Just as Summer was closing for business for another year, the UK Government announced some sweeping insolvency reforms. In late August the Department for Business, Energy & Industrial Strategy (BEIS) published its response to its 2016 Review of the Corporate Insolvency Framework and its more recent Consultation on Insolvency and Corporate Governance launched earlier this year.
The response can be found on the BEIS section of GOV.UK and below we briefly comment on the reforms the Government plans following these consultations.
The proposed changes to the UK’s insolvency regime
Leaving aside the Government’s plans for strengthening the UK’s corporate governance framework (on which note please see our related bulletin prepared by our Corporate colleagues), the reforms it proposes to the UK’s insolvency regime cover the following:
- New powers to disqualify holding company directors who fail to give due consideration to other stakeholders of a financially distressed subsidiary when it is sold and subsequently enters insolvent liquidation/administration within 12 months post-sale.
- An extension of the investigative regime under the Company Directors Disqualification Act 1986 to cover former directors of dissolved companies.
- A prohibition of ‘ipso facto’ clauses, preventing suppliers of goods and services from terminating contracts on the basis of formal insolvency alone (suppliers will still be able to terminate for other reasons, including non-payment).
- An inflationary increase to the cap on the prescribed part from £600k to £800k.
- Updates to the existing antecedent transaction framework to enhance office-holders’ powers to challenge those transactions which result in ‘unfair value extraction’.
- An optional 28-day moratorium and a new role of monitor to act during such moratorium.
- A flexible restructuring plan enabling cross-class cram down in respect of both secured and unsecured creditors.
Something borrowed and something new
It’s fair to say that some elements of the Government’s proposals borrow features from the existing insolvency framework, whilst others offer the promise of something entirely new.
For example, the new restructuring plan seems to share many of the characteristics of the existing scheme of arrangement; there’s no requirement for insolvency, the procedure will involve an initial court hearing to approve class composition with voting based upon a company-produced circular, and if approved by the requisite majorities a second court hearing would be convened to bind minorities subject to the overriding discretion of the court. However the restructuring plan will also boast some entirely novel features, central among which will be the new cross-class cram down procedure for dissenting creditors (bearing some similarities to the absolute priority rule used in US Chapter 11 proceedings).
Also new will be the proposed moratorium, which offers distressed companies the prospect of a safe harbour from hostile creditor action (for at least an initial 28-day period) whilst they work up a restructuring proposal. However it will only be available to those companies which meet the eligibility criteria – most importantly, they cannot be actually insolvent but must be prospectively insolvent and the company must have the prospect of agreeing a compromise or arrangement with its creditors on the balance of probabilities (as determined by a monitor who we expect will be an insolvency practitioner). The process will involve an out-of-court filing in much the same way as the out-of-court administration route, with the monitor responsible for notifying all creditors. The monitor will have the power to extend the moratorium by a further 28 days, with the option to extend it further with the approval of the court or more than 50% of secured and unsecured creditors by value. Creditors will be able to object to the moratorium through the court.
Proponents of rescue or DIP financing for distressed companies will be disappointed however – the original proposal to introduce such measures failed to make its way into the Government’s proposed reforms.
What’s next?
The Government promises to implement the measures outlined above as soon as parliamentary time permits. So it’s very much a case of watch this space and where we see light, we will aim to shed it.
But in the meantime we can likely expect much debate around the precise formulation of these proposals. Many stakeholders and professionals who are active in the R&I sector have already raised questions, for example, around the operation of the new moratorium. In particular, it is only expected to be available to those companies which can satisfy themselves that it is more likely than not that the moratorium will result in the rescue of the company. What cashflow certainty or other evidence is required in order to meet this test is not yet certain. Moreover, companies which use the moratorium will still have to pay their debts as they fall due, meaning they will be unable to use the moratorium to avoid debt service. And the risk of directors being found guilty of wrongful trading will remain. Some have queried in what circumstances companies will find reason to use the moratorium, since it doesn’t seem long enough to replace a contractual standstill arrangement. However it might offer those companies backed by aggressive sponsors a short-term means of keeping lenders at bay.
IPs will be thinking carefully about the implications of acting as monitor. As monitor it will be for them to determine whether a company meets the eligibility criteria for the moratorium, whether to extend the moratorium beyond the initial 28-day period and whether to sanction non-ordinary course disposals by the company during the moratorium. IPs will be naturally concerned that they may start to share in the company’s risk.
And the prospect of holding company directors being disqualified for electing to sell subsidiaries which then go insolvent within 12 months of sale has also rung alarm bells. For many this feels like a populist knee-jerk reaction to situations such as the demise of BHS. Directors will not be liable if they can demonstrate that they had a reasonable belief (at the time of sale) that the sale would likely deliver a ‘no worse’ outcome for the subsidiary’s stakeholders than if it had been placed into formal insolvency. How precisely directors are expected to get comfortable that a company will not go insolvent within the 12-month period following sale is not immediately clear however; professional advisors are unlikely to give directors such an absolute reassurance. On a wider level, this proposal undoubtedly cuts across the established English law principle that a director is responsible to the stakeholders of the company of which he or she is a director, not to the stakeholders of other group companies who presumably have their own boards of directors who bear that responsibility. Also, the proposal to limit these provisions to large companies appears to lack any merit and, again, has the distinct whiff of populism about it. Why are stakeholders of larger companies more deserving of additional statutory protection than stakeholders of smaller companies? On its face, this seems like quite a blunt tool which might inadvertently encourage directors to put companies into administration or prepack sales rather than promoting legitimate business sales.
Matthew Padian