Welcome to our latest joint edition of On Target and Collateral.
There has been much focus in the corporate and insolvency world on the Corporate Insolvency and Governance Act (the “Act”) which made its way through the UK legislative process at breakneck speed and entered into force on 26 June 2020. The Act introduces both permanent, ground-breaking reforms to corporate insolvency law, including the introduction of a stand-alone moratorium and a new restructuring plan to help business rescue, and also short-term measures stemming from the COVID-19 crisis, including the suspension of wrongful trading legislation and restrictions on the use of statutory demands and winding-up petitions.
To coincide with another landmark – MJ Hudson’s 10 year anniversary – in this newsletter we answer 10 of our clients’ top questions relating to this trailblazing piece of legislation.
Thank you also to our two external contributors – Irvin Cohen from Begbies Traynor and Anthony Cork from Cork Gully LLP – for their insight.
One of the most significant permanent changes introduced by the Act is a new free-standing moratorium process to provide a financially distressed but viable company with respite from creditor action, in order to facilitate a rescue as a going concern.
“The moratorium regime is designed to provide businesses with breathing space for a restructuring or a rescue. This is the closest we have come to the Chapter 11 regime in the US with the directors remaining in control of the business but overseen by an Insolvency Practitioner who will be called a monitor. This regime is intended to be used where there is a realistic prospect of saving the company and provides an alternative to administration or a company voluntary arrangement earlier on when finances are less stressed” says Irvin Cohen, Insolvency Practitioner at Begbies Traynor.
The moratorium is a welcome addition to the restructuring toolkit and is available to all “eligible” companies as set out in the Act1. But the list of excluded companies is fairly wide. For example, financial services companies (e.g. banks and insurance companies) are excluded from applying for the moratorium as are companies who have issued a debt capital markets instrument in excess of £10 million (for example, a bond). The exclusion for capital market arrangements was questioned in Parliamentary on the basis that it was unduly restrictive, but ultimately retained. It is therefore apparent that the moratorium will not be suitable for all companies and appears better suited to trading companies and SMEs.
Much weight has historically been attached to the Chapter 11 regime in the US permitting ‘debtor-in-possession’ financing, which allows a company in difficulty to raise additional liquidity from its creditors which may be secured on a super-senior basis.
The Act provides that during a moratorium, the debtor company can obtain new money funding, with the monitor having to approve the grant of new security. This has been broadly viewed in the market as opening the door to rescue finance for eligible companies but not going as far as introducing a full US-style DIP regime. The government has however indicated that some form of follow-on DIP financing legislation may be forthcoming. It remains to be seen how long it will take for such legislation to be implemented.
A significant aspect of the moratorium is the ability of stakeholders to challenge management of the company by the directors. A creditor or member can apply to court for an order on the grounds that, during the moratorium, the company’s affairs and property have been managed in a manner that has unfairly harmed the interests of the company’s creditors or members or a proposed act would unfairly harm their interests. Such an application can be made during or after the moratorium, which raises the possibility of post-moratorium claims. This puts an additional duty on the directors managing the company and contrasts with an administration process where the onus falls upon the administrators because they are managing day-to-day company affairs.
As a step before a formal insolvency procedure, businesses might be persuaded to use the new moratorium as it facilitates ‘debtor in possession’, where the company directors remain in control thereby overcoming one of the difficulties with a classic administration. But the new moratorium still requires an insolvency practitioner to be satisfied that, on the facts at the time, it is likely that the moratorium will result in the rescue of the company as a going concern.
The issue here is that if a company needs a moratorium urgently, the monitor at that point is unlikely to be in the weeds of the business. Whether the threshold is, as some fear, too high, and whether insolvency practitioners will be willing to make the relevant declaration, will be key points of interest once companies begin to use the new moratorium.
Perhaps following the framework of US insolvency law, the Act introduces a new form of restructuring plan between a company and its creditors, requiring a vote of creditors and/or shareholders and the sanction of the court. Creditors will vote on the plan in separate classes similar to those in schemes of arrangement and the plan will require the approval of a minimum of 75% of each class that votes. However, the plan introduces an unprecedented form of ‘cross-class cram-down’, meaning that the court has the discretion to sanction a plan even if certain classes vote against it.
On the face of things, companies will now have considerable flexibility to proceed with a restructuring, even where they cannot obtain the consent of all creditor classes.
But the conditions for ‘cross-class’ cram down could also conceivably lead to potential challenges. The Act states that if (i) the court is satisfied that none of the members of the dissenting class would be any worse off than in the event of the most likely ‘relevant alternative’ scenario, as determined by the court and (ii) the plan has been agreed to by a class that would receive payment or has a genuine economic interest in the company in the event of the ‘relevant alternative’, then the court can sanction the plan notwithstanding dissenting votes from a class of creditors or members.
The ‘no worse off’ safeguard puts an onus on the court to consider fairness of the plan, when deciding whether to sanction it. Valuing stakeholders’ realisations and the ‘relevant alternative’ scenario also has the potential to involve the courts in resolving valuation disputes.
“Valuations are likely to be a highly contentious area when determining those who have a genuine economic interest and those that do not” says Anthony Cork, Partner at Cork Gully LLP.
Valuation assumptions and economic outcomes are bound to be made more problematic by the Covid-19 crisis – and it will be interesting to see how this plays out in any near-term cases.
If a company is subject to an insolvency procedure, a supplier frequently seeks to terminate its contractual relationship with the company. However, the Act now prohibits a supplier (with some exceptions) from terminating its contract with a company where the company has entered or proposes to enter into a formal restructuring or insolvency procedure.
This is a significant step – a move away from freedom of contract so that contractual termination provisions in supply of goods or services contracts can be overridden.
It should be noted, however, that the legislative changes cover only supplier arrangements, not general commercial contracts or financial services agreements, and the prohibition will only have effect once the company is subject to an insolvency process.
But an ‘insolvency process’ will include the new restructuring plan procedure and moratorium so it is conceivable that companies might try to use the moratorium in order to trigger the termination prohibition at an early stage.
From the supplier perspective, a supplier may still terminate the contract if the insolvency officeholder or company consents or if the court is satisfied that the continuation of the contract would cause the supplier hardship.
According to Anthony Cork, Partner at Cork Gully, “This is likely to keep the Courts busy until there is settled case law on what is determined as “hardship”. In the interim it may prove beneficial for suppliers to widely define what constitutes “hardship” in their contracts”.
In any event, a supplier will need to act quickly and assess whether or not to terminate the contract early, in anticipation of an insolvency process. In future we may see suppliers demanding broader non-insolvency grounds for termination (such as security enforcement, suspension or cessation of business) to allow for such pre-emptive termination.
As mentioned in one of our previous newsletters [link to April 2020 On Target / Collateral: Directors of cash-squeezed and distressed companies – 5 liability points to note], the Act has introduced a temporary measure to support and protect company directors by suspending personal liability for wrongful trading for the period 1 March 2020 to 30 September 2020. The effect is that, even if directors allow the company to continue trading where an insolvent liquidation looks unavoidable, directors will not be considered to be responsible for the worsening of the financial position of the company or its creditors.
“In reality, if a business was in difficulties before the pandemic, the temporary suspension of wrongful trading provisions is not going to solve its problems. It will however give company directors greater confidence to use their best endeavours to continue to trade an otherwise profitable business without the threat of personal liability should the company ultimately fall into insolvency” says Irvin Cohen, Insolvency Practitioner at Begbies Traynor.
The existing regime with respect to directors’ duties will continue to apply, including the rules on fraudulent trading, misfeasance and transactions defrauding creditors.
Directors are therefore advised to respond cautiously to the temporary relaxation on wrongful trading and to keep evaluating their role in light of these other duties. The legislative changes do not mean that directors are exempt from taking steps to act in the best interests of the company (and in the best interests of creditors if insolvency is on the cards). Directors should also bear in mind that their behaviour during this period is likely to come under much greater scrutiny as the pandemic tapers, accounts and reports are published, and shareholders regain bandwidth to question day-to-day decision-making.
The Act enacts a temporary measure that presenting a winding-up petition against a company between 27 April and 30 September will be prohibited unless the petitioning creditor can demonstrate to the court that they have reasonable grounds to believe that the company’s inability to pay its debts was not caused by COVID-19 or the company would have been insolvent irrespective of COVID-19’s financial effect on it.
This temporary measure has already been tested and in several cases petitions have been removed by the courts.
Winding up orders made on or after 27 April 2020, but before the Act came into effect on 26 June 2020 are also deemed void unless it can be shown that the order would still have been made had the above-mentioned provisions been in force (i.e. that the company would have been insolvent notwithstanding the effect of COVID-19).
Companies that are due to hold a general meeting during the period 26 March 2020 to 30 September 2020 are permitted to hold these electronically even if their constitution would not normally allow it. In addition, the meeting may be held without a quorum having to be assembled in one location.
The Act also provides for secondary legislation to be introduced to extend certain key filing deadlines at Companies House, including accounts, confirmation statements and notices of appointment and resignation of directors. Companies House has already brought in provisions which allow UK companies to apply for a three-month extension to their accounts filing deadline if they are unable to meet that deadline owing to COVID-19.
Measures such as the suspension of winding-up petitions, liability under wrongful trading and relaxation of certain corporate deadlines are due to come to an end on 30 September 2020. Given that the commercial impact of COVID-19 will in all probability continue beyond the end of that period, the suspension may be extended for up to 6 months (and even longer) using secondary legislation.
“It is not inconceivable, in these unprecedented times, that the temporary restrictions on winding-up petitions may be extended further” says Anthony Cork, Partner at Cork Gully LLP.
In fact, certain market participants have recently been in touch with the government to try and extend these temporary measures until the end of the year. This should allow consumer and retail businesses additional breathing space to reinforce their debt and operational positions ahead of Christmas trading.
Is this brief too brief? Expert legal advice is on hand from MJ Hudson’s corporate, finance and restructuring teams. Just contact any of the Collateral or On Target teams (details below), and we’ll gladly help.
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