Administration explained

These days, we're always hearing about the administrators being called in. But what's it all about?
Commercial awareness
Financial theory

Administration is a relatively common event in the business world - particularly so during tough financial times. The onset of the economic downturn in 2008 led to the largest number of profit warnings from public companies since 2001. And the number of profit warnings issued by UK quoted companies during this period was 17 per cent higher than in 2007. The retail sector has had to weather a particularly stormy stretch since - and it's not out of the woods yet.

What is administration?

Administration is a legal procedure governed by insolvency laws in a number of common law jurisdictions. It functions as a rescue mechanism for insolvent companies and allows them to carry on running their businesses. The process - an alternative to liquidation of the company's assets - is often known as going into administration. In the UK, the administration regime is governed by the Insolvency Act of 1986. It states that an �administrator" can be appointed without the company or by its directors petitioning the court. Other creditors (firms or individuals owed money by the company in question) must ask the court to appoint an administrator. The administrator is a neutral party which must act in the interests of all the creditors and attempt to rescue the company while ensuring, as far as possible, that its debts are paid. If saving the company is impossible, it is the duty of the administrator to recover the maximum share of the money owed to each of the creditors. During this period of reorganising the company's finances, the administrator usually steps in to run the business, displacing the directors of the company. This status grants the administrator the power to do whatever it deems necessary for the management of the affairs, business and property of the company. Often this will involve finding a buyer or an investor for the business.

Why put a company into administration?

Despite the alarming press attention usually given to the administration process, it is in fact a common and often effective means of rescuing a business which would otherwise find itself bankrupt and be unable to pay back its creditors. In the UK, the administrators are called in by the company itself rather than any external body, in recognition that it is usually the best option available to them in their time of need. In some cases, it may be that a brief spell in administration is all that's needed to get the company's cash flow back on track.

The owner of the business agrees with the insolvency practitioner to take the company into administration and buy back its assets at a discount while agreeing a percentage pay-out to the creditors.

Administration is not the only option available to a struggling company. There are other routes open to them, though these are often far less viable or attractive. The primary alternative is for the company to seek outside investment from a �turnaround investor" - an investment firm with particular expertise in rescuing failing companies - in exchange for an equity share. The third option is for the business to simply fold - not an attractive option for the owner who will suffer a number of penalties, including being prevented from managing a company again in the near future. With the help of an administrator, all parties agree the best way to go forward, which with luck will allow the company to survive, saving jobs and keeping the business going for all its stakeholders.

Who are the administrators?

The �Big Four"� professional services firms all have established insolvency arms to their businesses. These have all been involved in the administration process of major companies in recent history. Lehman Brothers' administration was handled by PwC whilst KPMG handled the insolvency process for Leeds United F.C.

The Lehman Brothers' administration in 2008 was one of the most high-profile in recent times. While the firm failed in September of that year, the unwinding of Lehman Brothers' debts is still taking place and the likelihood is that it will take several years for all of its accounts to be fully settled with the relevant parties. At one point approximately 1,500 of Lehman Brothers' creditors, ranging from hedge funds to pension firms and lawyers, poured into the O2 Arena, the venue where the public auditing process was held. Despite the scale of the operation, as in any administration case, full due diligence had to be undertaken to correctly assess what proportion of the company's remaining assets was owed to each individual creditor. Tony Lomas of PwC who headed the administration, made the following comment: �I make no apologies: we're extremely nervous about the risk of disposing of client positions incorrectly. You won't be surprised that a number of counterparties have instigated or threatened to instigate litigation against the estate to reclaim assets. We recognised that as a risk and were concerned not to simply give in to the person who shouted loudest."

As the UK public begin to feel the sting of the government spending cuts, the relatively under publicised world of administration is more than likely to become more of a regular feature in the business press. The one positive to the situation is that graduate recruits in this area will benefit from the experience gained by working on difficult administration cases. For students with an interest in the complexities of the corporate world, there may never be a more interesting time to join a professional services firm.

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