The Corporate Insolvency and Governance Act 2020 (“CIGA”) became law on 26 June 2020. CIGA sets out the detail of the UK Government’s reforms to the existing restructuring and insolvency regime as part of its response to the economic crisis caused by the COVID-19 pandemic.
Background
The legislation was enacted in little more than 6 weeks and introduced the most significant reforms to the UK’s restructuring and insolvency regime in almost 35 years. According to CIGA’s explanatory notes its overarching objective is “to provide businesses with the flexibility and breathing space they need to continue trading, and to help them avoid insolvency during this period of economic uncertainty. The measures are designed to help UK companies and other similar entities by easing the burden on businesses and helping them avoid insolvency during this period of economic uncertainty.”
CIGA complements various COVID-19 related legislation and schemes enacted earlier in the year (including the Coronavirus Act 2020). It makes 3 significant permanent reforms to the UK’s restructuring and insolvency regime and implements a number of temporary measures designed to mitigate some of the economic challenges of COVID-19.
Permanent Reforms
CIGA introduces 3 permanent reforms. These were subject to a previous consultation by the UK government and culminated in a report by the Department for Business, Energy and Industrial Strategy in August 2018. These changes are intended to introduce greater flexibility into the insolvency regime and maximize the chances of survival of struggling businesses by affording them breathing space to explore rescue options.
Restructuring Plan
CIGA has introduced a new form of restructuring allowing the court to impose a compromise on a company’s creditors and shareholders even where a class votes against it.
CIGA introduces a restructuring plan procedure to offer companies facing financial difficulty a flexible means of implementing a restructuring. The procedure is modelled closely on the existing UK Companies Act scheme of arrangement but with some important distinctions. In particular a key feature is the inclusion of a “cross-class cram down” mechanism which will allow a company to bind all creditors even those who vote against the plan.
This will enable the court to sanction a plan even if the support of a creditor class has not been obtained. There are conditions to this namely that no dissenting class will be worse off in the “relevant alternative” and the Plan is approved by 75% in value of creditors or members who are “in the money” i.e. would receive a payment or have a genuine economic interest in that “relevant alternative”.
The “relevant alternative” is whatever the court considers would be the most likely outcome if the compromise is not sanctioned.
The overarching objective of the plan is to eliminate financial difficulties affecting the company’s ability to carry on business. All companies will be eligible to apply for an arrangement and reconstruction plan, including overseas companies which can demonstrate a sufficient connection to the UK.
Whilst a company need not be insolvent to avail itself of the restructuring it must satisfy two conditions to propose a plan:
the company must have encountered or be likely to have encountered financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern
a compromise or arrangement must be proposed between the company and its creditors or members and the purpose of such compromise or arrangement must be to eliminate, reduce, prevent or mitigate the effect of any of the financial difficulties the company is facing.
Moratorium
A new moratorium is introduced which will allow businesses protection from creditors without court or creditor approval and prevent the commencement of legal or insolvency proceedings against the company.
The second permanent reform is the introduction of a standalone moratorium procedure designed to facilitate a rescue of the company by allowing distressed companies breathing space to explore restructuring options.
The moratorium is intended to result in a better, more efficient rescue plan that benefits all of the company’s stakeholders - consistent with the rescue purpose of the reforms. The rescue could take a number of forms including a Company Voluntary Arrangement (CVA), a CIGA reconstruction plan (see above) or the introduction of new capital.
The moratorium will:
protect a company from winding up petitions and most types of legal proceedings
impose a payment holiday in respect of certain pre-moratorium liabilities
prevent creditors from taking certain enforcement action
It should be noted that there are a number of exceptions limiting the number of eligible companies and the liabilities caught and little or no protection against financial creditors.
There are two routes to obtaining the moratorium:
In the case of a UK company which is not subject to an outstanding winding-up petition, its directors file the “relevant documents” with the court namely:
a notice that the directors wish to obtain a moratorium
a statement from a qualified person (“the proposed monitor”) that they are a qualified person who consents to act
a statement that the company is an “eligible company”
a statement that the company is, or is likely to become, unable to pay its debts and that, in the proposed monitor’s view, it is likely that the moratorium would result in the rescue of the company as a going concern
If the company is subject to an outstanding winding-up petition, or is an overseas company, application can be made by the directors as above but the Court may only make an order for a moratorium where it is satisfied that it will achieve a better result for the company’s creditors as a whole than would be likely if the company were wound up (without first being subject to a moratorium).
A company is “eligible” unless it is an “excluded” company. Unfortunately the list of excluded companies is wide and captures potentially many SME and larger companies.
Termination Clauses
Contractual provisions permitting termination of supply on a customer’s entry into an insolvency procedure will cease to have effect.
The final permanent reform is also one of the most significant features of the legislation for suppliers namely that provisions in supply contracts allowing for termination by the supplier on the customer’s insolvency (or similar) will cease to have effect (ipso facto provisions). Suppliers will also be prevented from making payment of outstanding debts a condition of continued supply i.e. demand ransom payments for continued supply (see our June newsletter). The prohibition will not apply to a wide range of financial contracts nor will it cover all types of commercial arrangements.
The measures are intended to complement the policy for the moratorium and the Plan and part of the general objective of enhancing the rescue opportunities for financially distressed companies.
However whilst this measure offers some protection for distressed companies, it will only exacerbate the exposure of suppliers who will be obliged (subject to certain exclusions) to continue to supply. Suppliers will need to be extra vigilant in monitoring the financial condition of their counterparts. There will remain a limited window of opportunity for suppliers to act where the onset of a customer’s insolvency appears likely. In particular, the measures do not affect the enforceability of a provision which is linked to the customer’s inability to pay its debts (i.e. cash flow or balance sheet insolvent) rather than the entering into of a formal insolvency process; the prohibition is triggered by formal insolvency, rather than actual insolvency.
Suppliers should review their contracts and consider the inclusion of early warning triggers to mitigate their potential exposure to struggling customers.
Temporary Measures
These measures were introduced specifically to help businesses during the current crisis and concern the suspension of liability for wrongful trading and restrictions on statutory demands and winding up petitions. The measures are designed to support directors of struggling businesses to continue trading through the emergency without the threat of personal liability whilst protecting their companies from aggressive creditor action.
Wrongful Trading
Liability for wrongful trading is largely suspended where incurred in the period between 1 March 2020 and 30 September 2020.
As part of its early COVID-19 response the Government announced in March that the wrongful trading regime would be temporarily suspended. This was intended “to give company directors greater confidence to use their best endeavours to continue to trade during the pandemic emergency without the threat of personal liability should be company ultimately fall into insolvency”. The suspension applies retrospectively from 1 March 2020 until 30 September 2020.
The new regulations provide that when determining the contribution a director who has wrongfully traded is to make to a company’s assets, the Court is required to assume that a 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 September 2020. In this way CIGA reduces rather than suspends the wrongful trading regime and does not protect directors who may have wrongful trading liability which pre-dates that period.
Directors would be well advised to proceed with caution and not view these measures as some form of “green flag”. It also worth remembering that the measures do not affect the raft of other legislation under which directors can incur personal liability.
Winding up Petitions
CIGA imposes restrictions on the presentation of winding up petitions based on statutory demands dated 1 March 2020 to 30 September 2020. A creditor will be unable to wind up a company unless it has reasonable grounds to believe that COVID-19 has not had a financial effect on the company.
CIGA has introduced a number of obstacles into the path of a creditor’s potential winding up of debtor companies. Any creditor considering whether to serve a statutory demand or present a winding up petition needs to consider these new measures and the obstacles they create.
In summary:
No petition can be presented on the basis of a statutory demand where that demand was served in the “relevant period” i.e. from 1 March 2020 ending on 30 September 2020.
No creditor may present a petition on the grounds that the company is unable to pay its debts unless it has reasonable grounds for believing that coronavirus has not had a financial effect on the company or that the relevant ground would have arisen anyway.
If a moratorium is obtained then, except with the permission of the court, no steps may be taken:
to enforce any security over the company’s property (save under a financial collateral arrangement or a step to enforce a collateral security charge);
to repossess any goods under a hire-purchase agreement;
to forfeit a lease by peaceable re-entry of business premises; and
to commence or continue legal proceedings against the company or its property (with limited exceptions).
A moratorium prevents the crystallisation of a floating charge
This reform is likely to represent a significant hurdle to creditors obtaining a winding-up order in the current climate. Conversely it reduces the threat of wrongful trading personal liability for directors of struggling businesses who continue to trade through the present crisis while uncertain whether their company will ultimately avoid insolvency. Debtor companies need to remember that this legislation does not preclude creditors taking other action for payment defaults such as seeking to trigger an administration process.
Closing thoughts
Clearly designed to be debtor friendly the new measures are intended to enhance the rescue culture of the UK insolvency regime and, set against the backdrop of the current crisis, provide tools for directors and their advisers to save struggling businesses which are otherwise fundamentally sound. There remains a question whether the reforms strike a fair balance between the various stakeholders and the UK government will be watching the position closely to determine whether further reform or review is necessary.
