Mills and Reeve is increasingly being asked to advise on the consequences of challenging financial circumstances for higher education providers. The government, higher education regulator and media are also showing significant interest in universities’ financial position, including the prospect of mergers, market exit and insolvency.
In the first of a series of webinars based around the work of our financial resilience taskforce, which brings together lawyers across fields including regulation, real estate, corporate, finance, employment and pensions, four of our experts examined what would happen if a university became insolvent and how – as the law currently stands – a higher education provider would actually exit the market.
Uncertain process (03.10*)
Matthew Howling, from our finance and restructuring team, told the webinar that a major problem was uncertainty over what insolvency processes would apply to higher education institutions and that this could potentially lead to a disorderly exit in the sector. Different types of higher education provider have very different constitutional structures, most of which are not subject to the processes that apply to corporate insolvency.
Old case law dating back to the Victorian era suggests that higher education providers incorporated under Royal Charters could probably be wound up as unregistered companies, while this is also likely to be true for higher education corporations, he said. But this would be a terminal process. No mechanism exists for an insolvency practitioner to trade a business through a compulsory liquidation, which could cause serious problems for a higher education institution.
The Office for Students has tried to address the sort of planning needed to cope with the prospect of a liquidation, asking providers to consider issues such as teaching out, student transfer, ensuring that students have a formal record of achievement if they do transfer, dealing with student complaints and information and establishing archiving arrangements to maintain a record of exam results.
But Howling said that this was no substitute for a legal process. Demands for such plans can also put a huge burden on providers at times when they are already struggling. Moreover, a market exit plan may not be binding, particularly as the legal obligations of a liquidator are towards creditors as a whole, rather than specifically to students. There are also questions over who would fund measures outlined in the plan.
Questions for trustees
He suggested that the regulator’s request for institutions in difficulty to contact their competitors to talk about a merger or transfer of students could also pose problems. First, if such discussions leaked and became public it could make a bad situation worse. Then, if the higher education institution involved was in trouble but not legally insolvent, talking to competitors may not be considered in its best interests as a charity, which could be difficult for trustees. Another issue for trustees, he suggested, was lack of clarity over whether provisions in the Insolvency Act dealing with wrongful trading and misconduct would apply. It was therefore wise for trustees to act as if they did apply, which could force them to act in the best interests of creditors rather than of staff or students.
One benefit of the uncertainty surrounding insolvency processes is that lenders are likely to tread cautiously and treat the sector with forbearance, said Howling. However, he suggested it also risked a “land grab”, with lenders, creditors and pension funds all seeking to obtain mortgages on land and property as the one sure form of security.
Special administration regime (15.16*)
The next speaker in the webinar, Neil Smyth, from our restructuring team, looked at whether a special administration regime could help address some of these issues.
A special administration regime came into force just over five years ago in relation to further education. It allows an administrator to operate a business during the insolvency process and gives an institution breathing space by preventing creditors from enforcing their rights immediately. While Smyth made clear that such a regime could pose challenges in terms of funding and processes, he suggested it could be a way to allow a teach out and transfer of students in a manageable way. It would provide a specific duty to act in the best interest of students and give clarity to trustees about how they should proceed in the event of an insolvency, as well as to lenders about how they would recover any money lent.
Engaging with the regulator (25.59*)
Next, specialist education regulatory partner Richard Sykes looked at the role of the OfS in dealing with market exit – particularly its use of Student Protection Plans (“SPP”) and Student Protection Directions (“SPD”). All institutions need an SPP in order to register with the OfS; an SPD is used by the OfS if it determines that a provider is in financial distress.
Before the OfS can issue a SPD, the legislation requires that OfS must reasonably believe that there is a material risk that the provider will fully or substantially cease (or will legally be required to cease) provision of higher education in England. It may require institutions to take a series of measures to plan for what happens next, including making arrangements for refunds and compensation to students.
But Sykes felt that sometimes it appeared that the OfS was applying a lower threshold of risk to that required by the legislation before issuing an SPD. Also, it was not clear over what timeframe the OfS’s risk analysis operated - was an SPD permitted if there was a material risk the provider would exit the market in two years, one year or six months?
He said that when issuing an SPD, the regulator did not always take into account a provider’s obligations to parties other than students and that directions requiring providers to get commitments from other higher education institutions would be difficult to enforce since there was no obligation on these institutions to comply.
As a result, he advised any institution on the receiving end of a provisional SPD to engage with the OfS, seeking specialist advice on whether there may be grounds upon which validly to challenge the draft SPD - particularly in light of the fact that a failure to comply with a final SPD could amount to a breach of a Condition of Registration.
Considering mergers in a market exit environment (36.53*)
The final speaker was Poppy Short, a partner in the corporate education team, who discussed the impact of mergers, having recently been involved in the two biggest mergers in the sector for decades.
She said that while there can be many benefits to a university merger, the process can be highly complex, resource intensive and require significant specialist advice.
A planned strategic merger is a very different transaction to a merger that arises as the result of an institution facing a disorderly market exit. In the latter scenario, the University will be operating from a burning platform and will have minimal opportunities to protect its intellectual property, brand, students and staff. The fact that it is in trouble and needs to act fast is likely to put the university in a weaker position and crucially it may make it harder to find the right merger partner.
To avoid this, she advised that all institutions should ensure that contingency planning for mergers is on the Council’s agenda at governing body meetings, and that universities should consider potential partners early on. She urged stronger providers to consider whether they would be prepared to take over a financially weaker institution, and if so would they prefer a local institution or were they looking to expand into other regions. Meanwhile, financially weaker providers should think about what kind of partner could best provide financial security in the longer term.
She also offered advice based on experience from previous mergers:
- have a strategic approach to finding a merger partner and to the timings of making an approach to potential partners
- research the partner thoroughly and know what your red lines are but be prepared to be pragmatic
- recognise that mergers take time – she estimates at least 18 months minimum – and will ideally need to start operating at the beginning of an academic year
- note that most mergers involve a split exchange and completion process, with a period after exchange to get banking, regulatory and other operational arrangements in place
- take into account that the process is resource heavy and expensive so take advice and establish a joint financial plan early on
- keep regulators on side and talk to them early on
- consider comms, including communication with staff and students -make sure you take them on the journey with you and consider amending student offers early on to ensure the merger changes are recognised
- recognise that the personalities and dynamics between the different parties will be key and that strong leadership will be needed to ensure a smooth transition
Practical actions (48.30*)
The webinar ended with Sarah Seed, our head of not-for-profit finance, looking at practical steps to take to prepare for financial challenges:
- make sure you know what is in your student protection plan and update it if necessary
- look out for OfS guidance on market exit plans expected to be published with the regulator’s annual report in May
- keep governing bodies up to speed with what is happening not only in the university but in the wider sector because major decisions in this area often have to be made quickly
- discuss your response should you be approached by another institution with a merger proposal
- refresh your knowledge of lending arrangements, including provisions that may come into play in the current environment that were not previously considered important
To catch-up on the 60 minute webinar, please visit our university financial resilience hub here. For an in-depth discussion on financial resilience or to connect with our experts, contact Matthew Howling or Sarah Seed. You can also contact your usual Mills & Reeve representative.
*webinar timings