New Measures Designed to Aid Companies in Financial Distress

As the UK economy heads towards what is likely to be the worst recession in living memory, Simon Gerrard, Head of Insolvency at Prosperity Law LLP, provides an update on a new package of measures that are designed to aid companies in financial distress.

An update on the Corporate Insolvency and Governance Bill

Yesterday, the House of Commons went through the second reading of the Corporate Insolvency and Governance Bill, which represents potentially the most significant change to the insolvency industry for at least 20 years.

Since the start of lockdown, one-fifth of businesses have ceased trading and entered into a ‘holding pattern’, with a quarter of all businesses reporting a 50% reduction in trade. These are stark and alarming statistics.

The Bill encompasses permanent and temporary measures to give businesses breathing room in the impending financial crisis, as well as fast-tracking innovations within the industry that have been on the table for the past couple of years. There is a resigned acceptance from the Government that it cannot save all businesses – but what this Bill aims to do is to give businesses a fighting chance.

The key measures in the Bill are summarised below.

Temporary measures

Statutory demands and winding-up petitions

The Bill introduces temporary restrictions on creditors from presenting statutory demands and winding-up petitions against companies where the debt is unpaid due to the effects of COVID-19. The restrictions will have retrospective effect – a winding-up petition cannot be presented by a creditor during the period 27 April 2020 until 30 June 2020 (or one month after the Bill coming into force, whichever is the later) unless the creditor has reasonable grounds for believing that:

1. COVID-19 has not had an effect on the debtor; or
2. The debtor would have been unable to pay its debts even if COVID-19 had not had a financial effect on the debtor.

The evidentiary burden of proof regarding (a) & (b) above will be on the creditor. Unless the test for establishing the threshold of “financial effect” is clarified as the Bill moves towards royal assent, there will undoubtedly be confusion within the industry as to exactly how this provision ought to be applied – leaving it to the industry and the courts to interpret its meaning.

There has been reasonable debate as to whether the (short) longstop date of 30 June 2020 (or one month after coming into force) is sufficient time for the measure to have any meaningful effect. There has been debate as to whether the longstop date ought to be extended until the end of September 2020 (a move that was endorsed by Ed Miliband during yesterday’s House of Commons debate), but the Government appears to be leaning towards building into the Bill the flexibility to extend the longstop date by way of Statutory Instrument.

The prohibition on the presentation of statutory demands and winding-up petitions has been criticised as undermining the market by limiting the rights of creditors to recover debts, which could lead to an increased reluctance on the part of lenders to offer much needed financial support.

One feature of the new measures creates a potentially problematic situation whereby companies that have already been wound-up by the court during the prohibited period may be brought back to life by the winding-up order being declared void.

Significantly, it ought to be noted that the Bill does not encompass reciprocal protection against the presentation of statutory demands against individuals or bankruptcy petitions.

Suspension of wrongful trading

The Bill proposes to suspend the wrongful trading provisions under the Insolvency Act 1986, which would otherwise impose personal liability on directors of insolvent companies that continue to trade the company beyond the time when there is no reasonable prospect of the company avoiding insolvency.

The suspension will have retrospective effect from 1 March 2020 to 30 June 2020 (although debate continues over an extension to the longstop date). As a result, liquidators and administrators will be prohibited from pursuing wrongful trading claims against company directors for breaches of the wrongful trading provision during the period of suspension.

This measure has been lauded as creating a protective bubble to directors to continue trading through the COVID-19 crisis. Crucially, however, the directors’ fiduciary duties (including such duties owed to creditors) will continue during the period of suspension, and we believe that this provision is unlikely to be as effective in practice as it is intended.

Permanent measures

Company moratorium

A permanent feature of the Bill is the introduction of a new ‘moratorium’ regime, which applies some of the attractive features of administration to allow a viable business that is likely to become insolvent a 20 business day moratorium to restructure or seek new investment free from creditor action (with the possibility for further extension). This moratorium is available to all businesses with limited exceptions.

In order to obtain the protection of the moratorium, the director(s) of the business will need to make a statement that the company is, or is likely to become, unable to pay its debts as they fall due. The moratorium will be supervised by a ‘monitor’, who must be a licensed insolvency practitioner.

The role of the monitor will be limited to ensuring that the company complies with the moratorium requirements and approves the sale of assets outside the normal course of business, as well as approving any grant of new security. Significantly, the directors will remain in charge of running the business.

New restructuring plans

The Bill introduces a new restructuring mechanism, which is designed on the existing Scheme of Arrangement procedure.

A novel feature of this new scheme will allow the court to sanction a plan that binds dissenting classes of creditors and members, provided they are no worse off than the alternative scenario (which, in many cases, will be the liquidation of the company). This process has been ascribed the curious name of ‘cross-class cram-down’. By implementing the cross-class cram-down, this new restructuring plan is intended to make it easier for companies to reach compromises with its creditors without needing to resort to the use of other restructuring procedures, such as pre-pack administrations.

Supplier termination clauses

Suppliers of goods and services will no longer be able to terminate a contract when a company enters into an insolvency procedure. As a result, companies will be able to preserve their supply contracts in order to aid a rescue plan.

The measure does, however, contain safeguards for suppliers to ensure that continued supplies are paid for, and there is a provision to apply to the court to terminate the contract on the grounds of hardship. Suppliers can still terminate contracts on grounds other than a company entering into an insolvency process.

Conclusion

Necessity is the mother of all invention. This latest innovation in the insolvency industry will introduce a package of new measures that have been in the pipeline for some time, and some that are targeted at mitigating what is shaping up to be the worst recession in living memory.

In addition to the new measures set out above, there have been calls for reform to the governance of the insolvency sector, and it remains to be seen as to whether these new measures and the current climate proves to be a catalyst for further change in the industry.

Our view is that the measures are, at least in principle, sensible and ought to provide a degree of breathing space to businesses; however, we cannot help but feel that there is a risk of the measures being rushed through without sufficient consideration for how they might work in practice.

Ultimately, the devil will be in the detail and we wait to see what shape the Bill takes as and when it is given royal assent.

For legal advice on any insolvency related issue, please contact Simon Gerrard at [email protected]