George Eustice MP: The law must prioritise business rescue over business closure

George Eustice is MP Member of Parliament for Camborne, Redruth and Hayle.

Individuals who put their own money on the line to create wealth are the lifeblood of a free market economy and those who give a bank security over their assets have a special right to be treated honourably. But most entrepreneurs need to discover how to lose money before they learn how to make money.  Failure is an important step on the way to success in terms of testing new ideas.

Sometimes, the failure of a business will be terminal and liquidation can be the right option for all concerned.  But, very often, a business that hits hard times can emerge from the other side of its troubles stronger than ever.  The value of failure can only be realised if a business is given the chance to survive.

The US has always had a better attitude towards failure than Britain.  Here, the banks hold all the cards and frequently exploit their bargaining position to bully their small business customers into accepting higher interest charges or less favourable terms.  It is time to rebalance the law in favour of enterprise and this is the subject of my paper - published yesterday by the Free Enterprise Group*.

In the US, companies can file with a federal bankruptcy court for protection under what is termed “Chapter 11” which allows the borrower to remain in control of the day to day running of the business and where the focus is on trying to save it.  The UK law on bankruptcy was reformed in 2002 to borrow some aspects from the US system. Under the new form of “administration”, there is some protection from the court and the emphasis is on trying to hold a company together until it can be restructured or sold as a going concern. 

But there remains one giant hole in the UK system: it doesn’t cover smaller businesses.  In the US all businesses are covered by these protections but in the UK, “administration” can only be accessed by companies or partnerships.  The vast majority of small businesses and sole traders have no protection at all and winding up procedures are largely dictated by the hopelessly outdated 1925 Law of Property Act.

Receivers appointed to small businesses under the Law of Property Act (LPA Receivers) are totally unregulated and, in many ways, behave like the discredited, old style “administrative receivers” that the government thought it had abolished ten years ago.  They do not need a possession order before seizing and selling off assets and they work for the banks but are paid for by the borrower.  Figures from the Council of Mortgage Lenders shows that the number of receivers appointed in this outdated way jumped four-fold to a staggering 4500 in the first quarter of 2009.

The original Law of Property Act 1925 envisaged that receivers would simply receive income from and be caretakers for the assets over which they were appointed.  It also stipulated that their fees should be limited to 5 percent of the income they received.   However, clever lawyers working for banks have continuously worked to undermine the original intentions behind the Act.  They use their “standard terms and conditions” to give LPA receivers general powers of sale, to circumvent the specified limit on the fees that a receiver may charge and to load all associated costs on to the borrower.  In short, the banks have seized new rights for themselves through their standard terms and conditions and this has led to a complete inequality of bargaining position between banks and their small business customers.

The principle of “freedom of contract” is crucial to a free enterprise economy but, while businesses might negotiate rates of interest from their bank, there is no prospect of them negotiating a variation of a bank’s standard terms and conditions.  In practice, there is no freedom of contract on the part of the borrower when it comes to such terms.

When things go wrong, the banks then use the threat (and cost) of receivership to force their business customers into accepting extortionate management fees and higher interests rates. To make matters worse, many of the high street banks pay “permanent retainers” to the most able law firms to set up a notional ‘conflict of interest’ that precludes the best litigators from acting against the banks, so they seek to deny their business customers access to justice.

It is time sort out the law so that small businesses have the same protections as larger businesses through access to the administration procedure.  We also need to place new limits on the powers of receivers, cap their fees and require the banks to obtain permission from a court before being allowed to sell assets.  Most important of all, the law must always prioritise business rescue over business closure. 

* Read ConservativeHome's profile of the Free Enterprise Group.