difficulty,
failing that to try to preserve as much of the business as possible,
and that would include a pre-pack, it would include a business
sale, a trading on, whatever, and only—failing all of those
avenues—to liquidate the business and distribute the assets
to the creditors. I think the difficulty with pre-packs is, as
I said earlier, that they are one technique that is available
to insolvency practitioners. They are unregulated but they are
a technique that is available, but I do not think they cause the
effects that people worry about uniquely differently from, for
example, trading a business on or selling a business on after
administration has begun.
Q56 Chairman: I think there is a
difference. The view I am coming to provisionally, and it is only
anecdotal evidence so far, is that the promise of pre-packs is
all right particularly for smaller companies that go into administration,
which typically rely more on their trade credit to finance the
operation than the more sophisticated business might, so having
long periods of payments to your suppliers is the way you keep
going in business quite often. You use trade credit to finance
your business, and some big companies do too. Some of the supermarkets
one thinks of do, and the fact is they are not being particularly
noble, but it is particularly true of small businesses. They rely
on trade credit and so there are large numbers of unsecured trade
creditors, and do not forget that 99% of all businesses in the
UK employ fewer than 50 people so it is a huge issue in terms
of employment in the UK. Another test also is where the company
is effectively a phoenix company with the existing ownership and
management. Often it is good to have the same ownership and management
because they are the best placed to run the company and give it
a fresh start, but often this combination of factors—smaller
companies with a large amount of trade credit and a phoenix company
emerging, which is effectively the same business all over again
with just the trade creditors dumped rather painfully—seems
to be where the issue arises. In macroeconomic terms this may
not be of huge significance but good pre-packs of big companies
might deliver macroeconomic benefits, but the impact on a lot
of small businesses in a recession can be very serious.
Mr Speed: And we heard some excellent
examples of that on the File on Four programme.
Q57 Chairman: Including from my own
constituency.
Mr Speed: Yes, indeed, and clearly
when that happens to you that is not a nice thing. I am still
struggling though to understand why it is that we draw a distinction
between what would happen in a pre-pack in a given situation to
those people and what would happen where the administrator cannot
sell the business and effectively has to liquidate it. Those unsecured
creditors are going to be pretty much in the same position either
way. What I struggle with is trying to see what specific evil
pre-packs bring. One of the things that people talk about a great
deal is this phoenix business, that is to say, where a connected
party, which is a polite way of saying the same person in many
ways, ends up with the business again, and I would draw a little
bit again on some of the research that Dr Frisby has done, which
shows that, to the extent that connected party sales fail a second
time down the line, that second failure is very rarely connected
with the first. That suggests that these connected party transactions
on the whole are innocent, ie, they are people who have run into
innocent failure, want to start again, and where they fail the
second time the failure is not connected with what happened to
them the first time.
Q58 Chairman: This Committee believes
in failure. We believe failure is very important, the principles
underlying it. There is nothing wrong with that at all because
it happens that some people fail and sometimes we have heard evidence
that people who have failed have gone on to be better business
people the second time around; we can understand that, but there
are a lot of anecdotes, particularly in the printing industry,
for example, about individuals behaving in a predatory manner.
Mr Speed: Perhaps we need to look
at this from a slightly different angle, and I would like to invite
Graham to comment on some work that he has been doing, which is
that we have to use all the tools at our disposal. We have talked
already about the enforcement regime that we have. We have regimes
which I mentioned earlier which allow us to disqualify directors.
We also, of course, oversee the Insolvency Practitioner Regulation
Framework and I think it is very important to get on the record—
Q59 Chairman: Regulation we want
to talk about at the end of our session.
Mr Speed: Yes, sure, but it is
germane to this as well because the parties who are concerned
with this are the company directors, their financiers and the
insolvency practitioners. I have talked about the duties that
insolvency practitioners are under. Directors have their own duties
under company law. What we have is a suite of powers which enable
us to test whether those duties have been adhered to, and Graham
might like to say a bit about SIP 16 and the extent to which we
think that is quite a big step forward but also what the Insolvency
Service is doing in parallel with the introduction of SIP 16 to
try to get a better handle on this question.
Mr Horne: As you may know, SIP
16 came into force on 1 January. It imposes duties upon administrators
to disclose certain things to creditors in relation to the actions
they took prior to their appointment. They have to give details
of how they were introduced to the company, what work they did
prior to their appointment, what marketing they did at the company,
what valuations they took of the business, really to explain to
creditors why they felt that a pre-pack was the best thing for
them, and it is really down to the administrator's judgment as
to, in this case, whether the best thing was a pre-pack. What
the SIP 16 statement does is put on record the insolvency practitioner's
explanation of why he or she came to that decision. What we are
going to be doing is proactively policing those SIP 16 statements.
We are going to be getting every SIP 16 statement into our office
and we are going to be looking at them to see two things: one,
that the administrator has followed not just the letter but the
spirit of SIP 16, and we will be asking more questions of administrators
about whether they did take the right decision in those cases,
not second-guessing their commercial judgment but trying to say,
"Have you really explained to creditors why you chose this
particular route?", so we are looking at how the insolvency
practitioner has behaved but also how the directors have behaved.
Clearly, for there to be an abuse there probably has to be negligence
(at best) on the part of the insolvency practitioner and abuse
on the part of the director. We will be able to use the regulatory
and enforcement sanctions available to us to approach it on both
fronts.
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