Coronavirus - Corporate Insolvency and Governance Bill - UK

• United Kingdom

• Banking and finance
• Coronavirus - Country overview
• Restructuring and insolvency

27-07-2020

The Corporate Insolvency and Governance Act 2020 (“CIGA 2020”) received Royal Assent on Friday 26 June 2020, having passed through Parliament in a little more than a month. Following our series of articles analysing the key provisions of the Bill as first published, we now revisit and summarise the key aspects of CIGA 2020 as enacted:

1. the temporary restrictions on statutory demands and winding-up petitions

2. the temporary, retrospective suspension of liability for wrongful trading

3. the introduction of “standalone” moratoriums for companies that are viable, but are experiencing financial difficulties

4. the introduction of “Part 26A Schemes” for companies that have encountered, or are likely to encounter, financial difficulties that threaten their ability to carry on business as a going concern

5. the permanent extension of protection of the supply of all goods and services to companies in financial difficulty

Temporary provisions

1. Temporary amendment to Insolvency Law: restrictions on statutory demands and winding-up petitions

CIGA 2020 imposes temporary restrictions on the use of statutory demands and winding-up petitions until 1 October 2020, unless extended by the Secretary of State for reasons relating to the effects of coronavirus on business or the economy. The process for obtaining a winding-up order is also modified temporarily.

What if I have already served a statutory demand?  Or, if I have already been served with a statutory demand?

Unless the statutory demand was served on the debtor before 1 March 2020, then the creditor cannot rely on the statutory demand to support the presentation of a winding-up petition.

But can you still present a winding-up petition?

Perhaps: you can present a winding-up petition provided that you are not relying on a statutory demand served on a debtor after 1 March 2020, and that you have reasonable grounds for believing either that:

• coronavirus has not had a financial effect on the debtor; or
• the debtor would have been insolvent even if coronavirus had not had a financial effect on it.

We will call that belief the “Pre-existing Insolvency Requirement”. There is no guidance on the “reasonable grounds” that must be shown for the petitioner’s belief that the Pre-existing Insolvency Requirement is met, but the court will want to see evidence that the debtor was in financial difficulty before the onset of the COVID-19 pandemic, such as:

• unpaid invoices, or evidence of late payment, from before 1 March 2020; or
• annual accounts from the previous financial year showing deteriorating cash flow and asset base against increasing liabilities.

An Insolvency Practice Direction relating to CIGA 2020 (the “CIGA IPD”) has also modified the usual process for the presentation, listing and hearing of winding-up petitions by providing that:

• to be accepted for filing, a winding-up petition must contain a summary of the grounds relied upon by the petitioning creditor in respect of the Pre-existing Insolvency Requirement;
• if the winding-up petition is accepted for filing, the Court will conduct a “pre-trial review” at which the Court will give directions for a preliminary hearing;
• at the preliminary hearing, the Court will:
• decide whether it is likely that it will be able to make a winding-up order, having regard to the Pre-existing Insolvency Requirement; and
• only list the winding-up petition for a hearing in the winding-up list if it is satisfied that that is likely.

If I want to present a winding-up petition, what do I need to do?

If you present a winding-up petition before 1 October 2020, you must include (in addition to the usual evidence of the debtor’s insolvency) a statement that the Pre-existing Insolvency Requirement is met, as well as a summary of the grounds you rely on to support that statement.

Ahead of the preliminary heading you should also prepare, file and serve a witness statement setting out, in detail, your reasonable grounds for believing that the Pre-existing Insolvency Requirement is satisfied.  The onus is on you, as the petitioner, to show this.

What if I have already presented a winding-up petition?

If a creditor presented a winding-up petition after 27 April 2020 but before CIGA 2020 came into force, and it is still yet to be heard, if the Court is not satisfied that the Pre-existing Insolvency Requirement is met it may make an order restoring the position to what it would have been if the petition had not been presented. 

If you are the petitioner, to mitigate the risk that your winding-up petition is dismissed on this basis, you should prepare and submit a witness statement setting out your reasonable grounds for believing the Pre-existing Insolvency Requirement is satisfied. 

What if a winding-up petition is presented against my company?

You should consider preparing a response to the winding-up petition showing that the company’s failure to pay the petition debt is solely a result of coronavirus.  However, you do not need to be concerned immediately about the advertisement of the petition: in addition to the changes to the winding-up process set out above CIGA IPD provides that, until the Court orders otherwise, winding-up petitions presented before 1 October 2020 are to remain private.

In addition, if a winding-up petition has been presented against your company (or if you are dealing with a company which has a petition pending against it), then you need not be concerned that payments, or dispositions of assets, made whilst the petition is pending will be voided (under section 127 of the Insolvency Act 1986 (“IA 1986”)): the automatic avoidance of such transactions during the period between presentation of a petition and a winding-up order will be suspended.

Will the Court make a winding-up order?

The Court can still make a winding-up order based on a winding-up petition presented before 1 October 2020, but – if it appears to the Court that coronavirus had a financial effect on the debtor before the presentation of the petition – it will only make such an order if satisfied that the debtor would have been unable to pay its debts as they fell due even if coronavirus had not had that financial effect on the debtor.

CIGA 2020 provides that coronavirus “…has a ‘financial effect’ if (and only if) the company’s financial position worsens in consequence of, or for reasons relating to, coronavirus”.

If the Court is not satisfied that the debtor would have been insolvent even if it were not for coronavirus, the Court may not wind it up, and may make an order restoring the position to what it would have been if the petition had not been presented.

2. Temporary amendment to Insolvency Law: suspension of liability for wrongful trading

CIGA 2020 provides for the retrospective, temporary suspension of liability for wrongful trading for company directors from 1 March 2020 until 1 October 2020, unless the suspension is extended for reasons relating to the effects of coronavirus on business or the economy.

What is wrongful trading?

Wrongful trading refers to the trading of a company after the point at which the directors (i) knew (or ought to have concluded) that there was no reasonable prospect that the company would avoid insolvent liquidation or administration and (ii) did not then take every step with a view to minimising loss to the company’s creditors.  A subsequently appointed administrator or liquidator (or their assignee) may bring a claim for wrongful trading under section 214 or section 246ZB of the IA 1986 against its directors.

In considering whether the directors knew (or ought to have concluded) that there was no reasonable prospect of the company avoiding insolvent liquidation or administration, the court will assess the conduct of each director against both the subjective knowledge, experience and skill of that director and also the objective knowledge, experience and skill of a reasonable and competent director carrying out the same function in a similar company.  If the court concludes, on those bases, that the directors knew (or ought to have concluded) that the company could not survive, it will then consider whether they took every step to minimise loss to the company’s creditors. The requirement is not to take every reasonable step but absolutely every step that the directors could have taken.

If a director is held to be liable for wrongful trading, the court may order the director to make a contribution to the company’s assets.  The award is compensatory in nature and the court will determine any contribution by reference to the loss caused to creditors and each director’s conduct from the point in time at which the directors knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation or administration.

Has liability for wrongful trading really been suspended?

Technically, the rules on wrongful trading have not been suspended; rather, CIGA 2020 has simply provided that directors will not be liable to contribute to the company’s assets in respect of wrongful trading that occurred between 1 March 2020 and 30 September 2020 (that is, during the “Coronavirus Pandemic period”) .

This is achieved by way of an evidential assumption that the directors were, in fact, responsible for worsening the company’s position during the Coronavirus Pandemic period.  Addressing queries raised during the passage of the Bill, the Government clarified that this assumption is not intended to be rebuttable by evidence.

What does this mean in practice?

Where a company is forced into insolvency proceedings as a result of the coronavirus pandemic, its directors may still be sued for wrongful trading under Section 214 or Section 246ZB of the IA 1986, if the criteria summarised above are met. However, in the event that a director is found liable for wrongful trading, the effect of CIGA 2020 is that, in considering what contribution (if any) the director should make to the company’s assets, the Court will assume that the director was not responsible for any worsening of the financial position during the coronavirus pandemic, and disregard any losses incurred during that period.

The director may still be liable for wrongful trading committed before or after the Coronavirus Pandemic Period of suspension. This means that the comfort which directors can draw from the suspension is limited. Not only do other risks of personal liability remain (as noted below), but also any director of a distressed company will need to consider very carefully whether the company has a realistic prospect of survival once the period of suspension comes to an end. If it does not have a realistic prospect of survival, and the director causes it to continue to trade, they will be at risk of liability for any loss that the company suffers as a result of continued trading after the end of the Coronavirus Pandemic Period. As a result, the suspension could create a “cliff edge”, precipitating a spike of insolvencies when it ends.

What about other risks and liabilities?

Directors should bear in mind that, although they cannot be liable for wrongful trading during the Coronavirus Pandemic Period because of the provisions of CIGA 2020, all other sources of risk and liability under the law are unaffected.

If directors are concerned that a company is insolvent or likely to become insolent, they should ensure that they take the interests of creditors into account in all the company’s decision-making, take every step to minimise potential loss, record all their decisions fully, in writing, and seek professional advice.

Permanent changes to Insolvency Law

3. Introduction of new restructuring tool: the standalone moratorium

CIGA 2020 introduces the option of a new, “standalone” moratorium for companies that are insolvent or likely to become insolvent but which, in the opinion of an insolvency practitioner, are capable of rescue as a going concern.

What is it?

The standalone moratorium is distinct from the existing formal insolvency processes, such as administration or liquidation, and it is not necessarily a gateway to such a process: it is designed to be a breathing space from which companies can (and should) emerge as a going concern. 

How does it work?

The standalone moratorium restricts creditors from taking steps to recover debts and/or enforce security for its duration; it is a flexible process that allows the company to continue to trade under the control of its directors, subject to monitoring by an insolvency practitioner (known as the “monitor”), while they pursue a turnaround strategy. 

To assist with turnaround, the key features of the standalone moratorium are that:

• the company has a “payment holiday” for pre-moratorium debts, except for the costs of continuing to trade during the moratorium;
• the presentation of winding-up petitions and the appointment of administrators is prohibited, except by the directors (or, in the case of winding-up, on public interest grounds);
• except with the permission of the Court:
• landlords cannot exercise rights of forfeiture;
• creditors cannot enforce security, unless it relates to collateral arrangements or it was granted during the moratorium with the consent of the monitor;
• no legal process can be commenced or continued against the company, unless it is employment-related; and
• creditors cannot take action in respect of debts for which the company has a “payment holiday” or apply to the Court for permission to do so.

How long does it last?

The standalone moratorium lasts for an initial period of 20 business days. This initial period can be extended by the directors of the company without the consent of its creditors for a further 20 business days or, with the consent of its creditors, for up to a year.  The moratorium can also be extended by the Court, following an application for its extension or in the course of other relevant proceedings, to a date at its discretion.  The period will also be extended until any proposal for a company voluntary arrangement is disposed of.

To prevent abuse of the moratorium, extension depends on confirmation from the monitor that it is likely that the moratorium will result in the rescue of the company as a going concern.

Can it be brought to an end earlier?

The standalone moratorium can be brought to an end at any time by the company entering into a compromise, an arrangement, a company voluntary arrangement, administration or liquidation.  It may also be brought to an end by the Court, following an application to challenge the conduct of the monitor or the directors on the basis that it has caused, or would cause, unfair harm to the applicant.

The monitor, however, must bring the moratorium to an end if they are of the opinion that (i) the rescue of the company is no longer likely; (ii) the rescue of the company has been achieved; (iii) they are unable to carry out their functions as a result of a failure of the directors to provide information; or (iv) the company is unable to pay any moratorium debts or pre-moratorium debts for which the company does not have a payment holiday.

Can it really help to rescue a company?

In theory, yes: with the consent of the monitor, the company can grant security during the moratorium, which will likely be an essential part of any refinancing.

The practical challenge for directors will be stakeholder management.  Unless the turnaround strategy is very straightforward, and takes less than two months to implement, the directors of the company will need the support of creditors or the approval of the Court to extend the moratorium. They will also need to ensure that the monitor is satisfied that a rescue remains likely throughout the process, to prevent the monitor bringing the moratorium to an end. 

The standalone moratorium may therefore be of most use to companies with a straightforward rescue plan. For more complicated rescue strategies it is likely to be combined with a more formal insolvency process, such as a company voluntary arrangement or the new “Part 26A Scheme” (also introduced by CIGA 2020).

What does it mean for directors?

The standalone moratorium represents a flexible tool for the reorganisation of companies.  It allows directors to retain control, and companies to continue to trade, while a solution is sought with creditors.

As noted above, working with stakeholders will be key, as the moratorium will only last as long as the monitor is of the view that a rescue of the company is likely (note: not merely possible) and the creditors of the company or the Court are supportive.

Directors will need to remain cautious about the effect of their decisions made during the moratorium on the company’s creditors. The moratorium will not change the duties of the directors to act in the interests of creditors, and CIGA 2020 creates various new risks and criminal offences which directors will need to consider.

Directors should also note that the Pensions Regulator and the Board of the Pension Protection Fund have various rights to receive notifications in respect of moratoriums and challenge the conduct of the directors, depending on the company’s pension scheme status.

What does it mean for creditors?

Unsecured creditors and suppliers may be anxious about the introduction of the moratorium, which is relatively easy to access and will prevent recovery of their debts, but may take some comfort from the fact that it can only be used by companies that are likely to emerge as a going concern (and that the monitor is responsible for keeping this under review). 

CIGA 2020 also includes strict provisions as regards the payment of debts incurred during the moratorium, which will assist creditors with their own cash flow and give suppliers comfort in light of the new provisions prohibiting termination of supply of goods and services. In the event of a winding-up which follows a failed moratorium these “moratorium debts” will have super-priority (subject only to debts secured by fixed charges).

Secured creditors may also be concerned about the moratorium, which will prevent them from enforcing their security without the permission of the Court.  However, liabilities in respect of most lending is still payable in the moratorium and the support of the secured creditors is obviously likely to be essential for the rescue of the company as a going concern, so that they will have considerable influence over the process.

4. Introduction of new restructuring tool: the Part 26A Scheme

CIGA 2020 introduces the option of a “Part 26A Scheme” for companies that have encountered, or are likely to encounter, financial difficulties that threaten their ability to carry on business as a going concern.

What is it?

The new Part 26A Scheme shares many characteristics with the pre-existing Part 26 scheme of arrangement – and like Part 26 schemes, will form part of the Companies Act 2006, rather than the IA 1986. The principal difference between the new procedure and a scheme is that a company will be able to use a Part 26A Scheme to impose a restructuring on dissenting classes of creditors or members, in a way which is not possible with a scheme.

How does it work?

A Part 26A Scheme may be proposed by a company, it members or its creditors.  It must propose a compromise or arrangement between the company and its creditors and/or members with the purpose of addressing the actual, or anticipated, financial difficulties of the company.

The stakeholders must be provided with sufficient information to make a decision whether or not to support the Part 26A Scheme and the Court will oversee its proposal and implementation. After the compromise is proposed there will be a Court hearing at which the Court will consider how the classes of creditors and/or members of the company should be constituted. The Court will also hear any challenges to the constitution of the classes, and the terms of the Part 26A Scheme, by the creditors and/or members.

If the Court is satisfied with the proposal, the creditors and/or members will then vote on it. The Part 26A Scheme requires the approval of 75% in value of a class of creditors or members; there is no requirement that this includes 50% of that class in number, so that proposed compromises are less likely to be frustrated by a large number of creditors with low-value debts.

How can it bind dissenting creditors and/or members?

As noted above, it is possible for a Part 26A Scheme to bind creditors or members to an arrangement which they voted against, which is known as “cram down”. Cram down is a well-established feature of restructurings in other jurisdictions – most notably the US – but has until now not been available under English law.

If a class of creditors or members votes against the Part 26A Scheme, the Court may still sanction the compromise, but only if: 

• it is satisfied that, if the Part 26A Scheme were to be sanctioned, none of the members of the dissenting class would be worse off than under the “relevant alternative”, where the “relevant alternative” is "whatever the court considers would be most likely to occur in relation to the company if the plan were not sanctioned"; and
• the Part 26A Scheme is supported by at least 75% by value of a class of creditor or members which would receive a payment, or have a genuine economic interest, if the relevant alternative were pursued.

Valuation evidence, and the comparison of potential outcomes, will be key to whether a Court sanctions cram down in a particular Part 26A Scheme, and these issues are likely to be the primary focus of any challenges brought by dissenting stakeholders.

Should creditors be concerned by cram down?

The potential for cram down will be of most concern for creditors that are “out of the money” (i.e., creditors that would not receive a dividend if the company were placed into the likely alternative insolvency process).  Their rights may be altered by the Court, despite voting against a Part 26A Scheme, if it would result in a positive outcome for other stakeholders. Although in principle out of the money creditors should not be prejudiced by cram down, under the law before CIGA 2020 such creditors could sometimes have been able to negotiate a better position for themselves by withholding consents. The new procedure will make such hold-out positions considerably less effective.

With regard to “in the money” creditors, including secured and super senior creditors, the risk of cram down affecting their rights is more remote. However, there is in principle no reason why a Part 26A Scheme could not vary their rights, provided that all of the conditions set by the legislation were satisfied.

The Part 26A Scheme offers a restructuring tool which is more flexible and powerful than any currently available under English law. As such, it is a welcome addition to English law, and will assist the UK in keeping pace with (or staying ahead of) developments in other jurisdictions.

5. New restrictions on terminating contracts for insolvency

 CIGA 2020 imposes significant restrictions on rights to terminate contracts for the supply of goods and services to insolvent companies.

What protections did the law apply to the supply of essential goods and services before CIGA 2020? 

Before the introduction of CIGA 2020, the general rule was that insolvency termination clauses (also known as ipso facto clauses) were enforceable. As a result, a company which became subject to insolvency proceedings could find that many of its contracts were terminated simply because of the insolvency (irrespective of whether it had complied with its obligations under the contract).

The exceptions to this general rule were very limited: termination was barred only in the case of contracts for the supply of utilities (electricity, gas and water) and goods or services relating to communications and IT.

What changes has CIGA 2020 made?

By CIGA 2020, the Government has sought to strengthen the UK’s rescue culture and bring it into closer alignment with a number of other jurisdictions whose laws prevent the exercise of insolvency termination clauses (including for example the USA and Germany).

CIGA 2020 introduces a new s.233B IA 1986 which apples to any contract for the supply of goods or services with a company in a “relevant insolvency procedure”, including:

• a standalone moratorium;
• administration
• a CVA; or
• liquidation.

Suppliers of goods and services to the insolvent company will be unable to rely on any provision in their contract which gives them the right to terminate the relevant contract or supply, or provide for the automatic termination of the relevant contract or supply, as a result of the insolvency.

In addition, a supplier cannot “ransom” the company for the supply of goods or services during the relevant insolvency procedure.

Can a supplier still terminate for a pre-insolvency termination event?

In a significant extension of the law, CIGA 2020 provides that where a supplier was entitled to terminate a contract because of an event occurring before the relevant insolvency procedure but did not do so, it cannot exercise this right after the company becomes subject to the insolvency procedure.

For that reason, suppliers would be well-advised to monitor the compliance of their customers with contracts closely and, if they become entitled to exercise termination rights, consider whether to do so before the commencement of any insolvency proceedings. However, they should bear in mind that termination will not always be the best course for either the supplier or the customer. In particular, termination may simply exacerbate the position of a distressed customer and jeopardise a restructuring that would otherwise have resulted in a better outcome for the supplier.

In what circumstances can suppliers terminate contracts?

New s.233B IA 1986 is not an absolute bar to the termination of supply contracts to insolvent companies. Termination is still possible:

• if a termination event arises after the commencement of the insolvency proceedings (other than the fact of insolvency proceedings themselves);
• with the consent of the insolvency officeholder or the company; or
• with the permission of the Court (if it is satisfied that continuation of the contract would cause the supplier hardship).

Is there other comfort for suppliers about the extension of protection? 

The restriction on termination rights for suppliers of all goods and services may be a source of concern for many suppliers, especially now when companies have outstanding accounts because of the coronavirus pandemic. However, there are various aspects of CIGA 2020 and commercial practice that provide further comfort:

• under CIGA 2020 there is a temporary exclusion from the new provisions for suppliers of goods and services that are “small entities” so that, until 1 October 2020, such entities can rely on termination provisions which would otherwise be invalid.  To qualify as a “small entity” a supplier must satisfy certain criteria, e.g. that the supplier’s balance sheet total is not more than £5.1 million and the number of the supplier’s employees is not more than 50.
• CIGA 2020 expressly states that the Secretary of State can by regulation exclude certain kinds of company, supplier, contract, goods or services from the restriction on termination rights.  This recognises that the legislation was enacted urgently – with very little consultation – and refinement of the current restrictions may be desirable;
• in many cases, a customer and supplier will not have a contract which obliges the supplier to provide the customer with specific goods or services in the future. Rather, they may have a framework agreement which sets out the terms which will apply to future contracts, or simply a course of dealings relating to individual contracts.  If such an arrangement is in place then, if a customer enters a relevant insolvency procedure, a supplier is unlikely to be obliged to accept orders and perform new contracts for supply; 
• if suppliers do supply goods or services to companies in certain insolvency procedures, further provisions of insolvency law will apply to protect them, for example:
• a supply of goods or services to a company in administration will be payable as a “expense” of the administration, so that the supplier is paid in priority to other creditors (except for fixed charge creditors); and
• a company subject to a standalone moratorium must pay for goods or services supplied during the moratorium, otherwise the monitor must terminate the moratorium.  If winding-up or administration proceedings in respect of the company are then started within 12 weeks, any amount owed to the supplier will have “super priority” in that process (subject only to fixed charge realisations).