On 25 May 2016, the Insolvency Service published a consultation paper aimed at reforming various aspects of the UK's corporate insolvency regime. It has now collected responses from various interested parties including Dentons. Some proposals focus on the issue of rescue finance, and how to make sure businesses have access to suitable finance to continue to trade out of financial difficulty or achieve a suitable restructuring. Will Gunston considers the new consultation and whether it offers anything new to the ideas that have been explored before in this area.
The overall impetus of the proposed changes is for the UK to remain at the forefront of insolvency best practice. They aim to ensure businesses, investors and creditors remain confident of the best outcome when faced with financial difficulty, and give a company the best possible chance to restructure its debts and return to profitability while protecting employees and creditors.
This consultation follows a recent World Bank survey, which, unfairly in our view, placed the UK behind its European and international counterparts in the World Bank league tables because of the lack of a debtor-led process applicable to all UK insolvency procedures. Since then the UK has voted in favour of "Brexit".
With other EU countries amending their insolvency legislation and calls (pre-Brexit) for closer harmonisation of insolvency laws within the EU, the UK was under pressure to amend its insolvency procedures and has, perhaps unsurprisingly, turned to the US for inspiration. This has led to the consultation being hailed as "Chapter 11 in the UK". It should be noted that the US underwent its own review of Chapter 11 in 2014 because of perceived difficulties of how it works in practice.
The consultation suggests:
- creating a new (single gateway) three-month moratorium against creditor action while a business develops a restructuring plan;
- ensuring preservation of "essential supply contracts" during an insolvency procedure to enable businesses to continue trading in a restructuring;
- making restructuring plans bind both secured and unsecured creditors and introducing a "cram-down" so a majority of creditors can bind the rest to a restructuring plan; and
- developing further the rescue financing market. In particular, whether to allow companies to grant security interests, during administration and other rescue processes, with priority (super-priority) over existing security (including prior fixed charges). This suggested priority position would always be subject to creating safeguards for existing secured creditors, and on allowing rescue financing to take priority over administration expenses.
The consultation as drafted, however, seeks to add bolt-ons to the existing UK framework rather than propose a complete overhaul to reflect the Chapter 11 regime.
The last suggestions on rescue finance are perhaps the most controversial part of the consultation, particularly from the perspective of financial institution stakeholders.
The idea of a free-standing restructuring moratorium is not new and was the subject of a previous consultation in July 2010 which never got off the ground. It was seen as too rigid and too expensive to turn out to be a popular restructuring tool and would, in reality, only work for a small number of businesses. It also included suggestions on how to deal with debts incurred during the moratorium and, in particular, the issue of rescue finance, which were also abandoned. Moratorium debts were to have "super-priority" status in any distribution made in an insolvency process. They were to rank below claims secured by a fixed charge but above other claims, including administration or liquidation expenses.
The new proposals largely follow these suggestions but pay particular attention to companies being able to grant rescue financiers security ranking in priority to existing lenders, thereby ignoring any earlier negative pledge.
A regime that gives third party rescue finance providers priority over existing fixed charge holders, including those existing fixed charge holders that have the benefit of a negative pledge, would very likely encourage rescue finance providers to fund businesses in financial difficulty. However, the ability to lend in these circumstances would likely be at the expense of higher costs for, say, an originating lender, and a decline in the availability of funds in a non-distressed trading environment. The current lending regime has the benefit of a clear and unambiguous risk profile for fixed charge holders. To disrupt such a risk profile would undermine the incentive for lenders to support young and growing businesses.
In reality, rescue finance, namely providing funding to enable a business to continue to trade while in an insolvency rescue process, happens all the time. It is usually the existing financiers who are most willing and able to provide this finance, to protect their own recovery position if nothing else. This levels the playing field for new entrants to the market. The market players most likely to provide DIP finance are likely to be expensive and take sufficient collateral to enable them to take all the assets of the business on a later insolvency process, leaving the existing banks with little in the way of collateral.
If DIP finance is to be combined with the proposed moratorium, (during which any unencumbered assets can be used to secure the DIP financing), the banks may not even be willing to lend from the outset to healthy companies.
It is unlikely the banking community will agree to have its negative pledges in security documents overridden in this way. It remains to be seen whether there will now be parliamentary time to table the proposals or whether they will need to be reconsidered in view of, and in the context of, the Brexit debate. The rescue finance proposals may of course, in view of Brexit, be forced upon the banking community, in order for it to remain competitive. But we prefer to take a more positive view!
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