The Corporate Insolvency and Governance Act 2020 is the most significant piece of legislation affecting the UK insolvency law of recent years.
The act makes three substantial permanent reforms to the UK’s restructuring and insolvency regime, and also contains temporary measures designed to mitigate some of the economic and practical challenges of COVID-19.
The critical question will be whether the new measures are effective at saving businesses, and how effective those measures are compared to the restructuring regimes in other jurisdictions.
The act modifies the UK’s wrongful trading provisions
Having been in gestation for some years, with many of its measures consulted on originally in 2016, the act entered into force in June of this year.
Until COVID-19, it had seemed unlikely that reform to insolvency law would be a legislative priority, and it was unclear when – if at all – these measures would be introduced.
The impact of the pandemic, and its immediate economic consequences, changed all of that.
1. WRONGFUL TRADING
The act modifies the UK’s wrongful trading provisions and focuses on the financial consequences of a wrongful trading finding.
The court must assume that a director is not responsible for any worsening of the financial position of the company or its creditors between 1 March and 30 September 2020 (with scope for extension).
This significantly reduces the risk that a director will be held personally liable for wrongful trading. However, some companies do not benefit from the modified regime, and the list of excluded companies is widely drafted.
The risk of disqualification following a wrongful trading finding has been significantly reduced, but all other aspects of the directors’ duties and disqualification frameworks remain in place.
2. WINDING-UP PETITIONS
The act introduces temporary restrictions on the presentation of winding-up petitions and the making of winding-up orders.
Creditors will not be able to present a winding-up petition based on a statutory demand served between 1 March and 30 September 2020 (with scope for extension).
And, until 30 September 2020 (with scope for extension), creditors will only be able to present winding-up petitions on other grounds if they have reasonable grounds for believing that coronavirus has not had a financial effect on the company, or that the relevant ground would have arisen anyway.
This is not a blanket ban, but while these restrictions remain in place, it is likely to prove challenging for creditors to obtain a winding-up order in many circumstances.
These restrictions will not stop a debt becoming due and directors will need to be mindful of other consequences of defaulting on payment, including the possibility that a creditor might seek to place the company into administration.
1. RESTRUCTURING PLAN
The act introduces a restructuring plan procedure to offer companies facing financial difficulty a new, flexible means of implementing a restructuring.
The procedure is closely based on the scheme of arrangement, but with some important distinctions. Most notable is the inclusion of a cross-class, cram-down mechanism.
This will allow the court to sanction a plan even if the support of a class has not been obtained, as long as certain conditions are met.
The restructuring plan has the potential to be a very useful addition to the toolkit, and the first such plan has already been proposed, although there are a number of complex issues that will need to be worked through and tested in practice.
2. MORATORIUM
A standalone moratorium procedure is available under the act, with the aim of allowing distressed companies breathing space while they explore restructuring options.
When in force, the moratorium will protect a company from winding-up petitions and most types of legal proceedings, give the company a payment holiday in respect of some liabilities incurred before it came into force, and prevent creditors from taking certain enforcement action.
However, the utility of the moratorium is likely to be limited by a number of factors, including a number of widely drafted exceptions which limit the companies that will be eligible to apply for a moratorium and the liabilities that will be caught.
Importantly, the moratorium will not extend to liabilities owed to financial creditors.
3. TERMINATION CLAUSES
The act provides that certain provisions in supply contracts will cease to have effect if the counterparty becomes subject to an insolvency procedure (including liquidation, administration, a Company Voluntary Arrangement, the new moratorium or the new restructuring plan, but not a scheme of arrangement).
This includes provisions for automatic termination and provisions that allow the supplier to terminate or do ‘any other thing’ (such as change pricing) by reason of the company entering into an insolvency procedure.
Also in scope are provisions that would have allowed the supplier to terminate before the company entered into a process, if the termination right arose but was not exercised.
Suppliers will also be prevented from making payment of outstanding debts a condition of continued supply.
This measure offers some protection for distressed companies, but it will not apply to a wide range of financial contracts or where one or both of the contracting parties is in the financial services sector.
Nor will it cover all types of commercial arrangements.
For those that are in scope, it is likely to lead to greater focus on including and exercising early-warning triggers.
The original prompt in 2016 for the UK government to consult on the measures now contained in the act was the perception that the UK restructuring toolkit was at risk of falling behind its international peers, as evidenced by the UK slipping down a number of relevant World Bank league tables.
Since then, it has become clear that, while a number of the UK’s existing restructuring procedures (such as the scheme of arrangement) are best in class for achieving balance sheet restructurings, they are not well suited to protecting and facilitating the restructuring of a company hit by a combination of operational, liquidity and balance sheet issues.
That is, the types of issues facing, to a greater or lesser extent, a wide range of companies today.
There is an open question around how those measures will perform in practice and how comparable they are compared to restructuring regimes in other territories.
Chapter 11 in the US is the restructuring regime that others are most frequently benchmarked against. In that respect, it’s notable that the UK government referred to the act as introducing a UK Chapter 11.
While the measures contained in the act all feature (to a certain extent) within Chapter 11, the comparison is not entirely accurate, as they do not replicate the extensive and well-integrated protections and tools offered by the US Bankruptcy Code.
In that respect, it is notable that the UK government shied away from including a ‘debtor in possession’ regime to enable distressed companies to raise funds on a priority basis.
However, not replicating Chapter 11 is not necessarily a bad thing, as it hopefully means we avoid some of the disadvantages of that process (notably cost and time).
The critical question for the UK will instead be whether companies, lenders, restructuring advisers and the courts can combine to use these new tools to provide creative and pragmatic restructuring solutions that save jobs and businesses.
We expect the impact of the act on treasurers when negotiating new loan documents to be limited, and the Loan Market Association has concluded for now that it does not need to make any changes to its template documentation as a result of the act.
We are, though, starting to see some firms, acting for lenders, seeking to make specific reference to the moratorium and restructuring plan in insolvency-related provisions (representations, events of default, ‘defaulting lender’ definitions and other aspects).
Therefore, lenders can be comfortable the new processes will trigger the relevant provisions.
Evelyn Fleming is an associate, and Oliver Storey is a partner at law firm Slaughter and May
This article was taken from the October/November 2020 issue of The Treasurer magazine.