On 20 May 2020, in response to the coronavirus pandemic, the UK government published the text of the Corporate Insolvency and Governance Bill 2019-2021 (the “Bill”), a 238-page document which sets out some of the most sweeping reforms to insolvency law for 20 years. This alert considers the provisions of the Bill in detail, voicing some concerns from our Business Restructuring and Insolvency Group.
This alert is relevant to all businesses, particularly those in industries struggling as a result of the pandemic.
The Bill brings in a package of reforms, many of which we have discussed in our earlier client alert, including
1. the suspension of the law on wrongful trading;
2. the suspension of statutory demands and winding up petitions;
3. a new moratorium period to protect businesses from their creditors;
4. a new restructuring plan; and
5. protections for supply contracts.
The text of the Bill and updates as to its legislative stage are available here. What follows is a brief summary of each of these measures, together with our initial thoughts on them.
The measures described below are only intended to cover the duration of the pandemic.
Currently, directors can be personally liable in insolvency proceedings if they continue to trade:
1. in circumstances where they knew (or ought to have known) that there was no reasonable prospect of their company avoiding insolvent liquidation; and
2. did not take every step to minimise the potential losses to the company’s creditors.
The intention was for these provisions to be suspended retrospectively from 1 March 2020 until 30 June 2020 (with the possibility of an extension of up to six months). This has now crystallised as a presumption that the directors were not responsible for the worsening of the company’s financial position.
We have a number of concerns with this measure:
1. Potential for abuse. As the proposed leniency appears to apply to all directors, not just those with companies in difficulty as a result of the pandemic, some directors may continue to trade despite unrelated financial difficulties.
2. Relevant period. The period for which wrongful trading has been relaxed is rigidly defined – it remains to be seen what approach will be adopted by the courts to actions just outside the relevant period.
3. Efficacy. The Bill does not truly suspend wrongful trading, rather it puts in place a presumption that the directors did not worsen the financial position of the company. Further, directors can still be liable in (i) breach of their fiduciary duties, (ii) fraudulent trading, (iii) disqualification and misfeasance actions, and (iv) the law on antecedent transactions. The “suspension” is therefore not a panacea, and its effectiveness can be questioned. If anything, its only effect may be making matters more difficult for insolvency practitioners.
4. Necessity. Courts are generally unwilling to second-guess honest directors and impose liability for wrongful trading. This may be particularly true in the current highly volatile and challenging environment. Some commentators therefore question whether a court would have ever exercised its discretion to impose liability without clear reason.
5. Duty to consider individual creditors. The City of London Law Society (CLLS) have noted that the Ralls Builders decision has made it difficult for directors to continue operating in insolvency situations without breaching their duties, as they must currently consider the interests of all creditors individually, rather than taken as a whole. Including wording to mitigate this issue for directors who wish to operate under the suspension would be helpful.
The Bill also includes a temporary ban on filing winding-up petitions and statutory demands from 1 March 2020 until 30 June 2020, where coronavirus has had a “financial effect” on the debtor. As with the other measures below, this allows businesses more opportunity to reach a fair agreement with creditors. However, a creditor can still file if they have reasonable grounds for believing that (a) coronavirus has not had a financial effect on the debtor, or (b) the debtor would have been unable to pay its debts even without this financial effect.
We note the following points here:
1. Scope. There was previously an expectation that this would be limited to hospitality, leisure, and retail sectors. However, this has not been the case, and we will be interested to see whether this more extensive scope is questioned in Parliament.
2. Potential for abuse. If the cause of non-payment is in dispute, presumably the only method for resolving this will be in court. This could mean costly delays and litigation for struggling creditor firms, further exacerbating concerns of contagion, whereby a whole supply chain would be affected due to lack of recourse.
The measures described below are permanent reforms to English insolvency law introduced by the Bill, based on a previous 2016-2018 governmental consultation.
The Bill introduces a moratorium period which companies (solvent or otherwise) can use to preclude creditor enforcement claims while they seek a rescue or restructure.
During the moratorium, directors will retain most of their management powers. However, a monitor, being a licensed insolvency practitioner who will represent creditors’ interests, will supervise the directors by (i) verifying that rescue of the company as a going concern continues to appear likely, (ii) approving sales of assets outside the ordinary course, and (iii) approving the grant of new security over assets. The monitor also has powers to challenge the actions of directors.
Once the directors file a statement that the company is likely to become insolvent, and the monitor files a declaration that the moratorium will likely result in company rescue, the moratorium commences, lasting for 20 days. This can be extended by a further 20 days within the last 5 business days of the initial period, if the directors file the relevant documents at court. Any further extension will require the consent of creditors (for extensions of up to 1 year), or otherwise the court.
During a moratorium, the company may not obtain credit to the extent of £500 or more from a person unless the person has been informed that a moratorium is in force in relation to the company. Further, the company may, with the permission of the court, dispose of property which is subject to a security interest as if it were not subject to the security interest.
Creditors will be able to challenge the actions of directors/monitors if their interests have been unfairly prejudiced.
We are concerned by this moratorium period as it currently stands:
1. Eligibility. While government proposals previously only covered “prospectively insolvent” companies, the moratorium is now open to both solvent and insolvent businesses. Further, the scale of the requisite “financial effect” is unclear, and so it will be interesting to see how this is assessed by the courts.
2. Potential for abuse. The CLLS had suggested two solutions for further lender protection:
3. Role of monitor. During the consultation process, it was suggested that the monitor be prohibited from taking up a subsequent position as company administrator, to avoid potential conflicts of interest. This has not been implemented here.
4. Was this necessary? Only very aggressive creditors will seek to enforce their rights in the current environment, where recoveries will be low and reputational damage considerable. The benefit to certain debtors with aggressive creditors must be weighed up against the risks of creditor contagion to the market at large.
The Bill sets out a new restructuring plan that solvent and insolvent companies can use to manage creditors. The plan is mostly modelled on the existing scheme of arrangement procedure, though it is somewhat similar to US Chapter 11 proceedings.
Notably, the plan includes a “cross-class creditor cram down”, meaning that the court can force secured and unsecured creditors from any class to agree to the plan. For the court to agree to this, it must ordinarily be satisfied that:
Creditors and shareholders will also have the right to apply to court with counter-proposals.
We have some outstanding questions on this plan:
1. No absolute priority. The concept of absolute priority, whereby senior dissenting classes should be satisfied in full before a more junior class, has been removed from the proposals. There is therefore little protection for senior creditors, and we will be interested to see whether this is reintroduced.
2. DIP financing. There is still no mention of whether super-seniority will be available to rescue lenders as seen in US debtor in possession financings. The removal of this incentive hampers the prospect of struggling businesses being able to secure new lending.
3. Jurisdictional reach. Will this plan be broadly available to companies from other jurisdictions (as with Chapter 11), or will more specific criteria be applied?
The Bill would also prohibit a company’s suppliers from terminating contracts purely because that company is insolvent. This protection will be triggered in a variety of circumstances, including where the moratorium or restructuring plans above are initiated, and where the company enters administration or liquidation.
Creditors will retain the ability to terminate a contract for other reasons. Suppliers can also be relieved of their obligations if it causes hardship to the supplier's business; and there is an exception for small company suppliers during the pandemic.
We also have a number of concerns with this protection:
1. Freedom of contract. The proposals here negate the commercially agreed terms of the parties, representing a considerable interference with freedom of contract. There is an argument to say that if the parties wanted this kind of protection, they should have agreed on it.
2. Court powers. When applying for court permission to terminate a supply contract, it is up to suppliers to show that continuing with the contract would cause it “hardship”. It will be interesting to see how this provision is developed by the courts.
3. Interaction with drafting. It would be problematic if the law’s effect only extended to particular drafting, and we are interested to see how the market and drafting of termination clauses evolves in response.
4. Customer contracts. In the US, similar restrictions can apply to customer contracts. However, these were not mentioned in the proposals, and so this may limit the usefulness of the measure.
We understand the motivation for these reforms in the current environment. Many businesses struggling as a result of the pandemic need more time and flexibility to deal with their creditors as they ride out the market downturn. The Bill provides both of those things for debtors, and so it might be viewed as a welcome first step in that respect.
However, these reforms are the most extensive English insolvency law has seen for 20 years, and rushing them is dangerous. There is a real risk of exacerbating creditor contagion, and potential abuses. This is all the more cause for concern considering that many of these reforms are drafted so as to extend beyond the pandemic. Without the benefit of thorough legislative scrutiny, there is a risk that courts will be left to fill in the gaps, and that the market will have to live with the consequences of these uncertainties and vulnerabilities for the years to come. The government has been given further powers to make additional changes to insolvency law by secondary legislation, and so this may provide one route for it to adapt quickly, but we will be monitoring developments as they arise.
Christopher Lloyd, London Trainee Solicitor, contributed to the drafting of this alert.