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A new ‘chapter’ | Feature

The low down 

According to the OECD, the UK economy will shrink by 11.5% this year and by as much as 14% in the event of another lockdown. Unsurprisingly, the government has rushed through legislation to avert a deluge of corporate insolvencies, pushing it through parliament in just six weeks. It moves UK law closer to Chapter 11 of the US’s Bankruptcy Code, providing protection from creditors and weakening the position of ‘dissenting’ creditors who could block a rescue plan to which others agree. But the supervision and professional advice needed to assert a right to greater protection from creditors are not cheap, and critics claim only bigger companies can use the new laws. Meanwhile, insolvency practitioners and lawyers warn that Brexit could damage recognition in EU courts of UK schemes of arrangement.

The Corporate Insolvency and Governance Act (CIGA) received royal assent on 25 June. The Insolvency Service described it as ‘the largest change to the UK’s corporate insolvency regime in more than 20 years… [with] new corporate restructuring tools and temporary easements to give distressed businesses the breathing space they need to get advice and seek a rescue’. 

CIGA suspends directors’ liability for wrongful trading; it also restricts the use of debt recovery tools such as statutory demands and winding-up petitions for when a company cannot pay its bills (including rent to a landlord) due to the shutdown. These temporary provisions will stay in place until at least the end of September and most are retrospective to 1 March.

Robert Russell, head of UK restructuring at DLA Piper, says the act ‘formalises’ what had already been announced in the daily Number 10 briefings in March and April. But it also implements permanent changes planned under the administration of former prime minister David Cameron.

The bill was raced through parliament in just over six weeks, Russell observes. ‘There was a political – with a large p and a small p – imperative to have a meaningful legislative response to Covid-19 from a business community rescue point of view,’ he says, although ‘much of the bill was based on a consultation that predated Brexit’.

That consultation was undertaken by the Insolvency Service (part of what is now the Department for Business, Energy & Industrial Strategy) between May and July 2016, and focused on the permanent measures that CIGA introduced. These include a new restructuring procedure, a new statutory moratorium regime and changes to termination clauses in supply contracts.

These are all significant reforms. ‘Insolvency law in this country is very creditor-friendly and the permanent provisions that have been brought in give tools to create a more debtor-friendly environment,’ says Edward Judge, a partner at Irwin Mitchell.

He adds that ‘a lot of these debtor-friendly provisions are imported from America’, and points to Chapter 11 of the US Bankruptcy Code, which gives a company protection from creditors while it reorganises.    

Roger Elford, a partner at Charles Russell Speechlys, says that whereas in the US a company in financial trouble can file for Chapter 11 bankruptcy to obtain ‘a wide range of protections – a breathing space to try to restructure its affairs – in the UK, to date, all the power has really been held by secured creditors who have the ultimate ability to pull the plug on the company as soon as there has been a default’.

Allen & Overy corporate partner Jennifer Marshall says: ‘The restructuring plan in particular will assist when dealing with dissenting creditors who no longer have any economic interest in the company. Although it was possible before the act to deal with “out of the money” shareholders and junior creditors, this often involved a transfer to a new company through a pre-packaged administration, which added to the cost and complexity of the restructuring. It is now possible to do the same restructuring through a single process.’

Will Brexit make the uk less attractive? 

Robert Russell, DLA Piper’s head of restructuring, says Brexit potentially threatens the UK’s status as ‘one of the premier jurisdictions for international cross-border restructuring’. This includes the English scheme of arrangement. He points out that some EU jurisdictions such as the Netherlands are emulating England by ‘seeking to implement an attractive, creditor-friendly regime that can be used by those debt-holders that are jurisdictionally agnostic’.

 

Several EU countries are adopting restructuring tools, such as schemes of arrangement, in response to the European Restructuring Directive. But Allen & Overy partner Jennifer Marshall is confident that ‘the new restructuring plan will enable the UK to keep its competitive edge in this area’.

 

She adds: ‘It is fair to say that there are a few issues that need to be ironed out via the restructuring plan, including what factors the court will take into account when exercising cross-class cramdown, but given our excellent, commercial and experienced judges, I have no doubt whatsoever that the courts will resolve these issues in the next few years.’

 

Charles Russell Speechlys partner Roger Elford says the new Chapter 11-inspired cross-class cramdown feature increases the attractiveness of the UK as a place to restructure. For companies seeking protection from creditors, Chapter 11 of the US Bankruptcy Code is considered ‘the gold standard’. The English scheme of arrangement is ‘more flexible but it requires a higher degree of consent by your creditors to use it. The introduction of the cross-class cramdown means you can actually come and use the scheme in the UK, even though you haven’t got all your creditors on board, and that is helpful’.

 

He concludes: ‘Where I think the UK as a jurisdiction for schemes is going to suffer is because of Brexit.’ He points out that the EU courts may no longer recognise schemes of arrangement granted by English courts, once the transition period expires. ‘That depends on what arrangement is reached between the UK and Europe on the recognition of judgments, but there is a lot of uncertainty. Many practitioners who do schemes are very concerned about what Brexit will do to this work.’

In the new ‘restructuring plan’, creditors are divided into classes; each class votes on the proposal, which will need the approval of at least 75% of creditors by value and a majority by number of each class. The process includes a ‘cross-class cramdown’ mechanism to bind dissenting creditors to the plan if a court sanctions it to be ‘fair and equitable’. This draws inspiration from the ‘absolute priority rule’ in the Chapter 11.

The new provisions continue with the culture of seeking to save companies as opposed to the businesses operated by those companies and the protection of jobs

Frances Coulson, Moon Beever

Frances Coulson, senior and managing partner of Moon Beever, considers the new restructuring plan and cramdown feature (amending the Companies Act 2006) to be ‘possibly the largest change to corporate insolvency at the mid- to lower-market end. It remains to be seen whether this will be used in addition to or replacing administration’.

‘The restructuring plan is essentially a version of the scheme of arrangement with certain sweeps around the edges,’ explains Russell. This court-supervised debt restructuring procedure, detailed under Part 26 of the Companies Act, has been a popular UK export, although it is mainly used by companies with complex financing.

Steven Cottee, a partner at Pinsent Masons, suggests that, as with the English schemes of arrangement (and Chapter 11 bankruptcy, too), the new restructuring plan will mainly be used by large businesses.

‘The government believes that SMEs will regularly use the restructuring plan procedure,’ he says. ‘However, it will be an expensive court-driven process that is likely to only be used by larger corporates with complex debt structures and the act may not actually achieve the significant long-lasting changes that the government desires.’  

The other main measure introduced by CIGA is the moratorium, which gives insolvent businesses protection from creditors for up to 40 working days while they pursue a rescue plan such as a company voluntary arrangement or the new restructuring plan.

Elford says: ‘It is the first attempt by a UK government to introduce a form of debtor-in-possession insolvency proceeding that is akin to Chapter 11. Many European countries are moving this way as well.’

Unlike in other formal insolvency procedures such as administration or liquidation, the board retains control of the company throughout the moratorium. Elford argues that ‘the perceived wisdom is that value for creditors and shareholders is better preserved by companies being able to restructure themselves, rather than directors of companies having to cede control to administrators and liquidators’.

But this process may be too pricey for smaller companies. Elford argues that the new role of a ‘monitor’ is the ‘biggest impediment to the moratorium’s working in a wide range of scenarios’. The monitor is a licensed insolvency practitioner (IP) appointed to oversee the process and to confirm that it is likely to result in the rescue of the company as a going concern; if that is unlikely, the IP will terminate the process.

‘So, on the one hand, you are trying to give directors of the business the power and the opportunity to rescue the company, but [on the other] the monitor retains a pretty stringent oversight of the company’s affairs during the period,’ he says.

Not only does the monitor introduce ‘a layer of cost that the small businesses the government is seeking to rescue simply cannot afford’, it is also a ‘hurdle and a risk’ for the IP, Elford concludes.

Coulson concurs: ‘The moratorium having to rest on a certification by an IP that the company, not the business, can be rescued as a going concern will limit its use.’

The biggest statutory change before CIGA was the Enterprise Act 2002 (EA). Coulson says that ‘the culture change that the government wanted to achieve via the Enterprise Act of rescuing companies as opposed to saving businesses or increasing the return to creditors did not materialise’. She questions whether CIGA will have the same impact as its predecessor, which ushered in ‘a fast-track route to administration and the increase in pre-pack insolvencies’.

Pre-pack administrations are frequently used in the retail sector, most recently by Jones, Oak Furnitureland and M&Co.

‘That is a tried and tested way of rescuing businesses, but the underlying company is lost and all the value to shareholders is lost,’ notes Elford.

Judge remains sceptical about take-up of the new processes in the UK. ‘Just by changing the law, you don’t automatically change the business culture,’ he says. For one thing, the overwhelming majority of insolvencies in this country are among companies with £5m-10m turnover. For another, the UK business community has traditionally focused more on saving the underlying business and assets, including the workforce, rather than the corporate vehicle.

Coulson is similarly cautious: ‘The new provisions continue with the culture of seeking to save companies as opposed to the businesses operated by those companies and the protection of jobs, [but] it remains to be seen whether they will be embraced in practice.’

How has the new corporate insolvency law translated into work for lawyers?

Marshall says that in terms of providing netting and collateral opinions to clients, the moratorium and the changes to termination (or ‘ipso facto’) clauses are having ‘the most impact’.

The latter is another debtor-friendly, Chapter 11-inspired reform complementing the moratorium and the restructuring plan. It prevents a supplier from terminating a contract for the supply of goods and services when a company enters a formal insolvency procedure, bar a few exceptions.

‘Luckily, the exclusions for financial contracts have, so far, allowed us to continue to give positive advice in these areas,’ says Marshall.

The suspension of termination clauses on the grounds of insolvency is already affecting contracts and contract management. ‘Lawyers are trying to work out how best to draft contracts to make sure that they can terminate for other reasons,’ she adds.

The new restructuring plan is already generating significant new work for some of the larger firms. Virgin Atlantic Airways, assisted by Marshall’s firm, was one of the first companies to test the new restructuring tool in a bid to raise £1.2bn. The High Court sanctioned the plan on 2 September.  

Cottee has been busy advising financial sector clients. He says: ‘The cross-class cramdown provisions are the most controversial of the act and this has been a key focus for our bank clients as potentially secured creditors can be compromised against their wishes.’  

Coulson, who mainly acts for IPs, says: ‘The first are very busy with advisory work, which we assist them on, and with formal insolvency in some obvious sectors such as retail, travel, hospitality and entertainment. But I think that though busy and getting busier, they are gearing up with a lot more work in Q3 2020 and through next year. The government support for business has held back the flood of formal insolvencies.’

This, together with other measures, including the temporary easing of regulatory requirements by CIGA, has helped to keep the number of company and individual insolvencies low, according to the Insolvency Service. Its latest monthly statistics showed that in June, three months after the lockdown, company insolvencies in England and Wales were down by half compared with the same month in 2019.

Consequently, as Coulson points out, ‘the measures that have affected us and instructions in the past few months are much more the restrictions on winding-up petitions’.

She adds: ‘Creditor clients have higher hurdles to jump to petition, and director as well as corporate clients are seeking advice on their options, given a sudden shutdown of business in many cases and managing the risks associated with sudden loss of revenue or staff furlough.’

Judge, who typically issues between 10 to 20 winding-up petitions each month, says the temporary ban until the end of September, which he believes will be further extended until the end of the year, has had ‘quite a big impact’ on his practice.

‘We’ve been having a problem since about May. That’s 60 to 70 petitions that I haven’t issued,’ he says, speaking to the Gazette at the end of July. The loss of this work from landlords and other clients has not been balanced out by the new insolvency tools: for example, he was working on only one moratorium.  

Fundamentally, though, insolvency work will be determined by the state of the economy. But there are important differences between now and the last major downturn from 2008.

‘That was a crisis that hit the banks and this is a crisis that has hit everybody, every business, at every level, so this is a Great Depression-type crisis,’ Elford says.  Furthermore, lenders and HM Revenue & Customs were more lenient towards enforcing the payment of loans or taxes.

Dealing a further blow to creditors and therefore the availability of finance for businesses in the UK is the reinstatement of ‘Crown Preference’ (abolished by the EA) from 1 December. HMRC will become a preferential creditor for unlimited amounts of VAT and taxes collected and held by the business on behalf of employees, such as PAYE and National Insurance contributions.

‘The act along with the reintroduction of Crown Preference further reduces the value of the floating charge and could result in less lending, at a time when the UK economy needs an environment that actually encourages [it],’ says Cottee, who acts for lenders.

While the overall effect of CIGA can be seen as negative for creditors, one element could help them. For example, a bank demanding its money back could ‘force’ the company directors to call a moratorium and, if this did not work and the company went into liquidation or administration (within 12 weeks of the end of the moratorium), ‘the bank would be able to go back above the HMRC again because they would get the moratorium super-priority’, according to Judge.

‘Other than that, I am not sure the new statutory insolvency moratorium will be used an awful lot anyway. It will be used more as a means to an end, to create a priority for banks and other lenders,’ he concludes.

There are concerns about the way in which CIGA was introduced. Lyn Green, head of operations at the Insolvency Practitioners Association, says: ‘It was an achievement to create and introduce the legislation in so short a time. However, the truncation of the established legislative procedures may mean that there will be unintended consequences, and further changes may be needed as we gain practical experience of implementing the provisions.’

Green says that to address this concern, ‘the CIGA includes more so-called “Henry VIII clauses”, which allow changes to be made by regulations without further reference to parliament, which, while being pragmatic, is not something we would want to see becoming the norm in future legislation’.

Russell says that ‘the Insolvency Service would concede that there is no way the act could wholly cater for all the nuances that it should cater for, or perhaps would have catered for, had there been a slightly longer legislative process’.

Elford points out that ‘the permanent provisions relating to the ban on ipso facto clauses will need clarification as to their scope or extent’, either in the form of further legislation or case law, highlighting that this is an area that ‘could be ripe for litigation’.

One ‘obvious unintended consequence’, according to Bevan Brittan partner Virginia Cooper, is that ‘some suppliers, anticipating the effects of Covid-19, may seek to sidestep these restrictions by terminating contracts at an earlier stage in circumstances where they may otherwise have granted debtors a degree of forbearance’.

Other concerns relate to the ‘temporary’ provisions that could now be extended further, beyond the end of September. Under CIGA, directors or owners will not be held personally liable for continuing to trade after they knew or ought to have known that there was no reasonable prospect of the company avoiding insolvent liquidation or administration. Coulson warns that they should not feel a ‘false sense of confidence from what has been rather mis-sold as a “get out of jail free” card’.

Keystone Law partner Patrick Elliot says: ‘Directors may think the suspension of wrongful trading gives them licence to misbehave, without realising they still have potential liability under the Insolvency Act 1986 and the Companies Act 2006.’ The fact that the temporary easements introduced by CIGA are retrospective means ‘potential litigation as parties fight over its applicability’, he adds.

‘Perhaps the most controversial aspect of the new legislation is the retrospective effect of the restrictions for serving statutory demands and filing winding-up petitions [effective from 1 March and 27 April 2020, respectively], which will relate to pre-Covid-related debts, some of which may have already been outstanding for some time,’ Cooper observes.

Chris Parsons, solicitor at Paris Smith, says: ‘Retrospective legislation, particularly with regard to statutory demands and winding-up procedure, has essentially been penalising those who had their “ducks in a row” to commence enforcement against their debtors, but who are now being told that the action they have taken is no longer possible, having spent costs on both legal fees and disbursements.’  

Judge says ‘there will be an awful lot of winding-up petitions as soon as the ban stops’, including from commercial landlords who are currently not entitled (until the end of September, at least) to forfeit business tenancies for non-payment of rent, as a result of the Coronavirus Act 2020 introduced in March: ‘There will be quite a few landlords that [will] get into financial problems.’ 

 

Marialuisa Taddia is a freelance journalist


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