Changes to UK Insolvency Law in response to COVID-19

United Kingdom

Introduction

On Saturday (28 March 2020) the UK Government announced certain changes to insolvency laws in response to COVID-19, intended to help companies and directors.

There are two aspects to the changes:

  1. Retrospective suspension or relaxation of wrongful trading: there will be a temporary suspension or relaxation of wrongful trading provisions for company directors to remove the threat of personal liability during the COVID-19 crisis, applied retrospectively from 1 March 2020.
  2. New restructuring procedure and new temporary moratorium: the Government is fast-tracking the implementation of certain reforms that were announced in August 2018. New legislation will implement these plans to add the following new restructuring tools:
    • the option for a company in financial difficulty to obtain a new pre-insolvency moratorium or “breathing space” to give it time to explore options for rescue;
    • a prohibition on the enforcement of so-called ipso facto clauses i.e. termination clauses which permit one party to terminate a contract due to the insolvency or financial condition of the other party; and
    • the introduction of a new standalone restructuring procedure that may be proposed by solvent or insolvent companies and can be used to bind dissenting stakeholders to a restructuring plan.

Further details of all these proposals are awaited and are needed urgently. The full text of the announcement can be found on the UK government website.

Timing

The Government plans to bring forward legislation to effect these changes “at the earliest opportunity”. The precise timing remains uncertain.  Parliament is currently in recess until 21 April.

Wrongful Trading

Wrongful trading rules have been of particular concern to directors since the COVID-19 crisis started, given the risk of personal liability for directors if they fail to take every step to minimise potential losses to creditors once there is no reasonable prospect of avoiding an insolvent liquidation/administration. A concern -and perhaps the most significant concern which is behind the Government’s decision to act – is that directors could be pushed to file the company for insolvency proceedings prematurely out of a concern that they might otherwise have personal liability if the company ultimately falls into insolvency.

Existing laws for fraudulent trading and the threat of director disqualification will remain in force as a deterrent against director misconduct. Fraudulent trading requires a business to have been carried on with the intent to defraud creditors of the company concerned or creditors of any other person, or for any fraudulent purpose.

It's not yet known if the wrongful trading suspension will be an absolute suspension (i.e. as if s214 of the Insolvency Act 1986 was not in force at all for the relevant period) or if it will simply exclude liability for a director who mis-judges the effects of COVID-19. The announcement talks of both ‘relaxation’ and ‘suspension’.

The changes ought to assist directors in their decision:

  • to access Government or other funding without concerns regarding potential personal liability; and
  • to continue trading pending greater clarity as to the likely duration of the lock-down and effect generally of the current crisis on the future viability of the company’s business. 

An unintended consequence of the changes may be that directors of companies that were not viable before the crisis continue trading and thereby incur additional liabilities for longer than they might (and arguably should) have done without the changes. It remains to be seen if there will be anything in the legislation aimed at addressing this concern, beyond the protection afforded by existing rules on fraudulent trading and director disqualification.

New Restructuring Procedure and New Temporary Moratorium

There is very little detail on these measures in the Government’s announcement on Saturday and instead there’s a cross-reference to reforms previously announced (in August 2018).

The three main aspects to these reforms are as set out in the introduction above. In the Appendix to this Law-Now is a summary of these proposals.  It’s understood that the Government is fast-tracking these proposals as part of its response to the current crisis.

The Business Secretary announced that these reforms are intended to enable UK companies undergoing a rescue or restructuring process to continue trading, giving them breathing space that could help them avoid insolvency. This will include enabling companies to continue buying certain essential supplies, such as energy, raw materials or broadband, while attempting a rescue.

A key point that is not yet clear is whether companies that are already insolvent (i.e. unable to pay their debts as they fall due) will be eligible for the new temporary moratorium. The Government’s proposals in August 2018 excluded companies that were already insolvent from the scope of the moratorium, opening it only to companies with sufficient liquidity to pay their debts for the proposed moratorium period as they fall due. Query therefore which companies hit by the current crisis will be able to qualify by the time it becomes law unless the proposed rules are perhaps relaxed in the case of those companies that would have been solvent but for the effects of COVID-19.

Appendix

Summary of key elements the Government Response to the Insolvency and Corporate Governance Reform Proposals – August 2018

On 26 August 2018, the Government published its response to the consultation (which ran from March to June 2018) on Corporate Governance and Insolvency and to the 2016 consultation on a Review of the Corporate Insolvency Framework. From a corporate insolvency law reform perspective, the three main areas of interest were:

  1. A new moratorium
  2. Protection of essential contracts – ipso facto clauses
  3. A new restructuring procedure

A summary of each is set out below.

Pre-Insolvency Moratorium

A new voluntary moratorium will be introduced, triggered by a court filing (similar to the current out of court administrator appointment procedure). It will not be available to companies which have been subject to a moratorium, or an administration or company voluntary arrangement (“CVA”) in the previous 12 months.

The test for entry into a moratorium will exclude companies which are already insolvent (although neither a winding-up petition in the previous 12 months not the existence of a current petition will be a bar, although in the latter instance, the commencement of the moratorium would require a court order, rather than a simple filing). The moratorium would be available if (a) company would become insolvent if action is not taken (the “eligibility test”), (b) on the balance of probabilities, a rescue is more likely than not and (c) the company would be able to meet its current obligations and new obligations as they fall due in the course of the moratorium. Conditions (b) and (c) are described as “qualifying conditions". 

The initial duration will be 28 days, subject to extension for a further 28 days if the qualifying conditions continue to be met. Any further extension beyond 56 days should only be done where there remains a good prospect of achieving a better outcome for creditors than might otherwise be possible. It would therefore require the approval of more than 50% in value of both secured and unsecured creditors (or a court order if seeking creditor consent would be “impracticable”). Where a proposal for a CVA or scheme has been proposed but not yet determined, there would be no need to seek an extension if the moratorium expires midway through the process – it would automatically continue until the vote took place.

A “monitor” (who will, at least initially, be required to be an insolvency practitioner) will be required to confirm that the eligibility test and qualifying conditions have been met. Creditors would have the right to challenge both the entry into the moratorium and the moratorium itself at any time during its course, either on the basis that the qualifying conditions are not met or unfair prejudice. The monitor would not be able to consent to actions which contravene the effect of the moratorium (such as consent to legal proceedings).

The monitor will be an officer of the court and will be responsible for terminating the moratorium when the conditions cease to be met, as well as sanctioning asset disposals outside the normal course of business and the grant of any new security. The monitor will have statutory immunity, where acting in good faith, to claims arising from erroneous termination. The monitor’s fees will be a contractual matter between the proposed monitor and the company, but they will be open to challenge in a subsequent insolvency. The monitor him/ herself will not be permitted to take an appointment in a subsequent liquidation or administration within 12 months. The monitor will be permitted to act as supervisor in a subsequent CVA, as well as advising in relation to the new restructuring plan (see below).

Protection of Essential Contracts

The proposals seek to prohibit the enforcement of contractual termination clauses in contracts for the supply of goods and services (including intellectual property licences) on the grounds of formal insolvency, a restructuring moratorium, or a new restructuring plan (see below). There would be certain limited exceptions.

There would be protections for the supplier, and an affected supplier would have the ability to apply to court to terminate supplies on the grounds of undue financial hardship (that is that the supplier would be more likely than not to enter an insolvency procedure as a result of being compelled to supply) which the court would balance against the effect on the debtor company and its rescue prospects.

The supplier would have super priority for supplies made during any moratorium period in the event of a subsequent insolvency.

New Restructuring Plan

The proposals included a new restructuring plan available to companies of any size (but subject to certain exceptions).  Both solvent and insolvent companies (including those already in an insolvency procedure) will be able to propose a plan.

The process will closely resemble that for schemes of arrangement: a proposal will be sent to creditors and shareholders and filed at court, with subsequent consideration of, and possible challenge to, classes (the provisions for class formation being based on class formation for schemes). Voting by electronic means would be encouraged. The court would then be asked to confirm the plan (subject to appeal).

The proposals envisage a minimum prescription on the nature of the proposal. Sufficient information would need to be made available to creditors to enable them to vote on the plan.

Rights extinguished under the plan, once confirmed, will not be reinstated in any subsequent insolvency occurring following failure of the plan.

Voting thresholds would be 75% in value of voting creditors within each class (with the additional provision that more than half of the total value of unconnected creditors must vote in support). However, the restructuring plan would allow for cross-class cram down of dissenting classes of creditors by way of the absolute priority rule (as opposed to the relative priority rule). This provides that a dissenting class of creditors must be satisfied in full before a more junior class can receive a distribution or keep an interest under the restructuring plan. However, the court can confirm a plan even if it does not comply with this rule where non-compliance would be necessary to achieve the aims of the restructuring and is just and equitable in the circumstances. At least one class of impaired creditors must vote in favour of the plan in order for a cross-class cram down to be confirmed by the court.

In determining whether a plan which affects a cram down of dissenting creditors is fair, and recognising that determining out of the money creditors by reference to a minimum liquidation value can lead to unfair results, the proposals include a “next best alternative” basis for valuation (which is anticipated may usually be an administration outcome).