UK Life Sciences and Healthcare Newsletter - September 2020: Changes to Insolvency Rules Provide Breathing Space

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The UK Government has long been considering significant reforms of the UK’s insolvency framework, even before the advent of COVID-19. The pandemic resulted in the acceleration of those reforms and the passing of the new Corporate Insolvency and Governance Act 2020 (the “Act”), which came into force in June.

In addition to permanent landmark changes, such as the new statutory moratorium process and the restructuring plan procedure, the Act contains a number of temporary measures designed to help businesses cope with the economic effects of the COVID-19 crisis. These measures may be particularly helpful for early-stage life sciences companies that do not yet generate revenue and are experiencing a cash crunch.

COVID-19 temporary measures

  • Suspension of winding-up petitions and statutory demands

From 27 April, statutory demands served on companies between 1 March 2020 and 30 September 2020 cannot be used as the basis for presenting a winding-up petition, effectively meaning that those statutory demands are void. Furthermore, during the same period, a creditor may not present a winding-up petition unless they have reasonable grounds to believe that COVID-19 has not had a financial effect on the company, or that the company would still be unable to pay its debts even if COVID-19 had not had a financial effect on the company. The courts will likely find this a difficult question to determine, though perhaps less so in respect of life sciences businesses that did not generate revenue even before the pandemic.

Even so, these changes should help to reduce the use of statutory demands and winding-up petitions processes as an aggressive form of debt collection. In particular, these provisions seek to prevent landlords using statutory demands to get around the moratorium on forfeiture introduced in previous coronavirus related legislation.

The Government has the ability to extend the suspension beyond 30 September 2020, but this has not been confirmed at the time of writing.

  • Suspension of wrongful trading rules

Under the “wrongful trading” rules, directors can be personally liable if the company enters into liquidation or insolvent administration, and the director knew (or should have concluded) that there was no reasonable prospect of the company avoiding such proceedings. The Act temporarily suspends directors’ personal liability for any worsening of a company’s financial position from 1 March 2020 to 30 September 2020 (subject to any extensions).

The suspension of these rules should help directors of companies affected by the pandemic to make decisions without fear of personal liability arising from the application of the wrongful trading rules.

However, it remains important for directors to take legal advice. Directors will still be subject to their usual directors’ duties (such as their duty to promote the success of the company and considering creditors’ interests in certain circumstances). Directors can also still be personally liable for fraudulent trading.

It is worth noting that the temporary suspension does not apply to certain excluded companies, including any company that is a party to a qualifying capital markets arrangement. This is broadly defined to include companies that have granted security or guaranteed obligations in respect of a capital markets instrument, including any rated or listed bonds. Life sciences companies with capital structures that include listed securities may therefore not be within scope of the temporary suspension.

Permanent reforms

  • New statutory moratorium

Companies in distress may be given more breathing space to negotiate with creditors if they take advantage of a new statutory moratorium mechanism. The moratorium stops creditors taking enforcement action, restricts insolvency filings and provides a payment holiday for certain types of pre-moratorium debts as well as post-moratorium debts. The moratorium will not prevent enforcement action by financial creditors however and debts owed to such creditors during the period must be paid for the moratorium to remain in effect. The moratorium must be proposed by the company's directors and lasts for a fixed period of time (initially 20 business days with the option to extend for a further 20 business days without consent, with further extensions possible by consent or court order).

Although the directors remain in control of business operations during the moratorium, a licensed insolvency practitioner called a "monitor" is appointed to supervise the moratorium, in order to protect creditors’ interests and ensure continued compliance with the moratorium requirements and conditions.

As with the temporary suspension of the wrongful trading rules, some companies are excluded from using the mechanism, including any company that is party to a ‘capital market arrangement’. The width of this exclusion was widely highlighted as a concern as the legislation passed through Parliament but was not addressed in the final text of the Act.

  • Restructuring Plan

The Act introduces a new “Restructuring Plan”. A company in financial difficulty will be able to propose a compromise or arrangement between its creditors and/or shareholders, subject to the approval of the court and approval from 75% of each class of creditors.

This is similar to the existing “scheme of arrangement” process, with a key difference being that a plan will only be available where a company has encountered, or is likely to encounter, financial difficulties that affect its ability to carry on business as a going concern. In addition, the purpose of the plan must be to eliminate, reduce, prevent or mitigate the effect of any of these financial difficulties.

A significant feature of this mechanism is that, in contrast to schemes of arrangement, the court may sanction the plan even where one or more classes do not vote for the plan in certain circumstances (known as “cross-class cram-down”). This could prove helpful for distressed life sciences companies that have a varied investor base with competing economic interests.

The first plan, relating to Virgin Atlantic Airways, was sanctioned by the court in early September.

  • Other provisions

The Act also introduces measures that prevent suppliers from relying on contractual clauses that allow termination (whether automatic or on notice) because a counterparty has entered an insolvency or restructuring process (including the new moratorium). This significantly extends the existing UK insolvency regime, which previously only required the continuation of certain "essential supplies", and is inspired by U.S. Chapter 11 proceedings.

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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