The new Corporate Insolvency and Governance Act: Implications for asset-based lenders

Key points for asset-based lenders

We explore the implications for the Act in the context of asset-based lending below. Key points to note are:

• The Act introduces a new “moratorium” procedure allowing eligible companies to continue to trade whilst being protected from creditors who may not take enforcement steps against them. The moratorium is a rescue process intended to give the company a breathing space to allow time to implement a rescue plan. It is not an insolvency process. Importantly, the directors of an eligible company can file the necessary documents required to put the company into a moratorium without giving notice to the holder of a qualifying floating charge. This is a major change, when compared with administration, where the company is required to serve notice of intention to appoint administrators on the holder of a qualifying floating charge. As a result, asset-based lenders could be faced with a borrower informing them that it has gone into a moratorium without prior warning. This may not happen in practice because the lender’s support for the proposed rescue plan is likely to be needed if the plan is to be considered by the proposed monitor to be “likely” to succeed. Further, the asset-based lender’s close monitoring of the business should alert the asset-based lender to any deterioration in performance in advance of the appointment of a monitor. In addition, in light of the payments which need to be made in the moratorium if it is to continue to support a successful rescue, the lender’s agreement not to use its rights to accelerate during the moratorium is also likely to be required.
• There is a payment holiday during the moratorium for all pre-moratorium debts other than in relation to six categories of excluded debt, which include debts payable under financial services contracts. These include loans, leases and guarantees and commodities contracts (see further below) and so will include debts falling due to asset-based lenders. As a result it is “business as usual” for the asset-based lender other than as regards the enforcement of security.
• The realisations available for the asset-based lender from the floating charge will be reduced in an administration or liquidation following a failed moratorium. This is because certain of the payments, defined as “priority pre-moratorium payments”, which the company is required to pay in a moratorium, if unpaid when the moratorium is terminated, will attract a super priority status in the subsequent insolvency. The principle here is that those providing new credit in the moratorium should be paid for the new credit in the moratorium, or the subsequent process if the moratorium fails.
• The Act introduces prohibitions on the effect and use of ipso facto clauses which would otherwise allow the supplier to terminate by reason of insolvency. These provisions may require borrowers to continue to supply customers in an insolvency or restructuring procedure, without insisting on the payment of arrears, which could cause problems for the supplier in terms of its own cash flow and its ability to rely on its credit insurance. Certain categories of supplier and categories of contract are excluded. In particular, the new rules do not apply to “financial contracts”, which include certain “commodities contracts”. However the Act does not define those contracts which are excluded commodities contracts, so this will therefore be likely to be tested in case law in the courts.

Key aspects of the Act

In this section, we consider the implications of the three permanent changes to insolvency and restructuring law set out in the Act, namely:

1. The new moratorium and its effect
2. Termination clauses
3. The new restructuring plan

We will then consider implications of the Act on asset-based lenders.

(1) The moratorium and its effect

Who can use the procedure?

The moratorium is a new standalone procedure (which is not an insolvency procedure) which gives the directors of a company the ability to apply to the court for a moratorium to give the company protection from creditors while implementing a rescue plan. During the moratorium process, the directors remain in control of the company but a “monitor” (who is an insolvency practitioner) is appointed to monitor the company’s affairs to check that the company is making the payments it is required to make in the moratorium and to keep under review whether it remains likely that the moratorium will result in the rescue of the company as a going concern.

The directors are required to file a number of documents at court to commence the procedure, including a declaration that the company is, or is likely to become, unable to pay its debts and a statement from the proposed monitor that a moratorium would be likely to result in a rescue of the company as a going concern.

There is no requirement for the company to give notice to the qualifying floating charge holder of the intention to file the application for a moratorium with the court.

Some companies are not eligible to use the moratorium procedure, such as banks, insurers, PPP project companies and companies which have entered into a capital markets transaction (such as the issuing of bonds) involving debt of at least £10 million.

The moratorium procedure is available to an overseas company if it has a sufficiently close connection to England and Wales. For example, a holding company incorporated abroad might be eligible by virtue of holding shares in a company incorporated and doing business in England, particularly if it carried out no other business.

What are creditors prevented from doing during the moratorium?

During the moratorium, creditors are prohibited from commencing insolvency proceedings against the company so they are unable to:

• Petition to wind up the company; or
• Put the company into administration.

Creditors are also unable to take the following steps against the company without the permission of the court:

• Enforce security other than in relation to financial collateral (see below);
• Repossess goods or premises;
• Commence or continue a “legal process” (save for some types of employment proceedings);
• Enforce a judgment;
• Take steps to crystallise a floating charge.

Implications for asset-based lenders:

An asset-based lender would be able to exercise its usual contractual rights under the asset-based lending facility to, for example, implement reserves, adjust advance rates, etc.

What enforcement steps can a charge holder take during the moratorium?

Lenders are able to enforce collateral security charges or security created under a financial collateral arrangement notwithstanding the moratorium. They are prevented from enforcing other security and from appointing an administrator.

What payments does the company have to make in the moratorium?

During the moratorium, the company has a payment holiday in respect of all pre-moratorium debts that have fallen due prior to the moratorium. That payment holiday continues during the moratorium in relation to amounts which fall due during the moratorium other than in relation to six excepted categories. These categories include amounts that fall due during the moratorium and are amounts payable in respect of:

• Goods or services supplied during the moratorium;
• Rent in respect of the moratorium period;
• Wages and salaries;
• Liabilities arising under a contract involving financial services (such as a bank loan, finance leasing agreement or bonds).

As a result it is business as usual for the asset-based lender, with amounts falling due under the facility being payable in the moratorium.

Implications for asset-based lenders:

Asset-based lenders are able to exercise contractual rights during the moratorium, for example, to accelerate a loan. This would mean that the full amount of the loan would fall due and would be likely to result in the termination of the moratorium by the monitor as the company would be unable to pay the amount due. As a result, in practice, companies are likely to need to secure the support of the asset-based lender before seeking to use the moratorium procedure or immediately following the entry into the procedure.

What is the role of the monitor and what happens in the moratorium?

The proposed monitor has to file a declaration that the company is eligible for the procedure and that in his/her view, the moratorium would be likely to result in the rescue of the company as a going concern. The moratorium is initially for a relatively short period of 20 business days, extendable to 40 business days by the directors on a further application to the court (provided that the monitor confirms that the debts payable in the moratorium have been paid and the rescue is still likely). The moratorium can then be extended for up to a year with the majority consent of creditors or an order of the court, again provided that the same confirmations are made by the monitor.

The moratorium procedure aims to give the company time to progress plans for a rescue whilst having protection from its creditors. The rescue could be, for example, a refinancing, or a company voluntary arrangement (CVA) or a debt restructuring. It is likely that the company would have discussions with its lenders prior to entering into the moratorium, as without those discussions it would be difficult for the proposed monitor to express a view on the likelihood of rescue. In addition, given that the lender is still entitled to exercise its contractual rights during the moratorium, it is likely that a standstill with lenders extending the date that payments to the lenders which would otherwise fall due during the moratorium would need to be negotiated prior to the entry into the moratorium.

What happens if the rescue fails?

If the monitor considers that it is no longer likely that the rescue of the company as a going concern will be achieved, or that the company is unable to pay the sums it is required to pay during the moratorium period, then the monitor must terminate the moratorium, and should not consent to any further extensions of the procedure.

The directors will then need to consider what steps they should take in light of the failure of the rescue. It is likely that they would then take steps to put the company into an insolvency procedure, with the options likely to be administration or liquidation.

Priority payments in a subsequent insolvency

If an insolvency procedure commences within 12 weeks of the end of a failed moratorium, and the company did not make payment in full of all the payments falling due in the moratorium, certain of those unpaid amounts will have super priority in the subsequent insolvency.

Payments that would otherwise have fallen due to lenders (including any amounts falling due under a facility that has expired or under a revolving credit facility) would be priority moratorium debt qualifying for super priority. However if the lender has used its rights to accelerate debt, “relevant accelerated debt” will not qualify as a priority pre-moratorium debt for these purposes and will not have super priority. Priority pre-moratorium debts will rank ahead for payment from floating charge assets, above the liquidation or administration expenses, including the remuneration of the subsequent officeholder who is likely to be an administrator or liquidator, and payments to preferential and secured creditors.

Realisations to the asset based lenders from invoices assigned to it would be unaffected by these provisions, as would any realisations from fixed charge assets.

However realisations from floating charge assets will be reduced, and this reduction needs to be factored into the calculations by the asset based lender of the relevant provisions it needs to make regarding the facility.

(2) The use of termination clauses in supply contracts, which allow termination “ipso facto” or by reason of the insolvency

What were the ipso facto prohibitions prior to the Act?

Prior to the Act coming into force, the Insolvency Act 1986 provided that suppliers of gas, electricity, water and IT systems could be required to continue to supply to a company in an insolvency procedure and were not entitled to terminate supply agreement by reason of, or “ipso facto” the insolvency procedure. They were also not entitled to force a company that had gone into insolvency to pay arrears as a condition of further supply. All other types of supplier were able to terminate the supply contracts by reason of the insolvency, or to demand that arrears be paid before making further supplies. This was detrimental to the rescue culture if rescue of the company relied on the continuation of supplies. Other jurisdictions such as the US, Canada and Australia have implemented restrictions on the exercise of ipso facto clauses in relation to companies in an insolvency or restructuring procedure and a prohibition on the ability of suppliers to demand “ransom payments”.

How does the Act affect contracts of supply?

The Act significantly extends the prohibition on the use of ipso facto clauses in supply contracts and the restrictions on the ability of a supplier to terminate because of the entry of the counterparty into an insolvency or restructuring procedure, to all contracts for the supply of goods and services unless excluded by the Act. The ramifications for suppliers are threefold:

1. First, a provision in a contract for the supply of goods or services under which (a) the contract or the supply is to terminate, or for any other thing to take place, because the company goes into an insolvency procedure or (b) the supplier is to be entitled to terminate the contract or supply, or do any other thing, because the company goes into an insolvency procedure, ceases to have effect when the company goes into a moratorium, administration, administrative receivership, company voluntary arrangement, liquidation or has proposed a restructuring plan.
2. Second, where under a provision in a contract for the supply of goods or services a supplier is entitled to terminate the contract or supply because of an event which pre-dates the buyer’s insolvency and that entitlement arises before the buyer’s insolvency, that entitlement cannot be exercised once the buyer goes into insolvency.
3. Third, a supplier may not make it a condition of any supply of goods or services after the time the buyer goes into insolvency, or do anything which has such effect, that any arrears are to be paid.

The restrictions in (1) and (2) above can be overcome if the insolvency office-holder or the buyer (depending on which particular type of insolvency procedure is involved) gives consent or if the supplier can satisfy the court that forcing it to continue to supply would cause “hardship”. This term is not defined and its meaning will be developed on a case-by-case basis.

In practice, if the insolvent buyer does not want the ongoing supply then the company or the insolvency office-holder are likely to agree that the contract may be terminated. The supplier should communicate with the office-holder or buyer immediately upon hearing that it is in a relevant insolvency procedure to ascertain if the supply is still wanted. The company or office-holder is likely to be advised to communicate speedily with the supplier to confirm the position so as to not become liable for payment in respect of any ongoing supplies.

Which suppliers and contracts are excluded from the ipso facto restrictions?

The ipso facto provisions do not apply if:

• The supplier is a “small supplier” (although this exclusion falls away on September 30, 2020)
• Either party is a bank, insurer or payment institution; or
• The contract is a “financial contract”, which includes “commodities contracts” (see further below) and swap agreements; or
• The contract forms part of a PPP project.

A “commodities contract” is defined as including “a contract for the purchase, sale or loan of a commodity or group or index of commodities for future delivery”. Neither the Act itself nor the Explanatory Notes to the Act provide clear guidance as to what exactly will constitute a “commodity”, although the Act positively identifies EU emission allowances and UK renewable energy guarantees of origin as falling within the definition.

The Government is aware of this issue, and we therefore expect further guidance to be forthcoming. It is not currently clear if electricity or gas (as would be the supply under a power purchase agreement or a gas supply agreement) will be considered a “commodity” for the purposes of this exemption. We can however take some direction from conventional dictionary definitions of “commodity” which focus on raw materials and soft commodities. Other legislation, for example the Market Abuse Regulation (Regulation 596/2014) (MAR), also includes energy within the definition of commodities. The MAR’s definition of “commodity” states that “‘commodity’ means any goods of a fungible nature that are capable of being delivered, including metals and their ores and alloys, agricultural products, and energy such as electricity”.

Payment for ongoing supplies

Implications for asset-based lenders:

If the ipso facto prohibitions apply to a borrower in an asset-based lending facility, the lender should review whether the inability of the supplier to insist on payment of arrears could lead to cash flow issues for the supplier, and as a result to its own financial difficulties.

This is because if the provisions of the Act apply then the supplier will be required to continue the supply under the supply contract unless the buyer indicates that it no longer wants the supply and agrees that the contract can be terminated. Whilst the supplier cannot insist on the payment of arrears as a condition of ongoing supply, the restriction on the right to terminate does not affect the obligation on the buyer to pay for the supply from the date of commencement of the insolvency procedure, or prevent termination for non-payment in respect of supplies made after that time.

Credit insurance

Credit insurers may be entitled to refuse to continue cover for suppliers continuing to supply to a company in a moratorium, administration or liquidation under the terms of the credit insurance policy. This may lead to further financial pressure on the supplier. Further, most credit insurance policies provide that payments are allocated against the oldest invoices, which would result in a mismatch in the context of a moratorium, where there would be a payment holiday for the oldest invoices, and the supplier would be receiving payment for the newest invoices being rendered in the moratorium period.

Practical implications of the provisions

It is likely that, as a result of the Act, suppliers will include a wider range of triggers for termination upon signs of financial distress (for example, a ratings downgrade or a failure to meet creditworthiness tests set out in the contract) and will become more likely to act earlier in response to such termination events since if they wait and the buyer goes into an insolvency procedure those rights may no longer be relied upon.

We would expect that in the vast majority of cases, the question of ongoing supply will be satisfactorily resolved between the insolvency office-holder and the supplier without a court application. However, where ongoing supply is critical to the buyer’s business and there is a large debt outstanding to the supplier, disputes could arise. These are likely to be more complex where the supply has a cross-border element (for example, the contract is not governed by English law or the supplier is not subject to the jurisdiction of the English court) or where the supplier can show that the continuation of supply without being paid in respect of its arrears, will cause it severe difficulties.

For companies which rely on long-term supply agreements, such as outsourcing agreements, we expect to see more trading administrations where the administrator can now require the supplier to continue to supply, and the ongoing trading is likely to result in the rescue of the company or better realisations for creditors.

(3) The New Restructuring Plan

The Act provides that a company in financial difficulties may propose a restructuring plan (the Plan) to its creditors and shareholders. The procedure is similar to the existing process for the approval of a Scheme of Arrangement under Part 26 of the Companies Act 2006. The first step is for the company or its creditors to make an application to court for the approval of the Plan.

If any class of creditors or members approve the Plan, the court can then consider whether or not to sanction the Plan. The Plan can allow cross class cram down and cross class cram up of creditors, if creditors representing 75 per cent in value of one of the classes of creditors approve the Plan and it can then be referred to the court for sanction. The court can sanction the Plan and bind dissenting classes of creditors or members provided that:

• The dissenting classes are no worse off than they would be in the “relevant alternative”: usually liquidation; and
• The one class voting in favour of the Plan would receive a payment or have a genuine “economic interest” in the company in the event of the “relevant alternative”.

This procedure therefore could have an impact on asset based lenders if a borrower proposes a restructuring plan which affects the rights of any classes of creditors. The relevant creditors would then be asked to vote on the approval of the Plan. The ipso facto prohibitions would come into effect once the court convened the meetings of creditors and members.

The asset-based lender therefore needs to be ready to consider and evaluate a restructuring plan and to make an informed decision as to whether the proposals are fair in the circumstances. It will need to take advice on the likely outcome for the lender in the “relevant alternative”, and the chances that the lender could be “crammed down” or “crammed up” by an order of the court.

Potential implications of the Act on asset-based lending

Potential opportunities to fund the rescue process to be implemented in the moratorium

The moratorium is to support the rescue of companies and the rescue is likely to require funding. This therefore represents an opportunity for the asset-based lender to fund the rescue and support the business going forward. It is a process that is designed to support the rescue of companies with a good business, which should therefore provide attractive opportunities for asset-based lenders. In Canada which already has a monitor-supervised moratorium process, it is usual for the company to negotiate with its existing lenders prior to entering into the monitorship regarding the funding of the rescue.

Dilution of floating charge realisations by payment of priority pre moratorium debts in a subsequent insolvency

Asset-based lenders need to provide for potential additional dilutions to realisations from the floating charge as a result of a failed moratorium. This will require an assessment of the likely payments which a company will have to make in a moratorium, and a calculation of which of those payments will be priority pre-moratorium debts with super priority in a subsequent administration or liquidation.

These provisions will also need to reflect the increase in the Prescribed Part which took effect in April 2020 and the fact that crown preference will be returning in December 2020 under the provisions of the Finance Act 2020, which will further dilute the realisations to the holders of floating charges and consequently, increase the priority payables reserves held by asset-based lenders.

As a result of the potential reduction of floating charge realisations, the asset-based lender may wish to consider reducing lending on floating charge assets, and focusing instead on lending against invoices assigned to the lender and assets subject to a fixed charge where there is no risk of dilution.

Furthermore, asset-based lenders may look again at whether they are comfortable with post-closing periods for the delivery of satisfactory blocked account arrangements and fixed charges over receivables. Springing cash dominion structures (more common in US-led asset-based lending) may also be reconsidered, not only as this structure results in a floating charge over receivables, but also because it’s unlikely that the asset-based lender would be permitted to “spring” control over relevant bank accounts during a moratorium. Where a springing cash dominion structure is unavoidable, asset-based lenders may look to include more sensitive triggers for springing control in respect of the bank accounts of English companies.

Early consideration of whether the asset-based lender supports the rescue

It will be necessary for the asset-based lender to be able to consider quickly whether it wishes to support a rescue or not, and the terms on which it would agree to a standstill in the moratorium. The rescue could provide opportunities to the lender for further lending. Further, supporting a successful rescue would remove the risk of dilution of realisations in a subsequent administration or liquidation following a moratorium. In order to consider the options and the risks, the lending team will need to be familiar with the new procedures in order to assess the opportunities and risks for the lender in each case.

Conclusion

The new Act introduces ground-breaking changes to restructuring and insolvency law. We have produced a four-part webinar series on the Act which can be viewed here. We are also running further webinars on the practical points arising from the legislation as it is used. Please get in touch with your usual Norton Rose Fulbright contact or any of the partners listed below to discuss any questions and issues.