Are unsecured creditors apathetic?
Yesterday's post on unsecured creditors set me thinking about similarities between this class of creditor and certain species of shareholder. The Cork Committee, the OFT and the Insolvency Service have all identified that there is a certain amount of apathy amongst creditors. On this point the Cork Committee noted: “…it has been suggested to us that the elaborate structure for creditor control in bankruptcy and compulsory winding up is illusory, largely owing to apathy and indifference on the part of creditors themselves.” They continued:
“We consider it unsatisfactory that creditors, whose experience would be invaluable to the liquidator or trustee, are discouraged from participating in the administration of an insolvent estate. We are in no doubt that the machinery should be such as to allow, and indeed encourage, those creditors who have a genuine interest to involve themselves in all types of insolvent administration.”
On creditor apathy the Cork Committee noted that “because of the indifference of creditors towards supervising the administration of insolvent estates…there has also been an increasing measure of judicial control.” The Cork Committee proposed three reasons for this indifference:
“ - There is a generally held belief that most trustees and liquidators are efficient, reliable and experienced.
- There is a lack of interest on the part of business creditors, who allow for the occasional bad debt in fixing their prices and write if off when it occurs, thereby reducing their taxable profits.
- Thirdly, and perhaps of greatest significance there is a resigned acceptance of the fact that in most cases the general body of are only likely to receive a small divided.”
It could be argued that the position of unsecured creditors has some parallels with shareholders in widely dispersed ownership model companies. The famous Berle and Means thesis showed that shareholders become apathetic within large widely dispersed ownership model companies as they can have little impact on the way in which the company is managed. The separation of ownership and control can lead, and Pettet has called this an axiom in modern times, to the imposition of a self-perpetuating oligarchy. Shareholders simply feel powerless and there disengage with the proper monitoring of management. A similar pattern of behaviour may be occurring with unsecured creditors. The Cork Committee noted that unsecured creditors had little, if any involvement in Committees of Inspection because they felt confusion over the rules governing the committees of inspection and how these were constituted. They noted that they “received evidence of confusion over the interpretation of these provisions and precise nature of the functions to be performed by Committees of Inspection…most unsatisfactory.” Creditors should involve themselves in the insolvency process as “the underlying principle is that since the estate is being administered primarily for the benefit of the creditors, they are the persons best calculated to look after their own interests.”
One could respond to this unsecured creditors apathy and argue that it is not that complaints mechanisms and such like are defective but that unsecured creditors engagement is problematic. It is that issue which is at the heart of the problem that the IS Consultation identifies and it is because of this that we need to examine why the quantity of unencumbered assets are so small, rather than focusing on participation in the management of distributing such a small fund. Methods of distribution are important, but they do not resolve the question of the quantum of what is available to be distributed. A more far reaching evaluation of the nature and functions of our corporate insolvency laws is required for that task. For well over 150 years unsecured creditors have experienced numerous incursions into the pot that may have been available for their satisfaction, but for IP fee claims, security devices, ROT clauses, trust instruments, preferred creditors and such like.
At a relatively recent Insolvency Service conference on the use of information technologies, the Director of Policy at the Insolvency Service, Nick Howard, responded to a question from Professor Sir Roy Goode QC by suggesting that he might like to chair a Cork Mark II. The OFT report perhaps highlights that this may not have been an entirely unreasonable suggestion. If there is no substantive change then strong creditors will continue to dominate corporate insolvency. It could therefore be argued that the OFT Report and resulting IS Consultation amount to nothing more than an exercise in moving the deck chairs around. Cork was critiqued by one commentator for not visiting the fundamentals, a similar charge could perhaps be laid on the current consultation and reform process. One could respond however by noting that engaging in Warren like paternalism for unsecured creditors is commendable, but like apathetic shareholders, or missing tutorial undergraduates, there comes a stage when this paternalism is destructive of individual creditor motivation. As the IS Consultation has observed, the systems are there – use them!
Reform which truly impacts on unsecured creditors may involve, inter alia, a consideration of alternatives to pari passu such as paying in order of time of creation of the debt, payment by reference to ethical considerations, according to the size of sum owed, according to the need of each individual creditor and their inability to sustain losses, payment on public policy grounds, etc. an alternative view which has been promulgated by Milman suggested that, “as far as unsecured creditors generally are concerned, the main hope for the immediate future lies not in terms of classical priority rules being changed but more in the trend towards making directors personally liable for corporate debts.” This may be a truism, but have realisations from s.214 or s.239 of the Insolvency Act 1986, for example, actually recouped much for the unsecured creditors?
One final example will be given in relation to why the IS Consultation does no go far enough. There are current seven Recognised Professional Bodies (RPBs) for a total of 1313 Insolvency Practitioners. The Insolvency Service itself makes up the eight possible RPB. The OFT have noted that this is not an issue for the smooth running of corporate insolvencies. Really? This proposition must be tested with more examination.
 For an example of proactive unsecured creditor behaviour see the Privy Council case: Cambridge Gas Transport Corp v Official Committee of Unsecured Creditors of Navigator Holdings plc and others  UKPC 26,  3 All ER 829.
 Cork Report para 914.
 Cork Report para 917.
 Cork Report, at para 916.
 Cork Report para 914.
 Pettet, B. Company Law. 2nd Edition. Longman, London. 2004.
 Berle, A & Means, G. The Modern Corporation and Private Property. Revised Edition. Harcourt, New York. 1968. For a critique of their work see: Herman. Corporate Control, Corporate Power. Cambridge University Press, Cambridge. 1981.
 Cork Report para 918.
 Cork Report para 913.
 And outside the scope of this brief blog post. See further: Mokal CLJ. 'Priority as Pathology: The Pari Passu Myth’  Cambridge Law Journal 581-621. Whilst preferring Mokal and Cork’s conceptualisation of pari passu as, inter alia, a theoretical device (Cork Report at para 233) it must be noted that some commentators still view the principle as: a ‘cornerstone’ (Cork Report despite their earlier rather inconsistent note on it being on theoretical); ‘cardinal’ (Goode, R. The Death of Insolvency Law (1980) Co. Law 123); ‘fundamental’ (Keay & Walton. Insolvency Law: Corporate and Personal. Pearson, 2003, at page 396); ‘cornerstone’ (Seligson, C. Preferences Under the Bankruptcy Act (1961) 15 Vanderbilt Law Review 115); and finally a “grundnorm” although Milman does go on to note that, “the pari passu rule is a crude standard to apply in the legal system of the late 20th century.” (see Milman Priority)
 For two opposing views see: Warren, E. Bankruptcy Policy (1987) 54 Univ.Chicago L Rev. 775 and; Barid, D. Loss Distribution, Forum Shopping and Bankruptcy: A Reply to Warren (1987) 54 Univ.Chicago L Rev. 815. For a more recent and novel approach see: Mokal, RJ. Corporate Insolvency Law – Theory and Application. Oxford: OUP, 2005.
 See further: Buchler v Talbot  UKHL 9;  2 A.C. 298 and the subsequent amendment to the Insolvency Act 1986 reversing the affect of this judgment: s.176ZA Insolvency Act 1986.
 See related article "Insolvency Service's one day Insolvency Rules Modernisation Stakeholder Conference - Ludites beware!"
 Milman Priority.
 On these alternatives to pari passu see: Finch, V. Corporate insolvency law: perspectives and principles. Cambridge University Press, Cambridge, 2009, at pages 666 to 674 and her earlier: Finch, V. Is pari passu passé? (2000) Insolvency lawyer, 5 (Oct). pp. 194-210. ISSN 1350-5211
 Milman Priority
 IS Consultation
 IS Consultation para 2.33
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