Following consultations on insolvency and corporate governance in 2017 and 2018, the Government recently published its response setting out some notable proposed changes to the existing insolvency and corporate governance legislation. Following the high profile failures of Carillion and BHS, the Government’s response is largely aimed at encouraging the recovery of viable companies, improving transparency and promoting responsible directorship. This article will primarily look at the proposed changes focused on facilitating a rescue culture.
The response proposes the following changes to the insolvency legislation:
- The introduction of a pre-administration moratorium, throughout which the directors will remain in control of the company and a licensed insolvency practitioner (an “IP”) (referred to as a monitor) will support the integrity of the moratorium process and ensure creditors are protected.
- A prohibition on suppliers enforcing ipso facto clauses, which allow a contract to be terminated as a result of the company entering into a formal insolvency procedure, entering a moratorium or a restructuring plan.
- The availability of a new restructuring plan, which enables a company to bind all of its creditors with the approval of the court through a cross-cram down of creditors.
- The introduction of a new recovery power for an IP to undo a transaction, or series of transactions, which unfairly strip value from a company during the period leading up to insolvency.
Introduction of a restructuring moratorium
A key proposed change is the introduction of a pre-administration moratorium for financially distressed companies whilst they consider their options for restructuring. Unlike the CVA moratorium available to small companies, the moratorium would be available to nearly all companies that meet certain eligibility requirements and qualifying conditions, including that the company will become insolvent if no action is taken and that, on the balance of probabilities, rescue is more likely than not. A company, which is already insolvent, will not be eligible for the moratorium.
For a company to enter into the new moratorium, notice must be given to all creditors and necessary filings made at court. The consent of the monitor, who has objectively assessed that the eligibility test and qualifying conditions are met, must also be filed with the court.
The moratorium will initially last for a period of 28 days, which may be extended by the company for a further 28 days. The monitor must confirm that the qualifying conditions are still met prior to the company applying for an extension. Further, the Government believes that in certain circumstances it should be possible to extend the moratorium beyond 56 days, provided there remains a good prospect of achieving a better outcome for creditors than might otherwise be possible. The extension beyond 56 days will require the consent of more than 50% of value of both secured and unsecured creditors, except where seeking such consent is impracticable.
It is proposed that the directors of the company will remain in control during the moratorium; however, a monitor will be appointed to support the integrity of the moratorium process and ensure creditors are protected. The monitor will be responsible for approving any sale or disposal of assets outside the normal course of business as well as determining whether the eligibility and qualifying requirements are satisfied throughout the moratorium and terminating the moratorium if they are not satisfied. A monitor may provide additional services to the company during the moratorium period e.g. restructuring advice or being appointed as a CVA supervisor. However, a monitor cannot take an appointment as either an administrator or liquidator in the 12 months following the expiry of the moratorium.
At any time during the moratorium, creditors will have a right to challenge the moratorium on the basis that the qualifying criteria are no longer met or that the moratorium unfairly prejudices the creditor. The Government intends to take a similar approach as in administration and an application to court will need to be made to lift the moratorium. Generally, the court has been reluctant to interfere with the administration process and lift an administration moratorium, which suggests that it may also be reluctant to lift a pre-administration moratorium. Most significantly, secured creditors will be prevented from enforcing their security during the moratorium period and although, this is the same as in the current administration moratorium in that instance, the IP is generally receptive to requests from secured creditors to enforce their security. The question arises as to whether despite the ability to apply to court to lift the moratorium; a secured creditor will have any real ability to enforce its security during this pre-administration moratorium where the company is working towards rescue.
Costs incurred during the moratorium will be treated in the same way as an expenses in administration and super-priority status will be given to unpaid moratorium costs in any future administration, with highest priority being given to suppliers who are prevented from enforcing their termination clauses (as discussed further below), followed by other costs and the unpaid fees.
The rationale behind limiting the moratorium only to companies who are solvent is to encourage companies to deal with financial difficulties at an early stage however; in practice, it may be difficult to meet this criteria. Will a company be able to take advantage of this moratorium if it becomes unlikely that it will make certain payments during the moratorium period or will creditors be required to enter standstill arrangements during this period so that a company remains ‘solvent’?
Prohibition on enforcement of ipso facto clause
The Government have proposed a prohibition on suppliers enforcing a termination clause under a contract on the grounds that a counterparty has entered into a formal insolvency procedure, the new moratorium or a restructuring plan (referred to as an ipso facto clause). This prohibition will not apply to certain types of financial products and services, however it is intended that contractual licenses will be covered (other than those issued by public authorities).
Suppliers will, in exceptional cases, be allowed to exercise a right to rely on the termination clause on the grounds of undue financial hardship. To do so, they will need permission of the court, which will consider whether continuing the supply will more likely than not lead to the supplier’s insolvency and the reasonableness of the termination.
A new flexible restructuring plan
In addition to and independent of a moratorium, there is a proposal to introduce a new restructuring process which will allow a company to bind all creditors, including a junior class of creditors through a cross-class cram down provision. In order to protect minority creditor interests, a two-fold test requiring 75% in value, plus more than half the total value of unconnected creditors must vote in support. The restructuring plan legislation will further provide that a dissenting class of creditors must be satisfied in full before a junior class receive any distribution or keep any interest under the restructuring plan, however this can be departed from where it is vital to agree an effective and workable restructuring plan. Further, no cram down can occur unless at least one class of creditors who will not receive payment in full has voted in favour of the restructuring plan. The Government have proposed that the test for determining the fairness of a plan which is being crammed down will be whether the outcome is better than the outcome under the next best alternative, which could either be administration or liquidation and may ultimately be determined by the court.
The new restructuring process will be available to all companies (both solvent and insolvent) except those involved in specific financial market transactions or similar undertakings. The restructuring process closely resembles that for a scheme of arrangement, whereby a restructuring plan proposal will be sent to creditors and shareholders, as well as filed at court. The court will examine the classes of creditors and shareholders, who may challenge the formation of the classes. Upon satisfaction that the classes are appropriately constituted, the court will confirm that a vote on the proposal may be conducted ahead of a second hearing. Creditors and shareholders will then vote on the proposals and will be able to submit a counter-proposal or a challenge to the court. If no such challenge or counter-proposal is put forward, the court will decide whether to confirm the restructuring plan. Once confirmed, the restructuring plan is binding on all affected parties, although there will be a right to appeal. It is not clear from the Government’s response what the jurisdictional requirements will be for a company to apply for the new restructuring plan.
Value extraction schemes
In recent years, there have been certain high profile sophisticated schemes where companies extracted value from a company for the benefit of shareholders shortly before the insolvency of that company. The Government intends to enhance the recovery powers of IPs by allowing them to apply to the court to reverse a transaction (or series of transactions) which unfairly removed value from the company for the benefit of shareholders but to the detriment of creditors in the lead up to a company’s insolvency. The Government believes that such transactions will only occur with connected parties and proposes that this lookback period should mirror that which is in place for the existing recovery provisions in relation to transactions with connected parties, being 2 years.
The response paper also made a number of proposals in relation to the corporate governance of a company leading up to the insolvency of a company. For example, the Government proposes increasing enforcement powers against directors of dissolved companies. In addition, they are increasingly concerned with the sale of distressed subsidiaries and as such intend to develop guidance for considerations to be made prior to such sale. Finally, the Government highlighted the need to work with the investment community to strengthen and increase the efficiency of shareholder stewardship in large group companies.
The UK insolvency framework has traditionally been creditor friendly; however, the response paper paves the way for a shift in focus to a more debtor friendly framework. Overall, the proposed amendments are positive and highlight the Government’s goal of increasing the possibility of rescue of a distressed, but viable company. However, timing of the proposed amendments is unclear and although the response provides that legislation will be enacted as soon as parliamentary time allows, Brexit related legislation may slow it down by several years.