As from September 15, 2003, potentially major changes took place to insolvency procedures in the UK.

The changes that have been brought in under the Enterprise Act 2002 affect, firstly, receivership and, secondly, the respective rights of different classes of creditors in formal insolvencies.

Taking receivership first, a bank or other lender of finance to a business will usually insist, as a condition of making the loan, on taking a charge over the business's assets. The charge will give the lender the right to take specified action should the borrower default on his obligations to repay the loan.

In practice, a bank will usually insist on being entitled to appoint a receiver or, more usually, an ëadministrative receiverë ñ a receiver who is appointed over the whole or substantially the whole of the company's property ñ in the event of the borrowing business defaulting on repayment of the loan.

The function of the receiver is effectively to take control of the business and to realise whatever assets are available in order to pay the lender.

Under the changes which came into effect in September, banks lost the right to appoint an administrative receiver. Instead, banks will be entitled, in the case of the borrower's default, to appoint an ëadministrator'.

SIGNIFICANT CHANGES

The most significant difference here is that the administrator's main objective will be to save the company as a going concern.

Note, though, that the prohibition on the appointment of administrative receivers only applies to new loan agreements entered into after September 15; pre-existing agreements are not affected, so receivers may still be appointed in these cases.

The second big change relates to creditors' rights to payment in formal insolvencies.

Previously, certain classes of creditors enjoyed better rights than others. ëPreferential' creditors include debts owed to the Inland Revenue and HM Customs & Excise in respect of unpaid income tax, VAT and national insurance contributions. Such debts must be paid after amounts secured by a fixed charge but before all other liabilities.

After September 15, however, debts owed to government departments in respect of income tax, NICs and VAT no longer count as ëpreferential'. Other categories of preferential debts, including unpaid wages and pension contributions, are not affected.

GOOD INTENTIONS

The government's intention in abolishing Crown preference, which HM Treasury has estimated will cost it around £70 million each year, is that more assets are made available for trade creditors.

In respect of individual insolvencies, all monies which would in the past have gone to the Crown will be made available to trade creditors.

So what will these changes mean for small businesses in practice? As regards the abolition of banks' right to appoint receivers, on the face of it this sounds like good news ñ even if a business falls behind with its repayments on a loan agreement, the worst that can happen is that its bank appoints an administrator rather than a receiver.

For companies which are only experiencing temporary working capital-related problems, the prospects of survival will no doubt improve.

But it should be remembered that an administrator will only be guided to keep the business going if it is viable to do so and where it is in creditors' interests to do so ñ where a business has no reasonable chance of survival, then it cannot expect the administrator to keep it going.

And we should all keep a careful watch on whether the detriment to lenders' position as regards enforcement of security will have any material effect on banks' lending criteria.

ADDITIONAL DIVIDENDS

As for the abolition of Crown preference, the additional dividends that will be available to trade creditors should help to reduce the problem of domino insolvencies, where the insolvency of one firm drags down its unpaid suppliers with it.

On a wider level, though, the Treasury's willingness to give up the £70 million per year that it used to raise via insolvency procedures will not be seen by the business community as a totally altruistic gesture ñ the equivalent of the sums foregone will no doubt be raised via other means.

John Davies is head of business law at the Association of Chartered Certified Accountants.