Our review suggests that the Bill, whilst containing significant changes to the insolvency legislation framework will provide a new tool-kit for the profession to enable struggling companies to react and adapt to the devastating effects of COVID-19 to the businesses and the economy.
Whilst certain provisions do not match up to what the UK government proposed a few weeks ago, we are pleased to see that the key measures are bringing the insolvency legislation into line with a much needed rescue culture - in terms of dealing with creditors.
Many measures to be introduced will be permanent in nature and with the introduction of a new restructuring plan, it is expected that as with schemes of arrangement , it will be capable of having international effect and recognised in other jurisdictions where the creditors have submitted to jurisdiction of the English courts and under Chapter 15 of the US Bankruptcy Code. The question of whether the restructuring plan will be recognised as an insolvency proceeding for other jurisdictions that have implemented the UNCITRAL Model Law on Cross-border Insolvency Proceedings will depend on how those jurisdictions have implemented the Model Law but it looks like this is a key objective.
The key restructuring / insolvency measures included in the Bill are summarised below with commentary on parts of the proposed legislation.
Temporary Suspension of Liability for Wrongful Trading
The Bill temporarily limits wrongful trading provisions in the Insolvency Act 1986 from 1 March to 30 June 2020, or one month after the provision comes into force (whichever is the later). A court is to assume that a director is not responsible for the worsening of a company's financial position.
This temporary limits allow directors of companies impacted by the pandemic to make decisions about the company's future with a reduced threat of becoming personally liable, should the company later go into liquidation or administration. There is no requirement to show that the deterioration of the company’s financial position was due to the pandemic.
Nonetheless, the Bill does not impact the requirement that directors must act in accordance with the duties that they owe to the company under the Companies Act 2006, It also does not impact the rules relating to Fraudulent Trading and Directors Disqualification.
DWF analysis - The wrongful trading provisions do not do what the previous government announcements have suggested it would do. It was suggested that there would be a suspension of the wrongful trading provisions with the aim to reassure directors and allow them some breathing space to make decisions without the influence of being prosecuted. Instead the Bill addresses quantum not liability - one issue that is likely to arise is how the Court are going to calculate quantum – there are likely to be cases where wrongful trading has occurred pre COVID-19, carried on throughout the lockdown and will continue after, so how are the Courts going to quantify what proportion of creditors debts relate soleley and specifically to COVID-19 for a three month period?
The Bill proposed this as a new permanent measure, whereby the directors of insolvent companies or companies likely to become insolvent due to COVID-19 related issues can obtain a period of 20 business days statutory moratorium, allowing time for the board to restructure or seek new investment without creditor action. The directors must make a statement that the company is, or likely to become, unable to pay its debts. The 'monitor' must be an insolvency practitioner and make a statement that it is likely that a moratorium will result in the rescue of the company.
With certain defined exceptions, the company would not have to pay debts falling due prior to the moratorium but would have to pay debts falling due during the moratorium. The moratorium will be similar to that which is available in an administration. For as long as the moratorium applies, it would prevent the enforcement of security, the commencement of insolvency proceedings or other legal proceedings against the company and forfeiture of a lease. The moratorium will last for an initial period of 20 business days with an ability within the first 15 days to extend for a further period of 20 business days without consent and with the possibility that the directors can apply for further extensions of up to one year or more.
Whilst it does bear similarities to the existing administration moratorium, it will be overseen by a 'monitor' who must be a licensed insolvency practitioner. The monitor will be required to assess the likeliness of a rescue on an ongoing, forward looking basis. If the position changes and a rescue is no longer viable, the monitor will file a notice with the Court and terminate the moratorium early.
There are some protections for creditors during this period as directors a limited to what actions they can take without the consent of the monitor, for example limits on payments and dealings with property.
A new reorganisation procedure will be introduced permanently, based on the existing scheme of arrangement procedure, which many companies already use successfully to restructure their debts and featuring a "cross-class cram down" feature akin to US bankruptcy proceedings.
There are two conditions a company must meet in order to use a restructuring plan and application for it must be made to court;
- The company must have encountered or be likely to encounter financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern. (This is different to a scheme of arrangement, which can be proposed by a company in financial distress or a completely solvent company).
- A compromise or arrangement must be proposed between the company and its creditor or members (or any class of either) and the purpose of such compromise arrangement must be to eliminate, reduce, prevent or mitigate the effect of any of the financial difficulties the company is facing.
There are a number of steps which a company must adhere to in making a court application, most notably, by making an initial application for the court to consider each of the classes of creditors, which is the same as with a scheme. Each class of creditor will have the opportunity to vote on the plan and, provided that one “in the money” class of creditors approves the plan and the plan delivers a better outcome than the next best alternative option (i.e. liquidation or administration), the plan will become binding on creditors in all classes if sanctioned by the court. The court’s role is to consider whether the classes have been properly formulated, whether each creditor receives more than they would under the next best alternative and whether the plan is fair and equitable.
At present, a large number of company voluntary arrangements fail (up to 60%) and they are also unable to compromise the rights of a secured creditor to enforce their security – as such often a company voluntary arrangement will need to be coupled with bilateral agreements with secured creditors in order to achieve a wholesale restructuring of a business. This gives secured creditors a certain hold-out value. Moreover, a company voluntary arrangement cannot impact the shareholding of the company – being limited to compromising rights of creditors. This is not the case with the restructuring plan.
Under the terms of the Bill, all companies would be eligible to apply for a restructuring plan, provided certain the conditions below are met. However, there is power for the Secretary of State to make regulations which would exclude authorised persons (as defined under the Financial Services and Markets Act 2000 – broadly those providing financial services), or a sub-section of authorised persons, from the scope of the restructuring plan where the plan would involve a compromise of creditors who are themselves authorised persons.
Statutory Demands and Winding Up Petitions
The Bill will prevent the presentation of a winding up petition for the period of 27 April to 30 June 2020 unless the creditor has reasonable grounds to believing that the pandemic has not had a financial effect or that the debtor would have been unable to pay its debt regardless of the pandemic's financial effect. "Financial effect" is given a low threshold as it occurs if the debtor's financial position worsens in consequence of, or for reasons relating to, COVID-19.
Additionally, no winding up petition can be filed after 27 April 2020 arising as a result of a creditor failing to satisfy a statutory demand served between 1 March and 30 June 2020.
DWF analysis - There is a carve out which confirms that if a creditor can prove that the debtor has not been financially affected by COVID-19 or that the company would have been in the same position if not for COVID-19, a winding up petition can still be presented. This would appear to be a strange provision because it is for the creditor to prove a negative and it is likely that it will lead to a number of contested petitions because the company will inevitably say it has been financially affected by COVID-19.
It is unknown where the date of 30 June 2020 has come from (perhaps in line with quarterly rent date of 24 June 2020). It would appear very likely that creditors are simply going to wait 6 weeks to present a winding up petition after the 30 June 2020 deadline at which point they seem to have an unimpeded path to pursue the debtor as they would have done otherwise creating a "cliff face" scenario given that a lot of businesses will still be in limbo as of 30 June 2020 and many may not even be back open and trading (the government have given 4 July 2020 as provisional date for hospitality businesses to reopen).It would appear to be a very odd situation that the government is creating. Although it is noted that there is provision in the Bill to extend the relevant dates.
Supplier Termination Clauses/ Ipso Facto Clauses
The Bill prohibits all suppliers from stopping supply by reason of a company's insolvency if the supplies continue to be paid for. Whilst existing measures stop certain key suppliers, such as utility companies, from stopping supplies, this change may have a significant effect in aiding an insolvent company to continue trading.
Financial Sector Exclusions relate to the Moratorium and Supplier Termination Clauses
The following are defined as an “Excluded entity” for the purposes of ipso facto and moratorium provisions:
(b) Deposit-taking banks and banking group companies under the Banking Act 2009;
(c) Investment banks and investment firms;
(d) Electronic money institutions;
(e) Payment institutions;
(f) Operators of payment systems and infrastructure providers / companies;
(g) Recognised investment exchanges, recognised clearing houses or recognised CSDs;
(h) Securitisation companies; and
(i) Any overseas entities whose functions correspond with the above list of entities.
In addition, a company which has permission under Part 4A of FSMA to carry on a regulated activity, and which is not subject to a requirement to refrain from holding money for clients, will also be specifically excluded from being eligible for the company moratorium with temporary modifications and from the wrongful trading suspension.
The new provisions relating to the company moratorium, termination clauses and wrongful trading suspension will also not apply to building societies, friendly societies and credit unions.
There are also "Additional entities" which are excluded from being eligible for the company moratorium:
(a) Companies that are party to market contracts or subject to market charges;
(b) Participants in designated systems;
(c) Parties to a capital market arrangement where the debt incurred or expected to be incurred was at least £10 million and involved the issue of a capital market investment; and
(d) a project company of a project which is a public-private partnership project which includes step-in rights.
The Bill's explanatory notes recognise the urgency of the Bill as UK companies face the threat of insolvency due to the pandemic. The government intends to ask Parliament to expedite the Bill's progress. MPs will consider all stages of the Bill on 3 June 2020.
If you have any queries regarding the above or any restructuring or insolvency queries during this difficult time please do not hesitate to contact the writer Ashley Jaques.
To read our summary article on this topic, please click here.