At the end of August, BEIS (finally) responded to a May 2016 consultation paper which reviewed the UK's corporate insolvency framework. It also took the opportunity to respond to wider insolvency and corporate governance issues which were the subject of a consultation in March 2018.
At the time of the first consultation, Dentons provided the government with its views on the proposed reforms, many of which have been taken on board in the recent government response. (For our previous articles click here.)
In this article, we review the reform proposals to the corporate insolvency framework as they now stand, compared to what was proposed in the original consultation.
A new pre-insolvency moratorium
Sticking with the plan: The government remains committed to the idea of a new moratorium available to all companies against creditor action while a company is given breathing space to consider its rescue options. This idea was largely favoured by respondents to the 2016 consultation, including Dentons. Thankfully, and as supported by Dentons, the moratorium will not be a compulsory gateway before starting an administration (or other rescue procedure). Nor will it be a bar to companies negotiating informal contractual standstill arrangements with creditors without the use of a statutory moratorium.
How long? The moratorium can last "up to" three months, but will have an initial 28-day period, which may be extended. The government has taken on board respondents' comments that a blanket three-month period seemed too long for all situations. If the company has proposed a scheme or CVA (for example) during the moratorium, but the moratorium "runs out" before the outcome has been determined e.g. because the relevant meetings have not yet taken place, the moratorium will automatically extend until the point where creditors approve or reject the proposals. The moratorium's time period is also intended to be stand alone. If the company enters into administration after using a moratorium, the administration period will be unaffected by this previous moratorium and will still run for 12 months which is a welcome clarification.
How to apply? The government intends to model the new moratorium on the existing administration moratorium and have it triggered by filing similar papers at court as with the current out of court administration appointment regime. This is a sensible solution rather than requiring formal court sanction at a hearing. The existing "small companies moratorium" available to eligible companies proposing a CVA will be repealed and replaced with this new moratorium so that anyone considering a CVA will be able to take advantage of an initial moratorium should they so wish. The test for eligibility of the moratorium is proposed to be one of prospective (not actual) insolvency, based upon a requirement that the company will become insolvent if action is not taken. The test will be judged on the balance of probabilities i.e. that a rescue is more likely than not. The monitor, as an insolvency professional, and not the directors, would be responsible for ensuring the company meets this test. Certain companies will be excluded from the moratorium, but previous recent insolvency it seems will not be a bar. Unlike in current administrations, the monitor will not be able to consent to actions that contravene the moratorium, such as taking legal proceedings.
Who will be in charge during the moratorium? Directors will remain in control of the company and the new "monitor's" role will be limited and will cover assessing and continuing to review the eligibility requirements and sanctioning asset disposals (which are outside the ordinary course of business) during the moratorium period. The government has kept the provisions prohibiting individual monitors (but not other members of their firms) from accepting a subsequent appointment with a company as a liquidator or administrator for 12 months. However, they can still accept appointments as a CVA supervisor. It is likely that this watered down version of the prohibition, which favours large firms, is a reaction to the mixed response the government received to the idea.
Preserving essential contracts for businesses in financial difficulty
A revised approach: The government remains committed to ensuring preservation of "essential supply contracts" during a moratorium period to enable businesses to continue trading in a restructuring. In its response the government sets out a proposal which will prohibit suppliers of goods and services from relying on termination clauses that allow a contract to be terminated on the grounds of formal insolvency (so called "ipso facto" clauses but not other clauses, such as non-payment of liabilities due under the contract, or termination following expiry of the specified contractual notice period). Contractual licences will be covered under these general preservation rules, such as for software or patents. Licences issued by public authorities will be excluded. If a supplier is likely to face "undue financial hardship" as a result of a prohibition, they can apply to court to be able to seek permission to terminate the supplies.
At the time, Dentons raised some concerns about this idea in general, uncertain that a rigid "designation" of contracts as essential would even be possible, not least undesirable. Whilst some respondents thought the proposals would result in a higher number of business rescues, this view was not shared by us. As a result the government no longer intends to require the designation of essential suppliers by a debtor company. It also intends to exempt certain types of financial products and services from the provisions. There is, however, still a long way to go before all the issues surrounding this proposal are ironed out.
A new "flexible restructuring plan"
New wine in old bottles? The
government is still committed to introducing a new restructuring
procedure that binds both secured and unsecured creditors and
introduces a "cram-down" allowing majority creditors to
bind the minority, having received positive feedback on such a
proposal from the majority of respondents, including Dentons, who
welcomed the idea of a stand-alone procedure as an alternative to,
but not a replacement for, CVAs and schemes of arrangement. The
plan is likely to be modelled on the existing schemes model, but
with class and sanction court hearings as part of the process.
Those proposing a plan will be able to take advantage of the
protection of the new
stand-alone moratorium (which is currently within the purview of the court in the current scheme of arrangement).
Who, how and how long? The new plan will not be available to all companies, with similar financial market entities excluded, as per the current small companies moratorium for CVAs. However, no financial conditions will be set to qualify, so both solvent and insolvent entities will be able to benefit from such a plan, including those already in an insolvency procedure acting via their existing insolvency office holder. Companies proposing a plan would act via their directors (rather than a mandatory appointed supervisor). The parties to the plan would decide who, if anyone, would be needed to oversee its implementation.
Rather than imposing a fixed 12-month period for the plan, the government now states it will be for the parties to decide the time period.
US-style cram down: Dentons has always welcomed the idea of making a new restructuring plan universally binding in the face of dissention from some creditors, subject to there being suitable protection for creditors. In particular, we support the purpose of preventing creditors who are "out of the money" from deriving value from ransom situations, unless this is justified for commercial reasons (such as the need to continue trading with essential suppliers). The government agrees with this.
However, the government may have missed a trick here with the voting requirements suggested, namely to make these plans easier to implement than schemes and therefore increase their popularity.
The issue of how claims should be valued in a plan where dissenting creditors are being crammed down was, as predicted, a contentious topic amongst consultation respondents. Rather than using the minimum liquidation alternative value (which Dentons pointed out has not always been the correct comparator in a scheme scenario) the government is proposing to use a "next best alternative" test.
Legislating for rescue finance? Finally, the government has decided not to pursue proposed changes formalising the rescue finance market.
Exciting times? To implement these changes will represent the single biggest change to the corporate insolvency regime since 2002. It will require amendment to primary legislation. It is difficult, however, to get too excited about them. Whilst (especially post Brexit) anything that makes us more attractive as a restructuring jurisdiction within Europe is to be applauded, we do not envisage these changes will be brought in any time soon. If we look to the US for inspiration, how these principles will fit within the existing UK insolvency framework remains to be seen. The devil, as always, will be in the detail. It is also not certain that they are necessary. The UK already has, in our view, the benefit of a flexible and efficient set of procedures backed up by reasoned case law and practice. Will this overcomplicate the legislation to the detriment of the industry? There is a danger it might!
Not finished there!
The government has also committed to:
- applying inflation to the current figure for the Prescribed Part pot of assets available to unsecured creditors in an insolvency process, which will now increase to £800,000;
- bringing in legislation to ensure directors of holding companies must have regard to the interests of a subsidiary company's stakeholders when selling that subsidiary. Directors of a holding company could be subject to disqualification proceedings if they allow the sale of a subsidiary (that then goes into liquidation within 12 months) if they had no reasonable belief that the sale would likely deliver a no worse outcome for the stakeholders of the subsidiary than placing it into formal insolvency;
- issue further consultation with a view to amending the current legislation relating to preferences to connected parties and extortionate credit transactions; and
- introduce new directors disqualification legislation to include former directors of dissolved companies within its ambit.
The government is also considering:
- introducing a requirement for companies of a "significant size" to provide an organogram of their corporate structure and explain how corporate governance is maintained throughout the group;
- consulting with the FRC on the Stewardship Code to consider how investment mandates given to firms can include reference to stewardship;
- consulting with legal and accounting bodies to consider whether there should be an overall review of the dividend framework. For example, including a requirement that shareholders should be able to vote on at least one set of annual dividends; and
- bringing forward proposals to increase the level of training available to directors.
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