Collateral

 

Welcome to Collateral, MJ Hudson’s quarterly newsletter focusing on the latest restructuring, turnaround and debt matters with insight aimed at institutions at all levels of the capital structure.

Restructuring restructuring: Reforms to the UK restructuring and corporate governance regime

 

The government has announced that it will legislate to update the UK restructuring system and corporate governance regime relevant to companies in distress with the aim of ensuring that the UK’s insolvency system retains its preeminent status.

The proposals will have a significant impact on the UK restructuring and insolvency framework with a move away from creditor-led processes to debtor-led restructuring proceedings in a similar manner to the US Chapter 11 regime.

This latest edition of Collateral tells you what you need to know about the proposed reforms, their potential impact and the path to implementation.

1. New Restructuring Tools

Restructuring Plan

The government’s proposal for a new restructuring tool draws heavily from the current scheme of arrangement legislation but with some important distinctions.

  • The new “flexible restructuring plan” will allow a debtor to bind all creditors, including dissenting junior creditors, through a cross-class cram down provision which is comparable to the rubric contained in US Chapter 11. In effect, this means that if at least one class of impaired creditors vote in favour and the ‘absolute priority rule’ is followed (a dissenting class of creditors must be satisfied in full before a more junior class receive any distribution) then the court can approve the plan. However, the court will have the power to sanction a restructuring even if the absolute priority rule is not applied, provided that it is necessary to achieve the aims of the restructuring and it is fair and equitable to do so.
  • At least 75% (by value) of each class of creditors and shareholders will be required to vote in favour of the plan in order for it to be approved. There will be no majority in number test but a ‘connected creditor’ rule will apply meaning that more than half the creditors by value voting in favour of the restructuring must be “unconnected” pursuant to the definition in the Insolvency Act 1986.
  • The overall process will resemble a scheme of arrangement, with a court hearing at which classes of creditors and shareholders will be determined following which there will be a vote on the proposal. Ultimately, however, it will be at the court’s discretion to whether to confirm a plan and make it binding on creditors and shareholders. Procedurally this seems to make sense although market participants argue that this level of flexibility could create uncertainty which investors should be concerned about.

Restructuring Moratorium

The reforms also include a 28-day moratorium period (extendable to 56 days) which will allow companies additional time to restructure or seek new investment to rescue their business from creditor action. In order to qualify for the moratorium, the company must:

  • be financially distressed without actually being insolvent;
  • have the prospect of rescue; and
  • prove it can meet its financial obligations during the moratorium.

The directors of the company must appoint a qualified Insolvency Practitioner (as “monitor”) to oversee the company during the moratorium (so more work here for IPs!). Creditors may apply to court to challenge the moratorium if they believe the qualification conditions are not met or they can demonstrate that they suffer unfair prejudice.

But what’s not included…

Although the changes above have some familiarity with US Chapter 11 and a debtor-in-possession restructuring framework, the proposals have received some criticism from market players for not including a DIP finance or rescue finance element. In the US the mechanism is often used successfully to facilitate the reorganisation of a debtor by allowing it to raise capital to fund its operations as its bankruptcy runs its course. Importantly, DIP financing is unique from other financing methods in that it usually has priority over existing debt, equity and other claims. Although the concept was included in early government consultations, it has not been taken forward which feels like a missed opportunity in the context of promoting a rescue culture and helping companies access liquidity in the market when they get into financial difficulties.

2. Reforms to Corporate Governance and sales of businesses in distress

Among the proposed reforms to corporate governance in a restructuring and insolvency context, the government plans to introduce more exacting measures to ensure directors act in the best interests of group companies.

Directors of holding companies will now be legally obliged to take into account whether the sale of a large distressed subsidiary is in the best interests of the subsidiary’s stakeholders – as opposed to placing the subsidiary into formal insolvency proceedings. The proposed look-back period to assess whether the subsidiary’s stakeholders would be “worse-off” is one year and sanctions for non-compliance include director disqualification or being subject to a compensation order.

The government has produced a non-exhaustive list for the court to take into account to assess the reasonableness of a director’s conduct and whether sufficient care was taken to protect stakeholder interests. These factors include whether professional advice was sought and taken in respect of the sale and the extent to which the directors of the parent company engaged with stakeholders of the subsidiary due to be sold. These seem like sensible protections…

However, the restructuring market is concerned that the proposed reforms potentially create a chain of unintended consequences including:

  • more companies filing for insolvency to escape director liability,
  • additional scrutiny of buyer motives and the need to further diligence the transaction and the buyer’s long-term business plan – all of which are likely to be unappealing to a purchaser of a distressed business,
  • questions over the interplay between existing director’s duties to act in the best interests of the company with the new duty to also act in the interest of the subsidiary’s stakeholders, adding to the complexity of a director’s role and potentially introducing conflicts of interest.

It remains to be seen how these concerns play out….

3. Timetable for reform

While clarity is required in relation to certain of the proposed reforms, the government has advised that it intends to introduce the relevant legislation as soon as parliamentary time permits. In view of Brexit continuing to consume the parliamentary agenda, it is hard to predict when these changes might be implemented.

However, the rising levels of insolvency in the UK market, political attention on corporate failures coupled with the UK’s position as the restructuring hub of EMEA coming under the spotlight as it withdraws from the EU means insolvency reform remains on the agenda for the government. Given the political focus on distressed sales in the wake of recent retail failures, it is conceivable that at a minimum, the proposed corporate governance reforms will be implemented sooner rather than later. So watch this space…