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Understanding insolvency in higher education

As financial pressures on higher education providers begin to become apparent, there are still many questions about how insolvency would work in the English sector. David Kernohan investigates.

David Kernohan is Deputy Editor of Wonkhe

What would happen if an English HE provider ran out of money?

The peculiar answer is that we’re not exactly sure. For all the “restructuring regime” offers a way for the government to rescue or resituate the parts of a failing provider, and for all student protection plans (or the Covid specific “student protection directions”, following a consultation that closed last month) underlie the Office for Students’ laudable commitment to securing the best future for students – there is not a bespoke administration or insolvency regime for higher education providers that secures the interests of students, as there is in FE.

What’s insolvency?

Insolvency is the state of not having enough money. If someone or somebody can’t pay their bills as they come in, or have more liabilities (money they owe) than assets (money and things that could be converted into money), they are insolvent.

Administration is a process that offers protection to insolvent businesses, and ensures creditors and those with an interest in the business are looked after – in essence, things that have value are sold, and the money used to pay back creditors as far as is possible.

A business is encouraged not to trade pre-insolvency if this would damage the interest of creditors – if it does directors (or trustees in the case of a charity) risk action against them for “wrongful trading” or a “breach of fiduciary duty”. That said, there may be provisions in a charity’s constitution that limits trustee liability – unless they have acted fraudulently.

In English Law, insolvency procedures are set out in the Insolvency Act 1986, which itself is a codification of years of law on the topic. As Pinsent Masons set out, though the act refers to “directors” it is entirely reasonable to assume (as above) that “trustees” would play a similar role. The standard administration model sees an administrator (a licensed “insolvency practitioner”) brought in to manage the wind-down of the company for the benefit of the creditors. A “receiver” is an older but still-used variant where the receiver is appointed by a creditor to deal with a particular asset charged to that creditor. Liquidation is also available, usually where a company has ceased trading or following an administration.

In Further Education, the Further Education Bodies (Insolvency) Regulations 2019 and associated guidance provides a bespoke administration regime. The FE sector originally had a “restructuring regime” of its own in the form of area reviews leading to an inhouse restructuring unit at DfE – but it was pretty soon realised that a formal insolvency regime was needed.

Though the language in the HE “restructuring regime” allows the government the opportunity to make conditional loans to otherwise unviable providers, the regime does not provide a bespoke administration regime. If your institution was established by statute – a Higher Education Corporation, in other words – there does not appear to be an easy way to declare the provider itself insolvent, though it would be possible for a secured creditor to appoint a receiver to liquidate charged property assets.

A worked example

Let’s imagine our fictitious public higher education provider, Cow Eye University, is in a bad way. Finances have deteriorated over a number of years, to the extent that it is now unable to access new loans. It has a little bit of historic borrowing that is being slowly repaid, and a revolving credit facility with its bank that is regularly fully drawn. It has been a number of years since it ran a surplus, so reserves are depleted.

A lower than expected 2020 recruitment, coupled with additional costs associated with maintaining a crumbling late 60s campus, means that there are now serious questions about how it will continue to pay salaries and debts. A round of redundancies has already taken place, but the costs associated with redundancies mean that no more are possible, so it has reluctantly entered the government’s restructuring regime.

This means that Cow Eye has made a request for support from the government – looking for a loan to cover immediate costs and support restructuring. This request was assessed in an independent business review (IBR), which was unable to recommend to the Restructuring Board at DfE that this would be a good use of government funds.

Computer says no

Instead, the Board noted a core of locally critical higher education provision that it recommends could be transferred to a nearby FE college and a small but established school of engineering with courses that might be delivered more cost-effectively at a larger provider 40 miles away. There was no nationally significant research identified, and the IBR noted that tuition fee income was regularly used to subsidise research.

Clearly, the impact of these recommendations – and the refusal of direct financial support – mean that Cow Eye has no prospect of returning to financial viability. There will have been consultation with other interested parties as creditors – banks, lenders, pension funds – and with the Office for Students as regulator (both sector regulator and as the principal regulator of higher education charities).

OfS is, of course, concerned with the interests of students, and will need to ensure that consultation with students and their representatives would precede a final decision on “teaching out” existing provision. Of course, the financial pressure on the university means that it no longer meets conditions of ongoing registration with the OfS – specifically condition D on financial sustainability, and possibly condition E2 on effective governance.

The timing here is key. In avoiding a “disorderly market exit”, supporting the provision of teaching for students would be paramount. OfS would be involved in conversations with other providers, and with creditors. The latter would be understandably keen to get their money back, and may not wish to take any enforcement action that might be viewed as causing insolvency and prejudicing students. If action is required a creditor may opt to forego a portion of their debt to realise some at least some capital.

Thinking the unthinkable

This is all plausible, but it puts us into very new territory. The government has never before recommended (effectively) the closure of a university on financial grounds. For chartered universities (like most pre-92 providers), statutory corporations (a few earlier pre-92 providers), and higher education corporations (most former polytechnics) specific action is required from the governing body – in the latter case a request to the secretary of state for an order of dissolution. Some newer providers have either been established or converted to a company limited by shares or a company limited by guarantee – in these cases the standard measures in the 1986 Insolvency Act would apply.

Let’s imagine Cow Eye University is a higher education corporation (and therefore a charity). We’ve already started transferring parts of the institution to other providers as a going concern (on the basis that the students it currently teaches bring with them an income from the SLC and the staff associated with the delivery of those courses are fundamental to its continuation). Cow Eye, therefore, needs to have both of its eyes open to opportunities to realise value for its charitable assets and for its creditors. Creditors would need to be prioritised and any disposals of assets to non-charitable institutions would need to be for value.

If more money is released than is needed, the trustees would have a say in what happened to these funds. On a dissolution, surplus assets from a higher education corporation can only be transferred to a person “wholly or mainly engaged in the provision of educational facilities or services”, or a body established specifically for those purposes or the Office for Students. If no other charitable higher education institution was willing to take on the surplus assets these would be received by the Office for Students – in our example, the assets would remain as charitable assets, so we may well see the realisation of these assets by the OfS and an allocation of the surplus funds to other charitable providers in the sector. Even that mouldering 1960s concrete campus has value as land for development – though in the current economic climate it may not make as much as might be hoped.

Bad debt?

If the sale of assets doesn’t make enough to cover the debt, what happens to the bank (or if you find it hard to care about a bank, what happens to the Canadian teacher’s pension fund that invested in the university via a private placement)? It has lent money that now will not be repaid in full by the HEC it lent money to – how will it be repaid? In short, it will not

Before the 2017 Higher Education and Research Act amended the 1988 Education Reform Act the Secretary of State could just decide to wind a HEC up – since then, it needs to be done at the request of the provider. Chartered providers also have limited options, just compulsory winding up or receivership.

But universities have another thing that is of value – degree awarding powers. These would be very valuable to any business seeking to enter the higher education market, and – behind closed doors – interest has already been expressed by private HE providers. There is a fascinating test case (which, to be clear, is not linked to insolvency) with OfS for a decision at the moment – the merger of Regent’s University London with Galileo. Though a provider called “Regent’s University London” would still be delivering higher education in the same buildings with the same staff, the process of transferring Degree Awarding Powers (DAPs) to a new legal entity is not envisaged by the current regulatory framework. Many people will be keeping a very close eye on that decision.

Worse debt

But there’s the potential for something even sillier. Creditors would only be repaid in full if sufficient value could be realised from assets like that, and if not enough value is realised, only a portion of what was owned will be repaid. This is not silly in the sense that is better than having an outstanding debt with a provider that can’t pay it – and it is the normal way that insolvency works.

So why is it silly? As we’ve previously documented, a lot of people like to lend money to UK universities – and a lot of UK universities like to borrow money. Universities are seen as a fairly safe investment, in part because of a market perception that they are backed by the UK government. For those who followed the early “no bailouts” rhetoric from the Office for Students, this can best be described as a polite fiction. The OfS gets to talk tough, but lenders assume that it’s just words. Credit Rating Agencies methodologies assume a high level of govt support for the sector, and the recent announcement of the DfE’s restructuring regime also offers some comfort that funding may be made available to support the longevity and sustainability of UK HE.

The enforced closure of a provider, followed by debts not being covered, collapse this waveform. Lenders would look differently at similar providers, and perhaps even at the sector overall. Though in every case, anyone lending money for a provider would make decisions based on a full assessment of its financial strength – it is fair to imagine a UK higher education “halo” effect. People lend to UK public HE providers, in part, because it is seen as a stable sector – after an enforced provider closure it would no longer be seen as such.

Bank lending is risk-based, therefore the higher the risk driven by market forces, student demand, and financial strength – will result in some cases with security required or lower credit ratings. Those institutions with stronger financial positions will continue to be a safe investment due to lower risk and will still be able to access relatively cheap unsecured finance. Due to market forces, there will always be financially stronger and weaker operators within the sector. For this reason, an expedited merger between providers, followed by the sell-off of a campus, is another eventuality we may need to consider.

“Proper” insolvency

Were the government to come up with a bespoke insolvency regime, including measures for older forms of providers like statutory bodies and chartered universities, it would remove a lot of the uncertainty as regards students’ interests compared with the existing system. If the government is determined to reconfigure the sector, it would seem reasonable to offer HE students the same protection available to FE students in the worst case of insolvency.

To be clear, I’m not urging government close universities – I’m suggesting government bring in structures that could manage such a process more easily and in a way that protects students.

The early DfE and OfS involvement in discussions means that the initial parts of the process are likely to take student needs into account. But where administration is available, it will work to do the job – treating creditors normally and not prioritising students’ interests. Closing a university would be traumatic enough without watching DfE learning how to do it in real-time.

I’m grateful to Pinsent Masons, and Ian Robinson at HSBC UK, for conversations that have aided my understanding of this complex area.

2 responses to “Understanding insolvency in higher education

  1. For further discussion concerning the insolvency of a HEC see our OxCHEPS Occasional Paper No 68 (December 2018) on Bail-Out, Merger, or Closure. As David K states a for-profit registered company or a non-profit charitable registered company running HE provision would be dealt with by the ‘simple’ application of the Insolvency Act 1986 – although obviously his point about the possible rescue of a ‘public‘ provider would apply in the latter case. A U that is a chartered corporation would be dealt with under certain provisions of IA86 that allow the Court to apply the IA processes, and the distribution of its assets (if anything is left after paying off bank/bond debt AND now meeting massive USS liabilities, as well as redundancy payments for staff) would be a matter for Charity Law (the cy-pres doctrine) and the rather arcane Law of Corporations (in addressing the dissolution of a Royal Charter entity). A sensitive issue would be protecting funding for the Student Protection Plan required by the OfS (the cost of teaching-out, compensation for breach of the U-S contract, etc) from these and other creditors – which is why HE needs its own insolvency regime a la that for FE if the SPP is to be a credible device. All to be given more extensive and worryingly topical coverage in our 2020 third edition of The Law of Higher Education (Oxford University Press). David Palfreyman & Dennis Farrington.

  2. Thank you – a useful summary and good to see an article which recognises that insolvency law is the primary determinant in such an event.

    There are a few subtleties which would be complex.

    Firstly pensions. Most FE providers are either in USS or LGPS. This would make the position of identifying creditors and amounts due very complex. The pensions regulator might also become involved.

    Secondly is the issue of trading insolvent. If I am a director of a company which is insolvent I am required to cease trading immediately. Trade can only be continued once an insolvency practitioner has been appointed. In law there is no compromise here, even for the OfS seeking to ensure students can still study. Some arrangements would need to be made in the short term to cover trading after the insolvency is declared.

    Thirdly income cannot be transferred. If an institution receives a cash research grant and 50% is used at the point of insolvency the other 50% is not transferred even if the researchers are moved to another institution. The income becomes another creditor. It is probably unsecured meaning that it would come after banks and possibly pensions in the queue at best it will be several years before it is paid and most likely it will never be paid. Similarly SFE or student payments that have already been made cannot be ‘unmade’ and moved to another institution. Any institution taking on activities must understand the cash flows.

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