COVID-19 and corporate restructuring & insolvency – week 29: Creditor action restricted until end of year, pre-pack sales to be tweaked sometime, return of Crown preference looming

STOP PRESS: Since the introduction of The Corporate Insolvency and Governance Act 2020 (CIGA) in June 2020 and the date this blog was written, there have been multiple amendments and extensions to the temporary provisions intended to take account of the continuing unprecedented financial climate caused by the Coronavirus pandemic. We highlight the key updates as follows:

• ‘Suspension’ of wrongful trading liability retrospectively for the period 1 March 2020 to 30 September 2020 under CIGA 2020. Reintroduced by CIGA (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020 for the period 26 November to 30 April, and subsequently extended by the CIGA (Coronavirus) (Extension of the Relevant Period) Regulations 2021 and expired on 30 June 2021.
• Restriction on the use of creditors’ winding up petitions and statutory demands retrospectively for the period 1 March 2020 to 30 September 2020 under CIGA 2020. This period has been extended on four subsequent occasions to 31 December 2020, 31 March 2021, 30 June 2021 and 30 September 2021. For the period 1 October 2021 to 31 March 2022, winding up petitions can be granted for COVID-19 related debts (but not for outstanding commercial rents where the reason for non-payment was as a result of COVID-19), provided that the petition debt is £10,000 or more and that creditors have sought proposals from the debtor allowing 21 days for a response before petitioning.
• Restrictions on rent-related forfeiture of business tenancies retrospectively for the period 26 March 2020 to 30 June 2020, extended on four subsequent occasions to 31 December 2020, 31 March 2021, 30 June 2021 and is now due to expire on 25 March 2022, and the period in which commercial rent arrears recovery action (CRAR) is restricted has been extended for a further nine months to 25 March 2022.

Although, at the time of writing on 9 October 2020,  it has been almost 30 weeks (yes, we’re shocked too) since the announcement of the UK national lockdown in March to deal with rapidly increasing numbers of COVID-19 cases, and (more importantly, of course) the start of our blog series tracking the resulting impacts and changes in the field of restructuring and insolvency, we in the Paris Smith CR&I team are feeling something of a sense of déjà vu this Autumn.

Certainly, part of that sensation is because COVID-19 cases are (at the time of writing though hopefully not for much longer) back on the rise, and many of those lucky enough to have returned to their offices have been sent back to work from home again. Likewise, cleaning products and other essentials appear to be disappearing off the supermarket shelves once more, whilst pub opening hours are once again in the headlines. But for us the other main reason for this sense of déjà vu appears in terms of the government’s legislative response to the renewed threat to UK business, as the policymakers have once again succumbed to their tendency to kick the proverbial can down the road.

We blogged about the entry into force of the Corporate Insolvency and Governance Act 2020 (CIGA) almost 15 weeks ago so its moratoria and other procedures have been available to debtors for fully half the time since lockdown began. However, we still have seen little evidence of these being employed in any meaningful way in practice, despite the considerable haste and anticipation with which they were drafted. We suspect part of the reason for this is that government policy has continued to make it difficult for creditors to exert any legitimate payment pressure. What we have seen in the interim is the Finance Act 2020 being passed into law in July, an Act which will bring with it, amongst other things, the heavily criticised restoration of the Crown’s preferential status in insolvencies with effect from 1 December 2020. Very recently we have seen the announcement of plans to lay new legislation before Parliament to tighten up the procedure for pre-packaged, connected party business sales, but we do not as yet have the detail on this, and nor do we have any clear timeframe as to when the proposed new regulations might be passed into law.

So how has government acted to address the impact of a second spike in COVID cases upon insolvency numbers?

CIGA’s Extensions and Delays

The answer to this question is a little more nuanced than simply extending restrictions upon creditors and time and space for debtors, but these aims are at the heart of these new legislative changes. Temporary measures designed to provide a much needed breathing space during the COVID-19 crisis were generally welcomed in the Spring, but they were due to expire on 30 September 2020, to coincide with the continued phasing out of the furlough scheme. However, very quietly and unhelpfully at the eleventh hour, in news largely hidden behind the new Job Support Scheme, many of these measures were extended by government for either three to six months as follows:

Three-month extensions

• Statutory demands against corporate debtors are now restricted between 1 March and 31 December 2020, ostensibly to protect companies from ‘aggressive’ creditor enforcement action as a result of COVID-19 related debts;
• Winding up petitions presented between 27 April and 31 December 2020 are effectively suspended where a company’s inability to pay is attributable to COVID-19;
• Restrictions on the court’s jurisdiction to make a winding up order will now apply until 31 December 2020;
• Landlords are prevented from using commercial rent arrears recovery (CRAR) before 31 December 2020;
• Commercial leases cannot be forfeited for non-payment of rent or other sums due between 26 March and 31 December 2020; and
• The current relaxation of the requirements for general meetings of limited companies (to enable voting via remote meetings) continues until 30 December 2020.

Six month-extensions

• The current modifications to the new moratorium procedure, introduced to relax its entry requirements, are extended until 30 March 2021;
• Temporary moratorium rules are extended to 30 March 2021; and
• Small business suppliers’ exemption from the prohibition on enforcement of so-called ipso facto (contractual insolvency-related termination) clauses is extended until 30 March 2021.

In keeping with these changes, a new Temporary Insolvency Practice Direction came into force on 1 October 2020, which is largely unchanged from the last one issued on 6 April. In line with the longer extensions, the Practice Direction runs until 31 March 2021. Similarly, the government’s Report on Pre-Pack Sales in Administrations was published on the day of writing (8 October) and this adopts part of the findings of the 2014 Graham Review with proposed regulations which would require an independent opinion or creditor approval of future pre-pack administration sale. Opinion amongst commentators is divided, with some saying this additional burden will likely impede creditor returns, whilst others think the regulations should be extended to connected party liquidation sales. Notably, however, the report fails to clarify who will be empowered to give the independent opinion required or to provide a specific timescale for Parliament to adopt the proposed regulations into legislation. Chief ICC Judge Briggs has also issued a supplemental Guidance Note relating to the conduct of insolvency and company law proceedings in the Rolls Building, London. We recently attended our first live hearing in the Rolls Building since lockdown and it was a somewhat surreal experience after such a long absence.

Impact on Debtors and Creditors

The collective effect of these changes, with some safeguards, is to signal to businesses that they have another quarter or two within which to assess their long-term viability before they are forced to either restructure the business and/or its funding, or to explore formal insolvency options, which will seemingly continue to include a pre-packaged administration sale provided they manage to overcome some new hurdles.

These will doubtless still be difficult quarters for many, and continued trade during this period is certainly not without risk to their stakeholders and personal liability for their directors and members, but by and large this continued policy of can kicking has been welcomed by businesses who rely on credit.

However, from the perspective of creditors – many of whom had been gearing up to be able to recover at least some of their receivables this month, and others who perhaps had adjourned winding up petitions but advertised them and briefed someone to attend court on their behalf which is now a largely wasted cost – this news is much less welcome. Whilst some may still attempt to secure winding up orders on one of the permitted, if narrow, bases and/or to apply to court for relief from the obligation to continue to supply insolvent debtors, the majority of creditors and their investors now face another nervous wait as they continue to have their hands tied, watching to see if their debt books are still going to be worth anything in 2021.

Wrongful trading

The one notable exception to this trend, which should at least ensure that debtors think very carefully before delaying insolvency advice and/or taking new credit they might not be able to repay, is that the government chose not to extend the ‘suspension’ of wrongful trading rules, which therefore came to an end automatically on 30 September.

The reason why this provision has not been extended is yet to be confirmed. We like to think this reflects the commentary of many, like us, who pointed out to the government that this suspension was always a false promise to directors and members in any event (given that they could still be found liable for breach of their duties to the company if, for example, they applied for loans which ultimately made the overall debt position worse). However, we suspect that closer to the truth is that government spin doctors wanted to be seen to be doing something to reduce a worrying rise in the number of ‘zombie companies’ (those who in truth have no future but are being kept in suspended animation by policies not really intended for them) as we march inexorably towards Hallowe’en. The appetite of journalists to print stories with images from the latest episode of The Walking Dead is seemingly voracious at this time of year.

Ultimately, though, it is not in anyone’s interests (even the employees of those companies, who are clearly on borrowed time and would arguably be better off with a redundancy package and a chance for another company to assume their former employer’s position in the market and to re-employ them) for wholly unprofitable and cash-poor companies which realistically stand no chance of rebuilding themselves with their current levels of debt when left to their own devices after the pandemic, to outlive their usefulness. If there is no insolvency pressure coming from creditors, the incumbent management need to be shown that it is in their personal interests to do something about it rather than just carry on regardless.

The position now is that, aside from the period 1 March to 30 September 2020, directors are, once again, personally responsible for any worsening of the financial position of their company or its creditors. The reinstatement of this head of liability should bring home the importance for directors of seeking professional advice as soon as possible, and of minimising any other substantive breaches of their directors’ duties.

Crown Preference

When the extensions and delays were announced, it was hoped by many that they might be accompanied by at least a corresponding delay in respect of the controversial restoration of HMRC’s secondary preferential status (where HMRC will stand to recover debts from insolvent company assets before the holder of a floating charge) which is currently due to take effect from 1 December 2020. The insolvency trade body R3 and many others have warned the government repeatedly that this re-introduction will harm business rescue efforts at such a critical time for the economy, but those in power appear to be deaf to our entreaties.

If this legislative change is not now postponed or (better) reversed, it will act as a ‘double whammy’ to creditors who have already been kept out of their money and a disincentive to other lenders to refinance that debt. The chance of unsecured creditors – who have already through no fault of their own been prevented by government policy from recovering their overdue rents, invoices and charges – receiving a distribution at all in the event of the insolvency of their debtor will be ever more remote if the Crown suddenly ranks ahead of them.

The combined effect of the CIGA extensions already severely restricting creditors’ ability to recover debts due to them, and a refusal by government to at least delay the restoration of Crown preference would be to allow the Crown to effectively ‘sweep the pot’ in the event of a corporate debtor’s insolvency, at the expense of those same creditors. This policy directly contradicts the government’s rhetoric from the introduction of CIGA in terms of the promotion of the ‘rescue culture’. We have not lost hope that the government will eventually wake up to the folly of its current path, but we fear that if this does not happen very soon it will be too late for many companies who might otherwise have had a prospect of meaningful survival through refinancing.

Summing up

Over the next few months, we will be watching closely to see whether the government will grant any further extensions to the CIGA provisions and/or postpone or rethink the restoration of the Crown preference. We also await details of the new pre-pack procedures and our first meaningful sight of a CIGA moratorium or new restructuring procedure, and what we expect will be a wave of enquiries about the termination of services in the face of insolvency. It may be that the impetus for the directors of troubled companies to seek formal insolvency advice is not yet there, but we strongly suggest that – in view of the current uncertainties in various sectors of the economy – any board of directors experiencing current or expected future cash flow issues at least opens some sort of dialogue with a qualified insolvency practitioner accountant (IP). The sooner an IP is consulted, the greater the range of options will be available, and the greater comfort / reassurance you will have that it is appropriate for you to continue to trade, seek further funding, etc.

In the meantime, we are able to advise and assist you in relation to any insolvency-related legal issues you may have, including matching your needs to an appropriate IP. Please don’t hesitate to get in touch with myself or with any member of our Corporate Restructuring & Insolvency team who would be delighted to help.

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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