David Conn: Exeter could prove test case for game's rules on administration

Both reports which thumped into football this week, from the Independent Football Commission and the All-Party Parliamentary Football Group, calling for the game to run itself more responsibly - and, said the Parliamentary group, more equally - also recommended the abolition of the so-called "football creditors" rule.

The rule, introduced to deter clubs from overreaching themselves and prevent them from slashing expensive players' wages when they run into trouble, requires clubs coming out of administration to pay their "football debts", to players and other clubs, in full, while other employees and creditors, usually owed millions of pounds, can be left high and dry.

The Football League's spokesman, John Nagle, emphasised in response that the League intends to continue with the rule it has maintained throughout the administration of almost half its 72 clubs in the last 12 years: "If the rule were removed, clubs could unilaterally terminate players' contracts, which would jeopardise the future of the transfer system, and allow clubs to wipe out huge swathes of player-related debt.

"A club in administration could simply write off the financial consequences of bad decisions made in the past. Clearly this would be unacceptable to the other clubs in the same division."

The rule, however, is already under attack from one of the aggrieved creditors, the Inland Revenue. Previously the taxman was classed as a preferential creditor in insolvencies, and tended to be paid in full by clubs coming out of administration, although it has accepted less, including an initial 10p in the pound from Leicester City which infuriated many other clubs.

Since September's introduction of the Enterprise Act 2003, the Inland Revenue is no longer a preferential creditor, and so has to battle for its money along with the printers, piemen and St John Ambulance, while watching footballers get paid in full.

On 19 November last year, the Inland Revenue challenged the settlement - football creditors, £450,000, to be paid in full; everybody else, owed £3m, to get 10p in the pound - made by the first club to collapse into insolvency since the Act came into force: Exeter City.

If there is an ideal way to resolve this complicated issue, which could profoundly affect football's foundations, it has not been seen in the treatment of Exeter so far. The historic Devon club struggled for years with a hardcore of 3,000 fans to maintain its Football League status and went into administration previously, in November 1994, under threat of being wound up by the Inland Revenue.

The club paid off the debts agreed under that Company Voluntary Arrangement in 1999, but continued to haemorrhage money, losing £461,000 in the year to June 2001. They owed Mowlem, the builders of two new stands at St James' Park, £750,000, and relied on the directors, led by the ageing chairman, Ivor Doble, to prop up the club with loans of some £750,000.

In May 2002, Doble, who could see no salvation, passed on the running of the club to two men, Mike Lewis, formerly the commercial director at Swansea, and John Russell, a previous chairman of Scarborough. Devon and Cornwall Police are currently conducting an inquiry into alleged financial irregularities at the club last season.

In May last year, Exeter were the first to fall from the Football League into the Conference under the new two-up, two-down rule. Lewis and Russell were arrested and stepped down. Eventually, in September 2003, the Supporters' Trust, a group of horrified, committed fans with little money and nothing to gain except saving their club, took over Doble's shares.

They had raised £125,000, which went into the club and was lost, but the financial nightmare inherited from the previous regimes forced them to call in insolvency professionals, who worked to gain the agreement of creditors to a CVA.

They proposed that the Supporters' Trust would raise the £450,000 for the football creditors, over five years. The £300,000, to pay a 10th of the other creditors, including the Inland Revenue, is to be paid over two years. The local newspaper, the Exeter Express & Echo, has launched an appeal to raise that money.

The CVA was approved by 88 per cent of the creditors - 75 per cent is the legal requirement - but the Inland Revenue, owed £233,000, voted against, as did Customs and Excise, who were owed £132,000 of VAT.

The Supporters' Trust began the hard work of dragging Exeter into a new future, backed by fans who have stayed loyal in the Conference. Then, on 19 November last year, the Inland Revenue took the club to court, applying for the CVA to be revoked, claiming it was unfairly prejudicial because it treated football clubs and players as "Super-Priority Creditors".

Exeter believe they are being used as a test case. The detail is complex but the implications are clear: if the Inland Revenue wins - and for years insolvency experts have been arguing that football's policy cannot hold - Exeter's CVA would be undone. If the Conference continued to insist that football debts be paid in full, all debts would have to be paid in full. This would put the debts back to £4.5m, Exeter would be hopelessly insolvent and this time they would go bust and disappear.

As they only agreed that CVA settlement to satisfy football's rules, Exeter's supporter-directors say they asked for an opportunity to discuss the Inland Revenue's challenge urgently. They say John Moules, the Conference's chief executive, refused to talk about it, although he adamantly denies that. They took legal advice - their lawyers acting on a "no win, no fee" basis - which resulted in them issuing proceedings against the Conference arguing that football's insolvency policy is unlawful.

They also challenged the other misfortune that they have become the first club to suffer, the deduction of 12 points for an insolvent club, claiming it was not brought in formally in time to catch them. The Conference reacted furiously, accusing Exeter, in effect, of conspiring with the Inland Revenue, "inviting the Inland Revenue to apply to revoke the CVA", in order to avoid paying the football creditors. Exeter, in turn, were outraged at that suggestion.

On 23 December, Exeter's lawyers wrote to the Conference's lawyers asking for a meeting, with the Football Association, Football League and Professional Footballers' Association too, "to explain the club's dilemma and invite suggestions for its resolution."

Ian Huxham, Exeter's managing director, said he had no constructive reply. Instead, on 2 January, Moules wrote to all the Conference clubs saying the High Court action had to be defended vigorously and was going to cost up to £25,000 for each club. Days later, on 5 January, Huxham received a letter from Bill King, the Conference's chairman, saying that some clubs had called for Exeter to be expelled.

Since then, more civilised discussions have begun on how to resolve the issue. The FA is understood to be convinced that the Inland Revenue's challenge is not to the football creditor rules, but more technical.

Instead of cutting their debts via a CVA, people taking over other insolvent football clubs, such as Oldham recently, have formed a new company, which has bought the assets of the bust club and the football debts, then settled the old company's debts via a CVA.

Although the effect is the same - footballers paid in full, other creditors paid a fraction - the Inland Revenue has agreed previously that it will accept that as a solution. That stance puzzles most of the insolvency world, who cannot see the difference.

The football authorities believe Exeter should have done a "newco", not a CVA, and they should do that now. "The Inland Revenue is challenging Exeter's CVA, not the insolvency rules," Moules said. "This should have been sorted out without legal action." However, Exeter's Supporters' Trust were advised by their professionals that they could not save the club by forming a new company, mainly because they had no money to fund the purchase, and the creditors were unlikely to agree.

Huxham told me: "We had no interest at all in bringing this action. We are supporters who wanted to save our club when it was dying, and we have followed advice. We've told the football authorities that if they can find a solution, a way we can settle the debts, which will satisfy them and the Inland Revenue, we'll do it."

If a settlement cannot be found, the case will go where no happy outcome can be foreseen: court. The Parliamentary report this week described the rule as "iniquitous" and said it should be abolished. The football authorities maintain it is necessary to protect competition, although they accept there are problems with it. They are prepared to defend it even if Exeter are forced to go bust.

With so many clubs struggling, hearts are hardening to the possibility of "losing" a club. Exeter's supporters' advice is that the policy is unlawful, and they are doing what they can to save their club. It all seems an unfortunate mess to be in, when football is booming.