Quick Guide to: Insolvency law shake up to save businesses
The Corporate Insolvency and Governance Act 2020 (the Act), which came into force on 26 June 2020, has been described as ushering in some of the most significant changes to the UK’s restructuring and insolvency regime in nearly 20 years.
The measures, which are not limited in their availability to specific parties (such as landlords or tenants) or sectors, are wide-ranging and available to companies generally. They consist of a set of permanent, structural changes to the regime as well as some temporary COVID-19 pandemic relief measures and give a significant boost to the UK’s toolkit of available restructuring and insolvency procedures and continue to shift the balance towards company rescue and survival.
This note gives a brief overview of the main permanent and temporary changes and their key features below.
Main permanent changes to the UK’s restructuring and insolvency regime
New Moratorium for Companies
The Act introduces a new moratorium available to companies in financial distress, which gives those companies a minimum of 20 business days’ breathing space from creditor enforcement action to enable them to deal with their problem debts or seek a rescue.
The directors of eligible companies may apply to court for a moratorium and, as a “debtor-in-possession” process, the directors maintain control and decision-making responsibility for the company during the moratorium. The moratorium is a standalone pre-insolvency process – it need not be linked to any insolvency procedure and there is no need for creditor consent.
The moratorium is overseen by an independent monitor who must be a licensed insolvency practitioner and who has certain statutory duties including the duty to end the moratorium if rescue of the company is no longer likely, or if the company is not paying the debts that it must pay within the moratorium.
After the initial 20 business days, the directors can extend the moratorium up to 40 business days or, with creditor or court approval, up to 12 months.
The Act introduces a new restructuring procedure – the restructuring plan – to assist viable companies that are likely to become financially distressed. It is a further “debtor-in-possession” process, meaning the directors of the company retain control. The procedure is similar to the existing scheme of arrangement that has been widely used and accepted as a successful restructuring tool in the UK.
The plan is ultimately court sanctioned and, if approved, binds creditors to it. While creditors may vote on the plan, the court can impose it on dissenting creditors. As an innovation in UK restructuring procedures, the restructuring plan introduces “cross-class cram-down”, which is not available in a scheme of arrangement, and which can prevent a class or classes of dissenting creditors from blocking the plan. The ability to cram down dissenting creditor classes is a feature in common with the Chapter 11 bankruptcy process in the US.
Although the new procedure is available to all companies, it is more likely to be useful to large companies as it is likely to be expensive given the necessary involvement of lawyers and the court.
Prohibition of Ipso Facto Clauses
The Act includes a ban on “ipso facto clauses” in supply contracts. Ipso facto clauses are termination provisions that entitle a supplier to terminate a supply contract upon a customer’s insolvency.
Suppliers have traditionally been able to take advantage of such provisions in supply contracts in order to negotiate favourable terms when dealing with customers in financial distress, for example, by threatening or refusing to supply them – in effect, holding them to ransom.
The ban aims to prevent suppliers from jeopardising a rescue by preventing a customer getting the supplies it needs and it aims to tilt the balance in favour of company rescue and, in particular, the rescue tools above. Suppliers can apply to court if continuing to supply would cause hardship to the supplier.
Suspension of Wrongful Trading Rules
Under the wrongful trading rules, directors of companies that continue to trade the business of the company when they know or should know the business is approaching insolvency can be held personally liable to contribute to the assets of the insolvent company to discharge its liabilities.
Under the Act, the existing rules on wrongful trading by directors are suspended until 30 September 2020 (unless the government further extends them). As such, a liquidator or administrator of an insolvent company may not claim against the directors for losses to the company or its creditors resulting from the directors continuing to trade the business during the period when the suspension is in effect.
Removing the threat of personal liability reduces some of the pressure on directors facing the very hard decisions of whether or not to continue trading during ongoing uncertainty. It may encourage directors to make use of the government’s rescue schemes available without the fear of being personally liable for the additional liabilities assumed by the company. Directors must still pay attention to their general duties as directors including the solvency or otherwise of the company.
Statutory Demands and Winding Up Petitions
Statutory demands as a precursor to a winding up petition have been frequently used by parties as a method for collecting debts from a company (particularly landlords from tenants), rather than as a separate insolvency procedure for tackling and dealing with insolvent debtors. Filing a petition at court can have a damaging effect on a company as any other parties may be on notice of its financial situation and refuse to deal with it.
As a temporary measure, the Act provides that statutory demands may not be used as the basis for a winding up petition where the company’s inability to pay is related to the pandemic.
The measures under the Act:
- set a very high bar on creditors who must demonstrate to the court that it is their reasonable belief that a company’s inability to pay its debt is not due to the pandemic; and
- prevent advertisement or publication of a winding up petition until the court is satisfied that the company’s inability to pay is not related to the pandemic. This reduces the likely damage that would result from a challenge to the company’s solvency being widely publicised.
The result of the measures could be that parties are forced to engage with each other and to negotiate practical solutions for debt repayment or rescheduling since the real threat of petitioning to wind up a company that refuses to pay is removed.
How can we help?
We would encourage debtors and creditors to seek assistance early to maximise their use of the new measures and would be pleased to hear from you if you want more detail on either the measures or how they might affect or be of use to you.