The new college insolvency regime

24 Jan 2019

A new college insolvency regime comes into effect on 31 January 2019. There are five related changes:

  • normal commercial insolvency law will apply to colleges. 
  • in case of an insolvency, DfE can appoint an education administrator who will have wider duties - to protect students as well as creditors.
  • statutory insolvency is a backstop; DfE plans to use a non-statutory route in the first instance, including commisioning an Independent Business Review.
  • ESFA will end the current policy of offering exceptional financial support (EFS) to colleges from 31 March 2019.
  • ESFA is currently working hard to complete the remaining Restructuring facility (RF) transactions, several of which involve replacing short-term EFS loans with longer-term restructuring loans.

These are complicated but important changes. DfE and ESFA officials are working on new policies and procedures to set out what will happpen after 1 April 2019. DfE will also be issuing guidance next week which will explain the legal and technical aspects of the change. There is a risk that these changes will scare some people into inaction or confusion so we have produced a list of 20 questions and answers about the new arrangements to cover the main issues. DfE will be publishing some official guidance in January 2019. This document is designed to provide some context and analysis of the changes. This note does not constitute legal advice for colleges or others. Anyone who acts on the basis of this note does so at their own risk.

A word version of the note is available for download here 

The 20 questions and answers

What, when, who, why and with what consequences?

1. What is the college insolvency regime
2. When does the new law take place?
3. Why is the government introducing new rules?
4. What happens now when a college runs out of money?
5. What will happen after 31 January 2019 when a college runs out of money?
6. How many statutory college insolvencies will there be?
7. What is an Independent Business Review?
8. Who is the education administrator?
9. Isn’t there already an FE commissioner?
10. Weren’t area reviews supposed to sort out college finances?
11. Where did the restructuring facility money go?
12. Why do colleges borrow from the banks?
13. Why hasn’t there been more debate on the college insolvency regime?
14. What is the AoC view on the college insolvency regime?

What does this mean for those involved with colleges?

15. What are the implications for governors and what action must they take?
16. What are the implications for college students?
17. What are the implications for college staff?
18. What are the implications for those providing goods and services to colleges?
19. What about principals, vice principals, finance directors and governance professionals?
20. Any other questions

The 20 questions and answers

1. What is the college insolvency regime?

An important change in the law takes effect on 31 January 2019.

As a result of the 2017 Technical and Further Education Act:

• Most of the insolvency laws that apply to companies and charities will apply to colleges.
• New rules will allow the Secretary of State will appoint an education administrator to take over an insolvent college. The administrator will have wider duties than is normal in insolvencies because they are required to protect courses for learners alongside the duty to secure the best outcome for creditors.

2. When does the new law take effect?

On and after 31 January 2019.

The Department for Education promises to end the current system in which it provides exceptional financial support to colleges that run out of cash (see questions 4 and 5 for more detail on this).

3. Why is the government introducing these new rules?

The government announced plans for a statutory college insolvency regime in March 2016 at a time when all colleges were participating in the national area review programme (see answers to questions 10 and 11 for more detail). There were consultations in July 2016 and February 2018 on the principle and the details. DfE presented legislation to Parliament in November 2016 and secured Royal Assent for the Technical and Further Education Act in May 2017.

Although this has never been publicly stated, the decision to introduce a college insolvency regime was effectively a condition for providing restructuring loans as part of the area review programme. In addition, the experience of dealing with several financially weak colleges persuaded ministers and officials that it would help to have more clarity on what should happen and who should take responsibility.

4. What happens now when a college runs out of money?

There are currently no clear rules about what happens if a college ran out of money and the government did not stand behind it. When the Conservative Government transferred colleges out of local government in 1992, it created a new type of statutory corporation to run colleges but did not make clear rules for cases where they ran out of money. Governments that followed did not address this issue when they legislated about the sector. The position of other statutory corporations is still unclear.

Instead central government (via a succession of funding agencies) ended up acting as the lender and funder of last resort - to protect the college's students, courses and assets. Over the years the government has tightened up the rules so that there are quite stringent. The most recent set of rules are set out in a document titled “FE College Financial Intervention and Exceptional Financial Support” published in April 2018:

• Support as a last resort: ESFA will only make support available where it is clear that the college has “exhausted all other options, including increasing income and reducing expenditure as well as realising assets and raising new commercial finance”
• Decision-making and consequences: Several parties will assess applications, including ESFA, DFE, HM Treasury and FE commissioner officials. An application for help of this sort will generally trigger external intervention via a notice to improve or a commissioner visit. This makes the intervention public about 3-6 months later.
• Conditions: Any loans will be formally documented, may include interest, may require security over a college’s assets and will set out the consequences of default.

Most of the colleges with exceptional financial support loans are in the middle of mergers and restructuring facility applications. If all goes to plan, they will take out longer-term restructuring facility loans and use the money to repay their short-term EFS. The end date for this process is 31 March 2019 (see answer to Question 11). At that point, the new rules take effect.

5. What will happen after 31 January 2019 when a college runs out of money?

Exceptional financial policy continues until 31 March 2019 so there is no immediate change. DfE and ESFA officials are working on new rules for the period from April 2019 onwards. The new insolvency law is a big new factor. :

There are several key elements to the process are:

• Normal commercial insolvency:  Where a college is in severe financial distress and there is no other solution, new statutory insolvency procedures can apply. The college itself or its creditors can ask the court to apply normal commercial processes – either a company voluntary arrangement, administration, creditor’s voluntary winding up, court-directed winding up or receivership .

• 14 day period: The DfE has 14 days to step in and suspend these processes by appointing an education administrator.

• Education administration: The law gives DfE powers to appoint and fund an education administrator who would have a duty to avoid and minimize disruption to the studies or existing students as well as to secure the best outcome for learners. The fact that the education administrator has wider powers means that other creditors would probably end up with less money than if they did nothing.

While a review is taking place, ESFA will need to provide time-limited financial support to ensure the education and training activities of the college can continue.There are several reasons for thinking that there will not be very many statutory college insolvencies in 2019-20. In briefing documents for the legislation, officials describe the college insolvency regime as a "last resort" rather than a "normal route" to secure change.

6. How many statutory college insolvencies will there be?

Probably not many.

The financial situation for colleges at the start of 2019 is severe (see Q10) but there are several reasons for thinking there will be not very many statutory college insolvencies in 2019-20

• Independent business review (IBR): DfE explains in several official documents that it will commission an independent business review (IBR) before using the statutory process (see answer to Question 7).

• Statutory insolvencies will be risky for other creditors: As explained in the answer to Question 5, the rules create a disincentive for creditors to trigger a statutory insolvency because they may end up with less.

• Unknown costs:  The most likely organisation to trigger a statutory insolvency is DFE and officials have already stated they will try IBRs first. DfE has fixed budgets in 2019-20 and faces rising demand. There is currently no provision for the unknown costs of a statutory college insolvency.

7. What is an independent business review (IBR)

Independent business reviews assess the financial position of an organisation and recommend options. Banks sometimes ask borrowers to commission an IBR when a borrower has breached the key terms and conditions of their loan (to use the technical term: “breached the loan covenant”). Several colleges have commissioned bank-directed IBRs in the last few years. Banks generally require colleges to pay the costs of the IBR (which can run to tens of thousands of pounds) and to use firms on their panel (eg big four or second tier accountancy firms). DfE is likely to use insolvency practitioners on a government framework.

8. What is education administration

The law requires the education administrator to be a qualified insolvency practitioner.

One way of understanding the education administration regime is to look at what happens in other regulated sectors. In recent years, the government has put in place special administration regimes covering energy companies, railway, housing associations and the post office.  The aim is to protect a public service while creating an orderly process to deal with a situation where the organisation providing that service has run out of money.

9. Isn’t there already an FE commissioner?

The FE commissioner is a DFE-appointed independent advisor to ministers. The commissioner is responsible for assessing the capacity of leadership and governors in colleges  that have serious weakness in quality or financial health.

The new college insolvency regime will, inevitably, partly displace the FE commissioner role. Colleges operate in a complex environment with a number of regulators and organisations placing demands on them. New rules come into effect in 2019 as a result of new powers given by Parliament to the Office for Students (which will regulate around 180 colleges with respect to their higher education provision) and to Mayoral Combined Authorities (which will fund adult education provision in the majority of colleges, 60 of whom are located within their boundaries).

DfE, ESFA and FE commissioner staff are working on ways to improve the system and hopefully their work will make matters a little easier to understand:
 
10. Weren’t area reviews supposed to sort out college finances?

The idea behind area reviews was to help every college achieve financial sustainability. The government carried out and published 37 area reviews covering every college in the country between 2015 and 2017. There have been more than 50 college-to-college mergers and 20 sixth colleges to become academies since 2015 . Many of these changes were prompted by the area review programme but the decisions were taken by governing bodies and, in most, cases the funding came from college own budgets. ESFA provided transition grants of up to £100,000 but the process of restructuring colleges has proved to be more costly than this. Colleges have found it takes more time than expected to satisfy their banks, resolve pension issues and navigate rules devised by Ofsted, the Home Office and ESFA.

The financial outlook for colleges has not improved since 2016 for several different reasons:

• Gap between costs and funding: The funding rates paid to colleges have been fixed in cash terms while costs have risen because of inflation, the tight education labour market and unfunded obligations placed on colleges. The implied efficiency gain is 17% between 2015 and 2020 .

• Competition underpinned by cross-subsidies: Colleges face stiff competition from schools and universities in different areas with both organisations using other funding to cross-subsidise their activities. Schools use pre-16 funds to maintain sixth forms; universities use surpluses made elsewhere to develop their apprenticeship provision.

• Adverse changes in apprenticeship funding: The hope that apprenticeships would provide more income has not been realised because of falling numbers of apprentices. Where employers are training their staff, too many are focusing on older managers and finding ways to use the levy to replace other costs.

• Withdrawal of bank finance: The college sector is repaying more of its loans to the banks than they are paying out in new loans. A tougher bank approach on college lending has left some colleges exposed in terms of cashflow.

11. Where did the restructuring money go?

Officials predict that £300-400 million will be spent from the Restructuring facility in loans and grants by March 2019. This is less than the £600 million set aside for the purpose but it would inaccurate to say there has been an underspend. The higher sum was the maximum amount needed and included a substantial amount (£150 million) for sixth form college academy conversion which was not needed because there were fewer conversions than expected and those that converted did not need government loans.

ESFA has kept the terms and amounts of individual restructuring deals confidential but, by the time the fund winds up, the government will have supported around 30 colleges, most of whom have completed mergers. The government support has mainly been used to pay for redundancies necessary to cut running costs and to reduce debt levels from unsustainable levels. This debt was taken on in the past to secure government capital grants and, more recently, to secure savings in response to funding cuts.

12. Why do colleges borrow from the banks?

Colleges are self-governing charitable corporations and have full responsibility for their activities, for the staff they employ and the assets they use. Colleges have taken on bank loans since the 1990s to support longer-term investment in their buildings and operations. Government provides capital grants to support this investment but generally assumes colleges will borrow to pay part of the cost. Total college long-term loans reached £1.6 billion in 2015 but the amount is falling because most colleges with loans are repaying them (over 5-20 years) while the banks are making very few new ones. As well as the restructuring loans from the ESFA, some colleges have borrowed from their local council. There is limited competition in the banking market. Almost all loans are with 4 banks (Barclays, Lloyds, Santander, Natwest). The banks have responded to the financial stress in the sector and to the introduction of the college insolvency regime by asking security for the loans they offer. This puts them higher up the creditor queue .

13. Why hasn’t there been much debate on the college insolvency regime?

People running colleges have been talking about government’s plans ever since they were first announced in March 2016. The debate in Parliament was abbreviated because the snap election reduced the time available. As sometimes happens, MPs and Peers were distracted by other things (eg. Brexit, the higher education legislation). The FE media has covered the issue occassionally (for example this TES article) but has been distracted by other topics.

14. What is AoC’s view on the college insolvency regime?

AoC’s consistent position since 2016  has been that the government is right to regulate in this area to bring more legal certainty but think government should only use its new powers in exceptional circumstances because of the risk it will damage confidence .

What does this mean for those involved with colleges?

15. What about governors?

Colleges have been self-governing for more than twenty years and have developed strong traditions of governance and financial management. There have been mishaps in some colleges but there are people, systems, advisors and auditors in place to key finances under control.

The college insolvency regime is designed to change behaviour to avoid future problems so it is important for all governing to think through if they have the right arrangements in place.

Governing bodies cannot do everything so need to be clear how they are managing their workload. Many governing bodies set up a Finance or Resources committee to provide a focus for the area but they cannot delegate their collective responsibility for the solvency and viability of the college. They need clear reporting lines from committees and staff and must pay close attention to key decisions, for example the approval of the budget, the review of the external audit report and the approval of the financial statements. Governing bodies should make sure there is a written policy on who is responsible for what - a scheme of delegation.

Governing bodies need to act at points where they become aware there may be an issue. The action required is:

• Approvals: To ask questions and consider whether to approve financial statements that say colleges are a “going concern” and approve the annual budget. There is collective responsibility and governors should consider taking professional advice.

• Personal responsibility; Individuals have a responsibility to raise their concerns in meetings or outside the meeting with the chair or clerk.
Governing bodies should set and monitor suitable financial targets, This diagram provides some rules of thumb using ratings from the ESFA financial health assessment. ESFA plans to revise these ratings in 2019-20 so care should be taken to use measurements appropriate for the college.
 
Governors need to be aware that the new law extends the Company Director Disqualification Act to colleges. Director disqualification is a serious matter for those affected and can affect ability of those in professions like law and accountancy to practice. However, governors should note the following:

• Low probability of a referral: The statutory regime is intended to be used only in exceptional cases. Disqualification proceedings only start if the insolvency practitioner discovers conduct sufficiently bad to warrant a referral to the Insolvency Service. There are around one thousand company director disqualifications each year but very few covering charity trustees.

• High thresholds for enforcement action: The tests for disqualification require evidence of serious wrongdoing, generally involving a mixture of fraud, criminal activity, personal enrichment and failure to take professional advice.
College governors who are already company directors, charity trustees or academy governors are already in scope for the disqualification rules in these roles. Nevertheless no-one should be complacent about the penalties or about their responsibilities.

16. What are the implications for college students?

The law has been written to provide protection for college students in that the education administrator has a duty to ensure that those who have started courses can continue.

Students will, inevitably, be affected by the amount of funding available to colleges. Recent funding cuts have forced colleges to make difficult decisions about courses, class sizes and teaching hours. Colleges work hard to protect the interests of students but, ultimately, it is a matter for democratically-elected politicians how much to spend on the sector.

Students have a role in governing colleges because all colleges have a student governor. The regulations provide personal protection for student governors in this role. It is important that the student voice helps college governing bodies make good decisions in the long-term interest of everyone involved.

17. What are the implications for college staff?

If a college became insolvent, then staff would be at risk both of losing their jobs and entitlements to pay or redundancy above the statutory minimum.  A statutory college insolvency would involve a DfE-appointed administrator with a duty to provide course continuity. Staff would be needed to teach these courses which would provide them with some short-term certainty.

Staff who are directly employed by colleges are entitled in law to join either the Teacher Pension Scheme or Local Government Pension Scheme. The rights of existing or retired staff to these pensions would not change if there was an insolvency.

Staff have a role in governing colleges because all colleges have a staff governor. Staff governors have a role in helping governing bodies make good decisions in the long-term interest of everyone involved.

18. What are the implications for those providing goods and services?

The majority of colleges will be unaffected by the existence of a special administrator just as the majority of companies and charities never see a normal insolvency practitioner. There are several lines of control in place:

• Governing bodies, who have a duty to ensure the solvency and viability of colleges
• ESFA, which has financial oversight
• FE commissioner, who intervenes where the college has a notice to improve
• Independent Business Review, this is a new pre-statutory process that will apply for colleges in severe financial distress

If all the above fail to resolve matters, the college insolvency regime will apply and creditors will need to exercise their rights in the same way as in a normal insolvency.
Colleges required by law to offer Local Government Pension Scheme membership to the support staff they employ and carry substantial pension debts on their balance sheets as a result of past and current promises. Some LGPS fund administrators are quite concerned about these changes but the college/LGPS relationship is governed by law and statutory insolvencies are likely to be rare. One third of funds graded the financial strength of their employers in the 2017 valuation. Some colleges are financially strong or were able to offer security to secure a higher grade and lower annual contributions. For other colleges, this grading meant higher costs.

19. What about principals, vice principals, finance directors and governance staff?

There are particular issues for senior staff because in the rare event that there is a statutory college insolvency, there will be new questions about their conduct. Senior staff already face challenging situations where their college has a notice to improve or FE commissioner intervention. Running a college is very difficult in the current environment which is highly competitive, where Ofsted inspections happen at short notice and where funding levels are both too low and unpredictable. There is a risk that well qualified people will be put off from applying to and staying in leadership roles in financially stretched colleges.

20. Any other questions

If there is any question you have that isn't answered above or if you have comments or corrections,  please contact Julian Gravatt, AoC deputy chief executive on Julian.gravatt@aoc.co.uk