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Corporate recovery, restructuring & insolvency
This is the second of two articles considering the corporate insolvency aspects of the Corporate Insolvency & Governance Act 2020 (the Act). In the first article, we looked at the temporary measures introduced by the Act in response to the Covid-19 crisis. This second article explains the permanent reforms of insolvency law provided for in the Act. These changes came into effect on 26 June 2020.
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13 July 2020
This is the second of two articles considering the corporate insolvency aspects of the Corporate Insolvency & Governance Act 2020 (the Act). In the first article, we looked at the temporary measures introduced by the Act in response to the Covid-19 crisis and this second article explains the permanent reforms of insolvency law provided for in the Act. These changes came into effect on 26 June 2020.
The background to the Act is the Government’s expressed intention for the last few years to move the UK insolvency regime more towards US Chapter 11 bankruptcy. Principles known to Chapter 11 have therefore been introduced by the Act – debtor in possession, the cramming down of dissenting creditors on a restructuring and the banning of termination clauses on insolvency. However, any temptation to generalise should be resisted for the following two reasons: first, the Chapter 11 process has not been transferred wholesale into UK law and major differences remain between UK and US insolvency regimes; and second, the speed with which the Act passed through Parliament in order to be ready to deal with the expected influx of corporate insolvencies resulting from the pandemic means that these reforms have not been subject to the usual levels of scrutiny and debate with the result that many questions remain as to how these changes will operate in practice.
The Act introduces a new moratorium procedure, during which a company with financial difficulties can benefit from a range of provisions – certain pre-moratorium debts are subject to a payment holiday, no legal action can be taken against it without leave of the court, and restrictions are placed on insolvency proceedings. The most significant change, however, is that the directors are left in charge of running the company, albeit subject to the supervision of an insolvency practitioner acting as Monitor.
The payment holiday is only available in respect of certain pre-moratorium debts; excluded categories include payments in respect of wages, redundancies, rent during the moratorium and goods or services supplied during the moratorium. Debts or other liability arising under an instrument involving financial services (such as a loan agreement) are also excluded.
The directors may file for a moratorium out of court if they can show the company is, or is likely to become, unable to pay its debts. The Monitor must also file a statement that the moratorium is likely to result in the rescue of the company as a going concern. If at any point during the moratorium, the Monitor takes the view that rescue of the company is no longer likely, the moratorium will end.
Not every company is eligible to obtain a moratorium. The Act excludes certain types of companies from obtaining a moratorium, including those that have been subject to certain insolvency procedures in the previous 12 months, certain financial services providers, and parties to capital market arrangements. Certain regulated companies holding money for clients are also excluded.
The initial period of the moratorium is 20 business days. This may be extended for a further 20 business days provided that the Monitor confirms that it is still likely to result in the rescue of the company. An extension also requires the company to be able to pay all the moratorium debts that fall due and the pre-moratorium debts that do not benefit from a payment holiday. Further extensions of up to a year in total are allowed if they are supported by majorities in value of secured and unsecured creditors.
Questions remain as to how likely companies will be able to use the moratorium without also having to go into administration. If it is not very often used as a free-standing procedure, the move to debtor in possession may be more illusory than real. In addition, the exact role of the Monitor remains unclear, in particular the amount of supervision which will be required of them.
The Act also introduces a new restructuring plan for companies in financial difficulty, inserting a new Part 26A into the Companies Act 2006 (Arrangements and Reconstructions for Companies in Financial Difficulties). The new procedure is similar to the existing scheme of arrangement but is marked out by the new provisions allowing for classes of creditors to be crammed down.
The threshold for directors proposing a restructuring is relatively low. They only have to show that the company is in financial difficulties which affect, or are likely to affect, its ability to continue as a going concern. A majority of 75% in value of classes of creditors is sufficient – there is no additional requirement for a majority in number – and the plan may be sanctioned by the court even where only one class has voted in favour of it, provided it can be shown that the dissenting classes of creditors will be no worse off than if the next best alternative were to occur. This therefore gives the directors an incentive to constitute classes in a way which ensures that at least one of them will provide the necessary majority. It also raises the prospect that the courts may be involved in more disputes valuing the assets of the company in order to determine whether particular classes of creditors would be better off in an administration or liquidation than under the restructuring.
Restrictions on the exercise of termination clauses on insolvency
Contracts for the supply of goods and services commonly provide for the termination of the contract or supply, or amendment to payment terms, if the other party enters into an insolvency procedure. The exercise of such clauses, often by the supplier, can exacerbate the debtor’s financial difficulties by disrupting supply chains or imposing onerous payment terms. Under the Act, however, such termination clauses will cease to have effect where a company enters into a relevant insolvency procedure, including administration or liquidation, or when a company becomes subject to a restructuring plan or moratorium. Moreover, a right to terminate that has arisen prior to an insolvency, but has not been exercised, will be suspended on the company entering into the insolvency procedure.
There are some exceptions to this provision, including the exclusion of small suppliers (until 30 September 2020) or where the court is satisfied that refusing to grant permission to terminate the supply or contract would cause the supplier hardship. It also does not affect clauses under which the supplier is entitled to terminate for non-payment. It will therefore be of limited use where the purchaser is unable to keep up with payments under the supply contract, as may be the case for many companies subject to an insolvency procedure.
This restriction will have significant impact on suppliers, and the knock-on effect may be that, where the right to terminate arises prior to insolvency, suppliers opt to exercise this right earlier in order to avoid being locked into supplying an entity who become subject to an insolvency procedure. During contractual negotiations, suppliers may also push for more widely drafted termination clauses and may demand that security or other protection be provided.
13 July 2020
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Partner - Head of Dispute Resolution Services