Covid-19 Insolvency update – The UK's Corporate Insolvency and Governance Bill
The UK Government has published the long-awaited Corporate Insolvency and Governance Bill (the Bill). The Bill includes some of the most significant changes to UK insolvency law in many years and it is important for all directors to understand the changes. Some of the reforms introduced by the Bill have been seriously considered since the 2016 Government's Review of the Corporate Insolvency Framework. Others are short term reforms, introduced as a direct response to the financial pressures felt by businesses due to the coronavirus pandemic.
It is possible that the Bill will become law by late June or early July, due to the urgent need to support UK businesses in the coming weeks. Overall the changes introduced further promote the rescue culture in English insolvency law, with an emphasis on protecting jobs and rescuing viable businesses. The key changes introduced by the Bill are outlined below.
New Moratorium Procedure
Both insolvent companies and companies who are likely to become insolvent will be able to obtain a moratorium (that is, protection from legal processes against the company), initially for 20 business days. This will include a payment holiday for certain specified debts. The initial 20 business day period for the moratorium can be extended with consent of the company's creditors or permission of the court.
This new moratorium procedure will give companies a short window to take urgent steps to restructure, seek new investment or otherwise pursue a turnaround strategy, free from the immediate threat of creditor action. The moratorium is available to all companies, with limited exceptions.
The company's directors will remain in control but a licenced insolvency practitioner will be appointed as a "monitor" of the company during the moratorium in order to protect the interests of creditors. The monitor's role is limited: he or she will approve the grant of any new security and sales outside the normal course of the company's business, and will make sure that the moratorium is at all times likely to result in rescue of the company as a going concern.
Creditors will have the ability to challenge the directors' conduct and the actions of the monitor if they have been unfairly prejudiced during the moratorium. There is also provision in the Bill for prosecution of directors who commit offences in connection with the moratorium. Importantly, liabilities incurred during the moratorium will be payable as an expense (i.e. in higher priority to unsecured debts), granting some comfort to creditors regarding the ability of the debtor to repay liabilities that accrue during the moratorium.
Another major reform, which has been contemplated by the UK Government since 2016, is the introduction of a new restructuring procedure modelled on the existing scheme of arrangement. Both solvent and insolvent companies will be permitted to use the new restructuring procedure.
The procedure allows a compromise to be imposed on company creditor and shareholder claims, in accordance with the restructuring plan. Creditors will vote on the proposed plan in separate classes, and the procedure will be able to bind both secured and unsecured creditors if approved.
To be approved, the scheme must be approved by at least 75% of creditors in each class. However, the new procedure also includes the ability to "cram down" classes of creditors, similar to US Chapter 11 bankruptcies. The court may grant final approval to the restructuring procedure even if a class of creditors (or numerous classes) do not approve the plan.
Supplier Termination Clauses
Many contracts provide for one or other of the parties to terminate the contract upon specified insolvency events occurring. The intention behind these clauses in a supply agreement is typically to ensure that a supplier is not obliged to continue supplying a party who may be unable to pay for the goods or services provided. However, such clauses often make it more difficult for an insolvent company to be rescued as trading may become impossible following supply chain disruption.
There are already restrictions on certain suppliers, such as utility companies, from stopping supplies due to their customer's insolvency, provided that the supplies are still being paid for. The Bill extends this restriction, providing that a supplier will not be permitted to rely upon a contractual term to stop supplies by reason of the company's insolvency. A supplier will also not be permitted to vary the contractual terms in order to force an insolvent customer to pay pre-insolvency charges owed as a condition of providing future supplies. This prohibition is intended to prevent ransom payments being demanded of companies already in financial distress.
However, a supplier can apply to court to allow termination of the contract in some circumstances and if it would cause hardship to the supplier. What would qualify as sufficient hardship remains to be determined by the court. Suppliers which are small companies are also temporarily excluded from the prohibition during the coronavirus pandemic.
Restricting clauses which allow suppliers to terminate contracts due to the other party's insolvency could be a lifeline for many businesses that are reliant on their supply chain. However, the reforms could also lead to opportunism among debtors and place undue risk on suppliers: in addition to being unable to terminate a contract due to their customer's insolvency, a supplier may be unable to demand payment and threaten winding up proceedings if their customer fails to pay (see below). The Bill does not restrict suppliers from terminating supply contracts for other reasons than the customer's insolvency, if these are provided for in the terms of the contract or common law, but a supplier may suffer financial losses before these rights to terminate arise.
Temporary Restrictions on Statutory Demands and Winding up Petitions
The Bill will temporarily restrict the presentation of winding up petitions where the debt is unpaid due to coronavirus. A petition cannot be presented at Court until either 30 June or a period of one month after the Bill comes into force, whichever is later. The exception to this prohibition is where a petitioning creditor has reasonable grounds for believing that coronavirus has not had a financial effect on the debtor company, or can show that the ground for petitioning (i.e. the reason for the debtor's insolvency) would apply regardless of coronavirus' effect.
Notably, winding up orders are also restricted if it appears to the court that coronavirus has had a financial effect on the company, i.e. if the debtor's financial position worsens in consequence of, or for reasons relating to, coronavirus. Alternatively, the court may be satisfied that the ground for making a winding up order would have arisen even if coronavirus had not had a financial effect on the company. This is likely to be a significant obstacle for petitioning creditors and will lead to contested applications.
Winding up petitions presented after 27 April, on the grounds that the debtor has not paid a debt set out in a statutory demand served on the debtor between 1 March and 30 June, are also prohibited. These petitions will be dismissed and, if a winding up order has been made already, such orders will be void.
Temporary Suspension of Wrongful Trading
One of directors' principle concerns during the current pandemic is whether the continued trading of their businesses at present could be wrongful trading. Wrongful trading carries personal liability for directors under the Insolvency Act 1986.
The Bill will suspend, temporarily, the effect of the wrongful trading provisions of the Insolvency Act 1986 for the four months between 1 March 2020 and 30 June, meaning that insolvency practitioners will not be able to bring claims for director wrongful trading against the insolvent company's directors in respect of losses which accrue in this period. Directors will be assumed to not be responsible for any worsening of the financial position of the company between 1 March and 30 June.
This temporary suspension will not prevent claims for wrongful trading which takes place before or after this period, nor will it prevent other claims being brought against directors for their actions during this period, including fraudulent trading and breaches of director's duties (including the duty to have regard to creditors’ interests when a company is likely to become insolvent).
Temporary Use of Remote Meetings
The Bill provides for certain company meetings to be held remotely due to the need to maintain social distancing.
Temporary Companies House Filings
The Bill permits the Secretary of State to make further extensions to the deadlines for filing accounts with Companies House. The extended period for filing is:
42 days, if the existing time period is 21 days or fewer;
12 months, if the existing time period is 3, 6 or 9 months.
There is provision in the Bill for further regulation during the period to 30 April 2021. It remains to be seen whether further reforms will be necessary and how companies and courts will adapt to the far-reaching changes introduced by the Bill.