21 May 2020

Following the Government's announcement in March that the hotly anticipated changes to the UK's insolvency regime would be rushed through Parliament with further, temporary, provisions to mitigate the impact of COVID-19, insolvency practitioners and business professionals alike have been awaiting further clarity on what the Business Secretary's comments mean for businesses both in the current climate and more generally.

Clarification has now arrived in the form of the new Corporate Insolvency and Governance Bill 2020 (Bill), published on 20 May 2020. Whilst bills are often subject to change we think that the current draft provides a good indication of what the substantive changes will be given the levels of consultation preceding its first reading. In addition, the Government has announced that it intends to use emergency powers to introduce the Bill quickly, with an aim of receiving royal assent as soon as possible in June 2020, which may mean that less changes are made prior to the Bill becoming law.

What is changing?

The Bill, which represents the biggest change to insolvency legislation in 20 years, introduces the following permanent and temporary amendments to the current regime, detailed further below:

  • Permanent changes:
    • a new moratorium on enforcement action;
    • a new 'restructuring plan' process; and
    • disapplication of supplier termination of contract provisions for insolvency.
  • Temporary changes:
    • a temporary suspension of wrongful trading; and
    • changes to the Winding up Petition and Statutory Demand processes.

Permanent changes

A new moratorium on enforcement actions

Perhaps the most revelatory change introduced by the Bill is a new free-standing moratorium.

For those unacquainted, a moratorium is a mechanism whereby certain creditor enforcement or other legal actions are restricted for a period usually to buy breathing space to implement a restructuring or insolvency process.

The law currently ties moratoria to specific insolvency processes e.g. the administration moratorium (which is very similar to the new moratorium) or the small companies moratorium for CVAs. The limited scope of the latter, which is restricted to "small companies" (turnover of less than £10.2m, assets of less than £5.1m and fewer than 50 employers), was a driver for the newly announced moratorium. The old small companies moratorium under Schedule A1 to the Insolvency Act 1986 (the "Act") will be replaced by the new moratorium procedure since the eligibility of companies (see below) is not impacted by the size of the company.

The Bill is clear, however, that the proposed moratorium will be free-standing and not a gateway to a particular insolvency process – a first for English law.

The provisions relating to the new moratorium may be complex and detailed but we have sought to simplify matters by answering some key questions on the proposed moratorium:

What companies are eligible to apply for the moratorium?

All companies with the exception of financial services companies (e.g. insurance companies, banks etc.), companies already in a formal insolvency process, and companies that have been subject to a company voluntary arrangement (CVA), administration or otherwise in the period of 12 months prior to the filing date, are eligible to apply.

How can a moratorium be obtained?

In the case of a UK company, not subject to a winding up petition (which involves a slightly different process), the directors can obtain a moratorium by filing at court:

  • a notice that the directors wish to obtain a moratorium;
  • a statement from the directors of the company that, in their view, the company, is or is likely to become, unable to pay its debts; and
  • a statement from an insolvency practitioner that:
    • they are qualified to act and consent to act as monitor; and
    •  the company is an eligible company and, in the proposed monitor's view, it is likely that a moratorium will result in the rescue of the company as a going concern.

Once these documents are filed at court, the moratorium comes into force.

What is the role of the monitor?

The role of the monitor, who must be an insolvency practitioner, is to oversee the process of applying for the moratorium and any extension (if required).

What are the effects of the moratorium?

The moratorium will last for an initial period of 20 business days which may be extended, without creditor consent, for a further period of 20 business days, or up to one year (starting with the first day of the initial period) with the consent of creditors or by the court.

The moratorium will automatically end if the company enters into a compromise, arrangement or relevant insolvency procedure (CVA, administration (including on the filing of a notice of intention to appoint administrators) or liquidation).

Note also that if a CVA is proposed during the period of the moratorium the moratorium will be automatically extended until the CVA proposal has been disposed of.

A new 'Restructuring Plan' process

The Bill introduces a new option for businesses needing to restructure their liabilities – the Restructuring Plan. This Restructuring Plan is in addition to the existing mechanisms for compromising with creditors – the CVA and the Scheme of Arrangement (Scheme). The Restructuring Plan will operate much in the same way that the current Scheme mechanism does, and unlike a CVA (but like a Scheme), will be able to affect the rights of secured creditors without their consent.

Like a Scheme, a Restructuring Plan will require creditor consent (with 75% approval required for each class of creditors) and court approval (the latter is not required for a CVA). However, the key difference between this and a Scheme is that it can be sanctioned by the court (at the court's discretion) even if not all classes of creditors vote for it, subject to certain criteria.

Disapplication of supplier termination of contract provisions for insolvency

The Bill introduces a disapplication of the rights of a supplier to terminate a contract or do "any other thing" (e.g. amending payment terms) as a result of a company's insolvency. This means that, subject to certain exceptions, suppliers will need to continue to supply goods or services to an insolvent company, even when that supplier may be owed significant sums of money by the insolvent company prior to its insolvency.

Whilst the current law already provides some protection for insolvent companies against certain suppliers who provide essential goods and services (e.g. utilities and IT services), the Bill broadens the scope of these restrictions to a wider range of suppliers. In particular, subject to the exceptions noted below, various types of suppliers will be affected by these provisions (not just the limited category of suppliers provided for in the current legislation). Furthermore, the restrictions will apply not just to those companies which enter into administration or are subject to a CVA but those which enter into liquidation, are subject to the new statutory moratorium process and other prescribed insolvency procedures.

Exemptions apply to those suppliers and companies involved in the provision of financial services and those entities which were already protected by the existing legislation. The Bill also provides a temporary reprieve for those suppliers who are deemed to be "small entities" (by reference to certain financial metrics) but this is only until the later of 30 June 2020 or one month after the coming into force of this legislation (with a power to reduce or extend this period).

The broadening of the restrictions on suppliers from terminating contracts (or insisting upon disadvantageous amended terms) as a result of a company's insolvency is a welcome evolution of the existing law. This will give insolvent companies an additional tool in which to trade through a restructuring or insolvency process and increase the chances of a solution being found for the business (whether by a rescue of the company or a sale of its business as a going concern). These measures support the business rescue culture promulgated by this Bill and will complement the other proposed changes, including the new moratorium and restructuring plan.

Temporary changes

A temporary suspension of the offence of Wrongful Trading

Details on the long awaited suspension of personal liability for the offence of wrongful trading under the Act have now been provided. Our previous commentary on this can be found here.

The Bill will temporarily suspend the wrongful trading provisions for a period of three months with retrospective effect from 1 March 2020 to 30 June 2020 or one month after the coming into force of this, with the Court being able to 'assume that the person is not responsible for any worsening of the financial position of the company or its creditors that occurs during the relevant period' in connection with any action brought against a person for wrongful trading. Interestingly there is no clarity on the basis for the assumption nor whether this assumption is capable of being rebutted, as is the case with other offences under the Act where contextual presumptions apply.

Importantly, the suspension only applies to the offence of wrongful trading and not to the other duties that directors owe to a company when it moves closer to insolvency. As a consequence of this, this suspension, in our view, will not change much in practice as many of the considerations that need to be taken, whilst not now vulnerable to wrongful trading, will be picked up by the other duties that directors owe.

Crucially, as with other changes brought in to mitigate the impact of COVID-19, these changes are only temporary. Accordingly, whilst the current changes will undoubtedly factor into a board's decision-making process, particularly in deciding whether it is appropriate to continue trading notwithstanding financial distress or actual insolvency, it will remain important for directors to continually assess whether a company has a reasonable prospect of avoiding insolvent liquidation or administration (the current threshold test for wrongful trading actions). This is because, when the temporary suspension of wrongful trading liability is lifted, the directors may again need to be in a position to illustrate that 'every step' is being taken with a view to minimising losses to creditors. Board decisions during this period should, therefore, still be rationalised and minuted with professional advice being sought where appropriate.

It should also be noted that the suspension of wrongful trading only applies to eligible companies. This means that certain financial companies (e.g. insurance companies, banks etc.) and public-private partnership project companies are excluded from the suspension.

Changes to the Winding up Petition and Statutory Demand processes

This is another area of keen focus for companies that have faced aggressive creditor action taken in the wake of delays or deferrals in making creditor payments. This is of course of relevance to all companies and creditors seeking payment. There has, however, been a particular focus in the press on landlords making statutory demands and presenting winding up petitions with property interest groups lobbying the Government to implement changes to restrict aggressive debt collection practices in the current climate.

When the Government announcement came on 23 April 2020 one would be forgiven for thinking that the restrictions would only apply to landlord petitions, notwithstanding the potentially wider remit implied by conflicting statements within the announcement. This has led to much speculation. Indeed, in Re St Benedict’s Land Trust Limited, Re Shorts Gardens LLP [2020] EWHC 1001 (Ch), a case involving a supplier not a landlord, Snowden J. commented that 'it seems overwhelmingly likely that the proposed legislation will be limited to companies in certain identified sectors of economic activity, and to relate to statutory demands and petitions based upon claims by landlords for arrears of rent.'

The prohibitions introduced by the Bill, are as follows:

  • no petition for the winding up of a company can be presented on or after 27 April 2020 on the ground that the company has failed to satisfy a statutory demand if the relevant statutory demand was served during the period beginning with 1 March 2020 and ending with 30 June 2020 or one month after the coming into force of the Bill, whichever is the later; and
  • no petition for the winding up of a company can be presented by a creditor on or after 27 April 2020 until 30 June 2020 or one month after the coming into force of this Bill, whichever is the later, unless the creditor has reasonable grounds for believing that (a) coronavirus has not had a financial effect on the debtor, or (b) the debtor would have been unable to pay its debts even if coronavirus had not had a financial effect on the debtor.

There is limited guidance on the meaning of "financial effect" a limited definition which refers to the worsening of the debtor’s financial position in consequence of, or for reasons relating to, coronavirus. This would appear to be a relatively low threshold.

It will be interesting to see how the qualifier of financial effect will be assessed by the Court in practice and whether this has the intended effect of encouraging debtors and creditors to work together to find a solution, bearing in mind the temporary nature of the prohibition. Unless suitable compromises are reached during the prohibition period, debtor companies may well find themselves having to deal, once again, with the threat of petitions once the prohibition is lifted unless they seek to avail themselves of the other protections afforded by the Bill to implement a restructuring or rescue.

What do these changes mean for businesses?

This Bill can be split into long trailed, and long overdue, permanent changes to the insolvency regime, and altogether more hastily assembled temporary changes to help British businesses stagger through the present crisis.

The permanent changes are very welcome additions to the armoury of struggling companies, particularly as we face the prospect of a once in a generation recession. Used properly, they have the potential to save significant numbers of businesses and jobs that would otherwise be lost to preventable insolvencies, and, thus far, they appear to have had an almost universally positive response from those working in restructuring and advising companies in difficulty.

The temporary changes, suspending wrongful trading and limiting statutory demand and winding up petitions have not been as universally welcomed. This is understandable, as they seek to protect debtors during the height of this crisis, which is naturally at the expense of those who are owed money.

As discussed above, the suspension of wrongful trading is designed to prevent directors putting companies into an insolvency process in haste, but (rightly) does not water down directors' duties generally. The changes to demands and petitions are a blunt instrument, that will offer frustration for unpaid creditors (who may have cash flow issues of their own), but welcome (if qualified, and brief) relief for those in distress as the pandemic has caused cash flow to dry up.

The hope is that these short term measures will provide a bridge for vulnerable companies to survive until conditions improve and/or they can take advantage of the options that the very welcome new regimes provide, in the interests of themselves, their employees and their creditors.

We shall watch the Bill with interest as it passes through Parliament and report on any changes as they develop.

Watch this space.