Some legislative changes are announced with great fanfare and press excitement, whilst others struggle for attention amid more ‘interesting’ news about Premier League trophies, mini heat waves and unruly crowds littering beaches and parks. To be fair, even against a backdrop of huge economic uncertainty as the UK takes its first, faltering steps into life after lockdown, the passing into law (at midnight on 25 June) of an Act designed to ease some of the worst economic effects of the COVID-19 crisis and to improve our arsenal of corporate rescue tools was never likely to grab too many headlines. Still, it is no less significant for that.
Perhaps the lack of excitement stems from the fact that it was announced very loudly by the government more than 3 months before it became law, so many people (perhaps even some Judges) assumed (or otherwise treated it as though) it already was law, despite the fact that the final product differs from what was heralded in April in many important respects. Perhaps it was the title: the Corporate Insolvency and Governance Act 2020. Snappy enough, some might argue (although perhaps an unfortunate choice if we wind up referring to it as the CIG Act or CIGA) but does this actually mean anything at all to the man in the street, or the director, business owner, landlord or other stakeholder in their studies and (virtual) boardrooms? How readily will they explore this new frontier, and are we ready and able to guide them?
We are still struggling a bit, to be honest, with the idea that the Government missed a perfect opportunity to call it the Rescue and Recovery Act or something they could put a more positive spin on. Even its drafters and proposers seem ready to downplay it before it has a chance to gain any traction. At the time of writing (Monday 29 June), the official press release had just been published, curiously describing the Act not as the greatest or most important or most comprehensive or any other qualitative adjective to capture our imaginations, but rather blandly as, “the largest change to the UK’s corporate insolvency regime in more than 20 years”. In reality, whilst the Act does run to 50 sections and 14 Schedules, many of these are specific to Northern Ireland only, and it is in fact one of the smallest pieces of insolvency legislation on the statute books, but does it nevertheless live up to the claim that it’s a very big change for us all, and – more importantly – how confident are we that it will provide an important part of the framework the UK needs to get back into its economic stride?
What follows is our assessment of the good ship CIGA now that she is under sail, and of the likelihood of her helping to ferry us where we need to go next.
An Epic Voyage
Cards on the table, sad insolvency lawyers as we are, we have actually been looking forward to the launch of this legislation for some time. Not, as some might assume, since the Government announced in the Spring (as if this was some novel idea) that it would be bringing forward legislation in response to the threats to the UK economy posed by COVID-19, but for much longer than that. Indeed, whilst much of the academic focus latterly has been on the temporary measures introduced by the Act to things like wrongful trading and winding up petitions – which occupy just two effective sections and one schedule between them – by far the bulk of the Act is made up of permanent reforms which began life in a consultation phase some years ago. COVID-19 has simply been the backdrop against which those reforms have suddenly gained a sense of urgency and purpose.
The great odyssey which describes the voyage of this legislation from concept to open water certainly hit its first choppy seas immediately it was launched from the slipway by the Insolvency Service into its first reading in the Commons on 20 May. Hammered together with great speed and industry by a huge team of shipwrights at the Service (quite probably being whipped behind closed doors by those in government who had promised new legislation with almost indecent haste), the Bill was buffeted by early criticism from commentators and parliamentarians (as the Hansard reports show, many of them quoting the commentators).
Having been waiting impatiently and bemoaning the absence of a draft during the early weeks of our COVID chronicles blog series (which consequently became less frequent as it became clear we were in for a longer wait than expected), we confess to having been somewhat disappointed with the Bill, as our regular readers will have read in our last blog (and for those who missed it, the link is here ). We had hoped (against hope) that the legislation might have been able to make the partial suspensions of the winding up petitions and wrongful trading regimes – for example – clearer, fairer and/or actually workable. Perhaps, on reflection, we should have realised that they were always going to be a fudge because the policy objectives they were designed to achieve were inherently unrealistic, and that the best we could hope for (without a change of policy) was to preserve the necessary degree of discretion which the courts need to be able to balance the (often competing) interests of debtors and creditors.
Probably the greatest chance for the Bill to flounder, however, was in the committee stage in the House of Lords, where it entered with only the Government’s own amendments having been agreed in the Commons. In particular, the House of Lords were not overly enamoured with the Government’s decision to fast-track such a significant piece of legislation, and thus to reduce the scrutiny to which it would be subjected. Very sensible ideas were floated here, including clarifying the wrongful trading provisions to make clear that the relevant statutory assumption would be rebuttable, and that if perfectly good winding up orders were going to be rendered void retrospectively, the Government should compensate those affected. There was even a brief hope along the way that perhaps the Government might have seen the light by reversing the partial restoration of Crown preference (let’s not go there or we will be all day). There were also some rather less helpful suggestions along the way, such as making reference to the pre-pack pool compulsory for connected party pre-pack administration sales. Perhaps on the whole, therefore, it was best that the Bill finally emerged from the committees a little battle hardened, but generally none the worse for wear.
But what has this left us with? Is the Act ship-shape and Bristol fashion, ready to help carry the UK across the new frontier and into calmer waters beyond, once the storms of the COVID-19 era are behind us, or are the flaws in its rapid construction exposed by its scrutiny to date likely to mean that it outlives its usefulness before we get there?
At first sight we have to agree that the Act is the most significant insolvency reform since the Enterprise Act 2003, wherein (amongst other things) the now commonplace out of court company administration procedure was introduced, and HMRC’s previously preferential debt ranking was reduced to an unsecured status, to make way for what was lovingly called ‘the Rescue Culture’. It is debatable whether, as the Government effectively claims, CIGA represents a ‘larger’ change than the Enterprise Act, or whether the changes will be as welcome as those created by that Act, but the CIGA changes are certainly as noteworthy.
- ‘Suspension’ of wrongful trading (CIGA 2020, s.12)
The main amendment here between Bill and Act has been the extension of the ‘relevant period’ – originally carded to take us to one month after Royal Assent, now applying (retrospectively, as we expected) for the whole of the period 1 March to 30 September 2020, so two months longer than the period in the first draft of the Bill.
By section 12 of CIGA any notional court hearing an action for wrongful trading in the future is required to assume that a director is not responsible for any worsening of the financial position of the company or its creditors which in fact occurred during this period.
Our view, despite the short title to the section using the word, is that the terms of the section do not actually operate as a ‘suspension’ of liability for wrongful trading, so much as make it more difficult for a liquidator or administrator (or their assignees) after the event to secure compensation for what in effect will still have been wrongful trading.
The drafting of this section requires the reader to contort themselves into a fiction, wherein a person who in every factual and moral sense is the true cause of losses, is nevertheless not legally ‘responsible’ for those losses. There were, in our view, a number of other ways in which the drafters could have sought to achieve the desired effect here, if the desired effect was to arm directors with a ‘get out of jail free card’ for any continued trading until 30 September, but they chose to do it this way. In principle, this appears to leave open the possibility of a court starting from the statutory assumption in favour of the director, but – as with other assumptions in insolvency law such as those created with connected party transactions – to conclude that the evidence outweighs the assumption.
There are also notable exceptions within the section, whereby the provision will not apply, among others, to directors of insurance companies and financial institutions.
We agree that the drafters’ approach here is both sensible and fair, allowing for maximum flexibility so that courts can still, in principle and at their discretion, punish egregious cases of wrongful trading so that the Act does not operate as a rogues’ charter for delinquent directors to go on an irresponsible spending spree for 3 months over the summer. However, when you combine this deliberate drafting with the fact that directors still owe other, related and standalone statutory duties to the company and its creditors, we have to question how the Government can still claim that these provisions “temporarily remove the threat of personal liability arising from wrongful trading” or that “liquidators and administrators will not be able to make a claim against an insolvent company’s directors for any losses to the company or its creditors resulting from continued trading” (our emphasis). This statement appears to us to be palpably misleading. If that was the intention, as a matter of law the provision should have been drafted quite differently, in our opinion. The government’s guidance on this section on its website offers a worked example of directors of a Cornish pub, concerned about taking a Business Interruption Loan. It is notable that for the directors in that example to absolve themselves of liability for wrongful trading, the Government warns them that they must also take a significant number of other precautions.
At best, for directors of eligible companies, our view is that the new law offers honest and reasonable directors (no doubt the vast majority) some welcome ‘breathing space’. Their actions will still be constrained by their personal liability for breach of duty, especially once the ‘suspension’ has lifted after 30 September, so they still need to be careful to act in the best interests of creditors and work to restore their companies to rude health by 30 September, or at least ensure that the net position of the company is not getting appreciably worse after 30 September. If in doubt, they should be taking advice. For more information about directors’ duties in the face of COVID-19 related insolvencies, please see our blog on directors duties.
For directors in borderline cases, who are taking appropriate advice and documenting the reasonable basis for their decisions, this section of CIGA should offer some comfort. That said, we suggest these are the directors who would have continued to trade anyway, confident of doing the right thing. If the purpose of the new legislation is to persuade directors who perhaps are not taking this advice, and are instead weighing up for themselves the risks between personal liability and continuing to trade, or reopening the business, as they were, our view is that CIGA is unlikely to give those directors any confidence that they can continue to do so safely, at least not without adopting a series of other measures.
Some may say the Act does not go far enough to give such directors the comfort they need and that it should disapply liability for wrongful trading unequivocally and for all, others that the Act goes quite far enough and that it is not in the public interest to offer more. Either way, it seems to us that nobody should be misleading the public as to the true risks or encouraging directors to take new funding if it seems to them inevitable that the company will have to enter liquidation or administration in the coming months.
- Winding up petitions (CIGA 2020, s.10 and Schedule 10)
Under these provisions, no winding up petition may be presented unless the creditor has reasonable grounds to believe that Coronavirus has not had a financial effect on the debtor company, or can show that the debtor company’s inability to pay would have arisen even if Coronavirus had not had a financial effect on the company.
Again, the main amendment to this provision between Bill and Act was the extension of the ‘relevant period’, applying retrospectively from 1 March to 30 September 2020, and this new law is to be treated (another legal fiction) as having come into force on 27 April 2020.
The threshold for the virus having had a ‘financial effect’ seems here to be very low, which will inevitably act as an encouragement to some debtors to blame Coronavirus as the reason for their inability to pay their debts come what may. That said, even before the Act was in force we saw the court being willing to interpret the draft legislation as saying that the initial evidential burden (to prove that Coronavirus had a financial effect) is upon the debtor company. It is only after this that the (would be) petitioning creditor has to prove that the debtor would have been unable to pay regardless of the financial effect of Coronavirus (see Re A Company (Injunction to restrain Presentation of Petition)  EWHC 1551 (Ch), paras 40, 44).
Similarly, during this period, no creditor may present a winding up petition on the basis of the expiry of a statutory demand served on or after 27 April 2020.
As highlighted in our previous blog “the Corporate Insolvency and Governance Bill“, winding up orders made on or after 27 April are – unless it can be demonstrated that the order would have been made even on an application of the new law – now considered retrospectively void, which is the aspect of this section we consider most likely to lead to injustice. Many orders granted during this period were sought and obtained perfectly properly by creditors who were expecting the legislation in due course to deal only with petitions against commercial tenants (in keeping with Government announcements). We have in recent weeks seen examples of courts refusing winding up orders or granting restraint injunctions on the basis of what it was assumed would pass into law (again, don’t get us started!) which is one thing, but for a law to deprive a petitioning creditor of a remedy which existed when they obtained it, without building in a provision to compensate that petitioning creditor and/or any other affected stakeholder is, we suggest, profoundly unfair. Similarly, petitioning creditors whose petitions must now be dismissed should not have to absorb the court costs, and provision should have been made to ensure that debtor companies are not entitled to claim costs against petitioners whose petitions are dismissed solely for this reason. Given that winding up orders made in late April and early May are likely to have been acted upon by debtors, creditors, liquidators and others we do not agree that there is any public benefit in declaring them void retrospectively. It will be practically impossible and/or pointless to seek to restore those companies to the position they were in immediately prior to the order.
- Effective ban on enforcement of insolvency termination clauses in supply contracts (CIGA 2020, ss.14-15, Schedule 12)
These provisions have remained, on the whole, as drafted in the Bill. We are surprised in some respects that they have not been considered more controversial amongst commentators, given that the new s.233B Insolvency Act 1986 introduced by CIGA effectively precludes suppliers of goods and services (without the consent of the customer or the permission of the court) from relying upon insolvency clauses in their contracts as a justification for terminating supplies to customers entering an insolvency process or withholding supply pending payment.
There are temporary exclusions from these provisions, until 30 September 2020, for suppliers who are small business entities (where at least two of the following are met: turnover is not more than £10.2m, balance sheet total not more than £5.1m and/or the number of employees not more than 50), but larger suppliers are bound by this provision now and we shall all be so bound soon enough, unless we happen to be providing goods or services within one of the excluded categories, including financial institutions, who benefit from a permanent exclusion.
The Government rationalised these proposals by saying that terminating on grounds of insolvency (although why this rationale does not also apply to banks or funders is more difficult to explain) would ‘jeopardise’ a debtor company’s attempts to rescue the business, but this ignores the fact that as we stand in the UK today creditors as a body have not entered into a social contract with debtors as a body to support their attempts to rescue their businesses. Until relatively recently debtor-controlled restructuring was pretty much unknown in the UK, except perhaps through so-called ‘light touch administration’, which would have an administrator in office but the directors still effectively (and within certain constraints) in charge. Even CVAs put creditors’ interests at their heart. The Government therefore asks us here for something of a leap of faith.
Whilst it is easy to see how this provision in principle supports the prospect of the customer being rescued in a formal insolvency, in line with the retrospective elements of other provisions discussed above, these sections fundamentally alter the bargain achieved between contracting parties prior to COVID-19. In short, they flip the balance of the negotiating position towards the debtor, leaving certain classes of creditor arguably with a much more qualified asset list than perhaps they thought they had only a week ago.
It may be that debtor-controlled rescue was already our overall direction of travel, but even so this concept – about which many commercial landlords have already been forced to learn a great deal in recent weeks – is alien to many, and will take time to get used to.
Many insolvency termination clauses are specifically negotiated to protect the supplier from having to continue delivering goods or services when they know or expect they are not going to be paid.
In our opinion, this provision is capable in time of having a positive impact, but as with anything based on trust, if the ability to effectively compel continued delivery is used excessively (and it should be noted there is provision for the supplier to apply to court if the continued supply will cause hardship) we would expect to see contracting parties managing this risk in other ways. In practical terms, we suspect it would be difficult for insolvent entities to enforce their rights under this section as a refusal to continue supplies would amount to a breach of contract but where the debtor company would be unlikely to have access to funds to take action such as an injunction against an uncooperative supplier.
Ultimately, whilst we would hope this would not happen, suppliers may simply decline to enter into supply contracts with parties who cannot demonstrate adequate financial standing, or contract on terms involving personal guarantees, credit insurance funded by the customer, cash on delivery or funds on account, in an attempt to avoid the risk of having to supply without reward. This could of course prove ultimately counter-productive in terms of trading partners extending credit, in much the same way as the partial restoration of Crown preference is counter-productive to the prospects or raising tax revenues because it discourages floating charge lending. Whether it succeeds is likely to depend upon the extent to which debtor led procedures become normalised over the medium term.
- Moratoria (CIGA 2020, ss.1-3, Schedules 1-4)
Given that these mirror in some respects the underused, old Schedule A1 moratorium previously available only in connection with a CVA proposal, it is perhaps unsurprising that much academic attention has alighted upon the new moratorium regime. People write about what they know, or think they know, and in many respects these moratoria are familiar, particularly to those who remember successive notices of intention to appoint administrators, before the courts eliminated that practice.
Intended now as a completely freestanding procedure independent of any other insolvency process, under the Act, the new moratorium does not require to be anchored to another process. Applications are made by directors (following advice from an IP) either out of court or by application to court (if the company is subject to a winding up petition or is an overseas company, and the court must be satisfied that a moratorium would achieve a better result for the creditors than would be likely if the company was wound up).
The Bill was originally drafted so that financial creditors were able to accelerate their debts during the moratorium and obtain a ‘super priority’ for these debts in subsequent insolvency proceedings. Amendments were made to restrict the description of debts which would qualify for super priority, and, under the Act, expressly exclude amounts under financial contracts due during the period of the moratorium due to an acceleration or early termination clause. Exclusions from the previously drafted restrictions on the crystallisation of floating charges for collateral security, financial collateral arrangements, market charges and system charges were also added.
Whether the new regime succeeds in improving the prospects of consensual or majority vote restructuring is likely to depend heavily on the extent to which IPs in due course are prepared to embrace them. Initial take up seems to us to be very muted, but as with all new tools they will need people with the courage to use them in an appropriate case, to test their boundaries in court and then to grow our collective confidence through experience. We can see the potential in the new regime, if nothing else as a means of getting stakeholder attention and creating the required breathing space to properly examine funding options, but we can also see numerous practical difficulties including making sure that IPs can be paid for work conducted identifying proper cases for the moratorium and that IP monitors can engage other professional services where appropriate to assist them in their role.
- Restructuring Plan / Arrangements and Reconstructions (CIGA 2020, s.7 and Schedule 9)
Last, but by no means least, in our whistle stop tour of CIGA is our new, substantive tool, introduced through a new Part 26A to the Companies Act 2006. Again, there is familiarity here, and clear similarities with long established, if still comparatively little used, Schemes of Arrangement (under Part 26), but with the addition of a cross-class cram down mechanism to overcome the unreasonable objections of dissenting classes of creditors or members, similar to the US Chapter 11 model.
This new (or adapted, old) tool focuses on the rescue of the company. A compromise can be sanctioned by the court even if a class of creditors or members vote against it, so long as the court is satisfied that none of the dissenting class would be worse off under the plan than in the alternative scenario (e.g. liquidation), and at least 75% in value of a class of creditors or members which would have a genuine economic interest if the alternative was pursued, vote in favour.
In some ways this represents less of a paradigm shift than the provisions about insolvency termination clauses, because even the dissenting creditors here have a choice. It is a similar choice to that which they would face if asked to vote in favour of a CVA, but unlike in a CVA they will not be able to vote on a whim and cripple the restructuring process. Yes, they are deprived of the ability to take their chances on liquidation, but they would have a chance to make representations to the court and if they are in a position to challenge successfully the Scheme’s assumptions about the liquidation outcome, for example, they will be able to oppose it.
Like the new moratorium, whether this new tool is taken up in sufficient numbers by the insolvency profession to make a difference will be a question of evolution. It may be enough to know that it exists, and / or to use it as a backstop to bring creditors to the table to support a less complex solution from the IPs’ existing arsenal.
We began our journey with what is now the Corporate Insolvency and Governance Act 2020 a long while ago. As we have discussed in previous blogs, the reforms which have finally now made it to the UK statute book – particularly the permanent introductions of the freestanding moratorium and restructuring plan – provide some meaningful additions to the restructuring toolkit which in principle should be welcomed. In and of themselves, they are perhaps not so very different to our existing tools, so in principle it should not take too much imagination for us to start using them creatively, alongside administrations, liquidations and CVAs.
As noted above, however, the way that the Act turns old assumptions about the relative bargaining power and the roles and responsibilities of creditors and debtor companies upside down overnight may be – in the Insolvency Service’s words – the single largest change for us all to get used to. This alone justifies looking at the new Act as the most significant departure in UK insolvency law at least since 2003.
We at Paris Smith LLP have already seen a good deal of evidence of a change of business culture since the virus, particularly in reports we have been asked to prepare for landlords and their funders looking at IP-led options for corporate tenants. Only 6 months ago it was rare to see an IP engaged by a tenant company’s directors and a landlord even having a civilised conversation together. Often the first the landlord would know about a pre-pack administration sale was after the event, when the connected party purchaser waved at the landlord a licence to occupy granted (in breach of the lease) by the administrators.
However, this sort of newfound collaboration is not yet widespread. There is at least equal evidence of entrenched ideas and uncompromising attitudes, fuelled perhaps by elements of CIGA – particularly in the temporary provisions – which seem to have been less well thought through and which will potentially serve to undermine these laudable aims.
Whether (and to what extent) the changes introduced by CIGA have their desired impact in terms of promoting corporate survival, rescue and rehabilitation alongside or above more traditional methods of corporate failure and recycling of value by sale will depend to a large extent, we think, on the speed with which we can all get to grips with the idea of debtor in possession as a credible part of our business culture. COVID-19 has forced us to adapt our practices swiftly already this year, and has led in many respects to businesses in the same sectors putting aside old rivalries in favour of promoting a common good, so perhaps it is not too much to hope that – in spite of its temporary shortcomings – the insolvency profession and those who use our services will be able to embrace the new Act. This will clearly not happen overnight but it will be interesting to watch it unfold and to play our own small part in the process.
If you are affected by any of the changes discussed in this blog, or you have any comment to offer on our observations to date please contact one of our Corporate Restructuring & Insolvency team who would be delighted to help.
This blog has been co-written by Lucy Andrews, trainee solicitor, and Mike Pavitt, partner and Head of Corporate Restructuring & Insolvency at Paris Smith LLP.
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