Corporate Insolvency and Governance Bill 2020

Overview

The CIGB has been introduced on an emergency basis in a little over six weeks.¹ It is intended to and does compliment other legislation and schemes enacted in March/April, including the Coronavirus Act 2020 and the Coronavirus Business Interruption Loan Scheme (“CBILS”). Consistent with emergency legislation, the CIGB includes references, in no fewer than 23 places, to the ability of the Secretary of State to make amendments to its provisions by statutory instrument. In time, it is understood that the CIGB will be supplemented by a set of statutory rules (e.g. relating to the conduct of the Monitor), as well as (further) changes to the Practice Direction: Insolvency Proceedings.

The passage of the CIGB through the House of Commons was deliberately truncated, with all stages having taken place in a long parliamentary session on 3 June 2020 (which produced 13 pages of tabled amendments).² It will now be considered at further length by the House of Lords, where most amendments are anticipated, before finally obtaining Royal Assent. It is anticipated³ that it will become law in or around 30 June 2020.

According to its Explanatory Notes,⁴ the overarching objective of the CIGB is “to provide businesses with the flexibility and breathing space they need to continue trading, and to help them avoid insolvency during this period of economic uncertainty. The measures are designed to help UK companies and other similar entities by easing the burden on businesses and helping them avoid insolvency during this period of economic uncertainty”.

The Government has previously consulted on three of the five insolvency reforms: (1) the moratorium (2) the new arrangement and reconstruction plan and (3) the restriction on enforcement of ipso facto clauses. This consultation culminated in the publication by the Department for Business, Energy and Industrial Strategy in August 2018 of its response entitled “Response to the Insolvency and Corporate Governance Consultation” (“the BEIS Response”).

These three reforms are permanent.  They are intended to introduce “greater flexibility into the insolvency regime”⁵, and to allow companies breathing space to explore options for rescue whilst supplies are protected, so that they can have “the maximum chance of survival”. This puts the rescue culture established in IA86 (itself drawing on the recommendations from the Cork Report) at the front and centre of our insolvency legislation.

The other two central reforms are temporary emergency measures introduced specifically to assist businesses during the current crisis: (1) the suspension of liability for wrongful trading and (2) the restrictions on statutory demands and winding up petitions. These have been introduced to support directors to continue trading through the emergency without the threat of personal liability and to protect companies from aggressive creditor action.

Each of these five central reforms is considered in summary form below.

A comprehensive “mini-digest”, with a detailed breakdown and analysis of each aspect of the reforms, will be published by South Square later in June 2020.

The Moratorium

The centrepiece of the CIGB is the free-standing statutory moratorium (“the Moratorium”). The policy behind the Moratorium is to allow a company in financial distress a breathing space in which to explore its rescue and restructuring options free from creditor action. The provisions in relation to the Moratorium are set out in a new “Part A1”, which will be inserted before Part 1 (but within the First Group of Parts) of IA86.

The aim of the Moratorium is to facilitate a rescue of the company, which could be via a CVA, a “restructuring plan” (as introduced by the CIGB, see below) or simply an injection of new funds⁶. Consistent with the ‘rescue purpose’ of the reforms, the intention is that the Moratorium will result in a better, more efficient rescue plan that benefits all of the company’s stakeholders.

Obtaining a Moratorium

The eligibility for and the process of obtaining the Moratorium are addressed in Chapter 2 of the new Part A1.

There are two routes to obtaining the Moratorium.

First, if the company is an English (as opposed to an “overseas”) company, and it is not subject to an outstanding winding-up petition, the directors can obtain a Moratorium by filing the “relevant documents” with the court.⁷ These relevant documents include⁸ (1) a notice that the directors wish to obtain a Moratorium, (2) a statement from a qualified person (“the proposed monitor”) that they are (i) a qualified person who (ii) consents to act, (3) a statement that the company is an “eligible company” and, crucially, a statement (4) that the company is, or is likely to become, unable to pay its debts and (5) that, in the proposed monitor’s view, it is likely that the Moratorium for the company would result in the rescue of the company as a going concern.¹⁸

Second, if the company is an English company that is subject to a winding up petition⁹, or is an overseas company, the directors may apply to court for a Moratorium.¹⁰ On the application of the directors, the Court may only make an order that the company should be subject to the Moratorium where it is satisfied that the Moratorium would achieve a better result for the company’s creditors as a whole than would be likely if the company were wound up (without first being in subject to a moratorium). This test bears an obvious resemblance to the second statutory purpose of administration in paragraph 3(1)(b), Schedule B1 of IA86.

The Moratorium is available to all “eligible companies”. These are defined in Schedule ZA1. A company is “eligible” unless it is an “excluded” company. The list of “excluded” companies is wide.  It includes companies which already have their own bespoke insolvency regime: for example, insurance companies, banks, investment exchanges and securitisation companies.  However, it also includes companies that have participated in capital market arrangements incurring debt of at least £10 million involving the grant of security to a trustee, a guarantee or security by one party for performance by another.¹¹  This is likely to rule out many SME and larger companies.  Public private partnerships are also excluded.¹²

The Moratorium is not available to companies that either are subject or have recently been subject to a moratorium or other form of insolvency procedure. Again, this is provided for in Schedule ZA1, which provides that a company is excluded if, on the filing date, there is either a moratorium in force and/or it is subject to an insolvency procedure; alternatively, it is excluded where that has been the case at any point in the 12 months leading up to the filing date. For these purposes, an insolvency proceeding includes an interim moratorium under paragraph 44, Schedule B1, thereby protecting a creditor who has made an administration application or a qualifying floating charge holder who has filed a notice of intention to appoint an administrator.

Finally, an overseas company will only be eligible for a Moratorium if it is one which could be wound up under Part 5 of IA86; and in this regard the courts will apply similar principles when considering such an application as they would when considering the winding up of an overseas company.¹³

Effect of the Moratorium

This is addressed in Chapter 4 of A1.

The effect of the Moratorium is to provide the company with a “payment holiday” in respect of most of its “pre-moratorium debts” and with protection against legal and enforcement action (unless the Court has granted permission).

The new, core concept is the “pre-moratorium debt”. This is any debt or other liability that has fallen due prior to the commencement of the Moratorium or which becomes due during the Moratorium but under an obligation incurred by the company prior to the commencement of the Moratorium.

However, there are some wide-ranging and notable exceptions¹⁴ to what constitutes a “pre-moratorium debt” which qualifies for a “payment holiday”: these include amounts payable in respect of (1) the monitor’s remuneration and expenses; (2) goods or services supplied during the Moratorium (and which would otherwise be pre-moratorium debts because the relevant contract pre-dated the Moratorium); (3) rent in respect of a period during the Moratorium (where the lease pre-dated the Moratorium); (4) wages or salary arising under contracts of employment; (5) redundancy payments; and (significantly, see below) (6) debts or the liabilities arising under a contract or other instrument involving financial services.¹⁵

This “pre-moratorium debt” is to be contrasted with a “moratorium debt”, which is any debt or other liability to which the company becomes subject  during the Moratorium (other than by reason of an obligation entered into prior to the Moratorium) (e.g. a new debt arising under a new contract entered during the Moratorium) or to which the company may become subject after the end of the Moratorium because of an obligation incurred during the Moratorium.

Significantly, where a company commences administration or liquidation within 12 weeks of the end of the Moratorium, “moratorium debts” and “pre-moratorium debts” that do not qualify for a payment holiday are given super-priority, ranking behind fixed charge creditors but ahead of expenses, floating charge security and preferential creditors. This represents a major shift away from well-established insolvency priorities (and may well attract attention when the CIGB passes through the House of Lords).

The consequences of the Moratorium are far-reaching:

• • A20 (“Effects on creditors”) stipulates that during a Moratorium, except in certain circumstances (e.g. a director presenting a winding-up petition, or a public interest petition presented by the Secretary of State) no insolvency proceedings shall be commenced against the company. Further, if the directors intend to commence insolvency proceedings, they must notify the Monitor: see below.

• • A21 (“Restrictions on enforcement and legal proceedings”) provides that, except with the permission of the court, no steps may be taken to enforce any security over the company’s property (unless it is a security created under a financial collateral arrangement or a step to enforce a collateral security charge) or to repossess any goods in the company’s possession under a hire-purchase agreement. The Moratorium would also prevent the forfeiture of a lease by peaceable re-entry of business premises by a landlord, and the commencement and continuation of legal proceedings against the company and its property (with limited exceptions). These aspects of the Moratorium bear a strong resemblance to paragraph 43(6), Schedule B1 of IA86. The Court can give permission to take the proscribed steps, save that an application for permission may not be made for the purpose of enforcing a “pre-moratorium debt” for which the company has a payment holiday: see A21(2). However, and unlike paragraph 43(6) of Schedule B1, the Moratorium also prevents a floating charge from crystallising and prevents restrictions being imposed on the disposal of any floating charge assets.
• • A25-A32 provide for a series of restrictions on transactions, payments or disposals of property. For example, the company may not obtain credit to the extent of £500 or more unless the lender has been informed of the Moratorium; the company may only grant security over its property if the Monitor consents; and the company will not be permitted to make any payment or series of payments to any creditor in respect of any pre-moratorium payment obligations for which it has a payment holiday which exceed, in aggregate, £5000 or 1% of the total owed to unsecured creditors.

In this context, the CIGB does not introduce super priority DIP financing: however, this is one of the matters that will be considered going forward (and in relation to which there may be further consultation). It does facilitate secured borrowing that is enforceable during the Moratorium.  In particular, A26 provides that the company may grant security over its property if the Monitor consents.  The debt in respect of which security is granted is a “moratorium debt” that must be paid during the Moratorium, and in addition, A23 provides that such security is enforceable during the Moratorium.  Whilst this does not deal with priority over pre-existing security it does allow companies in a Moratorium to obtain Moratorium financing.

The Monitor

The new role of the “monitor” is addressed in Chapter 5 of A1.

A striking characteristic of the Moratorium is that the directors will remain in control of the company during the Moratorium, making this a Chapter 11-style debtor-in-possession process.  This overcomes one of the difficulties with administration.  It aligns UK law with the approach in Chapter 11, as well as the European Restructuring Directive.¹⁶ As a counterbalance to this, the Moratorium will be overseen by a monitor (who must be a licenced insolvency practitioner)¹⁷ and who must file their consent to act and confirmation that the relevant eligibility tests have been met (“the Monitor”). The Monitor will supervise the Moratorium and his or her consent will be required for, amongst other things, the payment of “pre-moratorium debts”, the disposal of assets and the granting of security.

The key obligation of the Monitor is to “monitor the company’s affairs for the purpose of forming the view as to whether it remains likely that the moratorium will result in the rescue of the company as a going concern”.  The provision of information to the Monitor by the directors is central to the operation of the process. The Monitor is entitled to rely on information provided by the company, unless they have reason to doubt its accuracy. The directors are required to provide to  the Monitor the information the Monitor requires as soon as practicable.¹⁹  If the Monitor thinks that, by reason of failure by the directors to comply with a requirement to provide information, they are unable to carry out their functions, the Monitor must bring the moratorium to an end.²⁰  The Monitor is an officer of the Court, and may apply to the Court for directions²¹ about the carrying out of their functions.

The likelihood of the rescue of the company as a going concern is the condition of not only entry, but also the “Termination of the moratorium by the monitor”: see A38.

The Monitor must bring the moratorium to an end²² by filing a notice with the court if they think that the Moratorium is no longer likely to result in the rescue of the company as a going concern or where they think that the company is unable to pay any of the following that have fallen due (a) moratorium debts and (b) pre-moratorium debts for which the company does not have a payment holiday during the Moratorium.

Length of Moratorium

This is addressed in Chapter 3 of A1.

The “initial period” of the Moratorium will be 20 days.²³ This will be extendable without creditor consent for a further maximum period of 20 days by the directors filing certain documents with the Court (at any time after the 15^th business day of the initial period).

Where the company obtains creditor consent, the Moratorium may be extended for a maximum period of 12 months: see A11 and A12(3). The consent of creditors will be obtained through the qualifying decision procedure.

The Court²⁴ may also extend the period of the Moratorium on the application of the company.²⁵  On hearing the application, the Court must take into account and consider the interests of pre-moratorium creditors, and the likelihood that the extension will result in the rescue of the company as a going concern.²⁶

The Moratorium will also be extended over proposals for a pending CVA²⁷, or on convening meetings of creditors to consider a scheme of arrangement or an arrangement and reconstruction over approval and sanction.²⁸

In each of these cases, the directors must confirm, when applying for any extension, the payment of all “moratorium debts” and “pre-moratorium debts” for which the company does not have a payment holiday.

Challenges

This is addressed in Chapter 6 of A1.

A creditor, director or member of the company or any other person affected by the Moratorium may apply to the Court on the ground that an act, omission or decision of the Monitor during a Moratorium has unfairly harmed the interests of the applicant. On such an application the Court may confirm, reverse or modify any act or decision of the Monitor, give directions to the Monitor or make such other directions as it thinks fit. Such application may be made during the Moratorium or after it has ended. Any such challenge is necessarily limited by the Monitor’s role.  The Monitor is not managing the company but monitoring the directors’ management of the company.

Of more significance is the power to challenge the management of the company by the directors.  A creditor or member can apply to court for an order on the grounds that during the Moratorium the company’s affairs, business and property are being or have been managed in a manner which has unfairly harmed the interests of the company’s creditors or members.²⁹  Such an application can be made during or after the Moratorium, which raises the possibility of post moratorium damages claims.³⁰ This puts upon the directors managing the company an additional duty not to harm creditors or members unfairly.  In administration this duty falls upon the administrators because they are managing the company.  In a Moratorium the directors continue to manage the company, but they are subject to this new duty.

Comment

The core precepts of the Moratorium – the focus on the rescue of the company as a going concern and the continuing management powers of the directors – mark a return to the original policy goals of the Cork Report, and the assumption of the flexible debtor-in-possession process that characterises Chapter 11.

Thankfully, there is one very key difference between the BEIS Response and the CIGB: the availability of the Moratorium for insolvent, as well as solvent companies. The Government had originally proposed that the Moratorium would only be available to a company that was prospectively insolvent. This raised obvious concerns about the number of companies that would not be eligible for the Moratorium and the fact that this would be counter-productive and would not sufficiently assist the policy of promoting the rescue culture.  It also gave rise to difficulties formulating that policy into a coherent and workable test.  The countervailing argument was that the Moratorium could be abused by the extension of a payment holiday to ‘zombie’ companies seeking to put off dealing with the company’s financial problems with yet further losses to creditors. It is understood that the shift from an entry test of prospective insolvency to actual insolvency took place relatively late in the drafting process: however, this was a critical intervention.

To protect against abuse by ‘zombie’ companies, the Moratorium imposes a high threshold i.e. that it is likely that a Moratorium would result in the rescue of a company as a going concern (and the termination of the Moratorium in the event that this is no longer possible). The Monitor will be required to state that in their view it is likely that the Moratorium will result in the rescue of the company as a going concern. This formulation is to be compared to, for example, the “reasonable likelihood” test³¹ adopted in the “Consent Protocol” for “Rescue Administrations” publicised by the City of London Law Society and Insolvency Lawyers Association, and drafted by Mark Phillips QC, William Willson and Stephen Robins of South Square. Whether the threshold is, as some fear, too high, and whether insolvency practitioners will be willing to make the relevant declaration, will both be key points of interest once the Moratorium has passed onto the statute book.

Another notable feature of the Moratorium, and one which may be a cause for concern for some creditors, is the relaxation of the conditions for obtaining a Moratorium, and extending it, during the initial period. Thus, the process will still be available to companies which are terminally insolvent such that they are likely to enter administration or liquidation.  Whilst the policy intention is to give such companies (of which there will be many) a chance of being rescued or restructured with the attendant protection of jobs, many will argue that the Moratorium is not the right process for such companies.

A further significant characteristic of the Moratorium is the sheer volume of exceptions to it. For example, the carve-out for any company that is party to a capital market arrangement, which will exclude numerous businesses which have bond financings (see above); and there are numerous exceptions to the definition of what is an “eligible company” (including financial services companies). The Moratorium will not be suitable for all companies in all parts of the market: it is far from being “one size fits all” legislation and appears to be better suited to SMEs. This will no doubt leave certain parts of the market relatively agnostic about the Moratorium and its inherent limitations, unless those are ironed out during the bill’s passage through Parliament.

Promoted by some as what administration (as originally envisaged) was always meant to be, there will be others who believe that administration is a well-established process which can already achieve the same policy goals.

The New Arrangement and Reconstruction Plan

The Plan

The CIGB introduces the new arrangement and reconstruction plan, as a new Part 26A of the Companies Act 2006, which is modelled on the scheme of arrangement, and pursuant to which a company can propose a restructuring plan to its creditors or members (“the Plan”).³² A company can use the Plan without first going into the Moratorium. Its key feature is that it will allow a company to bind all creditors, whether senior or junior, even if they vote against the plan, through the use of the so-called “cross-class cram down” provision.

Eligibility and Conditions

Under the CIGB, all companies will be eligible to apply for an arrangement and reconstruction plan, including overseas companies with a sufficient connection to the UK.

Section 901A provides that the company must meet two conditions in order to propose a reconstruction plan: (1) the company must have encountered or be likely to have encountered financial difficulties that are affecting, or will or may affect, its ability to carry on business as a going concern³³ (the company does not need to be insolvent); and (2) a compromise or arrangement must be proposed between the company and its creditors or members and the purpose of such compromise or arrangement must be to eliminate, reduce, prevent or mitigate the effect of any of the financial difficulties the company is facing.

That the Plan is to eliminate financial difficulties the company has or is likely to encounter which may affect its ability to carry on business is the context in which arrangements and reconstructions will arise and will inform the interpretation of the new Part 26A. However, no further guidance is provided on the meaning or scope of the term “financial difficulties”, which is seemingly very broad.

The Steps

The first step in the Plan process is for the company, either acting through its insolvency officeholder or its directors, to apply to the court for permission to convene class meetings to consider the Plan: see Section 901C.

At the first hearing, the court will examine the classes of creditors and members proposed by the company. Given the resemblance to schemes, the Court is likely to apply the same test when determining class issues: stakeholders should vote in the same class where their rights are “not so dissimilar as to make it impossible for them to consult together with a view to their common interest”.³⁴

As explained further below, there is a significant difference between schemes and arrangements and reconstructions. In schemes identification of the class is critical. That is because in schemes creditor votes in class meetings are determinative. The Court will not consider commercial questions. They are for the properly constituted class meetings. In an arrangement and reconstruction under Part 26A the identification of the classes is not determinative in the same way. If a difficult group of creditors are put into small classes that do not vote in favour of the Plan, the scheme can still be sanctioned under the cram down provisions.

However, the crucial distinction from schemes at the first hearing arises under Section 901C(4), which provides that the general rule that every creditor or member whose rights are affected must be permitted to participate in the meeting will not apply to a particular class of creditors or members who, on an application, the Court is satisfied do not have a “genuine economic interest” in the company. In such circumstances, this class or classes or creditors or members are not entitled³⁵ to participate in the meeting or in any stage of the Plan. This gives applicants an early opportunity to neutralise another creditor that is ‘out of the money’. This will inevitably give rise to difficult valuation disputes at the first hearing, in relation to which the Court will need to determine the scope and meaning of the new term “genuine” economic interest (i.e. whether that means real as opposed to fanciful, or something else).

The requisite vote will subsequently take place on the order of the Court at the meeting of creditors or members. Section 901F provides that, if the requisite voting majorities are met, the Plan will move onto sanction. The voting majority will be 75%³⁶ in value of the creditors in each class. This is different to schemes because the additional requirement for a majority in number has not been adopted. The 75% requirement has been questioned when compared to many restructuring processes that require 66% (and this is one of the provisions that might be changed by the Secretary of State). The Court has a discretion to sanction the Plan (“the court may……. sanction”), but (as referred to below), both the CIGB and the Explanatory Notes are silent as to the test that the Court should apply in the exercise of its discretion.

Cross-Class Cram Down

If all classes have approved the Plan, the Court may sanction it where 75%³⁷ in value of creditors or members present and voting in each class have agreed the compromise or arrangement.

However, even if the Plan is not agreed by 75% of a class, or more than one class, Section 901G (“Sanction for compromise or arrangement where one or more classes dissent”) provides that the Court may sanction the Plan provided that two conditions are met: first (“Condition A”) that the Court is satisfied that if the compromise of arrangement were to be sanctioned, none of the members of the dissenting class would be worse off in the “relevant alternative”; and second (“Condition B”) that the Plan has been agreed by a number representing 75% in value of a class of creditors or members who would receive a payment, or have a “genuine economic interest in the company”, in the event of the relevant alternative.

If these two conditions are satisfied the Plan can be approved. Significantly, this means the jurisdiction arises if only one class approves the Plan. Other classes may be ‘crammed down’ whether senior or junior to the approving class provided none of the dissenting classes would be worse off in the relevant alternative.

For these purposes, the “relevant alternative” is whatever the court considers in its discretion would be most likely to occur in relation to the company if the compromise or arrangement were not sanctioned by the Court under Section 901F. Given the context in which arrangements and reconstructions will be put to creditors the relevant alternative will be what the company faces absent (i.e. but for) the Plan in question to deal with its actual or likely financial difficulties affecting its survival as a going concern. That may be a liquidation. It might be an alternative Plan. This is likely to result in numerous valuation disputes about likely outturns.

This formulation of the test makes it possible for junior lenders to be ‘crammed down’ by senior lenders, but also for senior lenders to be ‘crammed up’ by more junior lenders. What the company has to show is that the crammed down creditors are no worse off. As a consequence, where one ‘in the money’ class of creditors approves the Plan and the Plan delivers a better outcome than the next best alternative option (e.g. administration, liquidation, or an alternative plan) the Plan will become binding on creditors in all classes if sanctioned by the Court.

Recognition and International Aspects

The Plan will be available to any company which has a “sufficient connection” to the United Kingdom. As in relation to scheme of arrangements, this will provide debtors with broad scope to found jurisdiction before the English courts.

However, and unlike in Chapter 11, there is no express provision that the (English) Court’s orders have extra-territorial effect, though it may be possible to apply for recognition internationally e.g. under Chapter 15 of the US Bankruptcy Code or according to the principles of private international law.

Comment

The plan for arrangement and reconstruction gives companies a more flexible tool than schemes of arrangement. The introduction of the cross-class cramdown is a significant shift and marks a move from class composition to competing economic outcomes. The potential leverage wielded by creditors with ‘hold out’ claims in schemes of arrangement and CVAs will no longer be an issue under Part 26A. Moreover, potential ‘cram-ups’ by junior lenders of more senior lenders are likely to present new opportunities for some market participants.

Given its long experience of schemes of arrangement, the Court will be well-equipped to address many of the new concepts. In this regard, the Explanatory Notes state that “The overall commonality between [Parts 26 and 26A of the CA 06] is expected to enable the courts to draw on the existing body of Part 26 case law where appropriate”. Though there is currently no guidance on the meaning and scope of “genuine economic interest”, there is well-established authority addressing ‘out of the money’ creditors that do not need to be invited to vote on a scheme of arrangement.³⁸ The identification of a test for the exercise of the Court’s discretion on a sanction hearing may be a new and greater challenge for the Court given the obvious inapplicability of the scheme sanction test³⁹ to a procedure that anticipates cross-class cramdowns on dissenters.

One further concern that has been voiced is that the imposition of the Plan on a dissenting class will generate more litigation than has been the case with schemes of arrangement. There will certainly be hard-fought valuation issues, given their relevance not only to identifying creditors who do or do not have a “genuine economic interest”, but also to the application of the “relevant alternative” test. In current circumstances, where businesses have been mothballed during the Covid-19 crisis, the identification and determination of the relevant valuation assumptions will be crucial (including whether and how quickly the business in question can return and recover). However, the Courts are well-equipped to deal with valuation disputes, even if some of the issues will be novel.

A further, unexpected, feature initially introduced by the CIGB was that the Plan, and the existing scheme of arrangement framework, will not be available in respect of creditors with “aircraft-related interests”.⁴⁰ The net effect of these provisions, if enacted, would have been to deprive companies with aircraft assets in financial distress of a valuable tool to restructure outside of a formal insolvency process. However, this provision was removed from the draft CIGB before it was presented to the House of Lords at the end of the parliamentary session on 3 June 2020.

Ban on Termination Clauses

Restrictions on Ipso Facto

When a company enters a rescue, restructuring or insolvency procedure, suppliers often cease supply pursuant to a contractual termination clause triggered by insolvency. This was previously well-established under English contract law, and supported by the highest authority: “Where a contract provides for the performance in the future of reciprocal obligations, the performance of each of which is the quid pro quo of the other, I see nothing objectionable or evasive about a provision entitling one party to terminate if the other becomes bankrupt”.⁴¹

As foreshadowed in the BEIS Response, there will now be a ban on the enforcement of termination or so-called ‘ipso facto’ clauses. This will mean that (subject to certain exclusions) contracted suppliers will have to continue to supply, even where there are pre-insolvency arrears.

Again, this new provision has its origin in Chapter 11 of the US Bankruptcy Code and is already a feature of numerous insolvency systems throughout the world.⁴² Its purpose is to preserve a company’s operational abilities during restructuring.

The prohibition operates via the creation of broad new rules to supplement the existing ‘essential suppliers’ regime under Section 233 and Section 233A of IA86, which preserve the continuity of supplies of certain essential services (e.g. electricity, water and IT services). In this regard, Schedule 12 of the CIGB inserts a new Section 233B (“Protection of supplies of goods and services”).

As a result, the CIGB will prevent a much wider range of suppliers of both goods and services from terminating a contract due to a company entering a formal restructuring or insolvency procedure. The measures are intended to compliment the policy for the Moratorium and the Plan, which are aimed at enhancing the rescue opportunities for financially distressed companies.⁴³

Importantly the prohibition is limited to suppliers of goods and services.⁴⁴

The new Section 233B applies where the company enters the “relevant insolvency procedure”. This includes existing insolvency processes, the new Moratorium, the new Plan: but not the pre-existing scheme of arrangement.

Under Section 12(3), a provision of a contract for the supply of goods and services to the company ceases to have effect when the company becomes subject to the relevant insolvency procedure if and to the extent that, because the company becomes subject to the relevant insolvency procedure, (a) the contract of the supply would terminate or “any other thing would take place” or (b) the supplier would be entitled to terminate the contract or the supply or to do “any other thing”.

The “any other thing” provision is broad and unclear. It appears likely to be a reference to exercising rights under any other provision in the contract which are triggered by an insolvency event, for example, acceleration clauses, default interest or any other contractual consequence.

Section 12(4) provides that where an event has occurred that would have allowed a supplier to terminate a supply contract before the company entered a relevant insolvency procedure but that right has not been exercised, it is suspended once the company enters the relevant insolvency procedure and the entitlement may not be exercised. If the supplier’s right to terminate arises after the insolvency procedure begins (for example, non-payment for goods supplied after that time) then this right is not prohibited.⁴⁵

Crucially, Section 12(7) stipulates that the supplier may not make payment of outstanding amounts (in respect of supplies made prior to the insolvency trigger) a condition of continuing supply.

However, there are various exclusions to the ban.

First, Section 12(5) provides that where the prohibitions are in effect, the supplier may only terminate the contract if (a) the relevant office holder consents to the termination; (b) the company consents to the termination; or (c) the court is satisfied that the continuation of the contract would cause hardship and it grants permission for the termination of the contract.

Second, Section 13 provides for an exclusion which applies to small entities where the counterparty became subject to an insolvency procedure before 30 June 2020 (or one month after coming into force of the section (whichever is later). In order to qualify as a small entity, at least two of the following tests must be met: (a) turnover does not exceed £10.2 million; (b) the balance sheet total is not more than £5.1 million; and (c) there are no more than 50 employees.⁴⁶

Third, there are also exceptions for financial services entities and contracts involving financial services: see Schedule 4ZZA.

As in relation to the Moratorium and the Plan, there is a broad Henry VIII clause which allows the Secretary of State, by statutory instrument, to make amendments to Section 233B and Schedule 4ZZA: see Section 233C.

Comment

This is an important amendment to IA86 and brings UK insolvency law into line with much of the rest of the insolvency world. Companies will be entitled to maintain important supplies. If the company does not wish to continue with the supply, it is able to consent to the enforcement by the creditor of the ipso facto clause.

It is very important to note that the CIGB only covers supplier arrangements in relation to goods and services. This may include commercial and financial contracts. Suppliers will still be able to terminate contracts on other grounds in the agreement – unless the ground in question had already arisen prior to the insolvency.

The CIGB does not define what hardship is. In the absence of further guidance, the Courts will need to develop principles to determine what factors to apply when determining whether the continuation of supply is causing the supplier hardship.

Temporary ban on statutory demands and winding up petitions

Ban

The CIGB puts into effect the Government’s proposal for a temporary “ban” on the use of statutory demands and winding up petitions in respect of debts that are unpaid as a result of Covid-19.

When the Government first announced on 23 April 2020 its intention to introduce the ban, it appeared to be focussed on commercial landlords in respect of unpaid rent. In Re Saint Benedict’s Land Trust Limited; Re Shorts Gardens LLP Harper v Camden Borough Council and another; Shorts Gardens LLP v Camden London Borough Council [2020] EWHC 1001, a case concerning a winding up petition threatened against a supplier of storage services, the applicant sought to rely upon the proposed ban as a ground for obtaining an injunction. Snowden J commented that it appeared to be “overwhelmingly” likely that the proposed legislation would only apply to certain limited sectors, e.g. retail and hospitality, and only in respect of claims by landlords for arrears of rent.

More recently there have two further injunction decisions in the context of the ban: first, Travelodge Ltd v Prime Aesthetics Ltd [2020] EWHC 1217 (Ch) (Birss J), which preceded the ban, but was based on ministerial statements; second, Re a Company (Injunction to Restrain Presentation of a Petition) [2020] EWHC 406 (Ch) (Morgan J), which was heard on 1 June 2020. In both cases, the Court took into account the possibility or likelihood of a change in the law.⁴⁷

The key temporary measures, set out in Section 8 and Schedule 10 of the CIBG, are as follows:

• Paragraph 1 provides that a creditor may not present a winding up petition on or after 27 April 2020 on the ground specified in Section 123(1)(a) of IA86 that a company has failed to satisfy a statutory demand, if the statutory demand was served during the “relevant period” i.e. between 1 March 2020 and 30 June 2020 or one month after the coming into force of the CIGB, whichever is the later;⁴⁸

• Paragraph 2 provides that a creditor may not present a petition for the winding up of the company between 27 April 2020 and 30 June 2020 or one month after the coming into force of the CIGB, whichever is the later, on any of the grounds specified in Section 123(1)(a)-(d) of IA86 unless it has reasonable grounds for believing that (i) Covid-19 has not had a financial effect on the company; or (ii) the company would have been unable to pay its debts even if Covid-19 had not had a financial effect on the company;⁴⁹ and

• Any winding up orders made between 27 April 2020 and 30 June 2020 or one month after the coming into force of the CIGB, whichever is the later, will be void if the order was not one that would have been made had the Court applied the relevant test, namely, whether or not Covid-19 has had a financial effect on the company before the presentation of the petition.⁵⁰

Paragraph 5 provides that, where a winding-up petition has been presented by a creditor during the relevant period that claims that a company is unable to pay its debts, the court will consider whether Covid-19 has had a “financial effect” on the company. The Court may only wind-up a company if (a) for a petition presented in respect of a statutory demand or unsatisfied judgment debt, the ground for winding up would have arisen even if Covid-19 had not had a financial effect on the company; or (b) for a petition presented in respect of a company that is insolvent (either on a cash-flow or balance sheet basis) even if Covid-19 had not had a financial effect on the company.

The CIGB applies a relatively low threshold test to assess whether Covid-19 has had a “financial effect” on a company. It will be met if the company’s financial position worsens in consequence of, or for reasons relating to, Covid-19. This is likely to catch the vast majority of businesses. However, as the Court must then go on to consider whether the company would have been unable to pay its debts even if Covid-19 had not had a financial effect on the company, this is likely to catch those companies that were unviable before the crisis. This goes some way to providing a necessary counterweight to balance these far-reaching provisions which restrict a fundamental class right to wind up a company.

A feature of the CIGB which was not anticipated is the change in the date of the commencement of the winding up in respect of petitions presented during the relevant period. Paragraph 8(9) of Schedule 10 provides that the commencement of the winding up will be the date of the order rather than the date of presentation of the petition, as provided under Section 129 of IA86. This means that Section 127 of IA86 is of no effect: dispositions of the company’s property made between the presentation of the petition and the date of the winding up order will not be void. Rather, paragraphs 10 to 18 of Schedule 10 makes modifications to various ‘look-back’ periods under the IA86, the most notable of which is in respect of transactions at an undervalue and preferences. The period is to start either (a) 2 years before the date of presentation of the petition (in the case of transactions at an undervalue) or six months (in the case of preferences) or (b) 2½ years before the day on which the winding up order was made (in the case of transactions at an undervalue) or 12 months (in the case of preferences) whichever is the later, ending with the day on which the winding-up order is made.

Comment

Many practitioners will be keen to see how the courts will interpret and apply the relevant tests under these provisions.

The key battleground is likely to be over the second limb of the test, namely, whether the debtor company would have been unable to pay its debts even if the Covid-19 pandemic had not had a financial effect on the company. There will be many different factual scenarios that will test the boundaries of this pre-condition. For example, it is unclear how the Court will treat those companies which faced temporary liquidity problems prior to the onset of the Covid-19 pandemic, and which expected them to be resolved in a reasonably short period of time but were not as a result of the pandemic. Does a company in this scenario fall within the second limb of the test? There will doubtless be many other scenarios in respect of which it is unclear what the outcome will be. Uncertainty will be felt by creditors and debtors alike.

In the majority of cases, creditors are unlikely to know very much about the detail of a company’s finances or the causes of its insolvency. Creditors will also be at risk of an adverse costs order if they litigate the issue and lose. As such, many creditors may well be deterred from seeking to wind up a company and will instead have to consider other insolvency processes, such as administration. Alternatively, this may encourage creditors and debtors to engage in a more consensual resolution of their disputes.

As to the change in the date of the commencement of the winding up, this is aimed at facilitating the ongoing trading of a company that is subject to a winding up petition by avoiding the automatic freezing of a company’s bank account.

However, there will be concern that this removes an important protection to creditors at a time when the company’s assets are under the control of the directors. The operation of Section 127 seeks to ensure that some creditors are not unfairly paid ahead of others and to give effect to the fundamental principle of pari passu distribution. Where a payment to a creditor during this period promotes the interests of creditors as a whole, it can be validated by the court. Further, given the limited circumstances in which a creditor may present a winding up petition, essentially only against a company that was not viable before the pandemic, some will argue that the protection afforded to creditors under Section 127 is still required and would not undermine the promotion of the rescue culture.

Temporary suspension of liability for wrongful trading

Suspension

The CIGB introduces a suspension of personal liability for wrongful trading under sections 214 and 246ZB of IA86.

On 28 March 2020 the Government announced that the wrongful trading regime would be temporarily suspended “to give company directors greater confidence to use their best endeavours to continue to trade during the pandemic emergency without the threat of personal liability should the company ultimately fall into insolvency”.

As anticipated, the suspension will apply retrospectively from 1 March 2020 until 30 June 2020 (or one month after the coming into force of the CIGB, whichever is the later).

However, the CIGB does not in fact suspend the wrongful trading regime. Instead, it directs the Court – when determining the contribution a director who has wrongfully traded is to make to a company’s assets – to assume that a director is not responsible for any worsening of the financial position of the company or its creditors that occurs during the relevant period.⁵¹ As such, the CIBG reduces, rather than removes entirely, personal liability for wrongful trading. It is not intended to allow directors with pre-existing wrongful trading issues to avoid liability. Directors will still have to consider during the relevant period whether to place the company into liquidation or administration.

Further, the provisions do not impact other routes to establishing personal liability of directors. Fraudulent trading is unaffected, as is the common law remedy for breach of duty. This means that directors will remain under the duty to act in the best interests of creditors at the point when it was known, or ought to have been known, that the company was, or was likely to become insolvent (see BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112). Nor do the measures impact the operation of the disqualification provisions under the Company Directors Disqualification Act 1986.

Comment

The necessary corollary of the continued operation of these provisions – and the narrower relief provided under the CIGB than anticipated – is that most directors will treat the proposed relaxation of the rules with caution.

Further, as with many of amendments in the CIGB, there are broad and notable exceptions, which mean that the temporary suspension does not apply to certain excluded companies, including parties to capital markets arrangements.⁵² The £10 million threshold that applies to the Moratorium will not apply in this context.

However, in reality, few directors have been able to make decisions about the trading of their companies during the Covid-19 period.

Conclusion

The insolvency reforms in the CIGB represent the most significant reforms in insolvency law since 1986. UK insolvency laws will become more debtor friendly. In the context of the current financial crisis they give the insolvency profession additional tools they can use to save businesses and livelihoods.

We look forward to providing you with a more detailed analysis of the reforms on an issue-by-issue basis in the forthcoming “mini-Digest” to be published later this month.