All Change in Corporate Insolvency?
The Corporate Insolvency and Governance Act 2020 (CIGA) became law on 26 June 2020. It contains some temporary provisions required as a result of COVID-19 and some permanent provisions that have been in the offing for a while which will make sweeping changes to the current insolvency rules.
The Temporary Provisions
The temporary provisions are aimed at providing businesses with some relief from problems created by the current COVID-19 pandemic including the temporary suspension of wrongful trading laws and the prohibition of the use of statutory demands and winding up petitions.
These provisions are debtor friendly and retrospective. They apply from 1 March until 30 September 2020. They make the presentation of a winding up petition to collect debt during this period a step only for the most courageous creditor and even include provisions to “unwind” legitimately made winding up orders made after 27 April 2020 and potentially to order the petitioning creditor to pay costs.
The Insolvency Service statistics for May 2020 show an overall 30% reduction in corporate insolvencies compared to last May partly driven by an 88% reduction in compulsory liquidation. This suggests that a significant number of businesses which would have failed regardless of COVID-19 are not being put out of their misery and this could continue until the autumn.
There are also a number of permanent changes to insolvency law being:
- the creation of a new moratorium,
- provisions relating to restructuring and
- provisions which will prevent suppliers from terminating contracts due to a customer becoming insolvent.
The idea behind the moratorium is to facilitate the rescue of a company as a going concern. It was initially thought that Administration would serve this purpose but this hasn’t been the case with the overwhelming majority of administrations resulting in a sale of the company’s business and assets with a view to a better outcome for creditors with the company ultimately being liquidated or dissolved.
The directors remain in control of the company during the moratorium albeit subject to the oversight of a monitor (who must be an Insolvency Practitioner).
Other than during the COVID-19 period it will not be available to a company which is (or has in the prior 12 months been) in an insolvency procedure. It will not be available without court order if the company has had the benefit of a moratorium (e.g. on filing a notice of intention to appoint) or has a winding up petition issued against it.
Directors will be able to obtain an immediate 20 business days moratorium giving a payment holiday from most debts.
It commences when certain documents are filed at court by the company and the Monitor including a statement by the company that the company is or is likely to become unable to pay its debts and from the Monitor that it is “likely that” the moratorium will result in the rescue of the company as a going concern. This could be via a refinance, a CVA or a restructuring ( including via the “new” Restructuring Plan) but there is no requirement to specify how the company will be rescued.
The directors of the company do not have to give notice to or obtain the consent of secured creditors prior to filing.
The payment holiday does not extend to “moratorium debts” which include the Monitor’s remuneration, the cost of goods and services supplied during the moratorium, rent for the moratorium period, wages and redundancy payments (not limited to the moratorium period) and sums due under contracts for financial services ( which means that the company will have to continue to pay capital and interest which fall due to lenders).
The company directors can file a second notice and obtain a further 20 business days moratorium (provided that they can certify that moratorium debts have been paid) and it can be extended for up to 12 months with creditor consent or by court order.
The Monitor must bring the moratorium to an end if he no longer considers that the company can be rescued as a going concern.
During the moratorium period:
- Floating charge-holders cannot crystallise their charge or appoint an administrator;
- Neither creditors nor the company can start insolvency proceedings;
- No steps can be taken to enforce security (without consent of the Monitor or court) or repossess hire-purchase goods (without court consent);
- No proceedings or other legal processes (except certain employment claims) can be commenced or continued without court consent;
- Landlords cannot forfeit leases without court consent;
- The directors can’t grant security over the company’s property or obtain credit of more than £500 (without the Monitor’s consent); and
- Pre-moratorium creditors cannot apply to court to enforce their debt.
Impact on Lenders
The directors can appoint an Insolvency Practitioner as a Monitor and file the documents to obtain a moratorium without notice or consultation with secured creditors.
“Sums due under contracts for financial services” are not subject to the moratorium so lenders will have to be paid capital and interest which is due.
As originally drafted it looked as though lenders could use acceleration provisions to demand repayment of the entire debt which would become due and payable during the moratorium period and if the company could not pay the debt, the moratorium would have to be terminated.
The lender would also get priority status in any subsequent administration or liquidation and could not be compromised in an insolvency within 12 weeks of the moratorium ending effectively giving lenders (a) the power to end the moratorium and (b) improved security for accelerated debt, allowing their floating charge recovery to rank ahead of administration expenses and preferential creditors, for example in a subsequent insolvency.
An amendment was proposed to prevent lenders from accelerating their debt during a moratorium. This was not accepted so lenders can still accelerate their debt and effectively end the moratorium (as the company would be unlikely to be able to pay the debts due in the moratorium) but they will not be able to terminate or demand payment in full on the basis of a default and claim that the accelerated sums have priority in an insolvency within 12 weeks.
Creditor consent for the purpose of obtaining a 12-month moratorium is from creditors caught by the moratorium. As debts under finance agreements still have to be paid during the moratorium lenders won’t be able to vote on requests for an extension of the moratorium up to 12 months.
There are provisions preventing termination of contracts on insolvency but financial services providers are exempt from these restrictions. They could, therefore, terminate invoice discounting or other facilities.
Where a company enters into administration or liquidation within 12 weeks of the moratorium ending debts that should have been paid during the moratorium will rank ahead of office holders’ expenses, preferential creditors and floating charge distributions.
The ranking of the moratorium debts is that lenders’ debt would rank ahead of the Monitor’s remuneration and expenses, but behind suppliers who are covered by the non-termination provisions and wages.
CVA proposals submitted within 12 weeks of the moratorium ending cannot provide for debts payable during the moratorium to be paid otherwise than in full and any restructuring plan applied for within 12 weeks of the moratorium ending, cannot compromise debts that should have been paid during the moratorium without first obtaining consent of each of these creditors.
What’s in it for the Insolvency Practitioner?
Obviously, they will be able to charge a fee for their services of acting as a Monitor.
Acting as a Monitor could also put them in a position to take an appointment as supervisor of a CVA or as liquidator or administrator if the company cannot be saved as a going concern (although the Monitor doesn’t have the power to apply for a winding up or administration order and, where there is a floating charge holder, they would still need notice/consent from the charge holder to take the appointment as administrator).
But the Monitor is not an agent of the company. He is an officer of the court and his actions can be challenged by creditors, directors or members whose interests have been unfairly harmed (although he can’t be ordered to pay compensation under the Act) but it remains to be seen if there are liabilities elsewhere, for example, based on accusations that the Monitor has acted as a shadow director..
Another new way under the legislation to save a company as a going concern is a Restructuring Plan. A beefed-up version of a scheme of arrangement, the idea behind the plan is that one class of creditors cannot block an arrangement which might benefit everyone else.
There’s quite a lot of detail in the legislation and we have summarised the main points below.
This is available to solvent or insolvent companies where:
- the company has encountered, or is likely to encounter, financial difficulties which are affecting, or will or may affect, its ability to carry on business as a going concern; and
- a compromise or arrangement is proposed between the company and (a) its creditors, or any class of them, or (b) its members, or any class of them, and the purpose is to eliminate, reduce or prevent, or mitigate the effect of any such financial difficulties.
Any creditor or member affected by the plan must be allowed to participate in the process, but those who have no genuine economic interest can be excluded.
A court application is made for permission to convene meetings of classes of creditors (and members, if applicable) at which the court will consider class composition, and in the case of overseas companies, jurisdiction.
If approved by 75% in value of creditors or the appropriate class of creditors, a further application to court for approval of the plan is made and it can be imposed on dissenting creditors. The court will probably adopt a similar approach as when considering whether or not to sanction schemes of arrangement, in satisfying itself that it has jurisdiction and that it is just and equitable to exercise its discretion to approve the plan (including checking that the Restructuring Plan has been voted through in accordance with the legislation & that those voting in favour are representative of those within the class and were not, for example, receiving ancillary benefits for voting in favour).
There are provisions for a “cross class cram down” whereby a class of creditors who voted against the plan can be bound by the vote of another class of creditors as long as the outcome for that class is no worse than it would have been under the likely alternative if the plan were not sanctioned.
Contrast with CVA:
- CVA can’t bind secured creditors,
- In a CVA you need the support of 75% of all unsecured creditors – here there is the possibility of dividing the creditors into classes (e.g., landlords, employees, trade creditors, secured creditors)
- In a CVA you need an IP as supervisor
Restrictions on termination of supply contracts
In what may be seen as a blow to suppliers, the new legislation introduces restrictions on termination of most contracts. Usually contracts for the supply of goods and services contain a termination clause on insolvency automatically terminating the contract or entitling the supplier to terminate it on notice.
The Act prevents these termination clauses from taking effect in order to “help companies trade through a restructuring or insolvency procedure, maximising the opportunities for rescue of the company or the sale of its business as a going concern.”
There are already provisions preventing “essential suppliers” (such as utility, IT/ telecoms companies) from terminating contracts on a company’s insolvency
The new provisions apply to contracts for the supply of most goods and services (including accountants and solicitors!).
The following are exempt:-
- “essential suppliers” (under the existing regime);
- certain financial services; (e.g. lenders); and
- “small suppliers”
The provisions apply to any termination clause in a contract for goods and services, which applies on insolvency and also prevents suppliers from doing “any other thing” (e.g. changing payment terms, making the payment of pre-insolvency debt arrears a condition of continuing supply).
There is no requirement for an office holder to personally guarantee the payment of ongoing charges as with “essential suppliers” under current legislation but there is no prohibition on terminating where another type of termination event has occurred after the start of the insolvency proceedings.
Will these changes make much difference?
This legislation provides extensive changes to corporate insolvency which could aid a company’s survival but could be detrimental to other stakeholders.
On the ground it’s hard to predict the level of take up for the moratorium from SMEs. It’s something which practitioners have been crying out for when proposing CVAs especially since the filing of NOIs in this context has been held to be an abuse of process.
However, the requirement that the directors and the Monitor must confirm that the company can probably be saved as a going concern is likely to put a lot of directors and IPs off using it in other contexts.
The requirement for two court hearings and potentially valuation evidence may well make the Restructuring Plan a relatively cumbersome procedure which is suitable for companies which might otherwise have considered schemes of arrangement. The Insolvency Service envisages only about 50-100 restructuring plans a year.
Query whether there will more than minimal uptake from SMEs given the costs of preparing a restructuring plan, obtaining valuations, making court applications and obtaining creditor approval.
So, like many things at the moment, it’s hard to say with any certainty how popular these changes will be but we watch with interest.
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