Implications of new moratorium and exclusion of directors' liability in the UK now Corporate Insolvency and Governance Act 2020 becomes law (Updated on June 29, 2020)

Dentons

On 26 June the long-awaited Corporate Insolvency and Governance Act 2020 came into force and introduced emergency measures to provide protection to directors of companies which continue to trade notwithstanding the threat of insolvency, and to prevent, where possible, companies entering into insolvency due to COVID-19.

  1. Wrongful trading provisions in the Insolvency Act 1986 will be suspended retrospectively between 1 March 2020 and 30 September. During this time if a director is otherwise found liable for wrongful trading, when considering the contribution a directors is required to make to a company's debts, the court is entitled to assume the director was not responsible for worsening the financial position of the company.
  2. The Act introduces following three new permanent financial rescue and restructuring strategies:
  • a moratorium (or "breathing space") period for companies in financial difficulty (though still ultimately viable). During this time, there will be a stay on creditors' actions and certain debts will be subject to a payment holiday, allowing the company engage with stakeholders and to prepare to restructure;
  • a requirement for suppliers to continue to supply to companies in financial distress during the moratorium; and
  • the creation of a "restructuring plan", with the ability to bind creditors to it.

Whilst action to help otherwise viable businesses weather the storm is welcomed, creditors and suppliers will be anxious that these provisions might be open to abuse or leave them exposed.

Wrongful trading: directors' liability

Section 214 of the Insolvency Act 1986 provides that a director can be held personally liable for company debts if the company continues to trade when the director knows (or ought to have known) that there was no reasonable prospect of the company avoiding entering insolvent liquidation/administration.

It is, perhaps, unsurprising that the government has chosen temporarily to suspend directors' financial liability in such circumstances, given the desire to encourage businesses to continue to trade in the present climate.

This suspension does not suspend entirely liability for wrongful trading nor effect a directors' other legal duties. For example under the 2006 Companies Act, a director has a duty to act in a way that would be most likely to promote the success of the company for the benefit of its members (as a whole). However, where he or she knows, or should know, that the company is, or is likely to become, insolvent, the director becomes duty bound to consider, or act in, the interests of creditors of the company.

Such a duty, in those circumstances, is owed by the director to the company (rather than to creditors), but this could still result in personal exposure on the part of the director in the event of subsequent insolvency.

Moratorium: eligibility criteria and assessment

Be it a standalone process (or as a gateway to a CVA, scheme or restructuring plan), the new moratorium is available to directors of an eligible company which is either insolvent or prospectively insolvent.

The moratorium is started by lodging documents at court, or for overseas companies or those subject to an existing winding up petition on formal application to the court for the appointment of a monitor – who must be an insolvency practitioner.

A moratorium is not available for companies which have, in the previous 12 months, entered into a moratorium, administration, or company's voluntary arrangement (CVA), or is subject to a winding-up order.

The moratorium initially lasts 20 business days (30 for small businesses) subject to extension by the directors (up to 40 days) or creditors (up to a year) or the court after that. It must also end if the company goes into administration or liquidation. It will continue while a CVA proposal is put in place and can continue during a scheme or restructuring plan with the court's permission. The monitor will bring it to an end earlier once the objective has been met or importantly if the monitor considers the objective can no longer be met.

Once in place the moratorium gives the company a payment holiday for pre-moratorium debts that have fallen due either before or during the moratorium period unless the debts fall within an exclusion.

Certain key payments are excluded from this payment holiday during the moratorium. Including the monitor's remuneration payments for goods or services, wages, redundancy payments and rent during the moratorium, and importantly debts or other liabilities arising under "a contract or instrument for financial services" will still need to be paid during the moratorium as well as those debts incurred during the moratorium are paid unless a CVA, scheme or restructuring plan is already under way.

In addition to the payment holiday, there is the usual stay on commencing insolvency proceedings, other legal proceedings, repossession and enforcement (like in an administration). This includes a stay on a landlord forfeiting a lease for non-payment and a stay on enforcement of most types of security. None of this can happen during the moratorium without the court's consent.

The company cannot obtain any credit over £500 (without disclosing the act the moratorium is in place. It can't grant security, dispose of property other than in the ordinary course of business or indeed pay any pre-moratorium debs over £5000 (or 1% of the company's total unsecured liabilities – whichever greater), without the consent of the monitor or the court. Hire- purchased property and property subject to a security interest may be disposed of during the moratorium, but only with the court's permission.

Protecting companies' supplies to help them continue trading during the moratorium

Again this is largely a permanent change to insolvency law. However certain exclusions to the new provisions for small companies do have a limited timeframe.

When a company goes into a number of formal insolvency processes, (e.g., administration, liquidation CVA, the new moratorium but not schemes of arrangement), and only when, a supplier to that company is not entitled to cease supplying goods or services under their contract simply because of the insolvency or restructuring process.

Any term in a contract that allows a supplier of goods or services to terminate on a company's entry into an insolvency process will be invalid. It doesn’t matter whether that provision operates automatically or requires an election to be made or notice given by the other party. Nor can the supplier demand payment of outstanding pre-insolvency charges as a condition of continuing supply. If the supplier was already entitled to terminate the contract or supply before the company went into an insolvency process, the Act prevents the supplier exercising that right once the company is in the insolvency process. All this applies, unless the company or an insolvency office holder agrees otherwise or the court finds (on the supplier's application) that continuation of the contract would cause the supplier hardship.

Small suppliers have the benefit of a temporary exclusion. To qualify the supplier must have at least two of the following (1) a turnover of no more than £10.2 million (or on average £850,000 pm if the supplier is in its first financial year), 2) balance sheet total of no more than £5.1 million or 3) no more than 50 employees.

Permanent exclusions where either the insolvent company or supplier is an insurer, a bank, or a series of other financial services institutions or payment systems providers or where the contract is a "financial contract" which covers most loans, overdrafts, finance leases, factoring arrangements and a wide variety of guarantees, securities and commodities contracts, commodities contracts, derivatives, securitisations, spots, futures or swaps, inter-bank borrowing or ISDA masters, capital market arrangements (and this term is the subject of debate within the industry) or arrangements forming part of a PPP - as are, it seems generally any potential financial markets set-off or netting arrangements (as defined by the Banking Act 2009).

Creation of a "restructuring plan" binding creditors

The Act introduces a new permanent remedy into the 2006 Companies Act giving companies that have "encountered or are likely to encounter financial difficulties that are affecting or will or may affect their ability to carry on business as a going concern" the ability to come to an arrangement or compromise with its creditors or members or any class of them. It is available to any company liable to be wound up, which includes an overseas company with sufficient connection to the jurisdiction. It can be used by a company not already in a form of insolvency procedure or as part of that process.

But only Companies Act companies can use the plan to effect a reconstruction or amalgamation involving a transfer of the company's undertaking or property. Currently no companies are excluded from using the plan, but the Bill gives the SoS the power to exclude FCA authorised entities.

To be sanctioned, a plan must have the purpose of eliminating, reducing, preventing or mitigating the effect of the financial difficulties the company is or will or may be encountering. It can include a reduction of share capital or a consolidation or division of share classes.

All creditors whose rights are affected must be allowed to participate in the meeting unless the court decides a particular class has no "genuine economic interest in the company".

If 75% in value of creditors or members affected, votes in favour of the plan, the court then sanctions the plan.

If one class does not achieve the 75% threshold, - a dissenting class - the court can still sanction the scheme and bind all creditors (including dissenting creditors) to it if the plan meets two conditions:

  • That none of the dissenting class would be worse off under the plan than under the "relevant alternative". The relevant alternative is whatever the court considers (on evidence) would most likely occur to the company if the plan were not sanctioned.
  • That a class of creditors representing 75% in value who will receive payment under the plan or who have a genuine economic interest in the relevant alternative – have voted in favour of the plan.

Where a plan is proposed within 12 weeks of any new style moratorium ending, any creditor with moratorium debt or excluded pre-moratorium debt may not participate in meetings (though they will receive the statement) and the court will not sanction the plan if that creditor has not agreed to it.

Conclusions

Having had some time to get to grips with the impact of the Act, now it is in force, most concerning for some creditors will be the possibility of being "locked in" to supply contracts they are unable to terminate.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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