Government response
1. The Government welcomes the interest that the
Business and Enterprise Committee has shown in the work of The
Insolvency Service ("The Service") and welcomes also
its commendation of The Service and its staff for the "generally
effective and efficient way in which its functions are discharged".
2. It is noteworthy that the Committee has reported
on The Insolvency Service at a time of a global recession when
insolvency itself is very much in the public eye. To a considerable
extent, the present recession was the result of ultimately unsustainable
levels of debt in the personal and corporate sectors. It is therefore
no surprise that in terms of personal bankruptcies at least, The
Service is dealing with an unprecedented volume of insolvency
cases. The Committee's report acts as a positive reminder that
The Insolvency Service performs a crucial role in contributing
to free and fair markets, by providing protection and confidence
for investors, businesses, consumers, employees and shareholders.
The Insolvency Service
We commend the Insolvency Service and its staff
for the generally effective and efficient way in which its functions
are discharged. We urge, however, a redoubling of efforts to ensure
that high levels of service are maintained throughout the economic
downturn. This must include action to address concerns about the
insolvency regime that have been raised during this inquiry. (Paragraph
11)
3. The Committee is right to point out that high
levels of service need to be maintained throughout the economic
downturn. Every bankruptcy is a sign of serious personal distress
and every creditor and debtor must be treated both fairly and
effectively. In setting targets for The Service for 2009-10, the
Government has agreed that the focus must be on maintaining present
standards as The Service works hard to deal with both increasing
caseloads and increasing caseload volatility. This reflects a
widespread view that this year, more than ever, The Service will
have to run hard to stand still.
4. The Service recognises that at a time of recession
it is even more important to ensure that the insolvency regime
is fit for purpose. The Service's actions in relation to the Committee's
concerns about pre-packs, insolvency practitioner regulation and
fees and policy development are detailed below.
Pre-pack administration
Criticisms of pre-packs are at their sharpest
where existing management buy back the business following private
negotiations with an insolvency practitioner and then continue
to trade clear of the original debts through a new "phoenix"
company. This means that unsecured creditors are initially kept
in the dark and then left empty handed. The phoenix company may
also have some advantage over competitors who honour their financial
obligations. The anecdotal evidence in media reports and confidential
letters to the Committee suggest that "phoenix" pre-packs
affecting smaller companies with high levels of unsecured trade
creditors cause particular concern and are more likely to damage
the supplier base without corresponding broader benefits to the
overall economy. (Paragraph 15)
Public confidence in the insolvency regime is
being and will be further damaged. Prompt, robust and effective
action is needed to ensure that pre-pack administrations are transparent
and free from abuse. Unsecured creditors tend to be kept in the
dark and recover even less than they would in a normal administration.
This causes particular outrage where the existing management buy
back the business and continue to trade clear of the original
debts. Pre-packs of this kind fuel understandable concerns about
illegitimate, self-serving alliances between directors and insolvency
practitioners. The interests of unsecured trade creditors must
take a higher priority, especially in "phoenix" pre-pack
administrations. The insolvency system, the Insolvency Service
and the insolvency profession all risk real reputational damage
if the situation is not addressed. More worryingly, many SMEs
appear to be suffering unreasonable financial harm with no corresponding
benefits to the wider economy. Where there are good reasons for
an insolvency practitioner agreeing to a pre-pack, which there
can often be, this must be explained clearly and fully. Where
there are no good reasons for entering a pre-pack, this must be
exposed before the damage is done. (Paragraph 25)
In view of this, we welcome the introduction of
the new practice statement, Statement of Insolvency Practice 16,
which aims to increase the transparency of pre- packs. We also
welcome the Insolvency Service's commitment to monitor its implementation.
This is a responsible first step, but the recession makes this
a matter of considerable urgency. There must be systematic monitoring
of the situation by the Insolvency Service and the Department.
If the new practice statement does not prove effective then it
will be necessary to take more radical action, possibly by giving
stronger powers to the creditors or the court. In the meantime,
we urge anyone who suspects the abuse of pre-packs to contact
either the Insolvency Service or the body that licenses the insolvency
practitioner concerned. We also encourage large creditors, in
particular Her Majesty's Revenue and Customs, to take an active
role in rooting out abuse (Paragraph 26)
5. The Government recognises the concerns expressed
by the Committee regarding pre-pack administrations, and is also
aware of the importance of this issue in terms of the potential
reputational implications for business, consumers and the reputation
of the insolvency profession. The Government's response to the
points made by the Committee on pre-packs is as follows.
The benefits of pre-packs
6. The Government welcomes the Committee's recognition
that in the right hands and in the right circumstances, pre-packs
are a valuable tool for rescuing insolvent businesses. During
the last 12 months, there has been a number of high profile pre-pack
administrations that have resulted in business rescues preserving
jobs and economic activity and providing future trading opportunities
for suppliers. Academic research has shown that 100% of jobs
in an insolvent company are saved in around 90% of pre-packs,
compared with about 60% in other business sales out of administration.
Likewise, a recent survey of insolvency practitioners found that
88% of jobs in pre-pack sales were preserved.
7. It is the Government's view that while vigilance
is certainly needed in this area, any action taken must not unduly
impair a means by which a material contribution is made to the
rescuing of jobs and economic value that might otherwise be lost.
Damage to unsecured creditors
8. The Government recognises the arguments made by
the Committee that pre-packs, while safeguarding businesses and
jobs, can damage the business of others in the supply chain and
perhaps lead to instances of unfair competition. Sadly, the commercial
reality is that when a company enters formal insolvency, unsecured
creditors, including suppliers, almost always lose out as the
value of remaining assets is rarely sufficient to cover the debts
owed to secured and preferential creditors who have higher priority.
The point is that the presence or absence of a pre-pack is unlikely
in any individual case to make a significant difference to the
quantum of any residual dividend that might be paid to unsecured
creditors.
The potential for abuse
9. The Government would agree with the Committee
that the system—like any system—is capable of being
abused by people intent on doing so. We recognise therefore that
that potential for abuse, regardless of its actual extent, (which
we do not believe to be widespread), may have the effect of eroding
confidence in pre-packs and in administration more widely. It
is therefore of the utmost importance that Government should use
the tools at its disposal to ensure that any abuse is spotted
and firmly acted upon and that the regulatory and enforcement
regimes which are used for this purpose should be well understood
and seen to be effective.
"Phoenix" pre-packs
10. It is an important part of the Government's enterprise
policy that directors who have been involved in a company failure
should not be precluded from trying again provided that their
failure cannot be attributed to any dishonest, reckless, wilful
or otherwise blameworthy conduct. However, the legislative framework
needs to strike the right balance between the need to encourage
entrepreneurialism and the interests of creditors. We believe,
that, taken with the robust enforcement regime we maintain, the
existing framework does that. Not only is there evidence that
in the great majority of "phoenix" pre-packs there is
no suggestion of misconduct, it is also the case that sometimes
the former directors of the insolvent company may make the best—or
perhaps the only—offer for the assets. In many such instances,
this will represent the best outcome for employees, the creditors
as a whole and the wider economy. This is a judgement that insolvency
practitioners must make and are they are accountable to creditors
for making it.
Minimisation of abuse
11. Abuse is tackled by using the regulatory system
to clamp down on unacceptable behaviour by insolvency practitioners
and by using civil and criminal enforcement powers to do the same
with regard to company directors. The former may result in withdrawal
of authorisation to practice, as well as a range of lesser penalties,
while the latter can lead to director disqualification or even
criminal conviction. In such cases, custodial sentences are not
uncommon.
Statement of Insolvency Practice 16 (SIP 16)
12. The Government is pleased by the Committee's
welcome for the introduction of SIP 16 and The Insolvency Service's
determination to proactively police compliance with it. The greater
transparency afforded by the new and detailed disclosure requirements
in SIP 16 will give creditors better and quicker access to relevant
information, which will enable them to make informed decisions
when considering subsequent proposals or resolutions sought by
administrators.
13. The Service is committed to continuing its oversight
of SIP 16 compliance so long as the public interest demands it.
In recognition of the Committee's concerns and those of others
in this area, The Service will shortly be reporting on levels
of compliance during the first six months of operation of SIP
16. Should that compliance prove to be inadequate, it will put
forward proposals for improving matters, including a potential
further strengthening of regulation in this area.
14. The Service's report will summarise its experience
of having reviewed in detail every SIP 16 statement copied to
it. For regulatory and enforcement purposes, The Service is cross-checking
information in SIP 16 statements with other information properly
available to it in the course of its work and from publicly available
material.
The reputation of Insolvency Practitioners
15. The Government agrees with the Committee that
the good reputation of the insolvency profession is of the utmost
importance if the public is to have confidence in it and in the
insolvency framework more generally. The Insolvency Service has
discussed this issue with the profession and has emphasised the
importance of each practitioner and the profession in general
acting in ways, whether under appointment or more generally, which
will engender greater public confidence. There remains considerable
work to be done, building on a robust regulatory platform, to
successfully promote the profession's vital role in the rescue,
recovery and renewal of distressed businesses across the economy.
Enforcement against directors
16. The Service uses its enforcement powers to clamp
down hard on serial "phoenix" directors where there
is good evidence that they have acted against the public interest.
In its evidence to the Committee in January, The Service stated
that its enforcement work and that of prosecutors more widely
leads to around 5 director disqualifications and one criminal
conviction per working day. At present, the average length of
director disqualification is 6.19 years.
17. In appropriate cases consideration is given to
exercising the Secretary of State's discretionary powers of investigation
available under the Companies Acts; specifically section 447 of
the Companies Act 1985. These powers allow for the affairs of
a live company, including a "phoenix" successor company,
to be investigated. Such an investigation may include the circumstances
in which pre-pack assets were sold on to a 'newco' under the control
of the same management team.
Publicising enforcement
18. In giving evidence to the Committee, The Service
acknowledged the need to do more to publicise its enforcement
outcomes so as to boost confidence in the enforcement regime and
increase deterrence. This is discussed in more detail at paragraph
28.
Insolvency Practitioner Fees
It may be inevitable that insolvency practitioners'
remuneration is perceived as unduly high by many creditors. There
must, however, be sufficient opportunity and information to allow
creditors to ensure that fees are reduced where that perception
is justified. We therefore welcome the Insolvency Service's commitment
to monitor whether insolvency practitioners are complying with
the current practice statement governing the approval of their
fees. We urge the Insolvency Service to make its findings publicly
available. We also urge the Government to respond to these findings
and to consider the case for strengthening control - possibly
through independent arbitration - of insolvency practitioners'
remuneration beyond the limited power to do so currently exercised
by creditors. (Paragraph 29).
19. Insolvency legislation places the question of
the amount of remuneration of insolvency officeholders to be determined
by those having a financial interest in the outcome of the insolvency
proceedings, primarily the creditors. Statement of Insolvency
Practice 9 (SIP 9) sets out what information insolvency practitioners
should provide to those responsible for the approval of their
fees, and provides a suggested format so that those receiving
such requests can make comparisons between cases and an informed
assessment of each application.
20. The legislation also makes provision for an application
to be made to the court, by either the office holder or creditors,
for a review of the amount of fees allowed or charged. As the
court has the final say on the matter of remuneration, an insolvency
practitioner's authorising body generally will not consider any
complaint about the amount of remuneration charged. It will, however,
consider whether remuneration drawn was properly approved in accordance
with the legislation and SIP 9.
21. The authorising bodies routinely monitor compliance
with SIP 9 through their monitoring visits. In turn the activities
of the Recognised Professional Bodies are subject to regulatory
oversight by the Secretary of State.
22. The Government proposes the introduction of measures,
via secondary legislation in April 2010, to provide improved transparency
and accountability to creditors in relation to the actual amounts
of remuneration charged and expenses incurred by office-holders.
Office-holders will be required to provide progress reports at
least annually (six-monthly in administrations) in which, amongst
other things, they will be required to set out details of the
work undertaken, amounts of remuneration charged and expenses
incurred during the period covered by the report. Creditors will
be given new rights to request fuller particulars of the amounts
detailed within those progress reports and to challenge them by
making an application to court where they consider them to be
excessive. Requiring office-holders to report remuneration and
expenses more regularly should enable creditors to scrutinise
those details on a more timely basis.
23. The Service will ask the monitors of all the
regulatory bodies to provide feedback on insolvency practitioners'
compliance with SIP 9. The Service will report on the findings
in the Statement of Insolvency Practitioner Regulation in March
2010.
Funding Arrangements
The Insolvency Service's Chief Executive, Mr Speed,
assured us that arrangements for funding its case administration
work are sufficiently robust to handle a dramatic increase in
insolvencies if this were to happen. While we hope that this assurance
is not tested, at this stage we can only hope that he is correct.
Both he and his staff will understand the serious consequences
if he is not. (Paragraph 36).
The Department for Business, Enterprise and Regulatory
Reform must work with the Insolvency Service to ensure that its
funding arrangements are sufficiently robust to handle the very
high levels of insolvency that are almost inevitable at a time
of steep economic decline. We welcome the Service's shift to projecting
demand for its services based on a lower and upper range, but
we believe that its funding and targets should be based on the
expectation that activity will be at the mid-range, rather than
the bottom end, of the scale. (Paragraph 47)
24. The Service's case administration functions i.e.
the official receiver's administration and investigation of bankruptcy
cases and compulsory liquidation cases is funded from fees. These
fees are reviewed and set each year in line with Managing Public
Money principles. Fees are set to cover planned costs based
on projected case levels. Monitoring of case levels, fee income
and costs is undertaken at management board level in The Service
on a monthly basis and is also reported to the Department monthly.
25. As noted by the committee, for 2009-10 case planning
forecasts have been set as a range and fees have therefore been
set to reflect this range. Although the financial table in The
Service's published corporate plan reflects fees and costs at
the lower end of the range fee income will automatically increase
as case numbers increase and increased costs would therefore be
covered from increased income. It is important that The Service
take a balanced and prudent view of its caseload projections.
A more aggressive approach carries with it the increased risk
of over-resourcing which could lead to costs and therefore fees
in future years which are higher than necessary.
Redundancy Payments
The Insolvency Service must consider changing
its agreement to operate a redundancy payments scheme on behalf
of Her Majesty's Revenue and Customs by ensuring that in future
years there is an entitlement to recover extra funding based on
a higher workload. We welcome the fact that this year any interdepartmental
wrangling over funding has been set aside to give priority to
ensuring victims of the recession get the payments to which they
are legally entitled. This should become permanent. (Paragraph
37).
26. The Service has worked with HMRC and they with
HM Treasury to confirm that funding for 2009-10 reflects the costs
of administering higher forecast claim levels and meets the planned
costs of a new replacement IT system for redundancy payments claims
handling. The Service has also supplied its current planning forecast
for 2010-11 and funding for this and future years will be aligned
to claim levels. All valid claims are paid and the budget covering
those claims is not cash-limited.
Investigations and Enforcement
It is surprising and disappointing that the Secretary
of State has reduced the funding for investigation and enforcement
activities for 2009-10, despite the expectation that there will
be an increase in the number of cases referred to the Insolvency
Service. It is unacceptable that the Service's new target requires
it to achieve no more than the same number of successful enforcement
outcomes than was achieved for 2008-09. This would mean that as
the recession bites there will be proportionately fewer wrongdoers
facing sanctions for their misconduct. This is unlikely to inspire
confidence among the insolvency practitioners and creditors who
report wrongdoing but see no sign of it being investigated or
penalised. The Department for Business, Enterprise and Regulatory
Reform must provide the Service with sufficient funding to meet
an increase in demand for its investigation and enforcement activities
and it should amend the target to ensure that the number of successful
outcomes the Service is expected to achieve in 2009-10 is increased
to ensure it is proportionately equivalent to the target in 2008-09.
(Paragraph 44)
Funding for investigations and enforcement
27. The Government notes the Committee's concern
about the allocation of resource by the Department to The Insolvency
Service for its investigations and enforcement work and welcomes
the opportunity to provide further clarification. While the Department
allocates funding for routine investigations and enforcement work
over the course of a Spending Review period, occasionally additional
funds are sought and allocated to fund work on especially large
and complex cases which would otherwise have a very substantial
impact on The Service's ability to continue with its routine work.
The figures for enforcement, published in The Service's corporate
plan, include some such funding which has been agreed with the
Department and is currently diminishing from a peak in 2005-6.
28. Setting this aside, the funding allocated by
the Department to The Service for investigations and enforcement
this year (2009-10) is £500k higher than the level allocated
for 2008-09. The Department and The Service have concluded that
this additional £500k should be invested in raising the profile
of The Service's investigations and enforcement work, for example
by giving more publicity to notable director disqualifications,
companies wound up in the public interest, or criminal convictions
(in conjunction with the Department) in order to help improve
confidence in the system generally and increase deterrence.
29. Aside from this funding, The Service's budget
is also affected, in-year, by the awarding of costs and damages
by the courts in individual cases that The Service has pursued
on behalf of the Secretary of State. Costs can be awarded in favour
of, or against, the Secretary of State. The Service manages this
risk carefully as part of its assessment of whether cases should
be pursued in the public interest. In recent years, The Service
has tended to make a positive net recovery of costs and damages
and this has increased the resources available to it to carry
out its investigations and enforcement work. In 2008-09, the net
recovery amounted to £1.8 million.
30. These factors help to explain why The Service's
headline outturn funding figure for investigations and enforcement
may fluctuate up or down from one year to another even when the
underlying allocation from the Department is unchanged or increased.
Targets for investigations and enforcement
31. The Government notes the Committee's views on
the level of the enforcement targets set for The Insolvency Service
for this year, but would offer the following explanation of the
rationale for why the targets have been set as they are.
32. The Insolvency Service is experiencing a change
in the case mix it is receiving with a trend towards more high-profile
companies and greater complexity of the cases. The Service has
taken a number of steps in recent months to further improve the
effectiveness and efficiency with which it uses its funding particularly
in seeking to improve the quality of reports and complaints. It
has also carefully reviewed the way in which it assesses and prioritises
cases according to public interest criteria. Given the trend it
is seeing, The Service's advice to Ministers was that it would
not be wise to set it a higher target which could have the perverse
incentive of encouraging the pursuit of smaller and simpler cases
at the expense of the more serious and complex ones. The aim
always is to strike an appropriate balance of investigation across
the full range of cases.
33. The Government has, to date, measured success
in this area by means of simply comparing the number of outputs
(director disqualifications plus bankruptcy restrictions plus
reports of criminality) against a pre-determined numerical target.
While this measure does convey some useful information about
the relative level of misconduct and enforcement, the Government's
developing view is that it does not, on its own, allow any meaningful
assessment of the effectiveness of the enforcement regime in meeting
its wider objectives. It also cannot, by definition, say anything
definitive about relative resource effectiveness as, in practice,
The Service sees a huge variation in the complexity and cost of
investigating individual cases. As observed above, it is arguable
that the present hard numerical targets, taken on their own, are
capable of introducing perverse incentives into the system.
34. In the light of this, The Insolvency Service
and the Department are working to move towards a profiling and
reporting system based on outcomes alongside outputs for enforcement
which more closely relates inputs to the desired policy objectives.
Initial thinking is that the impact and effect of investigations
and enforcement work might be assessed by looking at a combination
of enforcement outputs (as now) and a robust assessment of wider
confidence in the regime. The Insolvency Service plans to discuss
these ideas with interested parties in the autumn, after which
its plans will be set out in its Corporate Plan for 2010-11 to
be published in March 2010. The Department does not therefore
intend to change the targets for this year.
While the Service is securing sanctions against
a considerable numbers of individuals at present, there is a need
for additional funding to promote this more widely in order to
create the best possible deterrent effect. We recognise the heavy
demands on public expenditure, but maintaining confidence in the
market is a central task of the Department and, in the light of
regulatory failures elsewhere, we are surprised by the lack of
commitment shown by the Department in this crucial area. The sums
involved are, after all, very modest. (Paragraph 45)
35. The Government agrees that it would be appropriate
to do more in this area and has, accordingly allocated £500k
to The Insolvency Service this year for this purpose, as discussed
above.
Insolvency Practitioner (IP) Regulation
The Insolvency Service must increase the transparency
of its regulatory activities as a matter of priority. More generally,
the Department for Business, Enterprise and Regulatory Reform
should take the earliest available opportunity to provide the
Service with the same range of powers to discipline its licensed
members as are available to the other Recognised Professional
Bodies. We recommend that the Department and the Insolvency Service
should undertake a cost benefit analysis of the case for establishing
an insolvency ombudsman. (Paragraph 53)
Transparency of IP Regulation
36. The Government accepts the Committee's view that
greater transparency would be helpful in engendering understanding
of, and confidence in, the system. To this end, The Insolvency
Service is taking the following steps:
- publication in July 2009 and
thereafter in March each year of an annual statement of IP regulation,
setting out how the system works and what it achieved during the
previous year;
- periodic reports on the application and effectiveness
of SIP 16;
- working with the RPBs and the Joint Insolvency
Committee to establish full public consultation on all material
changes to and developments of regulation in the future;
- creating a clear and more arms'- length relationship
between its own overarching regulatory function and its role on
behalf of the Secretary of State in licensing and regulating individual
IPs.
Scope of the Secretary of State's powers with
respect to directly licensed IPs
37. Of the 1701 individuals authorised as IPs 92
are at present authorised by the Secretary of State. In order
to provide the Secretary of State with the same range of disciplinary
powers as are available to the Recognised Professional Bodies
in respect of their IPs, changes would be required to primary
legislation (the Insolvency Act 1986) as well as extensive changes
to secondary legislation. While the Government accepts in principle
the point that the Committee makes, its view is that the system
of Secretary of State authorisation, while not perfect is working
reasonably well and therefore has no immediate plans bring forward
legislation to make changes. Were such changes to be sought in
the future, it would be appropriate to consider them as part of
a wider review of the legislation relating to the regulation of
IPs.
An insolvency ombudsman
38. The Government notes the Committee's recommendation
on the issue of establishing an insolvency ombudsman and will
give it serious consideration.
Current economic conditions face the Insolvency
Service with considerable challenges. The Service itself recognises
this, and has some plans in place to meet them. However, we have
three concerns.
- Is there a case for strengthening control
of insolvency practitioners' remuneration?
39. The Committee's attention is drawn to paragraphs
19-24 above which address this issue.
- Will the Service and the Department be nimble
enough to reshape policy if necessary to address concerns about
pre-pack administration and other policy issues which may emerge
as a result of the recession?
40. The Government is concerned that the insolvency
regime should remain fit for purpose and world-class. It is currently
ranked in the top 10 internationally[1].
The Service always aims to respond swiftly and positively to general
or specific concerns that may emerge. Recent and ongoing policy
development work demonstrates this. For example:
- changes to advertising in insolvency
proceedings allowing greater discretion to insolvency office-holders
to advertise only when there is a real purpose and benefit in
doing so and enabling them to choose the most effective medium
in which to advertise insolvency events;
- on 6 April 2009 debt relief orders, a major new
debt solution aimed at those who are unable to afford access to
bankruptcy or individual voluntary arrangements were introduced;
- on 15 June 2009 the Government issued a consultation
document, seeking views on our proposed changes to the regime
aimed at furthering company rescue; and
- we are modernising the insolvency rules to reflect
technological developments and modern trading practices. These
changes will save an estimated £20m per year. This is expected
to be completed in April 2010.
- And is the service's funding model sufficiently
robust to deal with the expected increase in workload, and, in
particular, to maintain an appropriate level of enforcement activity?
(Paragraph 55)
41. As discussed above, The Government believes that
the funding model for The Insolvency Service's case administration
activities is sufficiently robust to enable it to respond effectively
to any increase in its work load. In addition, we believe that
the funding provided by the Department to The Service for its
enforcement activity is sufficient to provide the broad range
of outputs, including the disqualification of directors and investigation
of live companies.
1 The World Bank 'Doing Business Report'
2009 ranked the Insolvency Service 8th out of 155 countries
for the speed with which it deals with troubled businesses and
9th for the amounts returned to creditors. This compares
very favourably with the USA, France, and Germany. Back
| 
