Major change on the horizon – the Corporate Insolvency & Governance Bill

The most significant change to the UK’s insolvency regime since the Enterprise Act 2002 was introduced by the UK Government on 20 May – the Corporate Insolvency and Governance Bill (Bill).  The changes it contains have, in large part, been some time in the making, have now had first readings in the Commons and in the House of Lords and are likely to be passed into law by the end of June /beginning of July.

The Bill is still a work in progress, as Members of the Lords have proposed potentially important amendments which will be considered at the Committee stage.

This bulletin discusses the permanent measures that are being introduced, together with the temporary steps that have been introduced as a direct response to the Covid-19 pandemic.  These are:-

Permanent measures:

• Moratorium
• Restructuring plan
• Protection of supply

Temporary measures:

• Restriction on use of winding up processes
• Suspension of wrongful trading rules
• Relaxation on meeting rules and filing requirements

We provide in depth detail on each of these below.

Moratorium

The moratorium proposed has come in for some criticism since its recent introduction in the Bill.  This is not least because it seems to apply only to SME businesses and there is uncertainty as to the meaning of some of the wording of the Bill, not least the meaning of the word likely, which we explore further below.

Eligibility

Whilst there are some exemptions at the moment, directed at helping companies during the pandemic, the criteria in order for a moratorium to be permissible are:

• the directors state that the company is, or is likely to become, unable to pay its debts
• the company has not been in an insolvency process within the last 12 months
• A monitor (the Bill provides that a monitor must be a licenced insolvency practitioner – however, one of the Lords’ amendments would allow any qualified accountant to act as a monitor) considers it likely that the company will be rescued as a going concern.

The Bill requires that the monitor believes the company is likely to be rescued, not merely the enterprise or the business it operates, although an amendment in the Lords proposes a much lower bar requiring only that the “company’s business” could be saved by a moratorium.

The exclusion of companies which have been in liquidation, CVA or Administration in the previous 12 months is waived temporarily due to Covid-19.

Certain types of company such as insurance entities, banks, investment banks and institutions in the capital markets, are not eligible to apply for a moratorium.

How to apply for a moratorium

A moratorium is a director-driven process instigated by an out of court application providing there is no winding up petition already presented. If a petition is on foot, a court application is usually necessary but this requirement is temporarily suspended.  A court application is also necessary in relation to companies not registered in England and Wales.

Upon appointment, the monitor must notify all known creditors of his/her role.

The effect of the moratorium on creditors

The moratorium prevents enforcement of certain pre-moratorium debts but some creditors do not have this ‘payment holiday’ imposed upon them:-

a. Debts which are excluded from the moratorium are :-

• The monitor’s remuneration and expenses for the period of the moratorium
• Goods and services supplied during the moratorium
• Wages and salary
• Redundancy payments
• Rent in respect of the period of the moratorium
• Debts or other liabilities relating to financial services – which include payments to lenders.

All other pre-moratorium debts benefit from a payment holiday.

b. There is also a block (unless permission of the court is granted) on legal proceedings including:-

• Enforcement of security
• Crystallisation of floating charges
• Forfeiture of lease
• Re-possession of hire purchase assets.

c. With court approval, it is possible to dispose of secured or hire purchase assets.

Duration

The moratorium is for an initial 20 business days, which is thereafter extendable for a further 20 business days without consent of creditors and also up to a year with the consent of certain pre-moratorium creditors, and for any term by way of court order.

The moratorium is terminated either at the expiry of the time period set out above or if:

• the monitor deems it no longer likely to result in a rescue of the company as a going concern
• rescue has been achieved
• the monitor is no longer able to carry out his/her functions on the back of a failure to co-operate by the directors
• the company enters an insolvency process.

Meaning of ‘likely’ and the risk of abuse

’Likely’ is defined in dictionaries as either probable or more than 50% likely to happen, and accordingly a monitor will want to ensure that, in order to meet this high bar, there has been lots of planning and financial diligence in order for them to get comfortable when putting their reputation and, assuming an IP, their licence on the line.

If the amendments to this section do not survive the Committee stage, this test will deter some insolvency practitioners who would prefer a requirement that there should be ‘reasonable prospects’ rather than ‘likely’. It is inevitable that will lead to a bank of case law which will dictate, with much greater clarity, what is meant by the word ’likely’ in this context.  It is inevitable that moratoria will be followed in some cases by an insolvency process, and when moratorium debts remain unpaid, this creates a risk of abuse. Whilst there are always pockets of insolvency practitioners prepared to abuse the system, it feels inevitable that many will use moratoria as a stepping stone to a CVA which is not the intention of the Bill as drafted.

An important protection against the abuse of moratoria is that moratorium debts or pre-moratorium debts without a payment holiday, that are unpaid during the course of a moratorium, will be given priority in an insolvency occurring within 12 weeks of the end of the moratorium.  It is also worth noting that there is no restriction on the monitor becoming the supervisor of a CVA or administrator in an administration process.

Restrictions on the company during the moratorium

The company:

• Is unable to obtain credit without the proposed creditor being notified of the moratorium.
• Cannot grant security without the monitor’s consent.
• Cannot dispose of property except in the ordinary course of business or with the consent of the monitor (in the absence of a court order).
• Make payment of pre-moratorium debts where a payment holiday exists.
• Enter into a market contract, financial collateral arrangement, transfer order, market charge or system charge, or collateral security.

It is not clear whether moratoria will become commonplace – but for directors, turnaround professionals and insolvency practitioners, it is a welcome additional option. It remains to be seen whether the proposed amendment opening up appointments as monitors to non-insolvency practitioner clients will be implemented.

Suspension of wrongful trading provisions

The proposed suspension was widely applauded when it was announced by the Business Secretary at the end of March and the short provision at section 10 of the Bill does what it says on the tin.

Section 214 of the Insolvency Act 1986 provides that, if a director becomes aware, or ought to have become aware, that there was no reasonable prospect of the company avoiding insolvent liquidation or administration, then they may be ordered to make a contribution to the company’s assets, unless they take every step to minimise the potential loss to the company’s creditors as they ought to have done.

Continued trading without taking such steps (which would typically entail taking appropriate professional advice) is thus ‘wrongful trading’. The liquidator’s remedy in these circumstances is compensatory and intended to put the company in the position it would have been in had it ceased trading at an earlier date or taken the steps that ought to have been taken. Typically the contribution the directors are ordered to make is calculated by reference to the increase in the deficiency to creditors they cause.

Section 10 requires the court to assume the director is not responsible for any deterioration of the company’s financial position which occurred between 1 March and the later of 30 June or one month after the Bill is passed.

Section.10 does not apply to insurance companies, banks, and other financial institutions.

The object of the suspension is to mitigate the threat of personal liability for directors struggling with unprecedented challenges and who may find it very difficult to determine whether their company has a reasonable prospect of avoiding liquidation or administration but are concerned that, in two or three years’ time, a court will have much less difficulty in concluding they should have known a second Covid-19 spike was on the way and their business was therefore doomed. It should help.

Sensible as this provision is, if directors are in any doubt about the survival or long term solvency of their business they should still take professional advice. The Bill does not relax or remove the directors’ potential personal liability for entering into transactions at an undervalue or otherwise breaching the duty they owe to creditors when a company is insolvent or near insolvent. Further, an amendment proposed in the Lords would withdraw the protection from directors who are in breach of their general Companies Act duties. Prudent directors will continue to take advice before taking any significant or unusual steps whilst there is any danger their company will fail.

Remember that this Bill has already had a first reading in the Lords and will be law before we know it, at which point this suspension will have had a very short life.

Statutory demands and winding-up petitions

One of the temporary measures introduced to provide breathing space for companies affected by Covid-19 is the suspension of winding up petitions and issuing of statutory demands. These measures are set out in Clause 8 and Schedule 10 of the Bill.

Paragraph 1 of Schedule 10  stipulates that any statutory demand served during the relevant period (beginning 1 March 2020 and ending one month after the Bill comes into force) is incapable of forming the basis  of  a winding-up petition presented after 27 April 2020.

Paragraphs 2 and 3 of Schedule 10 prohibit a petition from being presented against a company on the grounds that it is unable to pay its debts, unless the petitioner has reasonable grounds to believe that the inability to pay its debts is not the result of Covid-19. You may recall that this policy was announced on 25 April as taking effect from 27 April. This measure applies during the relevant period which is defined as 27 April to midnight on the one-month anniversary of the Bill coming into force. One of the amendments proposed in the Lords is to extend this to 30 September.

Paragraph 4 of Schedule 10 state that, where a petition is presented in the period between the policy taking effect (on 27 April) and before the Bill being enacted and coming into force, and the petitioner did not have reasonable grounds, the court may make an order for the company’s position to be restored to what it would have been if the petition had not been made. This essentially allows the court to undo negative effects of winding-up petitions that are brought under pre-existing law, and the court may also order the petitioner to pay its costs.

Paragraphs 5 and 6 of Schedule 10 stipulates that he court may make an order for winding up of the company if it is satisfied that the grounds which apply would have arisen even if Covid-19 had not had a financial effect on the company.

If a petitioner intends to present a winding up petition against a company during the relevant period, the court will require the petitioner to prove thatCovid-19 has not has not had a financial effect on the company, or the debtor company would have been insolvent even if Covid-19 had not had a financial effect on it.

At present, the Bill does not define the meaning of financial effect so we will need to wait for further guidance/case law on this.

To protect companies from the harm they may suffer as a consequence of an unsuccessful petition in this period, the Bill provides that the court file cannot be inspected by a third party until the court has determined whether it is likely that the company will be wound up or provides permission to do so and suspends the rules on advertising until the court has determined whether it is likely to make a winding up order.

Prohibition of termination clauses

In usual circumstances, when a company is subject to an insolvency procedure, a creditor will often seek to rely on provisions in their contract that allow for the termination of the supply of goods or services and to terminate the contract on the ground of insolvency. This type of clause is known as an ipso facto clause.

The Insolvency Act 1986 (the Act) already restricts the termination of contracts for essential supplies (utilities) in sections 233-233A of the Act, and the Bill introduces a new section 233B which extends this prohibition. Schedule 12 of the Bill prevents suppliers of a much wider range of services terminating their contracts where a company is subject to an insolvency process or enters into a moratorium. The explanatory notes to the Bill confirm that, where a contract for supply of goods and services contains a termination clause or allows for any other thing (such as changing payment terms) to happen, this will cease to have effect.

The measures will apply to any supply contracts that the company enters into, both before and after the new provisions become law, and the restrictions will remain in place throughout the insolvency process.

The measures will apply to suppliers that are:

• All the main incorporated forms
• Mutuals (including co-operatives and community benefit societies)
• Limited liability partnerships
• Other bodies and associations, whether or not incorporated
• Individuals carrying on a trade or business.

The measures will not apply to financial services firms and contracts, public private partnership project companies and utilities, communications and IT service providers already covered by section 233 and 233A of the Act.

The Bill does afford some protection to the suppliers of goods and services. Suppliers must be paid for the continued supplies and there is also a provision that allows companies to apply to court for termination relying on grounds of hardship. The supplier can also terminate the contract with agreement from the company (where the company has entered a moratorium, voluntary arrangement or restructuring plan) or the office holder (in any other relevant procedure).

It will remain possible for suppliers to terminate for grounds other than the insolvency process, provided that the contractual right to terminate did not arise pre-insolvency and was simply not exercised. This means that a supplier would be permitted to terminate the contract for non-payment where this occurred after the company entered into the insolvency process.

Restructuring plans

The Bill proposes a new procedure referred to as a restructuring plan. Clause 7 and Schedule 9 of the Bill insert a new Part 26A into the Companies Act 2006, which sets out the arrangements for a company to enter a ‘restructuring plan’. The Bill also inserts new section 901A to 901L of the Companies Act 2006. The aim of the measure is to provide companies encountering financial difficulties with a more dynamic restructuring tool by introducing “cross-class cram down” provisions which allow creditors to agree to bind one or more dissenting class of creditors or shareholders.

The Bill stipulates that a “compromise or arrangement” can be proposed by the company and its creditors or members. Creditors and shareholders will need to vote to agree to the restructuring plan. The Bill requires 75% or more in value of creditors (or class of creditors) or members (or class of members) to agree to the restructuring plan and then an application may be made to the court to sanction the plan.

Any company that is liable to be wound up under the Insolvency Act 1986 (new section 901 A(4)(b) Companies Act 2006) can utilise the restructuring plan if the company satisfies the following conditions:

• The company has encountered, or is likely to encounter, financial difficulties which affect or may affect, the company’s ability to carry on business as a going concern
• The purpose of the compromise or arrangement proposed must be to eliminate, reduce, prevent or mitigate the effects of the company’s financial difficulties.

Where there are dissenting creditors/member (or classes of each), the court can still sanction the restructuring plan if:

• None of the members of a dissenting class would be any worse off under the restructuring plan than they would be in the event of the relevant alternative (the court considers the relevant alternative to be what would most likely occur if the restructuring plan was not sanctioned)
• That at least one class who would receive a payment or would have a genuine economic interest in the company in the event of the relevant alternative and must have voted.

As with the well-established principles in schemes of arrangement, the court has absolute discretion over whether to refuse to sanction the restructuring plan, even if the requirements have been met.

Process

The new process will almost mirror the process used in schemes of arrangement:

• A restructuring plan proposal is sent to creditors or members and filed with the court
• A first hearing will be listed and the court will review the classes of creditors or members. Creditors/members will have the opportunity to challenge class formation if they consider that the company’s classes do not reflect the right and interest of the different classes
• If the court is satisfied with the above process, the court will confirm that voting on the proposal can proceed on a specified date in advance of a second hearing if required
• Creditors will need to make a decision on the proposal. Prior to the decision being made, creditors are entitled to ‘necessary information’, which means anything the creditor requires in order to make a decision on whether or not to support the proposal
• If there are no challenges raised or no counter-proposals offered by the court, creditors/members will vote on the proposal
• Subject to compliance with the necessary voting thresholds and the rules for imposing cross-class cram down, the court will schedule a further hearing so that the court can consider if the requisite requirements have been complied with. The court will then make a decision on whether to approve the restructuring plan.

Once the court has sanctioned the restructuring plan, all creditors/members and the company are bound by it.

What does this mean in practice?

Whilst the restructuring plan is similar to a scheme of arrangement, the main difference is that it incorporates the ability for a company to bind a class of creditors/members to a restructuring plan even in circumstances where not all the classes have voted in favour of it.

If you need further advice in relation to the Corporate Insolvency & Governance Bill please contact Sam Payne.