Conor McLaughlin considers the temporary and permanent measures proposed in the Corporate Insolvency and Governance Bill

The Corporate Insolvency and Governance Bill: temporary COVID-19 protection for businesses and permanent reforms to the Insolvency Act 1986 and Companies Act 2006

On 20 May 2020, the Government presented the Corporate Insolvency and Governance Bill (CIGB) to the House of Commons. The Bill sets out the temporary measures announced by the Secretary of State for Business, Energy and Industrial Strategy, Alok Sharma, in response to the current COVID-19 pandemic as well as long-planned – and permanent – reforms to insolvency and company law to facilitate rescue of financially distressed businesses.

The Government intends to fast-track the CIGB through Parliament and it will next be considered on 3 June 2020.

Temporary COVID-19 measures

The shock to the UK economy as a result of COVID-19 and associated lockdown has been a sharp one. Although the Government has provided a number of measures to support businesses in the hope that they might pick up where they left off – such as the furlough scheme, Government-backed lending, grants and relief from non-domestic rates – the effect on businesses will be significant.

While the Chancellor made clear on 8 April 2020 that he can’t promise to save every job or protect every business, the CIGB introduces a series of temporary measures intended to give businesses breathing space and to delay the sometimes fatal effect of missed payments and cash flow pressures. The provisions described below may be extended for a limited period.

(i) Statutory demands and winding-up petitions

While not intended as a means of debt enforcement, creditors frequently employ statutory demands and winding-up petitions to secure payment from companies. Where a statutory demand remains unpaid, Section 123(1)(a) of the Insolvency Act 1986 provides that the company will be deemed to be unable to pay its debts.

The CBLG will prevent statutory demands served between 1 March 2020 and 30 June 2020 (or, if later, one month following the coming into force of the legislation) from forming the basis of a winding-up petition. Although this will apply to all creditors, this provision particularly addresses the issue of landlords who sought to sidestep the moratorium on forfeiture introduced by the Coronavirus Act 2020 by presenting a statutory demand.

In addition, creditors who wish to present a winding-up petition against a company before 30 June 2020 (or, if later, one month following the coming into force of the legislation) will be required to have reasonable grounds for believing that the company’s inability to pay its debts is not a result of coronavirus. A winding-up order will only be made against the company if the Court is satisfied that this is the case.

In order to ensure retrospective effect, the Court will be able to order that the previous position be restored where a winding-up petition was presented in the period between 27 April 2020 and the coming into force of the temporary provisions. If a winding-up order was made during that period and the Court would not have made the order in light of the temporary provisions, the winding-up order will be void.

Finally, in respect of winding-up petitions presented between 27 April 2020 and 30 June 2020 (or later date), Section 127 of the Insolvency Act 1986 will apply from the date of the winding-up order rather than the earlier and usual date on which the petition was presented. This will facilitate continued trading by preventing companies from needing to obtain a validation order and should mean that banks will not freeze the company’s bank accounts.

(ii) Suspension of wrongful trading provisions

Section 214 of the Insolvency Act 1986 allows an office-holder to apply to the Court for a declaration that directors of an insolvent company contribute to the assets of the company where they “knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation”.

Under the CIGB, the Court “is to assume that the [director] is not responsible for any worsening of the financial position of the company or its creditors” that occurs between 1 March 2020 and 30 June 2020 (or, if later, one month following the coming into force of the legislation). This is the case irrespective of whether it is shown that the worsening of the company’s position was a result of COVID-19.

While analysis conducted prior to the Small Business, Enterprise and Employment Act 2015 suggested that liability had only been imposed on directors in 11 reported cases, the wrongful trading provisions provide a powerful disincentive for directors against risky gambles which may be detrimental to creditors. The purpose of this provision is to remove the deterrent of personal liability for directors during the period of uncertainty caused by COVID-19.

Directors should note, however, that the suspension of liability for wrongful trading does not give them carte blanche. They may still incur liability for fraudulent trading or for breach of their duty to consider the interest of creditors where they “know or should know that the company is or is likely to become insolvent” (BTI v Sequana [2019] EWCA Civ 112, currently on appeal to the Supreme Court).

(iii) Meetings and company filings

The restrictions imposed by the lockdown and social distancing mean that physical meetings are not currently practicable. In addition, companies may be experiencing difficulties in compiling information for required filings with Companies House (such as accounts, confirmation statements, and notices of appointment or resignation of directors) or making those filings. The CIGB implements measures to alleviate these problems.

Notwithstanding any provision in their articles of association or the Companies Act 2006 on the holding of meetings, and until 30 September 2020 (or later specified date), meetings may be held by “electronic means or any other means” without attendees being together at the same place. Shareholders will also temporarily not have a right to attend in person, to participate in the meeting other than by voting, or to vote by particular means. Where a company is required to hold an AGM between 26 March 2020 and 30 September 2020 (or later date, if extended), companies will be able to delay the AGM until 30 September 2020.

Finally, public companies which are required to file their accounts and financial reports between 25 March 2020 and 30 September 2020 will have until the earlier of 30 September 2020 and the last day of the period of 12 months immediately following the end of their relevant accounting reference period to do so.

The Secretary of State will also be able, by regulation, to extend the time for filing various documents at Companies House including accounts (for private companies), confirmation statements and notices of appointment and resignation of directors. Secured creditors will also have more time to register a charge with Companies House, although the effect of delayed registration on the charge’s priority is not addressed in the Bill.

Permanent changes to insolvency law to facilitate the rescue of financially distressed businesses

Although the above temporary measures will be undoubtedly welcomed by businesses, the main – and permanent – measures introduced by the CIGB have been much longer in the making. These are the ‘free-standing’ debtor-in-possession (DIP) moratorium for distressed businesses and the introduction of a ‘recovery plan’ (essentially a scheme of arrangement which allows cross-class cram-down where there are one or more classes of dissenting creditors). In addition, it is proposed that the instances in which suppliers will be unable to rely on termination clauses triggered by insolvency be significantly increased.

The Government consulted on these measures as early as May 2016 (‘A Review of the Corporate Insolvency Framework’)  and announced plans to introduce new rescue and restructuring procedures in August 2018 ).

(i) A free-standing moratorium

The CIGB provides for a new Part A1 and Schedule ZA1 to the Insolvency Act 1986 which will allow companies to seek a moratorium without entering an insolvency procedure and with the directors remaining in control.

Traditionally, such a moratorium has been achieved by placing the company into administration or, in some cases, by proposing a CVA. More recently (including in the case of Debenhams), we have seen the use of ‘light-touch administrations’ whereby powers are restored to the company’s directors under paragraph 64(1) of schedule B1 to the Insolvency Act 1986. While the Insolvency Lawyers Association and City of London Law Society have produced a template consent protocol the ICAEW has cautioned against widespread use of the practice due to potential risks associated with giving too much power back to directors.

A moratorium will be available where (i) a company is, or is likely to become, unable to pay its debts; and (ii) it is likely that the moratorium would result in the rescue of the company as a going concern. It will not be necessary to specify exactly how such a rescue will be achieved. With the exception of certain financial services companies, all companies will generally be eligible for the moratorium unless they are already in an insolvency procedure or have been subject a moratorium, a CVA or an administration in the preceding 12 months.

The process for obtaining a moratorium is intended to be simple. In most cases, it will be sufficient to file a number of documents with Court stating that the above conditions are fulfilled (or, until during an initial period related to the COVID-19 pandemic, that the moratorium would be likely to result in rescue of the company “if it were not for any worsening of the financial position of the company for reasons relating to coronavirus”). If there is an outstanding winding-up petition against the company, then an application to Court will be necessary (again, this provision will initially be temporarily disapplied for the duration of the pandemic).

The moratorium will be effective immediately. It will provide initial breathing space of 20 business days to the company and, subject to various conditions – including, after an initial extension of a further 20 business days, consent of the company’s pre-moratorium creditors – this period can be extended such that it lasts for a maximum period of one year. The moratorium will come to an end if the company enters an insolvency procedure (or becomes subject to a scheme of arrangement or restructuring plan, discussed below) or if the monitor forms the view that the moratorium is no longer likely to result in the rescue of the company as a going concern.

While the moratorium is in place, no insolvency proceedings can be commenced except by the directors or the Secretary of State. Creditors will be unable to enforce security over the company’s property and floating charges will not crystallise during this period. In addition, no proceedings may be brought in respect of “pre-moratorium debts for which the company has a payment holiday”. This is intended to exclude certain debts including those relating to goods and services supplied during the moratorium, rent in respect of a period during the moratorium, or wages and salaries.

If a moratorium does not result in the company being rescued, moratorium debts and pre-moratorium debts for which the company did not have a payment holiday will be preferential debts if the company is wound-up within 12 weeks of the end of the moratorium.

Although control of the company will remain with the directors (similar to Chapter 11 proceedings in the United States, another debtor-in-possession mechanism), a licensed insolvency practitioner will act as a ‘monitor’ to monitor the company’s affairs and form a view as to whether it remains likely that the moratorium will result in the rescue of the company as a going concern. Creditors and members of the company will be able to apply to Court if they consider (i) that  any act, omission or decision of the monitor has unfairly harmed their interests or (ii) that the company’s affairs are being managed by the directors in a manner which has unfairly harmed the interests of some or all of the company’s creditors or members.

(ii) Recovery plans: a new scheme of arrangement allowing cross-class cram-down

The CIGB provides for a new Part 26A in the Companies Act 2006 to complement the existing Part 26 regime governing schemes of arrangement. Part 26A will allow companies in financial difficulties to enter into a ‘restructuring plan’ with greater scope for making the restructuring plan binding on dissenting creditors than would be possible under a scheme of arrangement.

The new Section 901A of the Companies Act 2006 will provide that it applies to a company that “has encountered, or is likely to encounter, financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern”. Such companies will be able to propose a restructuring plan with its creditors and/or members for the purpose of eliminating, reducing or preventing, or mitigating the effect of their financial difficulties. This may be combined with the moratorium discussed above which will prevent action against the company while the restructuring plan is being proposed.

In many respects, the process of binding creditors or members to the restructuring plan will follow the well-tested process for approval and sanction of a scheme of arrangement (and the relevant case law will no doubt be relevant). Thus, an explanatory statement must be produced and a meeting of affected creditors or members convened. If 75% or more in value of each class of creditors or members agree to a restructuring plan, the Court may sanction it.

The key differences with a scheme of arrangement are as follows:

 

  1. If the Court is satisfied that no members of a certain class have “a genuine interest in the company” – so called “out of the money” creditors – it may order that creditors or members in that class are excluded from any meeting convened to consider the restructuring plan.

 

  1. Whereas a scheme of arrangement requires approval by 75% in value and 50% in number of creditors or members in each class, a restructuring plan will not have a majority in number requirement. This means that a restructuring plan is less likely to be undermined by a number of creditors with low-value debts.

 

  1. The proposed Section 901G will allow the Court to sanction the restructuring plan despite it not having been approved by 75% in value of a class of creditors or members. This will only be possible if (i) none of the members of a dissenting class would be any worse off under the restructuring plan than they would be in the alternative of the restructuring plan not being sanctioned (the ‘comparator’), ie that they are not financially disadvantaged by the restructuring plan; and (ii) at least one class who “would receive a payment or have a genuine economic interest in the company” in the event of that alternative has voted in favour of the plan by the 75% in value majority.

 

  1. Where the restructuring plan relates to debts which were covered by a moratorium which ended less than 12 weeks previously, the Court may not sanction the plan if creditors with a moratorium debt or a pre-moratorium debt in respect of which the company does not have a payment holiday are affected and have not agreed to it. A similar change will be introduced in respect of schemes of arrangements under Part 26 as a new Section 899A.

 

(iii) Termination clauses in supply contracts

Finally, the CIGB makes provision for the insertion of a new Section 223B in the Insolvency Act 1986 prohibiting clauses which allow the supplier of goods or services to terminate or “do any other thing” – for example, accelerating payments or changing payment terms – in relation to that contract if the company enters a formal insolvency procedure (or the new free-standing moratorium discussed above).  However, where the supplier’s right to terminate the contract arises after this point in time – for example, if further payments are not made – its rights will not be affected.

The effect of this provision is to prevent suppliers from making it a condition of ongoing supply that pre-insolvency arrears are paid. This will complement the existing Sections 233 and 233A of the Insolvency Act 1986 which prohibits termination of utility, communications and IT suppliers.

Various safeguards are imposed to protect suppliers who would otherwise be ‘locked into’ contracts with an insolvent company. These include the ability of the relevant officeholder or the company itself (in the case of a moratorium) to consent to termination of the contract and the possibility for the supplier to apply to Court to permit termination where continuation of the contract would cause the supplier “hardship”.

Although these provisions are intended to apply generally, “small suppliers” will temporarily be excluded from the regime until 30 June 2020 or one month after the coming into force of the provisions. “Small suppliers” are those – perhaps not so small – in respect of which at least two of the following conditions apply in the most recent financial year: (i) a turnover not exceeding £10.2 million; (ii) a balance sheet not exceeding £5.1 million; and (iii) no more than 50 employees.

  1. Conclusion

The temporary measures should prevent businesses facing great uncertainty from having to deal with aggressive action by creditors over the next couple of months. However, unless payment holidays or deferrals have been agreed, creditors will ultimately at some point seek to recover those sums from companies. The permanent measures, in particular the moratorium, may provide some further relief once the temporary provisions cease to apply.

As for the moratorium generally and the possibility of proposing a restructuring plan, these measures will no doubt allow for more debtor-friendly restructuring in the UK similar to Chapter 11 proceedings in the US. In light of recent interest in ‘light-touch administrations’ which allow the directors to remain in (at least some) control of the company, the introduction of restructuring plans is to be welcomed. While the moratorium will provide time to the company to propose such a plan, it remains to be seen whether the costs involved in doing so make it a viable option for small and medium-sized businesses who have not traditionally engaged in restructuring exercises.

Barristers
Conor McLaughlin