In our article of 30 March 2020, we noted the importance of directors continuing to monitor their businesses’ solvency. We indicated that the impact of COVID-19 would not mean that all directors would automatically be at risk of claims of breach of duties, wrongful trading or other challenges, which could arise should insolvency be a realistic prospect at this stage or indeed become an eventuality. We noted that further developments were awaited and expected that further measures would be introduced.
On 28 March 2020, the UK Government confirmed that certain insolvency law reforms it was considering in its response to the consultation on corporate governance and insolvency would now be accelerated, with new legislation imminent. The purpose of these reforms is to provide some much-needed breathing space to businesses to consider the impact of the current situation and to review the options available. They will also provide welcome relief to directors who undoubtedly would otherwise be concerned about personal liability in respect of any possible wrongful trading claims should insolvency occur.
What is expected in the way of reforms?
Wrongful Trading - Suspension
We anticipate a temporary suspension of the wrongful trading provisions contained within the Insolvency Act 1986 in respect of the three-month period commencing 1 March 2020. The existing provisions currently enable wrongful trading actions to be brought against a director by an administrator or liquidator where a company enters into insolvent liquidation or administration. Such a claim requires that, prior to the commencement of the insolvency, the director allowed the company to continue to trade when the director knew or ought to have known that there was no reasonable prospect that the company would avoid insolvency.
A successful claim against the director could result in the director being made liable to make a contribution to the company’s assets. In considering any such claim, the courts give consideration as to whether the director took every step with a view to minimising the potential loss to creditors, and to the general knowledge, skill and experience of the director. The proposed suspension recognises that directors are facing exceptional circumstances and more significant challenges than ordinary trading conditions.
It is worth noting that the provisions in relation to fraudulent trading and director disqualification are expected to remain as currently drafted for the purposes of deterring director misconduct.
A moratorium is to be introduced for companies suffering financial distress as a result of COVID-19 to provide a period of time during which the company will have relief from the risk of enforcement action being taken against them to enable a rescue or restructure strategy. The UK Government’s response on the consultation did originally envisage this option being introduced. However, it is unclear the extent to which changes will need to be made to reflect the current circumstances. In particular, it was originally envisaged that the moratorium would be available to companies in financial distress but which are ultimately viable to enable consideration of the restructuring options.
The provisions were expected to mirror what is currently available in terms of the appointment of administrators where there is an interim moratorium available pending the appointment of administrators. The moratorium period was proposed as being 28 days unless extended (up to a further period of 28 days) and would come into effect on the filing of notice at court. There was also the prospect of the moratorium period being extended beyond the 56 days with the consent of secured and unsecured creditors – 50% in value of each, or, by the consent of the court. It was expected that a monitor would be appointed who would need to confirm that the eligibility and qualifying tests had been met. It is worth highlighting that, as originally proposed, the moratorium:
- would not be available to companies which were already insolvent or had been in an insolvency process within the previous 12 months. Further, it would only be available for use by companies where there is a prospect of insolvency, i.e. they will become insolvent if action is not taken. The distinction here being to avoid abuse of the system by directors of companies that should proceed straight to insolvency and those who are using it merely to deal with minor cash flow issues;
- was to be used where the monitor considers a rescue is more likely than not;
- required the company to carry on its business meeting obligations as they fell due during the moratorium;
- excluded certain entities from qualifying per the existing Schedule A1 to the Insolvency Act 1986 (e.g. public private partnerships, capital market arrangements);
- could be challenged by creditors once in place, e.g. on the basis that the criteria had not been met;
- would not involve suspension of wrongful trading liability during the moratorium period;
- envisaged that sanctions would apply where the process was misused by dishonest/reckless directors; and
- would provide that the costs of the moratorium would have super priority in a subsequent administration or liquidation of the company.
In light of the existing circumstances, we consider that certain of the criteria above will require adjusting.
A new restructuring plan is proposed. This was also a feature of the original UK response on the consultation, which envisaged this option being available in addition to the existing availability of schemes of arrangements and CVAs with certain elements of each being incorporated.
This option was proposed to allow for the cross-class “cram down” on both secured and unsecured creditors to implement the restructuring plan. Indeed, the consultation indicated that, on approval, the plan would be binding on all creditors and the rights of the parties will be as set out in the plan (with all previous rights being extinguished). Like the moratorium, the consultation envisaged this option being subject to certain qualifying criteria with certain companies being excluded.
However, that criteria did not include financial viability criteria and it was therefore expected to be available to companies already in insolvency. We understand that the proposed plan would involve a proposal being made by the company and a vote being held on the proposals (75% in value within each class with more than half of the total value of unconnected creditors voting in support of it for approval), with the ability for counter proposals to be made.
It was not envisaged that a supervisor would be appointed or there being a specified term for the plan. The response to the consultation also envisaged that the plan would protect the position of secured and priority creditors on the basis that a dissenting class of creditors must be paid in full before a junior class could receive any distribution unless the courts determined otherwise where it would be necessary to achieve the aims of the restructuring plan and it was just and equitable to do so.
Again, it is unclear whether the proposed restructuring plan will take the same form as outlined in the response to the consultation.
Protection of Suppliers - Essential Supplies in Insolvency
At present, insolvency legislation prohibits certain suppliers from enforcing the insolvency termination provisions within their contracts for supply where the supply is an ‘essential supply’ unless:
- the consent of the insolvency practitioner is obtained;
- the consent of the court is obtained; or
- the insolvency practitioner fails to make payment of the charges incurred within 28 days of their due date.
Current categories of essential supplies include gas, electricity, supply of communication, certain electronic services (e.g. computer hardware and software, data storage and processing amongst other things). As part of the consultation, proposals were sought as to whether these provisions should be further extended to all contracts that a company designates as essential and if the provisions should be invoked during a moratorium or CVA.
The response on the consultation determined that it would not be for the company to designate contracts as essential. Rather, it outlined that there would be a blanket prohibition on enforcing termination clauses on the grounds of insolvency, a moratorium being entered into, or a restructuring plan or process being implemented subject to certain exemptions. The intention was for the prohibition to also apply to licences (including, for example, software and patent licences) but exclude public authority licences. To balance against this wide prohibition and to protect the interests of smaller suppliers, the response on the consultation outlined that it would be open to a supplier to apply to the court to terminate a supply contract on the basis that the supplier would suffer undue financial hardship by the inability to terminate with it being more than likely that the supplier would enter into an insolvency procedure. This is a high test to meet. There was to be no requirement for a personal guarantee to be given by the insolvency practitioners, on the basis that the suppliers would have a super priority as an expense of the relevant insolvency procedure.
The most recent announcement of the UK Government indicates that there will be changes to the essential supply provisions to provide comfort around the ongoing trading of businesses as a result of the COVID-19 pandemic. However, whether or not those amendments will fully extend to what was outlined in the response on the consultation, remains to be seen.
We will continue to monitor developments in relation to the proposed new legislation and will provide further updates accordingly.
Allana Sweeney is a senior associate in Shepherd and Wedderburn’s restructuring and business advisory team. For more information, contact Allana on 0141 566 7215 or at email@example.com.