Insolvency regime for FE and Sixth Form Colleges comes into force and Government publishes long awaited guidance

• United Kingdom

• Education - Briefings

31-01-2019

Introduction

In previous briefings we have set out details of the Government’s consultation exercise on its proposals to introduce procedures for further education and sixth form colleges which become insolvent (see our briefings 21 July 2016, 31 October 2016 and 5 January 2018).

The new insolvency regime comes into force today and on Tuesday the DfE finally published the “Further education bodies: insolvency guidance (“the guidance”) it said it would provide “in advance of the regime coming into force”. Secondary legislation has also come into force today – The Further Education Bodies (Insolvency) Regulations 2019 make a number of modifications to existing corporate insolvency legislation to allow the provisions to properly apply to statutory corporations, and are referred to in the guidance.

In addition the DfE has announced that it will in March publish full details setting out what is changing within the FE college intervention regime with effect from 1 April 2019 and, in the meantime, has publishing some Q&A to help build awareness of the changes amongst FE colleges.

The guidance is expressed to serve two main purposes. Firstly, to provides general guidance on how to reduce the risk of insolvency through good financial management and secondly, it sets out technical information which provides:

 • an introduction to insolvency and the different insolvency proceedings that might occur in respect of an FE body and the roles and responsibilities of governors regarding those; and

• an explanation of the application of certain provisions of the Insolvency Act 1986 and the Company Directors Disqualification Act 1986 to college governors – including what disqualification, wrongful and fraudulent trading mean and what actions might be taken against governors.

The guidance says it is for governors of FE and sixth form college corporations in England but will also be useful for corporation clerks, college finance directors, other senior college staff and those with an interest in governance.

Key points

At the outset the DfE summarises what it regards as the key points of the guidance in relation to the two sections as follows:

Financial management and performance

• the board and executive should recognise that the monthly cashflow position is as important as the year-end position and that insolvency can develop quickly

• the board should ensure that the college executive undertake robust and comprehensive monthly cashflow forecasting and, where appropriate, ensure this is reviewed externally/independently

• the board should undertake regular monitoring and review of both cashflow and loan covenant compliance

• to ensure strong financial management, the board should ensure that its makeup includes good finance skills and that there is an effective finance committee - there should be a credible, professionally qualified finance director appointed with sufficient seniority within the college (preferably a senior post-holder)

• the board should ensure that there is adequate risk assessment and sensitising of key cash variables, in particular capital receipts and Adult Education Budget clawback

• the board should not rely solely on the Education and Skills Funding Agency (ESFA) or other review ratings to give an indication of solvency, which may either not fully reflect the college’s true financial position or may not be up to date

Insolvency technical points

• although instances of insolvency may be rare, the board and executive should familiarise themselves with the guidance and seek appropriate advice as necessary

• the board should be aware of their role during an independent business review and during an insolvency procedure, such as education administration

• only the Secretary of State can apply to court for an education administration order in relation to a further education body in England

• disqualification can apply to appointed governors, and also to people who are acting as a governor although not formally appointed as one – though it is important to recognise that governors will not automatically be disqualified as a consequence of insolvency

• not all offences and penalties apply to student governors

More detail is contained in the guidance and we set out further important points below.

Duties of governors of statutory corporations

The guidance points out that the governing body as a whole needs to ensure that within its membership it has the skills necessary to discharge its core functions and if it is lacking in a particular area the body as a whole should seek to address that as appropriate, such as through alternative appointments and/or training.

It reminds governors that they are required to have full regard to their duties as charity trustees, which will include questioning the financial position of the college where this is unclear, requesting advice and explanation as necessary, and taking action with the college principal and senior staff, if the college is at risk of insolvency.

Adopting best practice and reducing risk of insolvency

Picking up on a number of the key points above, boards should not limit their financial focus, for example prioritising year-end or even quarterly positions, but need to regularly monitor the college’s monthly cashflow position. In addition they should seek regular assurance on the cash reserve position, and up to date forecasts that extend beyond the end of the current financial year.

The DfE recommends that colleges recruit a qualified accountant onto their board and/or ensure that a Finance Director of sufficient seniority is appointed, who is capable of renegotiating covenants and lending facilities and driving through change where needed. Boards also need to ensure good risk assessment of financial plans and delivery, along with actions to mitigate risk, and regular monitoring and reporting.

Whilst it is stated that those governors who do not have a background in finance are not expected to become experts, they should familiarise themselves with financial planning and accounting guidance; undertake training if required; ask questions and seek adequate explanation and advice when finance papers are presented to them. The guidance reminds governors of the ‘College accounts direction’, and the ‘College financial planning handbook’ produced and updated by the ESFA and the guides on financial management, including the Accounts Direction Handbook, published by the AoC.

The guidance emphasises that governors should ensure that as soon as signs of financial difficulty emerge, either as an immediate issue or anticipated risk, colleges liaise with their bank and the ESFA, as appropriate. Although, Exceptional Financial Support will no longer be available from April 2019, the DfE states that a range of support will continue to be available from the ESFA and the FE Commissioner’s team. The DfE argues that It will be more straightforward to identify appropriate support and intervention if colleges tell the ESFA immediately if they judge that they may be running into difficulties.

Finally in this section, there is a section on the role of an independent business review (IBR). The guidance points out that prior to a corporate insolvency, it is not unusual for creditors to commission an IBR of the organisation or company to assess the options available and the strategy ahead of formal insolvency proceedings starting (and indeed some banks already commission IBRs of colleges as part of their normal course of business). The Government plans to take a similar approach in cases of college insolvencies. It expects that the most likely parties to commission an IBR of a college would be the DfE (following prior intervention actions), a secured creditor, or the board of the college to assist them in assessing the strategic options and the financial consequences of those options.

IBRs are usually conducted by an independent accountancy firm and would typically be undertaken by an accountant specialising in financial reviews and restructuring who may be a licensed insolvency practitioner (IP). During an IBR, the IP or accountant appointed is not running the college and the normal management arrangements remain the same, however, the principal, governors and senior staff of the college are expected to co-operate with the process and support the IP or accountant in gathering necessary information to make their assessment.

The FE insolvency regime

The guidance reminds governors that the new legislation applies aspects of insolvency law to FE and sixth form colleges that are statutory corporations (namely voluntary arrangements, administration, creditors’ voluntary winding up, winding up by the court and receivership) and introduces a new special administration regime (called education administration).

By way of reminder:

• an education administration commences as a result of a court order on an application by the Secretary of State

• the special objective of education administration is to avoid or minimise disruption to the studies of the existing students of the further education body as a whole, and ensure that it becomes unnecessary for the body to remain in education administration for that purpose

• the education administrator may achieve the special objective through rescuing the further education body as a going concern; transferring some or all of its undertaking to another body; keeping it going until existing students have completed their studies or making arrangements for existing students to complete their studies at another institution

What happens if a college corporation is insolvent?

Although the guidance states the Government expects cases to be rare, where it is clear that a college is in severe financial distress and there is no alternative viable solution for managing the college out of that situation, the expectation is that the college will enter into insolvency proceedings.

The role and actions that might be required of governors in such circumstances will depend on the type of insolvency proceedings but might include making out and submitting a statement as to the affairs of the statutory corporation; providing a notice of resolution to wind up; laying a statement of affairs before creditors; submitting a statement of affairs to the official receiver; providing notice that the statutory corporation is in liquidation (within invoices, business letters etc. and on the college’s website); and to co-operate with the IP.

Not all the duties and penalties apply to student governors on the basis that it was felt that they might be likely to have less knowledge of the college’s financial affairs than other governors of the college and that it would be unfair to put them in a position where they could potentially be fined for not being able to be involved in preparing and submitting statements of affairs about the college. Details of the duties and penalties which apply to student governors are set out in the guidance.

It should be noted, however, that all governors, including staff and student governors, and anyone acting in the capacity of a governor, are covered by the provisions on wrongful and fraudulent trading – although the guidance states that in practice, it is extremely unlikely that either staff or student governors would manage to find themselves in a position where they could direct decision-making in such a way as to cause wrongful or fraudulent trading.

Potential liabilities and offences applicable to governors

The guidance points out that, in their role as charity trustees, governors can already be held liable to their college corporation for financial loss that they cause or help to cause, although there may be financial protection for governors who have made an honest mistake and can rely on indemnity provisions in the statutory corporation’s governing articles of association, insurance cover or relief from the Charity Commission or the court.

Furthermore, the Learning and Skills Act 2000 also provides that if a governor of a body corporate is found liable of wrongdoing in civil proceedings, that individual has the right to apply to the court for relief from personal liability where they can prove that they have acted honestly and reasonably.

However, the introduction of the insolvency regime will mean that governors could potentially be liable for wrongful and/or fraudulent trading.

The offence of wrongful trading will occur when governors have allowed a college to continue to operate, when they knew, or ought to have concluded, that there was no reasonable prospect of avoiding entering insolvent administration, or going into insolvent liquidation and they did not take every step with a view to minimising the potential loss to the college’s creditors.

The guidance states that signs of wrongful trading “could include taking credit when there was ‘no reasonable prospect’ of being able to repay the creditor when the payment is due; failing to pay PAYE when due and building up arrears”.

For the more serious offence of fraudulent trading it is necessary to prove that any business of the college has been carried on with intent to defraud creditors, or for any fraudulent purpose.

There are also a number of other offences under insolvency legislation, such as false representation and fraud, which are explained in the guidance.

Finally, the Company Directors Disqualification Act 1986 provides that a variety of misconduct can result in a disqualification, and these provisions will now also be applied to governors of FE bodies that are statutory corporations. The guidance points out insolvency proceedings do not automatically result in disqualification proceedings and that governors can mitigate their exposure to possible allegations of misconduct by ensuring they act reasonably, seeking independent advice and having due regard to the advice received.

Conclusion

Nothing in the guidance should surprise corporations who have been following the tortuous process associated with introducing the new insolvency regime. College insolvency will clearly be a last resort. It may be that the biggest impact is felt in adding focus to the dialogue between regulators and the leaders of colleges who find themselves unwilling or unable to recognise the severity of a financial crisis.

Corporation members need to understand the new rules and continue to govern in a sensible and thorough manner. We see the focus on wrongful trading as the area of greatest risk for governors, albeit that risk is still low. Governors can mitigate that risk by spotting issues then seeking and following professional advice when it is needed.