Major changes to UK insolvency legislation
This article summaries the key measures set out in the Corporate Governance and Insolvency Bill 2020 introduced into the House of Commons this week.
The Corporate Insolvency and Governance Bill (the “CIGB”) has now been published here. It falls neatly into two parts. Firstly, temporary measures intended to deal with specific issues arising from the Coronavirus pandemic. Secondly, permanent changes which were trailed during consultations carried out in 2016 and 2018, but never implemented. These permanent changes are intended to promote corporate rescues and restructurings, and the current economic circumstances have clearly been the catalyst for implementing them now.
Our understanding is that there will be further readings of the Bill but significant changes are not expected. It is therefore anticipated that the Bill will become law in late June/early July 2020.
Below are brief descriptions of each of the measures. We remain sceptical as to the genuine benefits to be gained from the implementation of both the temporary and the permanent measures.
Temporary measures
Relaxation of liability for wrongful trading
Wrongful trading is a potential personal liability for directors who allow their companies to trade on and incur liabilities, without taking steps to minimise loss for creditors, when they know or should have known that the company had no reasonable prospect of avoiding insolvency.
In order to address the government’s concern that this potential liability may force directors to file for insolvency rather than take the risk of trading out of their current financial difficulties, thus potentially forcing otherwise viable businesses to close, CIGB relaxes the wrongful trading provisions with retrospective effect from 01 March 2020 to 30 June 2020 or, if later, one month after the coming into force of the CIGB. In particular, it is said that the Court will assume that a director is not responsible for any worsening of the company’s financial position during the relevant period.
Leaving aside the wisdom of encouraging directors to continue to incur debts they may not be able to pay, we (along with others) doubt that this on its own will protect directors from future claims. Directors of financially stressed companies also face potential liability for misfeasance (if they have breached their fiduciary and other duties). The facts that give rise to liability for wrongful trading can also give rise to liability for misfeasance. So liquidators and administrators may still bring claims against directors for their conduct during the relevant period – just on a different legal basis.
There is no proposal to suspend or relax misfeasance claims (or for that matter any other claims which arise from a breach of director’s duties beyond the scope of this note). Indeed this would be difficult in the case of misfeasance; it covers a much wider spread of potential wrongdoing, some deliberate, and so would be difficult to justify.
Statutory demands, winding up petitions and winding up orders
Winding up petitions and winding up orders made between 27 April and 30 June 2020 will be void unless a petitioner can show that coronavirus has not had a financial effect on the company, or, even if it has that the relevant ground for winding up would have been satisfied anyway. The Courts have already indicated that detailed evidence will be required to demonstrate this and, in practice, that evidence is likely to be easier for the Company (who has the knowledge) to rebut that for the petitioner (who may be a stranger to the Company) to demonstrate.
Statutory demands also cannot be relied upon as the basis for a winding up petition to the extent that they were served between 1 March and 30 June 2020.
If the Court has granted a winding up order after 27 April 2020 and has not considered the effect of coronavirus on the company’s position (which seems unlikely), the winding up order may now be revisited and potentially unwound.
AGMs and other meetings
Company meetings will now be allowed to take place by other means, even where a company’s constitution requires a physical meeting.
Filing requirements
The Secretary of State will be able to extend the deadline for filing documents at Companies House.
Permanent measures
Company moratorium
This will create a short moratorium restricting the commencement of insolvency proceedings and legal action for businesses for an initial period of 20 business day (but which may be extended further (a) by the directors filing certain notices at Court towards the end of the initial 20 business day period or (b) after the initial period, with the consent of creditors or permission of the Court).
Eligible companies will qualify for the moratorium if, in the director’s view, the company is, or is likely to become unable to pay its debts. The company must also be capable of rescue, as the proposed Monitor (an insolvency practitioner who will have oversight of the moratorium) will need to confirm that, in their view, it is likely that a moratorium would result in the rescue of the company as a going concern. This is a change from the original proposal – as it was thought that the moratorium would apply as a type of pre-insolvency process and that companies would need to be solvent to qualify.
The moratorium will prevent creditors from taking action, including enforcing security other than certain types of financial collateral (without the Court’s permission). It will also prevent the commencement or continuation of legal proceedings (unless they are employment claims or the permission of the Court is obtained).
Companies subject to the moratorium will also benefit from the ban on ipso facto clauses (unless one of the exclusions apply, such as when the company agrees that the supplier can still terminate the contract or where the Court grants permission). Lenders will however be able refuse to advance further loans and will be able to withdraw overdraft facilities. Companies will therefore need to be able to generate positive cashflow and operate bank accounts in credit. Furthermore, companies subject to the moratorium must not obtain credit of more than £500 without first informing the provider that a moratorium is in force. Similarly, the Monitor’s consent will be required for any fresh security granted during the moratorium period. The moratorium will not be available for most financial services firms.
Suspension of ipso facto (termination) clauses in contracts
So called ipso facto clauses are provisions in contracts which allow a contract to be terminated because the counterparty has entered an insolvency process. These types of clause are to be banned (as they are in a number of other jurisdictions, including the US), to try and stop suppliers of goods or services to businesses from jeopardising a corporate rescue. There were already provisions in the Insolvency Act 1986 banning ipso facto clauses in contracts dated after 1 October 2015 and in relation to suppliers who were defined as “essential”. Now, all suppliers (subject to some exclusions) will not be able to terminate on grounds of insolvency or in relation to breaches of contract which arose prior to the insolvency. However there appears to be no prohibition on terminating contracts for breaches of contract which occur post insolvency. Thus a failure to make contractual payments during the insolvency will give rise to a right to terminate. There are only limited safeguards to protect suppliers who continue to supply insolvent businesses, the main one being an application to court on grounds of hardship to the supplier.
There is a temporary (until 30 June) exemption for suppliers who qualify as small entities and meet 2 of 3 criteria – being turnover of less than £10.2m, balance sheet assets of less than £5.1m or less than 50 employees.
There are a much wider set of exemptions to the prohibition contained in schedule 12. These are defined in 2 ways. Firstly by entity. If the supplier or the recipient of the services or goods falls into a defined list of entities which includes banks, insurers, electronic money institutions, investment banks and others. Secondly by the nature of the contract. These are contracts mainly of a “financial” nature, and the definitions are widely drafted. They include loans, finance leases, commodities contracts, futures contracts, swaps, derivatives, capital market arrangements, public private partnerships and set off and netting arrangements. Because of the wide definitions used, careful scrutiny of the exemptions will be essential.
Once the bill becomes law these provisions will apply to existing as well as new contracts.
Restructuring plan
The bill also amends the Companies Act 2006 to introduce a new restructuring scheme of arrangement.
The new Part 26A restructuring scheme is based substantially on the existing scheme of arrangement under Part 26 of the Companies Act 2006 and it is anticipated that the extremely well-developed case law on the operation of Part 26 schemes will apply by analogy.
The new Part 26A scheme is available to a company which meets two conditions:
- The company has encountered, or is likely to encounter, financial difficulties that 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 its creditors (or any class of them) or its members (or any class of them) and the purpose of the compromise or arrangement is to eliminate, reduce or prevent, or mitigate the effect of, any of the financial difficulties.
The principle advantage that the Part 26A scheme offers over a Part 26 scheme is the opportunity to cram down a dissenting class of creditors or members.
Under a Part 26 scheme, creditors can cram down the dissenting members of their class, provided that at least 75% in value and 50% in number of the members of that class that are present and voting approve the scheme. However, each class of creditors must approve the scheme and if a single creditor dissents, the scheme will fail.
In the new Part 26A scheme, a Court may still sanction the scheme for approval provided that the following two conditions are met:
- Condition A: the Court is satisfied that none of the members of the dissenting class would be any worse off than they would be in the event of the “relevant alternative” i.e. whatever the court considers would be most likely to occur in relation to the company if the compromise or arrangement were not sanctioned; and
- Condition B: the compromise has been agreed by at least 75% in value present or voting of a class “who would receive a payment, or have a genuine economic interest in the company, in the event of the relevant alternative”.
It is important to note that there is no requirement that the class approving the scheme be impaired, nor is there any requirement for the equivalent of the absolute priority rule in US Chapter 11 proceedings, which requires a more senior dissenting class to have their liabilities repaid in full before any distribution is made to a more junior class of creditors. This may potentially open the door to junior creditors to potentially “cram up” and impose restructurings on a more senior class, where it can be demonstrated that the senior class remains better off than would be the case under the “relevant alternative”. This also opens the door to potential future disputes on valuation and what the correct “relevant alternative” should be.
It should also be noted that the numerosity test applying to Part 26 schemes does not apply to Part 26A schemes. Class votes are by value only, meaning that one party that holds more than 75% in value of the instruments in a particular class would be able to carry the class on their own.
Whilst it is helpful to have an extra option available to assist with workouts, it will remain to be seen how much take-up there will be of the new procedure in the short term. In deciding how to proceed, a company will need to weigh up whether the benefits of the cross-class cram down will outweigh the certainty of deliverability that comes with the use of the more established Part 26 scheme, despite its limitations.
For further information please contact one of our core team.
