Khai Nguyen (EUME) King & Wood Mallesons
In an effort to alleviate the impact of COVID-19 on UK businesses and encourage the supply of essential goods and services during the pandemic, the UK Government announced plans earlier this year to temporarily suspend wrongful trading laws and to fast track proposed permanent reforms to the existing insolvency regime (these reforms were developed in 2016 and consulted on in 2018).
The details of the reforms have been widely anticipated and have now been published in the Corporate Insolvency and Governance Bill (the ‘Bill’). The Bill was tabled in parliament on 20 May 2020 and is due to be debated for the first time in the House of Commons on 3 June 2020. If passed, it will provide cash-strapped businesses with much needed breathing space to help them avoid insolvency.
The measures proposed under the Bill are not only intended to soften the blow to the UK economy during the pandemic but also represents a long-term shift towards a more debtor-friendly insolvency regime. Notably, the Bill includes wide-ranging exclusions relating to a significant portion of the financial sector (including a wide range of financial arrangements) from the reforms other than the new restructuring regime, described in detail below.
1. Suspension of wrongful trading laws
Liability for wrongful trading under the Insolvency Act 1986 will be temporarily suspended with retrospective application from 1 March 2020. Whilst this relief will be welcomed by company directors, it is worth noting that directors are still obliged to comply with other duties and obligations, including the duty to act in the best interests of the company’s creditors if the company is insolvent or is likely to become insolvent. Additionally, directors remain exposed to personal liability for fraudulent trading.
Excluded companies: Directors of certain types of companies will not be able to benefit from suspension of wrongful trading liabilities (including certain regulated firms including insurers, banks, investment banks, investment firms, payment service providers, exchanges, clearing houses, and other entities such as securitisation companies, participants in certain capital market arrangements with debt value equal to or exceeding £10M, and public-private partnership project companies).
Tips for creditors: Creditors should continue to exercise diligence when entering into transactions with distressed businesses (including when negotiating amendments, waivers and rescue plans). Creditors should require companies to demonstrate that key decision makers within the business have given due consideration to all relevant factors and have obtained all necessary approvals when making key decisions on behalf of the business, and that these considerations and approvals are properly documented. This reduces the risk that payments and transactions will be “clawed back” or voided if the company later becomes insolvent.
2. Relief from statutory demands and winding up orders
Another temporary COVID-19 related measure being proposed is a restriction on the petitioning and making of a winding up order against a company based solely on a statutory demand served between the period commencing 1 March 2020 and ending 30 days after the enactment of the legislation. Winding up orders made during this period will be deemed void unless the creditor can show that the order would have nevertheless been made under the amended laws.
Tips for creditors: Notwithstanding the above, creditors may still file a winding up petition on the basis of cash flow or balance sheet insolvency, although this avenue presents significant evidentiary barriers for the creditor, who must gather sufficient reliable financial information about the relevant company in order to demonstrate that it had reasonable grounds for believing that either:
· COVID-19 has not had a financial effect on the company; or
· the company would have been insolvent even if COVID-19 had not had a financial effect on the company.
3. “Ipso facto” reform
The Bill introduces limitations on the ability of suppliers of goods and services to terminate, cease supply under, or vary their contracts solely on the ground that the counterparty (the recipient of the goods or services) has entered into an insolvency related event (“ipso facto clause”). This amendment extends existing protections available under the Insolvency Act 1986 which are limited to suppliers of essential services such as water, gas and electricity. Similar “ipso facto” reforms have been seen internationally, particularly in jurisdictions with strong debtor protections.
Under the proposal, ipso facto clauses will no longer be enforceable, meaning that if the contract counterparty becomes insolvent (or is subject to an insolvency procedure or related process including a moratorium), suppliers are prohibited from exercising any contractual right to cease supply, terminate the contract and otherwise take steps to enforce against the company.
Tips for creditors: These measures do not impact the supplier’s rights if the counterparty defaults in another manner (for example failure to make certain payments or provide notices). Set off and netting arrangements (as defined in section 48(1)(c) and (d) of the Banking Act 2009) are likewise not affected. The intention of the reform is to ensure that distressed debtors who can otherwise maintain their contractual obligations may maximise business continuity and be given a genuine opportunity to consider rescue arrangements.
The proposed measures apply to existing and new contracts, although a temporary exclusion for small businesses will be available for one month from the date the reforms come into force. In some cases, suppliers may seek permission to terminate a contract if they can demonstrate that continued performance under the contract will cause the supplier hardship. Suppliers are not obliged to renew a contract which has expired.
Excluded companies and financial arrangements: certain types of companies and suppliers are excluded from the ipso facto reforms (including insurers, banks, investment banks, investment firms, payment service providers, exchanges, clearing houses and securitisation companies). Additionally, certain contracts and other instruments involving financial services (including certain capital market arrangements, loans, financial leases, guarantees, securities contracts, trade commodities contracts and public-private partnership project contracts) are also not subject to the ipso facto restrictions.
Tips for creditors: Creditors whose arrangements are exempt from the “ipso facto” reform should remain cognisant of the indirect impact of these changes on their portfolios and counterparties, particularly the level of indirect exposure to counterparties who will likely be caught by these changes. Additional safeguards from a credit and legal perspective may include revisiting the pre-funding credit approval and due diligence process, enhancing informational covenants to improve the creditor’s ability to monitor and pre-empt areas of concentrated risk, “ring-fencing” transactions appropriately to promote bankruptcy remoteness and requiring debtors to update their insurance arrangements, particularly in situations where debts are secured primarily over the supplier’s supply contracts, or where a debtor’s repayment capability is highly correlated with cashflow under contracts for supply of goods and services.
4. New standalone moratorium regime
The Government has introduced the ability for cash strapped businesses to apply for a new kind of moratorium. The moratorium will last for an initial period of 20 business days and may be extended on application for a further 20 business days. Any additional extension thereafter can only be obtained with the consent of the majority creditors or with the permission of the court.
Excluded companies: Certain types of companies will not be able to benefit from this standalone moratorium regime (for example, certain regulated firms including insurers, banks, investment bank, investment firms, payment service providers, exchanges, clearing houses, and other entities such as securitisation companies, participants in certain capital market arrangements with debt value equal to or exceeding £10M, and public-private partnership project companies).
This moratorium will not override the provisions of the The International Interests in Aircraft Equipment (Cape Town Convention) Regulations 2015 relating to any interest in an aircraft registered on the International Registry, meaning that creditors who have registered their interest in such aircraft will remain unaffected by changes to the insolvency regimes to the extent of any interest so-registered.
If a moratorium is granted, the company will benefit from a “payment holiday” (unless the debt or liability arises from a “contract or other instrument involving financial services”, including certain capital market arrangements, loans, financial leases, guarantees, securities contracts and trade commodities contracts). Creditor enforcement will be suspended for the duration of the moratorium including the creditor’s ability to enforce any security granted by the company or to initiate legal proceedings. The moratorium also prevents a creditor from taking action to crystallise any floating charge it holds or to restrict disposal of property by the company, remedies which would have otherwise been available to creditors. During the moratorium, landlords and mortgagees are also specifically prevented from exercising their right of forfeiture by peaceable re-entry, without court permission.
Tips for creditors: The moratorium does not prevent a creditor from declaring a default, exercising its right to accelerate a debt or making a demand for payment. It also does not prevent a creditor from exercising security over financial collateral, including security granted over shares of the company.
For companies that are not yet subject to a winding-up petition, an application for a moratorium needs to be filed at court (a simple process akin to the current process for filing an out-of-court administration application) and the directors of the company must confirm that the company is, or is likely to become, unable to pay its debts. Foreign registered companies may also be granted a moratorium if the court determines that granting a moratorium will likely produce a better result for the creditors “as a whole”.
Specific court permission will be required if a company wishes to apply for a moratorium whilst a winding up application against the company remains outstanding, or if that company was subject to an insolvency procedure within the past 12 months.
During the moratorium, directors remain largely in control of the company’s operations, however creditors will derive some comfort from the requirement that the company’s operations will be subject to oversight by a court appointed “monitor” (who must be a licensed insolvency practitioner). At the inception of the application process, the monitor must confirm whether, in its view, a moratorium will likely result in the rescue of the company as a going concern. The company’s continued compliance with the qualifying conditions will also be monitored throughout the period of the moratorium. Monitors are required to act independently and impartially when performing their duties and certain dealings during the moratorium can only be entered into with the monitor’s prior consent, for example if the company wishes to grant any new security or dispose of its property. Creditors should note, however, that contravention of such restrictions does not necessarily render the transaction void or unenforceable.
Details of the moratorium must be published on the company’s website and a notice must be prominently displayed on at the company’s premises. A moratorium will need to be registered at Companies House and notice will need to be given to every creditor of the company (that the monitor is aware of).
It is envisaged that in practice, some level of consultation with key stakeholders including creditors will be entered into before the monitor can make a determination of whether the company has satisfied all qualifying conditions. Importantly the above described regime is designed to encourage companies and their stakeholders to genuinely consider alternative methods of restructuring and rescuing the business in the long run.
5. New restructuring regime for distressed companies and cross-class creditor cram down
To encourage effective debt restructuring and support rescue finance, the Government has introduced a separate ability of a company to enter into a restructuring plan in addition to the existing routes for entering into a CVA or scheme of arrangement.
The Bill does not provide for any particular types of entities to be excluded from the restructuring regime, although future regulations may introduce exclusions in the future.
Under the proposed laws, a distressed company, its creditors or shareholders will be able to propose a restructuring plan with the company’s creditors if the company has, 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. The restructuring plan must be a compromise or arrangement with the purpose of eliminating, reducing, preventing or mitigating the effect of financial difficulties. It is anticipated that the restructuring plan will be a flexible tool with a wide range of potential applications. A plan can include debt write-down or debt postponement as well as other matters such as a change in the management team or selling off loss-making parts of the company. It can also have potential cross border restructuring application.
Unlike company voluntary arrangements and schemes of arrangement under the existing insolvency regime, the key (and somewhat controversial) aspect of this proposal is the inclusion of a cross-class cram down provision. Under the cram down provision, dissenting classes of creditors would be bound to a restructuring plan sanctioned by the court if at least 75% of creditors (in value) consent to the plan. However, dissenting creditors can be reassured that cram down will only be approved by the court if the dissenting creditors will not be in a worse off position than they would have been in if the restructuring had not been approved by the court and the compromise has been agreed by at least 75% of the creditors who would have received a payment or otherwise would have a genuine economic interest in the company if the restructuring had not been approved by the court.
It is envisaged that the new restructuring vehicle will be complemented by the new standalone moratorium discussed above, together designed to buy companies additional time to prepare acceptable proposals to its creditors. This alleviates the need for companies to rely on judicial discretion for similar protection (as under a scheme of arrangement).
King & Wood Mallesons’ Banking & Finance team are available to discuss your queries on all areas of finance and financial markets law, please contact Khai Nguyen in our London office.