2 August 2018

Revised: the F1 definition of insolvent and why it matters

Formula 1 is a strange, often other-worldly, activity. But some rules do still apply. There is a thing called the law and very few people manage to get around that successfully. Those who do are rarely in the newspapers.

You can read elsewhere about a number of Formula 1 teams saying they won’t agree to allow Force India to have prize money after its period of administration. You might think why would they even have a say? So it seems wise to walk through the process and to explain the different possibilities.

The first thing is to decide whether or not Force India has ever been insolvent, under the law. This is defined by the Insolvency Act of 1986, in which Article 123 covers the definition of insolvency and the process that exists to get there. In order to file a winding-up petition, a creditor must have evidence of what is called a Statutory Demand for money. The company has 21 days to pay. If this is not done, then the company is deemed to be insolvent and the creditor can then apply for a winding-up petition to get the money by the sale of assets after the company is closed down. Thus a winding-up petition is a pretty good indication that a company is (or was) insolvent, during the 21 days given to pay a Statutory Demand. However a winding-up petition is not valid unless it has been advertised in a publication called the London Gazette. If the winding up petition has not been advertised in the London Gazette then the court will not make the necessary winding up order. The winding-up petition may be advertised in court listings but this is not legally the same as it being in the London Gazette. And if an administration petition arrives instead, it can trump the winding-up petition. Thus was the company legally insolvent, or not?

The problem with F1 comes because of the commercial agreements that exist between the rights holder (the Formula One Group) and the individual teams. These bilateral agreements are all different, but when it comes to insolvency, they all refer back to the Concorde Agreement of 2009, in which is defined what happens if a team runs out of money. The Concorde Agreement uses Article 123 of the Insolvency Act as one of the ways of defining a "Cessation Event". Thus, it is safe to assume that a winding-up petition, whether granted or not, is a Cessation Event, but only if it has been advertised in the London Gazette.  In the past we have seen teams go into administration and emerge without the other teams having a say, but in these cases there were never any winding-up petitions because the teams satisfied all Statutory Demands within the 21 days allowed and were thus never technically (or officially) insolvent. Given that Force India had a winding-up petition documented but not advertised, the team might not have been deemed insolvent. It's complicated.

So what does this all mean? If a team has gone through a Cessation Event its rights and benefits as defined in the commercial agreements are automatically cancelled. This means that the team is no longer entitled to any of the prize fund. And in order to be allowed to regain its position, all the other signatories of the commercial agreements must agree to allow this to happen. Teams generally don't look beyond the end of their own noses. If a team disappears, that means more money for the others. However it would be foolish indeed for the greed of a team to destroy what is essentially a strong and competitive operation, however poorly it has been run by the previous owners, and so there will inevitably be pressure on the signatory teams from the Commercial Rights Holder to sign, in the best interests of the sport. Of course, teams will try to use this situation to try to win concessions.

The rights and benefits are valuable (being worth, let's say, $70 million a year) and so to continue with a team without such rights means that a buyer will have to pay more. A new entity (as Haas was) will become eligible for different prize funds as it goes along but it will take three years to return to the same status as the other teams, and that will have meant a loss of at least $100 million, depending on their results. Having said that, if the new owner has very deep pockets then this is a good way to be clear of any nasty surprises that the old company might have. Given that acquiring Force India will be a relatively cheap operation with only $43 million in debt (compared to the $250 million which the owners were trying to get in the sale), some might consider it wiser to get the team without prize money and get on with building it up. However, there is little doubt that not having prize money will drive away some potential buyers.

But, if the team is not legally and officially insolvent then the company can go into the process of being rescued, using what is known as a company voluntary arrangement (CVA) with the creditors being offered a deal and accepting it. The deals are all different. However, there is a drawback in this case because the debt that Vijay Mallya is claiming from the team has no value if the company is insolvent, but will need to be paid if the company is saved, although this goes behind all other creditors. Thus the teams are being asked to allow the team to switch assets from one company to another (without losing the rights and benefits) in order to wipe out this debt and present a much more attractive package to potential buyers, in order to more easily keep the team alive.

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