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United Kingdom | Publication | May 2020
A summary of the new procedures and measures being introduced in the Corporate Insolvency and Governance Bill to seek to rescue companies in financial distress as a result of the COVID-19 pandemic and the resulting economic crisis
In 2016, the government circulated a consultation paper on proposed reforms to English insolvency law (Consultation Proposal). The proposals were intended to respond to the fact that the UK had fallen in the World Bank ratings for countries with the best restructuring and insolvency procedures for a number of years, and the objective of the reforms was to improve the ranking of the UK for restructuring in the future. The new restructuring measures included in the proposals were discussed extensively at that time in the restructuring and insolvency community and detailed comments fed back to government. Unfortunately the implementation of the proposals was delayed by parliamentary time being derailed, largely, until very recently, to considerations of Brexit-related issues.
One of the proposals, the increase of the prescribed part as defined in Schedule B1 Insolvency Act 1986, as amended (Act) from £600,000 to £800,000 (for charges created after April 6, 2020) was introduced in March 2020. This will allow an increased distribution from floating charge distributions to unsecured creditors. A second proposal, namely the reintroduction of preferential creditor status for debts claimed by the crown known as “crown preference”, was included in the Finance Bill and provides that crown preference will be re-introduced in December 2020. The Finance Bill is currently being considered by Parliamentary committees. The trade associations involved in restructuring businesses continue to lobby for the measure to be delayed, as it will add to the current difficulties for companies to raise finance and to restructure, as it reduces the appetite of lenders to advance funds, particularly the asset-based lenders, as the crown preference reduces their likely recoveries from floating charge realisations yet further, following the increase to the prescribed part referred to above.
Whilst the increase in the prescribed part and the reintroduction of crown preference were creditor-friendly changes, the further proposals which are now to be introduced in the Corporate Insolvency and Governance Bill (Bill) as part of the Government’s response to the COVID-19 crisis, are far more debtor-friendly measures. Many of them leave the current directors in office, seeking to restructure the business, with the benefit of a number of different moratoria and stays of creditor rights in the coming months. The bill is to become law in very short order, with the government’s intention being that the Bill is in force in July 2020. The Bill is likely to change from the draft as a result of the debates in Parliament. In addition the draft itself permits temporary amendments to the legislation using secondary legislation, to assist in reducing the number of companies entering into restructuring or insolvency procedures or to mitigate the effect of the insolvency regime on the responsibilities of directors whose businesses are struggling due to the COVID-19 crisis, for example to amend the time limits in the draft with immediate effect.
One of the criticisms of the restructuring procedures available in the UK was the lack of a process whereby the directors of a company were left in control of the company and able to look to restructure the company with the benefit of a moratorium, outside a formal insolvency process. In the United States, the debtor in possession tool for restructuring is Chapter 11, in which the directors remain in control under the supervision of the court.
The nearest procedure in the UK which can leave existing directors in control of a continuing business, is the company voluntary arrangement (CVA). The CVA is not suitable for all restructurings, but has been widely used in the retail and hospitality sector to compromise lease liabilities of underperforming stores and restaurants. The CVA procedure with a moratorium without administration is only available to small companies at the current time, so larger CVAs are negotiated without a moratorium unless they are an exit from administration. The disadvantage of the use of a CVA as an exit from administration is that it leaves the company having gone through the administration process prior to the CVA commencing. CVAs bind unsecured creditors, but require the agreement of secured and key creditors whose support is vital to the continuation of the business of the company, and who can derail the proposal of any CVA from the outset. So the negotiation process with the key creditors is vital and can take several months, and is difficult to achieve without the protection of a moratorium, as individual creditors can take enforcement steps in the negotiating period to seek to improve their position.
The Government guidance says that the Bill is aimed at ensuring business can maximise their chances of survival during the COVID-19 crisis (Crisis Period). The new moratorium is to be a seamless procedure that keeps administrative burdens to a minimum, makes the process as quick as possible and does not add disproportionate costs to a struggling business.
It is a freestanding procedure and not a gateway into any particular insolvency procedure. The exit from the moratorium could be to the recovery of the company without need for an insolvency process, or a sale or refinancing outside insolvency. Alternatively it could lead to a CVA, administration, scheme of arrangement or the implementation of a restructuring plan which is commented on below. Importantly it is a procedure which is not just available to English companies but can be available to overseas companies also.
The Bill provides that the directors can apply for a short-term moratorium for an initial period of 20 business days. In that period, the company will continue to trade under the supervision of a monitor, who would need to be a qualified insolvency practitioner. The monitor is to assist the directors with the negotiations to achieve the restructure and with the running of the business in the meantime.
Key features of the new procedure are:
A key concept in the process is the “payment holiday”. This is the restriction on the enforcement by creditors to seek payment of certain debts during the moratorium.
Pre moratorium debts for which the company has a payment holiday during the moratorium are amounts which have fallen due before the moratorium or that fall due during the moratorium OTHER THAN amounts payable in respect of:
(a) The monitor’s remuneration or expenses.
(b) The goods or service supplied during the moratorium.
(c) Rent in respect of a period during the moratorium.
(d) Wages or salary arising under a contract of employment.
(e) Redundancy payments.
(f) Debts or other liabilities arising under a contact or other instrument involving financial services.
The excepted payments have to be paid in full during the moratorium, and confirmations that these debts have been paid have to be filed at court to support any extension to the moratorium period. The draft provides that bank debts which fall due during the moratorium have to be paid, whether or not these are secured, whilst other creditors are not being paid. This may have a detrimental effect on the ability of the directors to effect a rescue. Further, what falls to be paid under (b) to (f) above could be the subject to much debate and could require payments for things which would not be paid, if the company to enter administration, for example rent on premises not being used for the purpose of administration. If the above are not paid the monitor is required to bring the moratorium to an end.
Pre-moratorium debts in amounts of over £5,000 or 1 per cent of the value of the debts of the company to unsecured creditors when the moratorium began, can only be paid if the monitor consents, and the payment is pursuant to a court order, and required in relation to the disposal of property as prescribed in the bill.
During the period a company can dispose of property not subject to a security interest in the ordinary course of business provided that the monitor consents and agrees that it will support the rescue of the company, or if the court consents. If the property is subject to a security interest, the company can only dispose of property with the approval of the court or in accordance with the terms of the security. What this means for floating charge security is not altogether clear, which may restrict by their terms disposals in the ordinary course of trading, being a narrower construct than the ordinary course of business.
The monitor must monitor the company’s affairs for the purpose of forming a view as to whether it remains likely that the moratorium will result in the rescue of the company as a going concern. He is entitled to rely on information provided by the company during the moratorium unless he has reason to doubt its accuracy. The directors are required to supply information that the monitor requests, and he can apply to court for directions.
The monitor must bring the moratorium to an end by filing a notice at court if he thinks that the moratorium is no longer likely to result in the rescue of the company as a going concern, or the objective of recue has been achieved, or as he is unable to carry out his functions as the directors have not provided him with the relevant information, or the monitor thinks that the company is unable to pay moratorium debts which have fallen due or pre moratorium debts for which the company does not have a payment holiday.
The monitor can be replaced by the court, and his actions can be challenged by an application to court by a creditor or anyone affected by the moratorium. That application can seek an order to reverse or modify a decision of the monitor, or give him/her directions or such order as the court thinks fit.
The monitor’s remuneration can be challenged by a subsequent administrator or liquidator.
The directors’ powers remain in the moratorium and their actions can be challenged by a creditor of member of the company by application to court, on the ground that the company’s affairs are being managed in a way that unfairly harms the interests of its creditors or members or some part of them.
There are criminal offences for the supply of false information in relation to the obtaining of the moratorium or of fraud in anticipation of the moratorium.
When a company goes into an insolvency process such as administration, suppliers often stop supplying the company, relying on an ability to terminate, or they change the terms of the contract, for example to increase pricing, by reason of the insolvency of the company. This often makes the restructure or the sale of the business as a going concern difficult, and reduces any realisations to creditors. The Bill proposes to widen the prohibition on reliance on such clauses which will prevent a far wider range of suppliers relying on them, and will therefore maximise the opportunities for rescue of the business.
The Insolvency Act currently contains provisions in Section 233 and 233A of the Act which force certain suppliers to continue to supply a company in an insolvency process. The provisions currently cover utility suppliers and the suppliers of the information technology requirements of the company, such as access to software and the internet. The payments due to those suppliers at the date of insolvency will remain as unsecured claims in the insolvency, but future supplies must be paid for by the company in the insolvency process, and will be administration expenses and covered by a personal guarantee from the insolvency practitioner who is the administrator of the company.
This process is extended in the new legislation to cover many more supply contracts, with the types of supplies which are excluded from these provisions being set out in a schedule. The excluded suppliers are predominantly suppliers of financial services. There is a short term exclusion of small suppliers in the Crisis Period.
There will no longer be a requirement for the insolvency practitioner to supply a personal guarantee, but the payments will be expenses of administration, or debts which would be payable in a moratorium period.
The supplier can apply to court for permission to terminate the contract on the grounds of hardship.
Currently there are two procedures under English law for compromise with creditors; the CVA (which cannot compromise the claims of secured creditors), and the scheme of arrangement under Part 26 Companies Act 2006 (Scheme). In a Scheme the company looks to compromise different classes of creditors and members with each class having similar rights. Each class votes on the Scheme and the approval of 75 per cent in value and a majority by number is required. The court then decides whether to sanction the Scheme.
The Government announced on March 28, 2020 what was referred to as a retrospective “suspension” of potential personal liability for directors for wrongful trading for a period from March 1, 2020 for three months (COVID Period). The Government said that it considered that this was important in order to support directors to continue to trade though the Crisis Period, without worrying about their potential personal liability for wrongful trading. This is thought often to be the trigger that leads to directors deciding to put a company into an insolvency process. It seems unlikely that directors would be considered to be wrongfully trading initially in the COVID Period, given that the best interests of the creditors of the company are likely to be by the company exploring the ability to obtain cash grants and loans from the government and its existing lenders and formulating a plan for the exit from lock down. The alternative of going into an insolvency procedure when it would be difficult to find a buyer who would pay a good price for the business given the uncertainties in the market, might not achieve the best realisations for creditors. However, as the lockdown eases the risks of wrongful trading will increase.
Irrespective of the suspension of wrongful trading, directors continue to have potential liability during the COVID Period and beyond, as do the potential liabilities of directors under other legislation and common law (with many such claims overlapping with those under the wrongful trading regime) such as:
In April 2020, the Government made a statement that in order to protect tenants from enforcement action by landlords seeking to recover rent in the Crisis Period, no statutory demands should be served, or winding up petitions issued, or winding up orders made in relation to the recovery of rent. In addition landlords were not permitted to forfeit leases in that period.
The Bill includes provisions which are far wider than those envisaged by that statement, and cover statutory demands and petitions by all creditors, unless the petitioning creditor can satisfy any addition condition, namely that it:
“has reasonable grounds for believing that:
(a) coronavirus has not had a financial effect of the company, or
(b) the facts by reference to which the relevant ground [to petition for the winding up] applies would have arisen even if coronavirus had not had a financial effect on the company”
This is a wide ranging restriction on creditors’ rights, as it would apply to a petition for a debt which related to a contract entered into some months prior to the Crisis Period, but where the debtor company has been unable to make payment dues to its inability to trade in the coronavirus period. This applies to any winding up petition presented in the period from April 27, 2020 to June 30, 2020 or one month after the coming into force of the legislation.
The provisions are to be taken as coming into force on April 27, 2020, so any winding up orders already made in this period where the condition would not have been satisfied are void. The Bill indicates that the Official Receiver or any liquidator or provisional liquidator is no liable in any civil or criminal proceedings for anything done pursuant to the order. The court may give directions to the Official Receiver or any liquidator or provisional liquidator as it thinks fit, for the purpose of restoring the company to which the order relates to the position it was in immediately before the petition was presented.
If the petition has been issued and no order made, the court:
“shall make such order as it thinks appropriate to restore the position to what it would have been if the petition had not been presented.”
These provisions do not affect the ability of the Secretary of State to petition in the public interest.
The Bill includes time limited powers for the Government to amend corporate insolvency legislation through regulations made by statutory instrument rather than further legislation, in the interests of speed. This will be useful regarding the further amendments required to the Insolvency Rules and perhaps to the time periods of the various Crisis Period suspensions referred to above, if needed to support rescues in an extended Crisis Period.
There are also a number of extensions to the time periods for the filing of various documents at Companies House, and the filing of company accounts, again, to ease the burden on companies at this time. Requirements to hold physical meetings such as annual general meetings are also relaxed for a limited time in light of the lock down.
The Bill includes a number of much needed measures to assist with the rescue of businesses in the Crisis Period and beyond, such as the new moratorium procedure. This gives directors a real chance to pursue a rescue outside an insolvency process, whilst remaining in control of the company. It marks a move to a far more debtor friendly restructuring process in the UK. This is to be welcomed, given the unprecedented shut down of most businesses due to the COVID-19 pandemic, and the severe impact on profitability that will arise from trading post lock down whilst observing social distancing measures, which will require all stakeholders to cooperate to ensure the survival of businesses in the “new normal” post lock down.
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Cross-border acquisitions and investments increasingly trigger foreign direct investment (FDI) screening requirements.
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