UK insolvency law shake-up to prevent corporate COVID-19 casualties

Jul 29, 2020

The UK Government has recently made urgent and radical changes to insolvency laws, which may help companies survive the COVID-19 crisis, write Michael Drumm and Sean Cavanagh.

The Corporate Insolvency and Governance Act 2020 represents the most significant reform of insolvency legislation in over 20 years. It was fast-tracked through Parliament and became law on 26 June. The laws apply to the whole of the UK, and specific clauses relating to Northern Ireland have been included.

Some of the new changes are permanent, and some are temporary. The permanent changes focus on reforms in three key areas:

  • A moratorium;
  • A ban on termination provisions; and
  • A new restructuring plan.
The temporary measures relate to the suspension of the wrongful trading regime, the suspension of statutory demands and winding-up petitions where financial difficulties arise directly from the effects of the COVID-19 pandemic, and some temporary extensions concerning company filing requirements.
This article is necessarily high-level, and readers are encouraged to speak to their advisors to explore the detail.

Permanent changes

A new ‘free-standing’ moratorium

This mechanism differs from existing moratoria in that it is a standalone procedure and does not necessarily need to be a gateway to any formal insolvency process.

The application 

In most cases, the moratorium can be initiated by merely filing the application with the court (a court order is not required). The application must contain:

• a statement by the directors that, in their view, the company is, or is likely to become, unable to pay its debts; and
• a statement from the proposed monitor (who must be an insolvency practitioner) that the company is an ‘eligible’ company and that, in their view, the moratorium would likely result in the rescue of the company as a going concern.

Length of the moratorium

It will last for an initial period of 20 business days, which can be extended to 40 business days by the directors (no creditor approval required). This 40-day period can be extended for up to one year, but only with creditor or court approval. A further extension beyond one year is also possible by applying to the court.
Each application for an extension must be accompanied by a statement from the directors and the monitor.

Effect of the moratorium

It will prevent the enforcement of security, the crystallisation of a floating charge, the commencement of insolvency proceedings or forfeiture of a lease.

The company will not be obliged to pay most pre-moratorium debts during the moratorium, but there are some exceptions (e.g. wages and salaries, finance loans and leases). However, debts falling due during the moratorium must be paid so access to cash or funding will be vital.

The monitor

During the moratorium, the directors remain in control of the business and a monitor oversees the process. The monitor is an officer of the court and as part of their role, they must protect creditors’ interests while also ensuring compliance with the conditions of the moratorium.

For the period of the COVID-19 crisis (at present, up to 30 September 2020), the monitor can disregard any worsening of the company’s financial position that is attributable to the pandemic, providing a going concern rescue is still likely.

How will it end?

The moratorium can come to an end via:

  • an agreement/restructuring with its creditors, possibly via a company voluntary arrangement (CVA);
  • a scheme of arrangement;
  • a court order;
  • termination by the monitor if he/she determines that the conditions have not been fulfilled; or
  • automatically, on expiry of the time limit.
The hope is that the company will emerge from the moratorium having achieved a rescue, but if this is not the case, a winding up or administration might happen. Where this insolvency procedure happens within 12 weeks of the end of the moratorium, certain unpaid debts in the moratorium and certain other debts have ‘super priority’ for payment ahead of other debts.

A new restructuring plan

This new procedure will closely resemble the existing scheme of arrangement, which is a statutory legal process that allows a company to restructure its debt. It is not an insolvency procedure but must be approved by the court.

The restructuring plan will require two court hearings, is likely to be technically complex, and will be expensive as a result. Thus, it may not turn out to be a practical solution for smaller SMEs in distressed scenarios.

The principal advantage of the new restructuring plan is that it will offer the ability to cramdown one or more classes of dissenting creditors or shareholders. In effect, this means that even if a class of creditor does not vote for the plan, the court may still sanction a cramdown provided certain conditions are met, including that no creditor is worse off than the relevant alternative.

The procedure is more likely to be used in more complex and larger distressed company scenarios, particularly with bond-holder involvement, meaning it is unlikely to be used regularly in Northern Ireland.

Suspension of termination clauses for suppliers of goods and services

When a company enters an insolvency or restructuring procedure, suppliers will often stop or attempt to stop supplies by virtue of the terms of its supply contract.

This new Act prohibits the termination of any contract for the supply of goods and services to a company by reason of the company entering into an insolvency procedure. This will include the new moratorium procedure outlined above, administration, CVA, liquidation or a restructuring plan. However, this prohibition does not apply to schemes of arrangement

Also, a supplier company cannot insist on any disadvantageous amended terms (e.g. significant price increases). There are some exceptions to this suspension, however, such as contracts for the supply of services from insurers and banks.

A temporary exemption (available during the COVID-19 period) to this supply restriction will be available to ‘small’ businesses. This may be of importance to Northern Ireland supplier companies, as many of them will qualify as ‘small’ for this purpose.

A company can also apply to the court to terminate supply where it can prove ‘hardship’. ‘Hardship’ is unfortunately not defined as yet.

Temporary changes

These temporary changes only apply during the period of the COVID-19 crisis.

Suspension of the offence of wrongful trading

This new Act directs the courts to assume that a director is not responsible for the worsening of the financial position of the company that occurs during this period (currently to 30 September).

This reduces, but critically, does not remove, the threat of personal liability on company directors arising from ‘wrongful trading’. This temporary suspension only applies to ‘wrongful’ trading – it does not exempt directors from possible personal liability arising from ‘fraudulent trading’.

Temporary suspension of statutory demands and winding petitions

The Act temporarily removes the threat of statutory demands and winding-up proceedings, but only where COVID-19 has had a worsening effect on the company. In these circumstances, statutory demands will be void if served on a company during this period. However, a company will not be protected from the making of a winding-up order where the financial difficulties of the company would have arisen regardless of the effects of COVID-19.

Analysis

These new measures will be welcomed as they have the potential to help many viable companies that have been directly impacted by the effects of this unprecedented crisis.

The intention of the new moratorium is that it will be a ‘debtor-in-possession’ process whereby the monitor acts in a limited capacity as overseer. This follows recent trends in some administrations (e.g. Debenhams) where administrators have provided consent to directors to make certain decisions via a ‘consent protocol agreement’ in what many are calling ‘light touch’ administrations.

Only time will tell whether this new moratorium procedure is preferred over the traditional administration process, but recent developments certainly indicate a move towards a more rescue-orientated restructuring culture, which will surely be required to save viable businesses and address the unique nature of the upcoming economic environment.

Michael Drumm is a licensed insolvency practitioner and an advisory partner at CavanaghKelly.

Sean Cavanagh is a Founding Partner of CavanaghKelly, a licensed insolvency practitioner and Chair of the Insolvency Technical Committee at Chartered Accountants Ireland.