The Corporate Insolvency and Governance Act 2020 came into effect in the United Kingdom on 26 June 2020. It makes major changes to UK insolvency law. The full extent of those changes will only become apparent in the following months, as the courts and insolvency practitioners grapple with its 254 pages. Three strange aspects of the Act will fundamentally affect how financings to UK companies are structured and documented.
A key feature of the new law is a moratorium on enforcement. The moratorium lasts for 20 business days, and can be extended for up to a year, subject to certain criteria. One criteria for the extension, is that specified debts incurred before the moratorium, and which “fell due before or during the moratorium”, must have been repaid.
If the borrower goes into liquidation, administration, or other restructuring within 12 weeks after the end of the moratorium, that specified debt which “fell due before or during the moratorium” (and has not been accelerated), will get super-priority over all other creditors (except creditors holding fixed charges).
TERM LOANS V. REVOLVING LOANS
A moratorium can confer super-priority on a revolving loan, but not a term loan.
For a loan that “fell due before or during the moratorium” to get super-priority, it must not have been accelerated during the moratorium. However, a revolving loan with an interest payment date during the moratorium, will become due during the moratorium without acceleration, if the lenders cease to make new replacement loans. Most revolving loan agreements will have a clause that allows lenders to stop making replacement loans, if the borrower or guarantor starts a moratorium.
If a revolving loan is not “rolled over” during a moratorium, and the borrower does not repay the revolving loan, the borrower will not be able to extend the moratorium, and is likely to soon go into administration or liquidation, with the revolving lender then having super-priority.
The new insolvency law prefers revolving loans over term loans, in most circumstances. It will encourage revolving lenders to not make replacement loans during the moratorium, in order to get super-priority in the resulting administration or liquidation (and ensure that they are not subordinated to other creditors that can get super-priority).
New lenders to UK borrowers should try to restructure their loans as revolving loans with one month interest periods, instead of term loans. Those new revolving loan should have clauses that do not oblige lenders to make replacement loans, when a borrower or guarantor is in a moratorium.
BORROWERS V. GUARANTORS
The new insolvency law treats borrowers and guarantors differently.
If there is a moratorium for a borrower and a guarantor, and the guaranteed loan “fell due before or during the moratorium”, other than from being accelerated during the moratorium, the lender cannot get super-priority in the subsequent administration or liquidation of the guarantor, but can get super-priority in the subsequent administration or liquidation of the borrower. The reason is that the liability of the guarantor which arises when the guaranteed loan becomes due, will be “relevant accelerated debt” because that liability of the guarantor only fell due, as a result of the happening of an event (i.e., the failure to pay the guaranteed loan and/or a demand under the guarantee).
The new insolvency law will encourage revolving loans to be made to the most creditworthy entities in a group of companies, rather than being made to finance companies or special purpose vehicles (with guarantees).
BONDS V. LOANS
The new insolvency law treats some bonds differently from loans.
For a debt that “fell due before or during the moratorium” to get super-priority, that debt must arise “under a contract or other instrument involving financial services”. That includes (inter alia) loans, derivatives, repos, “capital market investments”, etc. As a result, unlike all types of loans, some types of bonds (which are not “capital market investments”) cannot get super-priority.
For a bond to be able to get super-priority, it must be (1) a “capital market investment” (i.e., (a) listed, rated, or traded (or designed to do so), or (b) issued to specified classes of professional investors) or (2) secured by a “financial collateral arrangement”.
Other bonds (such as intra-group debt evidenced by loan notes, unlisted debt issued to custodians, etc.) will not be able to get super-priority.
In addition, a UK company cannot start a moratorium if it is a party to a “capital market arrangement”. In summary, this is a “capital market investment” (see above) in excess of £10 million, which is secured or guaranteed. A UK company may prefer a secured or guaranteed loan, rather than a secured or guaranteed bond, in order to preserve its ability to enter into a moratorium.
The new insolvency law will encourage financings to UK companies to be structured as loans, rather than as bonds.
CHANGES TO THE NEW INSOLVENCY LAW
The new insolvency law was rushed through Parliament with inadequate consultation. The UK government has indicated that it might later adjust the super-priority and moratorium arrangements, if they are not working. It can make those adjustments by secondary legislation.
However, it will likely require some insolvencies with adverse publicity before the government makes those adjustments. This LawFlash is unlikely to prompt that secondary legislation.
In the meantime, lenders should structure their financings so they can get super-priority, and cannot be subordinated to other creditors that can get super-priority.