A proposed new insolvency regime for the further education sector

Out-Law Analysis | 17 Mar 2017 | 10:38 am | 9 min. read

ANALYSIS: A new special education administration regime, designed to protect the students of further education bodies in England and Wales, should be in place for the start of the 2018/19 academic year.

The new regime is one of a number of changes to technical and further education introduced to parliament in October 2016 via the Technical and Further Education Bill. It follows a government consultation that concluded last summer.

Funding to the further education (FE) sector has fallen considerably in recent years, resulting in an increase in financial stress to FE bodies. The sector is also facing increasing competition with the impact of the apprenticeship levy and in-house training.

In 2015, in response to these pressures, the government began a programme of area reviews with the aim of ensuring “high quality, sustainable provision capable of meeting the future needs of learners and employees”, as well as reducing the potential for future financial failure through mergers and consolidation.

The 1992 Further and Higher Education Act created much of the law establishing the FE sector. However, it did not provide direction for insolvency scenarios. It is, for example, unclear whether all FE bodies fall within the definition of ‘statutory corporation’ in the 1986 Insolvency Act. This has created uncertainty regarding the extent to which normal corporate insolvency procedures can apply to FE bodies now that they have become commercial enterprises.

A special administration regime

The proposed special administration regime attempts to address this uncertainty, while effectively balancing the interests of students (referred to as ‘learners’), creditors and the taxpayer. The government’s high level intentions for the new regime are to “establish a clear insolvency framework for FE colleges and sixth form colleges which will focus on learner protection through continuity of provision, while recognising the interests of creditors and ensuring taxpayers do not provide indefinite financial support to failing colleges”.

A consultation on the proposals began in July 2016, with the results published in October. The first reading of the bill was in late October; and the proposals were debated by a Public Bill Committee in December with the intention that the new regime should be finalised and in place for the 2018/19 academic year.

The bill includes within the definition of ‘further education body’:

  • FE corporations and companies conducting designated FE institutions in England and Wales; and
  • sixth form corporations in England.

The three FE institutions run by charitable trusts will not be subject to the proposed regime because they cannot technically become insolvent, given that they have no legal identity separate from their trustees. The government concluded that the complications of applying the regime to them, balanced against the likelihood of them becoming insolvent, justified their omission.

The main features of the proposed regime are as follows.

Insolvency Act procedures

As a starting point, the bill brings insolvent colleges within the framework of the Insolvency Act and broadly seeks to treat colleges as corporates.

Specifically, company voluntary arrangements, administration, creditors’ voluntary winding-up and court-based winding-up procedures are permitted for colleges. The provisions relating to receivers and managers of property are also now allowed to apply to FE bodies. The bill contains the power to adapt the provisions of the Insolvency Act relating to these insolvency procedures so that they work for FE bodies.

The application of these Insolvency Act procedures should help alleviate the procedural uncertainty surrounding the insolvency of FE bodies. However, in the majority of cases, creditors will be unable to follow these procedures owing to the introduction of a new special administration regime for colleges.

Education administration orders and the 14-day notice period

Overlaying the traditional insolvency regime is the ability for the education secretary to apply to court for an education administration order where:

  • a FE body is unable, or likely to become unable, to pay its debts within the meaning of section 123 of the Insolvency Act; or
  • a FE body’s creditors, or the body itself, are petitioning for another type of insolvency regime under the Insolvency Act.

Education administration requires an order of the court, and only the education secretary can apply for the order.

Once granted, the education secretary must notify the FE body and any other person specified in the rules, which are yet to be confirmed.

If an education administration order has not already been made and a party wants to apply for an ordinary administration order or petition for winding-up they must first give the education secretary 14 days’ notice. During that time, the education secretary has the discretion to apply for an education administration order. A moratorium of enforcement of security applies during the notice period. It is worth noting that, while the 14-day period is the maximum time that the education secretary can take to decide to apply for an education administration order, in practice it is hoped that the process will take less than 14 days. An ordinary administration order or petition for winding-up cannot be made once an education administration order has been made.

There is currently no time limit set on an education administration as, according to the government, “the length of time a college may need to be in special administration will depend on the particular circumstances relating to that college”. Indeed, if new homes cannot be found for all the learners, the education administration may need to continue until their courses are completed.

The education administration order provisions enable the education secretary to intervene into any potential insolvency scenario for a FE body. Education administration will not be available where a FE body has already entered into ordinary administration or liquidation before the provisions are enacted.

Special education administration and the ‘special objective’

The key feature of the new special education administration regime (SEA) is the special objective to “avoid or minimise disruption to studies of existing learners and to ensure that it becomes unnecessary for the education body to remain in administration for that purpose (the ‘special objective’), which overrides other objectives for the education administrator.

The “existing learners” protected will include students at the college when the education administration order is made, or people who have accepted a place on a course at the college when the education administration order is made.

The options for the education administrator to achieve the special objective will include:

  • rescuing the college as a going concern;
  • arranging the transfer of the provision of education to another provider; or
  • allowing learners to transfer to another provider or to complete their courses before the college is wound up and dissolved.

In a college insolvency, the best way to meet these criteria would appear to be for a swift transfer of learners to nearby colleges offering equivalent courses – something which will be easier in metropolitan areas than in more rural locations. Where this is not possible, continuing courses for a further three or more years may be the only option.

Funding, guarantees and indemnities

The government's expectation is that institutions will remain responsible for their own finances. However, where an administration order is made, the education secretary is given the power, but not the obligation, to provide indemnities, guarantees, grants or loans in support of the SEA as they consider appropriate. No clarity is provided on whether such funding would be subordinated to existing lenders or potentially enjoy some super-priority status.

The government has stated in its consultation response that it “does not intend to commit, now or through proposed legislation, that funding will be provided on any particular terms or to achieve any particular outcome for creditors”. The response also highlights that a restructuring facility is available to FE bodies through the area reviews programme, adding that “whilst the [SEA funding] will provide a necessary safety net for colleges and their learners, its use will be exceptional”.

Although the government could not write a blank cheque to underwrite any SEAs, ultimately, where a SEA needs to be funded to look after learners until they have completed their courses as there is no option to transfer, government funding seems the only realistic option.

Governor liability

The bill gives the education secretary the power to create regulations that apply to governors of FE bodies, similar to those that apply to company directors under the 1986 Company Director Disqualifications Act. Wider powers are also given to make regulations providing for “any legislation about insolvency to apply” in relation to FE bodies.

The government stated in its consultation response that the intention of the new legislation, as far as possible, was to follow the principles of company insolvency; which will include extending liability for wrongful trading and fraudulent trading under the Insolvency Act to governors. The full extent of governor liability will be included in secondary legislation along with detailed supporting guidance. However, the government has indicated that fraudulent trading may extend to members of college staff and wrongful trading may extend to college principals and shadow or de facto governors.

Although potential direct liability is an important feature of corporate insolvency for creditor protection, it may be alarming to governors acting in a voluntary capacity.

What’s not included?

The government has stated its intention is that a “full suite of tools” should be available to deal with an insolvent FE body; and the tools available to an education administration will in fact be greater than the usual suite. There are, however, no provisions in the bill clarifying the decision-making process whereby SEA is initiated, although the government has stated that the SEA will probably apply “in most cases”. It is therefore difficult to assess how often the standard Insolvency Act procedures will actually apply – and, in particular, whether pre-pack administration could still be an option for a quick sale.

Members’ voluntary liquidation has not been included, as the Further and Higher Education Act already deals with the dissolution of solvent FE bodies and the government has assumed that members’ voluntary liquidation would rarely be required in the case of an insolvent FE body.

Although the bill applies Insolvency Act administration provisions to FE bodies, there is no provision allowing for the challenge of an education administrator on the basis that they are not carrying out their functions in accordance with the special objective. The government stated in its consultation response that it would address this omission in a future draft.

The bill contains no provision regarding the requirements to be put forward as an education administrator. However, in its consultation response the government stated that its expectation is that the education administrator will be a licensed insolvency practitioner who has sufficient expertise in the education sector, and that secondary legislation would follow including further clarification.

Impact on creditors

The introduction of education administration orders will reduce the control creditors have over the timing and conduct of the administration of an FE body.

Although an education administrator has a subsidiary duty to carry out their functions so as to achieve the best result for the college’s creditors as a whole so far as this is consistent with the special objective, the proposed regime risks a change in creditor appetite to lend into the sector. Historically, although they are nominally commercial bodies, lenders have tended to view FE colleges as enjoying an implicit state guarantee. The government has acknowledged this risk in its consultation response, but has made the judgement that this risk would be worth the extra benefit provided to learners.

As well as empowering an education administrator to transfer the provision of education to another provider, the bill allows an education administrator to transfer “property, rights and liabilities that could not otherwise be transferred”. This could include, for example, college buildings, equipment, bank loans, pension liabilities and staff contracts. Creditor banks have expressed concerns that transfers of loans without their consent could cause issues with ‘know your customer’ and anti-money laundering regulatory requirements. As assurance against this, the government issued a response that affected creditors would be given “sufficient notice” should such a transfer take place, and that “it is very unlikely that the education administrator or education secretary would permit a scheme proposal that would breach those regulatory obligations”.

The position of local authority pension schemes has also not been clarified. State schemes could potentially crystallise a significant claim in a college insolvency.

Transfers of assets could also interfere with lenders’ security rights. A request by lenders to permit floating charges over colleges to offset some of the non-creditor friendly provisions was not implemented.

It remains to be seen if the bill will be passed in its current form, or if any market reaction will be taken into account. The special objective of protecting learners is clearly a noble one; however, unintended consequences may play out over time. Questions still remain over the potential effect on lender appetite, where security rights and their insolvency position is unclear; and governor appetite, where faced with the directors’ duties and risk of wrongful trading.

Although the bill has created some apprehension in the sector given the potentially significant powers of an SEA, ultimately we will have to wait for the first SEA to operate to see if the government will in fact foot the bill to ensure the special objective is met. We may not have to wait too long, as mergers and consolidation put in place under the area reviews are likely to leave some casualties.

Nick Gavin-Brown is a restructuring law expert at Pinsent Masons, the law firm behind Out-Law.com.