The Corporate Insolvency and Governance Act 2020 received royal assent on 25 June 2020. Many of the provisions of the act are based on the bill which was initially proposed pre-COVID-19, with a framework having been set out in August 2018. However, since the pandemic struck, new temporary provisions have been added to the act.
The changes introduced in the act are the most significant changes in insolvency law since 2003, when the Enterprise Act legislation was introduced to revamp the administration process.
The changes can be distinguished between those that are permanent and those that are temporary, and which have been introduced in response to the extraordinary consequences of the coronavirus.
The moratorium is intended to be used by companies that are in financial distress but it is not intended to simply delay the insolvency of a company that has no realistic prospect of survival. The directors remain in control of the company overseen by a monitor. The monitor is a licensed insolvency practitioner. The monitor must be of the view that the moratorium would result in the rescue of the company were it not for worsening of the financial position of the company for reasons related to the coronavirus.
The moratorium is initially for 20 business days, extendable to 40 business days, to enable viable companies to pursue a rescue plan without creditors being able to take legal action. Any extension of the moratorium beyond 40 business days (and up to one year) will require the consent of the creditors or the court.
In order to provide respite from the financial pressures of pre-moratorium debts, the company benefits from a payment holiday in respect of certain liabilities incurred before the moratorium. However, companies will have to pay all moratorium debts, for example obligations incurred in relation to the performance of a contract for the supply of goods during the moratorium, salaries, rent, and the monitor’s fees and expenses. In particular, all finance payments need to be met during this period. To the extent that the company cannot pay those liabilities, the monitor should bring the moratorium to an end.
Moratorium debts and priority pre-moratorium debts (being debts which the company was required to continue to pay during the moratorium) will enjoy super priority in the event that the company enters into an insolvency process within 12 weeks of the expiry of the moratorium. However, any debt which is accelerated during the moratorium will not receive super priority.
During the moratorium, without permission of the court:
- Landlords cannot exercise a right of forfeiture,
- No steps can be taken to enforce security (except collateral security charges or under a financial collateral arrangement) without the permission of the court,
- There can be no appointment of administrators (unless appointed by the directors),
- No steps can be taken to repossess goods under hire purchase contracts, and
- No legal proceedings can be commenced or continued (save for proceedings involving employees).
The moratorium can be used in conjunction with either a CVA, a scheme of arrangement, or a restructuring plan. However, there are no express debtor in possession financing provisions — although it is still possible to structure similar arrangements through agreements with existing lenders.
Certain companies are ineligible for the moratorium, including banks, public-private partnership companies, and securitization companies.
The restructuring plan is modelled on the UK scheme of arrangement and, like the scheme, is incorporated within the Companies Act 2006 and not under an insolvency statute. As with a scheme, creditors will be divided into classes based on the similarity of their interests. Unlike a scheme, the restructuring plan includes cross-class cram down whereby dissenting creditors would be forced to sign up to the plan, if it is sanctioned by a court where:
1. The court is satisfied that none of the members of the dissenting class would be any worse off than they would be in the event of a relevant alternative; and
2. The arrangement has been agreed by 75% in value of a class of creditors or members who would receive a payment or have some genuine economic interest in the event of the relevant alternative.
The court may exclude certain members/creditors where it is convinced that those classes do not have an economic interest in the company.
Cross-class cram down is one of two key distinguishing factors compared to a scheme.
The other key distinguishing factor is, to use a restructuring plan, the company must be in or on the verge of financial difficulties that are affecting, or will affect, its ability to carry on business as a going concern.
The guidance to the act refers to the well-established principles in schemes and states that the court has absolute discretion over whether to refuse a plan even where the conditions are met, for example where it is not just and equitable to do so.
In addition, the court is able to bind shareholders into the terms of a restructuring plan. The effect of this may be to disapply certain shareholder rights. For example, shareholders' rights of pre-emption and the need to seek shareholders’ approval to allot and issue further shares. Accordingly, this would remove existing shareholders’ rights of consent over shares issued as part of a debt for equity swap restructuring.
There is no absolute priority rule, whereby a dissenting class of creditors — which does not approve the restructuring plan — would have to be paid in full before a more junior class could receive any distribution under the plan. This creates the theoretical possibility of senior lenders being dragged along by a restructuring plan which they do not approve and where they are not necessarily kept whole; referred to as ‘cramming up’. How that would work in practice remains to be seen. It follows that if the senior lenders are not kept whole, this would mean that the junior lenders are out of the money and the court may disregard those out-of-the-money interests, and therefore ‘cramming up’, in this scenario, would not be approved.
Virgin Atlantic Airways Limited is the first company to seek to implement a restructuring plan under the new act. Its restructuring plan was sanctioned by the court on 2 September, and became effective on 4 September. In this case, each class of creditors voted overwhelmingly in favour of the restructuring plan. Therefore, the court did not need to consider cross-class cram down. However, in considering whether to exercise its discretion to approve the restructuring plan the court relied on the usual tests for sanction of a scheme.
Ipso Facto Clauses in Goods & Services Contracts
The act prevents suppliers of goods and services from terminating or exercising any right under a contract (i) due to its counterparty entering into a restructuring or insolvency procedure or (ii) for a pre-insolvency event or breach not previously acted upon and where the counterparty has subsequently entered into an insolvency process. This a significant change to the existing law and is very widely drawn.
It is designed to promote business rescue and removes the leverage of suppliers to hold companies to ransom. For example, threatening to terminate unless their pre-insolvency arrears are paid. The supplier must continue to supply the debtor on the same terms and will not be guaranteed payment of arrears.
Suppliers can be relieved of the obligation to continue supplies if it causes ‘hardship’ to the supplier's business — ‘hardship’ is not defined in the act so it is difficult to determine what constitutes ‘hardship’. There is also a temporary exception for small suppliers during the emergency until 30 September 2020.
Void Statutory Demands (for the purposes of Winding Up Petitions)
The act contains a prohibition on presenting winding up petitions on or after 27 April 2020 based on statutory demands served between 1 March 2020 to 30 September 2020. This applies to all statutory demands, regardless of whether the non-payment of the debt demanded was COVID-19 related.
Restrictions on Winding Up Petitions
The act states that a creditor may not present a winding up petition between 27 April and 30 September 2020 unless the creditor has reasonable grounds for believing that:
- The coronavirus has not had a financial effect on the debtor company, or
- The facts by reference to which the relevant ground applies would have arisen even if the coronavirus had not had a financial effect on the debtor company.
For existing petitions which were presented on or after 27 April, the court will consider whether the creditor met the conditions set out above. Where the court is satisfied that the conditions are not met, the court may make such order as it thinks appropriate to restore the position to what it would have been if the petition had not been presented.
Winding up orders made between 27 April and 25 June 2020, when the act was not in force, will be regarded as void provided the order would not have been made if the act had been in force at that time. At this stage it is not clear how the liquidation and any actions taken by the liquidator or official receiver regarding the company’s assets will be unwound.
Furthermore, if it appears to the official receiver that a winding up petition presented on or after 27 April 2020 did not meet the new conditions set out in the act, he/she must refer the matter to the court to decide on the status of the winding up order and the company wound up.
For petitions presented on or after 27 April 2020 based on a failure by the company to pay its debts, the court may wind up the company only if satisfied that the company would have been in the same position even if coronavirus had not had a financial effect on the company.
Within the act "financial effect" of the coronavirus has a limited definition which refers to the financial position of the debt worsening in consequence of, or for reasons relating to, the coronavirus. However, there is no clear guidance as to how this is determined and how creditors should evidence their grounds for presentation of a petition to the court. This appears to be a point which will need to be determined by caselaw. It is anticipated that the courts will apply a broad interpretation in order to meet the intentions of Parliament when introducing this temporary measure (thereby protecting companies from debt recovery procedures during the relevant period).
Section 129 of the Insolvency Act 1986, for liquidations based on petitions presented between 27 April and 30 September 2020, is disapplied under the act and the winding up is deemed to commence on the date of the order (rather than on presentation of the petition). This means that the presentation of a petition will not prohibit disposals of the company’s property in the ordinary course of its business (which are currently void under section 127 of the Insolvency Act 1986 unless a validation order has been obtained). This change also impacts the hardening period for security and the look back period for antecedent transactions.
Lastly, winding up petitions presented after 25 June but before 30 September must not be advertised until the court has determined whether it is likely to make a winding up order.
These provisions apply to winding up petitions presented against all companies (there are no exclusions).
Suspension of Wrongful Trading Liability
The act introduces a suspension on directors’ personal liability for wrongful trading with retrospective effect from 1 March 2020 to 30 September 2020. During this period the court will 'assume that the person is not responsible for any worsening of the financial position of the company or its creditors’. This provision is not expressly linked to COVID-19 liabilities. Furthermore, there is no context for this assumption by the court or clarification as to whether the assumption can be rebutted.
However, other directors’ duties and liabilities will continue during the relevant period will not prevent liquidators/administrators from bringing claims against directors in respect of their actions during the relevant period based on other provisions of the Insolvency Act and/or the Companies Act 2006.
The suspension of wrongful trading liability does not apply to directors of excluded companies which includes insurance companies, banks, public-private partnership project companies, and overseas companies.
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At present the temporary provisions are anticipated to end on 30 September 2020. However, the act states that the Secretary of State has the power to extend the temporary provisions by up to 6 months.
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Simon ThomasPartnerFinancial Restructuring, European Offices