On 20 May 2020, the Corporate Insolvency & Governance Bill 2019-2021 was introduced to Parliament. With the Bill slated to be fast-tracked into law, here are some of the key insolvency aspects to be aware of.
Why now?
Consultations were opened back in 2016 in relation to new insolvency measures which were designed to add flexibility to the options available to companies in financial difficulty. These included a free-standing moratorium to provide companies with breathing space to effect a rescue while the directors remained in control and a new style of court-sanctioned arrangement between a company and its creditors, which would allow the cram-down of dissenting classes of creditor.
Legislation seemed to be on hold while Brexit took focus, but in the light of the recent COVID-19 crisis, the Government has decided it is essential to bring forward the proposed legislation – and to include some temporary measures designed to ease the impact of COVID-19 on the economy.
General Changes to Insolvency Legislation
Moratorium
The Bill provides for a company moratorium, adopting a debtor-in-possession model (somewhat akin to a US Chapter 11 Bankruptcy Code proceeding) whereby the directors of a company remain in control, subject to the oversight of an independent monitor (who must be a licensed insolvency practitioner). Filing is straightforward and does not require a court hearing (unless there is an existing winding up petition outstanding against the company).
During the moratorium, the directors are given an initial period of 20 business days in which to try to rescue the company. This period can be extended for up to one year with creditor consent or longer under a court order.
During the moratorium, the company:
- Has the benefit of a payment holiday from most of its pre-moratorium debts (although there is no payment holiday for, among other things, the monitor’s remuneration and expenses and goods or services supplied or wages arising during the moratorium)
- Is protected from creditor-led insolvency actions such as winding up petitions and administration applications
- Is protected from various creditor enforcement actions, which are not permitted during the moratorium without court consent – these include forfeiture by a landlord, the enforcement of most forms of security, repossession and various other legal proceedings
- Is restricted from incurring significant credit without informing the credit provider of the moratorium
- May only grant security or dispose of its property in certain circumstances (often requiring the consent of the monitor or the court)
There are limited provisions within the Bill which appear to provide for super-senior priority for funding granted to a company during the moratorium, where the company enters into winding up proceedings within 12 weeks of the end of the moratorium. Under those provisions, the moratorium debts (which could include debtor-in-possession financing if the financier and monitor consented to it) would, along with pre-moratorium debts for which there was no payment holiday, rank first for payment – in preference to “all other claims” – i.e. including the claims of the holders of floating charges. It is unclear as to whether such debts would also rank ahead of the claims of holders of fixed charges – the language of the Bill is ambiguous on this point, so clarification would be desirable. In any event, this would constitute a shift away from the traditional order of priority and may open the market for funders willing to provide emergency rescue funding on preferential terms.
Most companies are eligible for the moratorium, including overseas companies, although the Bill excludes certain types of company such as banks and insurance companies. However, the moratorium is not available to any company which is already in an insolvency process or has been in one within the past year.
Given the length of this (extendable) period and the flexibility of the process, it is foreseeable that even major restructurings could be effected during a moratorium, without the need for the company to enter into administration. However, of course, the directors and monitor must be of the opinion that the company can be rescued as a going concern (except in the case of a moratorium application where there is an existing winding up petition, where the court determines that the granting of a moratorium would lead to a better outcome for creditors than an immediate winding up). Whereas, the administration regime does provide for other outcomes i.e. where a rescue of the company itself as a going concern is not possible.
Arrangements and reconstructions
English law has long contained the concepts of a scheme of arrangement (which can be used in solvent and insolvent scenarios) and the company voluntary arrangement (or CVA).
The proposals under the Bill include a new form of arrangement between a company and its creditors for use where a company is, or is likely to become, in financial difficulty (an “Arrangement”), which bears many of the hallmarks of a scheme of arrangement, but includes some useful new aspects:
- It would be possible to ‘cram down’ the claims of dissenting creditors across various voting classes, where the court determines that doing so would not result in a worse outcome for those dissenting creditors
- The court can make a wide range of orders in connection with a transfer or amalgamation of interests between companies, including the transfer of liabilities and the allotment of shares
Given that the interests of shareholders could be crammed down under an Arrangement, the proposals may allow space for more companies to pursue debt-for-equity swaps where there is insufficient shareholders’ consent. Unlike a CVA, the interests of secured and/or preferential creditors could also be crammed down under an Arrangement, which could dramatically widen the restructuring options available to a company.
Ipso facto clauses – protection of supplies
Unlike many jurisdictions, the English legal system has generally allowed for the operation of so-called ipso facto clauses, which permit the termination or amendment of a contract in the event of an insolvency. Amendments have been made in the past to compel the continuance of certain essential supplies such as electricity, IT services and other utilities, but these have not extended to general contracts for the provision of goods and services – until now.
Under the Bill, where a company enters into an insolvency procedure, any provision in a contract for the supply of goods or services to that company which entitles the supplier to terminate the contract or ‘any other thing’ as a result of the insolvency shall not have effect (except where the company or insolvency office-holder consents). Suppliers are also prohibited from requiring the payment of past supplies as a condition for continued supply.
Exclusions apply to these provisions for certain types of supplier including banks and insurers. Insolvency netting and set-off arrangements remain available and are not affected by these proposed changes.
These changes will be of crucial importance to suppliers who might otherwise have been entitled to terminate supplies or impose conditions for continued supply under their contractual arrangements.
Temporary Insolvency Changes Related To COVID-19
The Bill includes a number of temporary measures which are designed to ease the impact of COVID-19 on businesses and the economy. If the Bill becomes law, most of these changes are proposed to take effect from 1 March 2020 and run until the later of 30 June 2020, or one month after the Bill comes into force as law. The Bill allows for the extension of this period by up to another six months. We call this the “Relevant Period”.
Ipso facto clauses and small businesses
During the Relevant Period, the provisions which prohibit the termination of, or amendment to, a contract for the supply of goods or services to an insolvent customer will not apply to “small” businesses. There are various statutory methods to determine whether a supplier is “small” but, broadly speaking, the supplier company must meet two of the following three conditions:
- Turnover of not more than £10.2m
- Aggregate assets on balance sheet of no more than £5.1m
- Less than 50 employees
This will ease the impact on supplier companies, who could otherwise find themselves compelled to continue to supply to an insolvent customer which has not paid for its pre-insolvency supplies or services.
Winding up of companies
The ability of creditors to present a statutory demand or issue a winding-up petition will be restricted during the Relevant Period. The key restrictions are summarised below:
- No winding-up petition may be presented on or after 27 April 2020 on the ground of inability to pay debts, where the statutory demand upon which the petition was based was served during the Relevant Period.
- No winding-up petition may be presented by a creditor on or after 27 April 2020 unless the creditor has reasonable grounds for believing that COVID-19 has not had a financial effect on the debtor or that the circumstances behind the demand would have arisen notwithstanding COVID-19.
- Where a winding-up petition was presented between 27 April 2020 and the coming into force of the legislation, if a court determines that the conditions above for presenting a petition were not met, that court may make an order to restore the position to what it would have been if the petition had not been presented.
- If a winding-up petition is presented on or after 27 April 2020 and the company is deemed unable to pay its debts but it appears that COVID-19 had a financial effect on the company before the petition was presented, the court may only make a winding up order if it is satisfied that the grounds for the petition would have been satisfied notwithstanding the impact of the coronavirus.
- Where the court has made a winding up order between 27 April 2020 and the coming into force of the legislation, which the court would not have made if the restrictions on making winding up orders had already been in force, the order shall be regarded as void (note that there is an exclusion of liability for the official receiver, liquidator or provisional liquidator in such cases).
- Various requirements to advertise a winding up petition or to make the court file available to interested parties have been restricted until such time as the court has made a determination as to whether it would be able to make an order under the new provisions – which may reduce the ability of supporting creditors to join existing winding up proceedings.
Assuming these provisions are brought into force in time, this may leave a lot of creditors with long-issued statutory demands and/or petitions unclear as to where they stand. Where winding up orders which have been made are regarded as void, quite how the parties involved will deal with restoring the position to that which would have been without the winding up order is unclear. The changes will, of course, provide comfort to debtors who are struggling as a result of COVID-19.
However, once the temporary provisions cease to have effect, there may be a wave of winding up petitions, which the courts may struggle to process without significant delays.
Wrongful trading
In a wrongful trading action, the courts will assess the net position of a company’s assets between the time (i) that the director in question knew or ought to have concluded that there was no reasonable prospect that the company would avoid insolvent liquidation or administration and (ii) the company’s entry into an insolvency process.
Assuming the Bill becomes law, when the courts consider whether to declare a director liable to contribute to a company’s assets, a new assumption will arise in favour of the director. The court will assume that the director is not responsible for any worsening in the company’s financial position incurred during the Relevant Period. There are exclusions for certain companies (such as those which carry on regulated activities under the Financial Services and Markets Act 2000) and bodies such as friendly societies.
This will offer some comfort to directors who have had to make difficult decisions about continuing to trade the company’s business since 1 March 2020, but it does not absolve them of all potential liability – for example, they must still comply with their fiduciary duties and be mindful to avoid any of the other potential claims which may be brought personally against directors in an insolvency.
If you would like to know more, please see our client alert, which provides more information on the changes to wrongful trading.
Other Changes
The Bill also introduced a number of changes in relation to corporate governance, which are beyond the scope of this note, but in summary include the temporary relaxation of company filing requirements and adding flexibility for the holding of meetings (including annual general meetings).
David Steinberg and Tim Carter, co-heads of the restructuring and insolvency practice at Stevens & Bolton, comment:
"The Bill introduces a number of temporary measures which will, of course, be of relief to companies facing winding-up proceedings or concerned about their supply chain. The relaxation of the wrongful trading provisions may help directors who might otherwise struggle to make the decision to continue to trade through this period. However, for every ‘winning’ debtor in these circumstances, there is likely to be a ‘losing’ creditor who is unable to enforce the payment of a debt owed to it. The law must attempt to strike an appropriate balance and it will be interesting to see the extent to which the courts are asked to determine the question of whether a debtor’s financial difficulties are attributable to (rather than simply exacerbated by) the COVID-19 pandemic.
Of more long-term significance is the introduction of the new ‘moratorium’ procedure, as well as the provisions for Arrangements. The moratorium will facilitiate debtor-in-possession rescue processes (as well as opening the market for debtor-in-possession or “DIP” finance) and may dramatically reduce the number of companies entering into administration. In particular, the new Arrangement provisions may herald a slew of debt-for-equity swaps being imposed upon incumbent shareholders, which up until now has only been achievable through recourse to cumbersome and expensive pre-packed administration sales of businesses and assets to creditor-owned newco vehicles. The flexibility to include the rights of secured and preferential creditors within an Arrangement will also widen the scope of what may be achieved in restructurings."
Notwithstanding some of the uncertainties it presents, we expect the Bill to progress rapidly through Parliament and to come into force in early June. You can track its progress here.
Tim Carter