INSOLVENCY: City law in practice

Case Study 1: The collapse of Enron Europe

The end of 2001 was marked by the collapse of multinational energy trading company Enron, the biggest bankruptcy in US corporate history. Once one of the largest energy trading companies in the world with a string of awards to its name, Enron’s parent company Enron Corporation announced on 2 December 2001 that it had filed for bankruptcy in the US to protect itself

from its creditors. Three days earlier on 29 November, four Enron Europe companies, the European holding company of the Enron group, based in the UK, had gone into administration, signifying the start of Enron’s European demise.

The rise and fall of Enron

Enron’s strength grew out of the deregulation of the energy industry in the 1980s, which the company was able to exploit to create a lucrative trading business. Enron then capitalised on its rapid growth by creating a web-based service during the internet boom of the 1990s.

By 2001, Enron had become the success story of the energy industry and was involved in about a quarter of the electricity and natural gas deals in the world. However, cracks started to appear in Enron’s veneer when its chief executive Jeffrey Shilling resigned unexpectedly last August for “personal reasons”. Doubts arose over Enron’s viability and its share price fell.

By November 2001, it was revealed that Enron’s chief financial officer had been running complex partnerships that allowed Enron to keep debts of $500m (346m) off its books, thereby hiding its losses. As a result, Enron revised its financial position and reduced its reported income by more than $580m (402m). Enron’s credit rating was downgraded and it was unable to service its debt. Companies ceased trading with Enron for fear of not being paid. Enron’s failure to include the full financial picture in its accounts meant that its decline was assured.

Dynegy, a company involved in the provision of energy, saw the opportunity to pick up a bargain and entered into merger negotiations with the failing Enron Corporation. Dynegy invested $1.5bn (1.04bn) cash in Enron before the proposed merger took place, in return for which Dynegy was to receive all the preference shares in a pipeline company. However, Dynegy abandoned the merger process at the end of November 2001, citing “misrepresentation” by Enron as the cause.

Dynegy’s withdrawal proved to be the last straw and Enron collapsed. By 30 November 2001, Enron’s shares had reduced in value from the previous year’s $90 (62) to 26 cents (18p).


Corporate insolvency is governed by the Insolvency Act 1986. A company will be insolvent if its liabilities on paper exceed its assets, or if it becomes unable to pay its debts as they fall due. A company that hits troubled financial times and is unable to remain solvent has three main options.

First, where its creditors are banking groups, it can attempt to negotiate with them to adjust its financial obligations so that its business can continue within its means, as happened with Eurotunnel.

Second, the company can go into liquidation, which effectively winds up the company; the business stops, the employees lose their jobs and the company’s liquidator collects its assets and distributes them to its creditors.

Finally, the company can go into administration which, despite its insolvency, allows the company to continue trading so that its business keeps going.

The administration order

An administration order essentially provides a company with an alternative to liquidation where the company is insolvent, but some or all of its business can be saved. A company seeking to go into administration has to obtain an administration order from the court. The company presents a petition supported by a witness statement and a report prepared by an independent insolvency practitioner, defined by the Insolvency Act as an individual authorised by a competent professional body recognised by the Secretary of State.

Enron Europe passed an ordinary resolution on a simple majority at a company board meeting to apply to the court for an administration order. The petition was presented by Enron’s directors and was supported by a witness statement prepared by one of the directors explaining the background facts of the company’s insolvency. PricewaterhouseCoopers (PwC), a firm of recognised independent insolvency practitioners, prepared a report providing the court with an analysis of Enron’s financial affairs. The presentation of the petition created a moratorium on Enron’s debts so that no creditors could take action to enforce their security or to repossess their goods without permission from the court.

The court will only make an administration order where it is satisfied that the company is insolvent and that the order is likely to enable the company to achieve one of the objectives enumerated in the Insolvency Act. PwC’s report set out that Enron was insolvent, what its assets and liabilities were and that an administration order would be likely to assist Enron in achieving the statutory objective of a more advantageous realisation of its assets than would be effected on a winding up.

Enron Europe consists of around 75 different companies, and on 29 November 2001 the process of those companies going into administration began when the court granted an administration order in respect of four of them. The court appointed four partners at PwC as joint administrators of Enron for an initial period of three months, extendable if necessary at the discretion of the court.

Linklaters, one of the UK’s magic circle of leading commercial firms, was instructed as the legal adviser to PwC. Richard Holden, a partner in the banking department at Linklaters, explained that there is significant partner involvement in this case due to the complicated nature of Enron Europe, but that teams of junior lawyers are also involved, particularly in drawing up the legal documents and conducting the necessary legal research and company searches.

The effects

The moratorium preventing Enron’s creditors from enforcing their rights against the company continued after the administration order was granted, and will continue as long as the order remains in force. PwC was appointed by the order to run Enron and its businesses with a view to obtaining an advantageous realisation of its assets. The administrator effectively holds the company, enabling its assets to be realised. However, there is no mechanism for the administrator to distribute the company’s assets to its creditors. Therefore, a company in administration will often go into liquidation or enter into a voluntary arrangement with its creditors once the statutory objectives have been achieved.

The administrator has to report to a committee of creditors within three months of the date of the administration order to set out the company’s financial situation and to make proposals as to how the statutory objectives will be achieved. The administrator must manage the company in accordance with the proposals once they have been accepted by the creditors. Realisation of assets

Realisation of assets

One method by which the administrator can realise the company’s assets is by selling them. The administrator is not required to obtain the court’s permission prior to the sale of the company’s assets, although in practice the court’s permission will be obtained prior to the sale of a significant asset.

On 4 December 2001, PwC sold Enron Direct, Enron Europe’s retail electricity supply business, to Centrica for more than $96m (66.7m). Linklaters advised PwC and Ashurst Morris Crisp advised Centrica. As the stationery of a company must state when it is in administration, the existence of an administration order can make it difficult for the company to continue trading and can affect its marketability.

According to Holden, Enron Direct was particularly vulnerable to insolvency because it would have been fatal to its business if it had ceased trading. As a result, PwC negotiated the sale of Enron Direct before it went into administration and the administration order was obtained only minutes before the sale agreement was signed.

The sale of Enron Direct represents the start of PwC’s successful negotiations to dispose of Enron’s assets. However, the administration of Enron is far from over and the repercussions of its collapse are likely to be felt for some time to come. In the meantime, PwC continues to look for buyers for Enron’s other operations to achieve the statutory objective of achieving an advantageous realisation of Enron’s assets while it remains in administration.

The fallout

The effect of Enron’s collapse has already been widely felt and its repercussions will continue for some time to come. The human cost is still to be counted, but in the immediate aftermath of Enron’s collapse, 4,000 of the 7,000 employees at its Houston, Texas, headquarters, and 1,100 of the 1,400 staff at its UK headquarters, lost their jobs. Thousands more redundancies are expected across Europe, so the position of Enron’s remaining 12,000-strong workforce is precarious. Those employees with pension plans based on Enron shares have lost a significant proportion of their investment as they were unable to change their investment as Enron’s share prices dropped. Up to 70 per cent of the assets in Enron’s pension fund have disappeared.

Many of Enron’s creditors are banking groups which are having to work hard to allay fears over the scale of their exposure to Enron’s fall. One of Enron’s biggest creditors is Barclays, which has invested about $4bn (2.7bn). Barclays has been quick to assure the public that its losses will not be “material” and is thought to have syndicated out the debt to other investors.

Other key creditors include Abbey National, which has announced that it expects to lose $95m (65.9m) as a result of Enron’s collapse. Speculation is mounting that many of the banking groups involved used credit derivatives to insure against the risk of default after one bank admitted that it had insured its entire exposure. In that event, the insurance industry may have to face a number of substantial losses.

Allegations of fault are flying in all directions. Enron is suing Dynegy for breach of contract, alleging that Dynegy wrongfully terminated the proposed merger, and is seeking damages of at least $10bn (6.9bn). Dynegy has issued a counterclaim against Enron for the return of its $1.5bn (1.04bn) investment or for control of the pipeline involved.

Critics have been quick to point the finger at the banks for failing to examine Enron’s accounts properly and Arthur Andersen, Enron’s auditor, is likely to face multiple actions. Both investors and employees have already launched actions against Enron’s senior management and the inevitable litigation is likely to be complex and long-running. The possibility of fraud from within has also been raised.

Investigations into the matter are already underway. Arthur Andersen and the US Securities and Exchange Commission (SEC), the regulator of the US stock market, are to give evidence to the House of Representatives’ Energy and Commerce Committee as part of its investigation into Enron’s collapse. In addition, Enron has appointed a committee of independent directors to conduct an internal investigation into the affair, the SEC is investigating Arthur Andersen’s role in the events and the American Institute of Certified Public Accountants is preparing new auditing standards for detecting fraud.

The collapse of Enron has raised questions over the deregulation of the energy markets and may lead to changes in the energy trading industry’s financial practices, but the damage caused to public confidence in the industry may take longer to repair.

Jargon Buster

Administration order

Order directing that a company will be managed by an administrator appointed by the court


Property or rights with a monetary value Creditor Someone to whom a debt is owed


A company’s actual or likely inability to pay its debts within the meaning of s.123 Insolvency Act 1986

Insolvency practitioner

Person acting as a company’s administrator, authorised to so act by a competent professional body recognised by the Secretary of State

Liquidation/winding up

Closing a company by selling its assets and paying its liabilities




Temporary stay on debt repayments

Realisation of assets

Conversion of assets into their monetary value