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Impact of the Corporate Insolvency Changes
The Corporate Insolvency and Governance Act 2020 (CIGA) came into force on 26 June 2020 and introduced some permanent reforms to corporate insolvency law together with some temporary provisions required as a result of COVID-19.
The reforms have been described as “the most significant change in English insolvency laws for commercial lawyers in a generation”.
We will focus on the impact of the new legislation on invoice financiers both in terms of their relationships with clients and in enforcing debts against clients’ debtors.
We will firstly examine the permanent changes before reviewing the temporary changes and ending with some thoughts on the overall effect of the reforms on the invoice finance sector.
A. Permanent Changes
CIGA introduces two new additional insolvency procedures and in addition for the first time imposes restrictions on the termination of supply contracts during the corporate insolvency process.
1 Moratorium
The new moratorium is available to directors of an eligible company which is either insolvent or prospectively insolvent.
The moratorium is started by lodging documents at court for the appointment of a monitor, who must be an insolvency practitioner.
In the long term a moratorium will not be available for companies which have, in the previous 12 months, entered into a moratorium, administration, or company’s voluntary arrangement (CVA), or are subject to a winding-up order, but due to the pandemic these provisions will not come into effect until 30 March 2021 at the earliest.
The moratorium initially lasts 20 business days (30 for small businesses) subject to extension by the directors (up to 40 days) or creditors (up to 12 months) or the court after that. It must also end if the company goes into administration or liquidation. It will continue while a CVA proposal is put in place. The monitor will bring it to an end earlier once the objective has been met or importantly if the monitor considers the objective can no longer be met.
Once in place the moratorium gives the company a payment holiday for pre-moratorium debts that have fallen due either before or during the moratorium period unless the debts fall within an exclusion.
Certain key payments are excluded from this payment holiday during the moratorium, including the monitor’s remuneration, payments for goods or services, wages, redundancy payments and rent during the moratorium. Most importantly for invoice financiers, there is an exclusion for debts or other liabilities arising under “a contract or instrument for financial services.” This is defined in the legislation so as to include “lending (including the factoring and financing of commercial transactions)”.
Therefore a client’s obligations to an invoice financier will still need to be paid during the moratorium as well as those debts incurred during the moratorium unless a CVA, scheme of arrangement or restructuring plan (as to which see below) is already under way.
In addition to the payment holiday, there is the usual stay on commencing insolvency proceedings, other legal proceedings, repossession and enforcement (like in an administration). This includes a stay on a landlord forfeiting a lease for non-payment and a stay on enforcement of most types of security. None of this can happen during the moratorium without the court’s consent.
The company cannot obtain any credit over £500 without disclosing the fact that the moratorium is in place. It cannot grant security, dispose of property other than in the ordinary course of business or indeed pay any pre-moratorium debts over £5,000 (or 1% of the company’s total unsecured liabilities – whichever greater), without the consent of the monitor or the court. Hire- purchased property and property subject to a security interest may be disposed of during the moratorium, but only with the court’s permission.
2 Restructuring Plan
The second new insolvency process is a Restructuring Plan, which is designed to operate as an alternative to schemes of arrangement, but The Insolvency Service envisages only a total of about 50-100 restructurings a year so they are unlikely to have much impact on invoice financiers (* see reference at end of article). Query whether there will be more than minimal uptake from SMEs given the costs of preparing a restructuring plan, obtaining valuations, making a court application and obtaining creditor approval.
3 Restrictions on Termination of Supply Contracts
The insolvency legislation has for some time contained provisions (s233A) relating to protection of the supply of essential services such as gas, electricity and IT. It has been thought for some time that this protection should be extended more broadly so a new section 233B has been introduced into the Insolvency Act 1986 (“IA”) the effect of which is to prevent a supplier from ceasing to supply a customer simply because the customer has gone into insolvency proceedings.
Section 233B applies:
- Where an entity becomes subject to any of a broad range of insolvency procedures (all the collective corporate insolvency procedures under the IA 1986 as well as the 2 new procedures);
- To all contracts for the supply of goods and (non-financial) services (and not just essential supplies).
However, it is important to note that:
(1) as in the case of moratorium debts, there is an exemption for supplies of financial services which is again defined so as to include “the factoring and financing of commercial transactions,” so these restrictions on termination of supply contracts do not apply to invoice financiers in their relationships with their clients; and
(2) there is also a temporary exemption from section 233B during the pandemic until at least 30 March 2021 in relation to suppliers who qualify as “a small supplier”, defined essentially as having at least two of the following (1) a turnover of no more than £10.2 million (or an average £850K per month if in its first financial year), (2) a balance sheet total of no more than £5.1 million, or (3) no more than 50 employees.
The new protections operate as follows:
(a) Section 233B applies to contracts that are already in force
Unusually the section 233B protections apply to all relevant contracts, regardless of when the contract was entered into, so long as the company has entered into insolvency proceedings on or after 26 June 2020 (the date the CIGA 2020 came into force) (section 14(4) , CIGA 2020).
(b) No termination (of the contract or the supply)
Any provision in a supply contract that provides for automatic termination, or which allows the supplier to terminate, based on the customer going into insolvency proceedings, ceases to have effect (section 233B(3), IA 1986.)
This prevents a supplier from exercising a contractual insolvency termination right and also from relying upon an automatic termination clause.
(c) No doing of any other thing
The protection also prevents a supplier from doing any other thing or allowing any other thing to happen based upon the company going into insolvency proceedings (section 233B(3), IA 1986).
The reference to doing “any other thing” (an active consequence) or any “other thing” taking place (a passive consequence) is deliberately broad and is the same wording used in section 233A.
Examples of what this is likely to encompass include: changing payment terms, increasing the contract’s pricing, changing credit periods, moving the company on to a different payment tariff, allowing for the current tariff to increase or adding a one-off or balloon payment.
(d) No reliance on pre-insolvency events
A supplier will be unable to rely on a contractual provision that would have allowed them to terminate the contract (or the supply) because of an event occurring before the company entered an insolvency process, where the entitlement arose but was not exercised before the commencement of the insolvency proceedings (section 233B(4), IA 1986).
So, for example, where the contract provides that the supplier may terminate for late payment, and the customer fails to pay an invoice on time, section 233B(4) means that it will be too late to rely upon that “past” event once insolvency proceedings have begun. This does not prevent a supplier from exercising any available contractual termination rights in the run up to a company’s insolvency but does prevent them from relying upon an earlier breach once insolvency proceedings have begun.
(e) No demanding that outstanding charges are paid
A supplier cannot make it a condition of continuing to supply that any outstanding payments are paid, or do anything that has this effect (section 233B(7), IA 1986).
This means that a supplier will need to continue supplying good or services, even though the supplier may be owed significant sums of money from before the company went into insolvency proceedings.
It does not mean, however, that the customer does not continue to owe the amounts outstanding under the supply contract. It is just that the supplier cannot make payment a condition of continuing the supply.
B. Temporary Changes
Some temporary changes have also been introduced during the pandemic.
1 Suspension of Directors’ Liability for Wrongful trading
Section 214 of the Insolvency Act 1986 provides that a director can be held personally liable for company debts if the company continues to trade when the director knows (or ought to have known) that there was no reasonable prospect of the company avoiding entering insolvent liquidation/administration.
The government has chosen temporarily to in effect suspend directors’ financial liability for the period between 1 March 2020 and 30 September 2020: if a director is found liable for wrongful trading during this time, when considering the contribution a director is required to make to a company’s debts, the court is entitled to assume that the director was not responsible for worsening the financial position of the company during that period.
The period has now ended and has not been extended.
This suspension does not suspend entirely liability for wrongful trading nor effect a directors’ other legal duties. For example under the 2006 Companies Act, a director has a duty to act in a way that would be most likely to promote the success of the company for the benefit of its members (as a whole). However, where he or she knows, or should know, that the company is, or is likely to become, insolvent, the director becomes duty bound to consider, or act in, the interests of creditors of the company.
Such a duty, in those circumstances, is owed by the director to the company (rather than to creditors), but this could still result in personal exposure on the part of the director in the event of subsequent insolvency.
2 Restrictions on the use of statutory demands and presentation of winding up petitions
CIGA also temporarily suspends the efficacy and potency of statutory demands, and restricts the circumstances in which an insolvent counterparty can be wound up.
The restrictions on serving statutory demands and presenting winding up petitions presently expire on 31 December 2020 with the power to extend beyond that date. They also have retrospective effect – this part of the Act is to be regarded as having come into force on 27 April 2020.
A winding up petition cannot be presented after 27 April 2020 in respect of a statutory demand served between 1 March 2020 and 30 March 2021. Unlike the changes to winding up petitions, the prohibition is absolute and there is no carve out for debtor companies unaffected by coronavirus.
Further, a creditor cannot petition for the winding up of a company on the ground it is insolvent (either on a cash flow or balance sheet basis) unless the new “coronavirus test” is satisfied. This test places an onerous burden on the Petitioning Creditor to demonstrate that it has reasonable grounds for believing that:
(a) coronavirus has not had a financial effect on the company, or
(b) the company would have been insolvent (either on a cash-flow or balance sheet basis) even if coronavirus had not had a “financial effect” on the company.
There is a new insolvency practice direction relating to CIGA which makes significant amendments to the relevant procedure. In particular, petitions will initially be treated as private and should not be advertised until the Court directs.
C. Impact on Invoice Financiers
It is too early to tell what effect these changes will have, particularly during the pandemic and its likely aftermath and there has been much debate even within the insolvency practitioners’ community as to what practical effect is likely to emerge.
From the point of view of invoice financiers it is difficult to see any upside to the changes, but equally a provisional view would suggest that the changes are unlikely to have much lasting significant detriment.
1 Moratoriums
Perhaps the most important point to note is that invoice financiers are not subject to the moratorium provisions in favour of a client, in the sense that sums due under invoice finance agreements are not affected and there is no interference with the financiers ability to terminate agreements or declare defaults.
If the client is unable to meet its obligations the monitor will have to end the moratorium unless the financier agrees to an extension, and once the moratorium is over the financier has its usual remedies albeit that it is restricted from enforcing security or commencing proceedings during the moratorium.
However, because finance debt falls outside the moratorium this means that invoice financiers do not have voting rights so to this extent may lose control over the destiny of a client where for example an extension of the moratorium is sought for up to 12 months.
And of course where a debtor is subject to a moratorium then the financial services exception does not apply and as assignee an invoice financier effectively stands in the shoes of the supplier so is subject to all the protective provisions of the new procedure.
2 Restrictions on Termination of Supply Contracts
Whilst the new restrictions do not directly interfere in the relationship between an invoice financier and its clients, again as assignee invoice financiers need to be aware that clients’ rights against their customers may be significantly diluted by the new provisions and part of the client monitoring process should now pay particular attention to long-term supply contracts which may have negative implications for collectability.
3 Temporary Changes
The temporary changes may have little practical significance for invoice financiers in view of the present financial climate, although the suspension of directors’ liability for wrongful trading is likely to have emboldened some dishonest clients and we predict that the incidence of fraud recovery claims may well increase in parallel with wrongful trading proceedings.
* For more detail on Restructuring Plans, and of the changes in particular from the point of view of Insolvency Practitioners, see the article by our head of insolvency Phil Farrelly at:
https://www.bermans.co.uk/all-change-in-corporate-insolvency/