UK insolvency and restructuring update: COVID-19 support and major reform

Suspension of wrongful trading rules

On 28 March 2020, the Government announced the temporary suspension of wrongful trading rules retrospectively from 1 March 2020, for a period of three months.

The wrongful trading rules apply if a person who is or was a director of a company knew or ought to have concluded at some point before the commencement of an insolvent liquidation or an insolvent administration of the company that there was no reasonable prospect that the company would avoid going into liquidation or administration, yet allowed the company to continue to trade. The sanctions for wrongful trading include personal liability for the director.

This announcement follows a number of other jurisdictions implementing similar measures.

The legislation pertaining to directors’ duties generally, the director disqualification regime and fraudulent trading rules remain in place and unamended.

Other measures

Based on the announcement of the Business Secretary, Alok Sharma, on 28 March 2020, it appears that the UK Government intends to fast track the implementation of reforms based on its March 2018 consultation on “Insolvency and Corporate Governance” and the earlier May 2016 review of the “Corporate Insolvency Framework”, the results of which were announced in August 2018.

While the exact timing and scope of reforms is currently unclear, we have set out a summary of the proposed reforms announced in August 2018.

New Business Rescue Moratorium

It is currently expected that a new moratorium will be available to companies that are solvent but risk becoming insolvent if action is not taken. The moratorium will be triggered by a company filing papers at court for an initial period of 28 days, with a further 28 day extension available. A moratorium may extend beyond 56 days, subject to 50% of secured creditors by value and 50% of unsecured creditors by value consenting to the extension.

The process must be supervised by a qualified insolvency professional called a “monitor”. A monitor will assess whether certain eligibility tests and qualifying conditions are met upon filing, including regarding the prospect of the company being successfully rescued and whether the company has sufficient funds to carry on business during the moratorium. The role of the monitor will be limited in scope, primarily to the initial and ongoing assessment of eligibility criteria being met and continuing. Otherwise, directors will remain in control of the company’s operations during the moratorium. If a monitor considers that a company no longer meets the eligibility criteria, they will be required to immediately commence the termination of the moratorium.

A creditor will be entitled to challenge the moratorium either on the basis that eligibility criteria is not met or that the process is prejudicial. Sanctions will be introduced to deter abuse of the moratorium by directors.

Historically in the context of consensual restructuring discussions, qualifying floating charge holders have retained the ability to appoint an administrator. A secured creditor would be prevented from appointing an administrator, if the new moratorium was triggered before the appointment.

New Restructuring Tool

It is also expected that a new restructuring tool will be introduced that closely resembles a scheme of arrangement but allows a company to bind all creditors, including dissenting classes of creditors, through a cross-class cram down provision. There will be no financial entry criteria to the scheme.

Similar to a scheme of arrangement, classes of creditors would be determined on a case-by-case basis, with a vote in favour of a restructuring requiring 75% of the class by value and 50% by number to agree.

The Court will ultimately be empowered to confirm the restructuring plan and bind classes of dissenting creditors, provided that at least one class of impaired creditors votes in favour of the proposal. Even if this threshold is not met, the Court may still sanction the proposal if it can be shown that is necessary to achieve the aims of the restructuring, and it is just and equitable.

Ipso Facto Clauses

Suppliers are expected to be prevented from relying on contractual clauses that allow termination as a result of a counterparty entering an insolvency process. A supplier will be able to seek permission from the court to terminate the contract on the basis that not being able to rely on the clause will cause undue financial hardship.

Sale of Distressed Subsidiaries

The Government has also announced plans to introduce reforms that mean a director of a holding company who does not give proper consideration to the interests of stakeholders of a financially distressed subsidiary when it is sold may be subject to disqualification action. The measures will apply to a subsidiary which enters an insolvency process within 12 months of the completion of the sale.

Value Extraction Schemes

Whilst there will not be any new powers in relation to “value extraction schemes” as initially envisaged, the Government does intend to refine existing insolvency office-holders’ powers to ensure such schemes can be challenged and unwound.

Corporate Governance

The Government intends to engage in further consultations in order to progress reform regarding transparency of complex group structures, shareholder stewardship, dividend payments and board room effectiveness.

Conclusion

The proposals represent the most significant reform to the UK’s insolvency and restructuring regime in a number of decades. The Government’s intention in August 2018 was to provide greater opportunity for viable businesses to restructure where they can be saved and, where they cannot be saved, ensure proper accountability of those charged with responsibility for the company.

These reforms are now being urgently progressed in response to the COVID-19 pandemic. The exact measures the Government will seek to implement have not yet been released and the devil will be in the detail. In response to the initial consultation, many creditors expressed concerns that the proposed moratorium could be open to abuse. Whether the draft reforms achieve a balance between the Government’s current aim of providing support to businesses during this unprecedented global event and those concerns, remains to be seen.