Introduction
In 1982 the Cork Report drew attention to the recently enacted Chapter 11 of the US Bankruptcy Code 1978 as a paradigm example of a flexible rescue procedure. As is now well known, Chapter 11 proceedings can be initiated without the involvement of the Court and enable the debtor to remain in possession of the Company. The company can have the benefit of debtor-in possession financing and in a Chapter 11 plan it is possible to cram-down dissenting classes of creditor. Almost forty years on from the introduction of Chapter 11 in the US, the UK government has announced plans to reform the UK’s insolvency and restructuring framework. It appears that the Government’s intention is to create a more debtor-friendly environment. It is not possible to examine every proposal in one article, but we examine the potential the Government’s proposals have to effect a shift in the dynamic of the UK rescue culture. On one view, the latest plans mark the end of a journey to a rescue culture that started with the Cork Report and took the UK through the Acts of 1986 and 2002. On another view, we have gone back to the future of 1986.
The proposals are set out in Section 5 of ‘Insolvency and Corporate Governance, Government Response’ published on 26 August 2018 1. They arise from a consultation titled “A Review of the Corporate Insolvency Framework (2016).” The proposed reforms are to be introduced as soon as Parliamentary time allows, and include the following:
1. A moratorium to enable distressed but viable companies to consider their options (which for convenience we will call the ‘restructuring moratorium’).
2. A new restructuring plan that, amongst other things, will enable cross-class cram downs;
3. Legislation preventing suppliers from relying on ‘ipso facto’ clauses when a company enters formal insolvency proceedings.
We anticipate that these reforms, in particular the restructuring moratorium and the new restructuring plan, will ultimately mark a turning point for the UK rescue culture. However, the teething problems that followed the introduction of the CVA and administration procedures in the Insolvency Act 1986 should not be forgotten. It is important that Parliament is alive not just to the present statutory possibilities in the UK insolvency and restructuring framework, but also to the history, particularly of what were purposes (b) and (c) of the administration procedure between 1986 and 2002.
The restructuring moratorium
The purpose of introducing a restructuring moratorium is to give financially distressed but viable companies time to consider their options, including restructuring existing debt or seeking new investment. This represents a significant shift in power in a restructuring. The company is able to discuss and negotiate the terms without the fear that one creditor could hold out for a better deal under the threat that if that creditor does not get what it wants it will enforce its debt and bring the whole deal crashing down. It should enable companies to achieve structures that give the company a better chance of surviving.
The automatic moratorium has always been an integral aspect of the administration procedure. A stay, albeit not a moratorium, has been used to support schemes of arrangement. In Bluecrest Mercantile NV v Vietnam Shipbuilding Industry Group 22 the Court exercised its discretion to stay proceedings of dissenting creditors,thereby effectively imposing a moratorium in circumstances where a scheme of arrangement had a “reasonable prospect of going ahead 3”.3 However, the moratoriums currently available in the UK have different, but significant limitations: the moratorium in Schedule A1 is limited to small and medium sized companies, the administration moratorium can only be obtained by the directors relinquishing control to an insolvency practitioner, and the Bluecrest moratorium can only be obtained following an application to the court if there are relatively advanced proposals for a scheme of arrangement and will only apply to specific creditors.
The restructuring moratorium will allow companies of all sizes to obtain a moratorium quickly and cheaply. The directors do not need to relinquish control to an insolvency practitioner and no court application will be necessary. The Report also emphasises that the restructuring moratorium is intended to be a stand-alone tool and not a necessary pre-requisite seeking creditors’ consent to a restructuring plan. This might be a mistake. If a moratorium was a required step it would not be open to companies to take ever more elaborate and expensive steps to avoid going into a moratorium in order to keep creditors on side, and there is a risk we will end up back where we are now. It would also avoid the protection to all creditors that will result from the restructuring moratorium supervisor (known as the ‘Monitor’), which is discussed in more detail below. The restructuring moratorium will be modelled on the administration moratorium.4 Certain companies will be excluded from being able to benefit from the restructuring moratorium.5 As a result of the restructuring moratorium the moratorium in Schedule A1 Insolvency Act 1986 will be repealed. There will also be no need to have a separate moratorium available only to small and medium sized companies.
Entering into the restructuring moratorium
The restructuring moratorium will be triggered by filing the necessary papers at court. This will be similar to the procedure for an out-of-court appointment of an administrator.6 This should be a cheap and efficient process. The Monitor will be required to 7 file their consent to act and confirm that they are satisfied that the eligibility tests and qualifying conditions are met’ send notice to all known creditors of the company and register the company’s entry into the moratorium at Companies House. This gives protection to all creditors against abuse of the process. There are two significant advantages to the company. First, monitoring is carried out by the Monitor and not, at least in the first instance, by the court. Second, the Monitor does not take over the management of the company. In the context of a restructuring, there is no need to take the management of the company away from the directors, one of the reasons why the moratorium through administration that was in place between 1986 and 2002 was underused.
A restructuring moratorium will be challengeable by applying to the Court.8 Grounds of challenge will include the qualifying conditions not being met and the restructuring moratorium causing unfair prejudice to creditors. The same principles as those established in the case law regarding applications to have administration moratoriums lifted will be applicable.9 This is a sensible protection. The first ground will only apply in the rare cases where a moratorium has been sought when it should not have been. The second is more nuanced. It has long been established that unfair prejudice does not mean that a creditor’s rights have been infringed.10 Infringement of rights will occur in every case as soon as a creditor is not entitled to enforce those rights as by his contract it had been agreed he could. Unfair prejudice (which harks back to section 27 of the Insolvency Act 1986) is a holistic question: there must be prejudice and it must be unfair, in other words something affecting that creditor in a particular and unfair way.
Eligibility criteria and qualifying conditions
In order to be eligible for the restructuring moratorium, the company must not have entered into another restructuring moratorium, a CVA or administration within the previous 12 months, or be the subject of a winding-up order or petition. 11If a winding-up petition is pending, a company will be precluded from triggering a restructuring moratorium by filing papers at court. However, it may be able to obtain a restructuring moratorium if the court grants permission.12 This is very similar to the position in an administration. Since the 1980s this has led to some creditors presenting protective petitions (and in earlier times to take qualifying floating charges) in order to give themselves a platform to be heard on the application for a moratorium. The difficulty with such a strategy is that the conditions will almost always be fulfilled, and unfair prejudice to the particular creditor is difficult to show. Consequently, while the petitioning creditor will be heard, there might not be much that he can say.
The company must be in a state of “prospective insolvency” such that it will become insolvent if action is not taken. If a company is already insolvent it is not eligible for the restructuring moratorium.13 It is not clear from the Report what the test for “prospective insolvency” will be in the new legislation, and in particular whether or not it will mirror the requirement that “the company is or is likely to become unable to pay its debts” in order for the Court to make an administration order.14 However, there is no need for a different test, and it is difficult to conceive of a test that would better fit the concept of “prospective insolvency” than the current test.
The Monitor must be satisfied, on a balance of probabilities, that if the restructuring moratorium is triggered, the prospect of rescue is more likely than not. 15 At first blush this appears to be different to that required by paragraph 11(b) of Schedule B1 Insolvency Act 1986, which is that an administration order must be “reasonably likely to achieve the purpose of administration”. However, that test resulted from extensive caselaw that considered the test “is likely to achieve” which is similar to the language used in the consultation. 16 The Courts have interpreted the current provision to mean that there must be a “real prospect” of achieving the purpose of administration, rather than it being likely: Hammonds (A Firm) v Pro-Fit USA Ltd. 17 The Monitor must also be satisfied that company has sufficient funds to carry on its business and meet its obligations as they fall due during the duration of the moratorium. In practice this is likely to be an important question, which we consider below.
Sanctions will be introduced to deter abuse of the restructuring moratorium by directors.19 The Government has stated that it is considering whether similar sanctions to those in the existing moratorium available to small and medium sized businesses for the purpose of entering into CVAs will be required for the restructuring moratorium.20
Length of the Restructuring Moratorium
The initial period of a restructuring moratorium will be 28 days.21 This can be extended by up to 28 days by the company.22 Further extensions can be obtained by approval of more than 50% of secured creditors by value and more than 50% of unsecured creditors by value. Alternatively, the company will be able to make an application to the court for an extension of time.23 The initial period and the extensions might be too short. The danger is that the risk of a moratorium running out, or having to explain to the court why there should be a longer period 24 is likely to incentivise companies to pre-package their deals. Once companies start to pre-package a deal they are unlikely to need a moratorium and again, we will end up where we are now.
The role of and qualification requirements for Monitors
Monitors will be required to be insolvency practitioners. The legislation will, however, have a mechanism allowing the government to permit other classes of professional to act as supervisors in future years, subject to developing regulatory frameworks.25We question whether expanding those who can be Monitors beyond insolvency practitioners is sensible. Licensing was introduced in 1986 to deal with abuses that had been endemic for some time, and it has proved relatively successful. Widening the group who might be Monitors is unnecessary and increases the risk that the current controls will not catch new less regulated groups. The role of the Monitor will be to assess the company’s eligibility for entry into the restructuring moratorium and whether it continues to meet the necessary criteria for the duration of the moratorium period. The Monitor will also be required to sanction any asset disposals outside the normal course of business and the granting of any new security over company assets.26These protections are sensible and support the arguments in favour of the role being limited to licensed insolvency practitioners.
Monitors who have acted for a company in a restructuring moratorium will be prohibited from being appointed as an insolvency officer of that company if the company enters administration or liquidation within 12 months of that restructuring moratorium. This prohibition will not apply if the company decides to enter into a CVA.27
Costs of the Restructuring Moratorium
Costs incurred during the restructuring moratorium will be treated in the same way as expenses in an administration. The Report states that 28
“Where a company exits a moratorium and subsequently enters administration or liquidation, any unpaid moratorium costs will enjoy super-priority over any costs or claims in the administration or liquidation, including the expenses of such procedures. Highest priority would be afforded to any suppliers prevented from relying on contractual termination clauses… Any other costs would rank next, followed lastly by any unpaid fees due to the monitor.”
The present rules regarding expenses of an administration are set out in Schedule B1 to the Insolvency Act 1986 and the Insolvency Rules 2016. In particular, paragraph 99(4) of Schedule B1 provides that any debts or liabilities incurred in respect of contracts entered into during administration will be afforded super priority in the payment waterfall. Transposing these provisions into the restructuring moratorium has the effect of enabling UK companies to access financing whilst the company directors remain in office. This is comparable to what is known in the US as ‘debtor-in-possession financing’ or ‘DIP financing.’ Companies will be able to enter into the process knowing that they can borrow and that the costs of the process will be paid. The fact that it breaks covenants in other financing agreements does not matter at this stage, because entering the moratorium will itself probably have the same effect. It will however be interesting to see how insolvency practitioners approach the restructuring moratorium, since whilst their expenses will be given the priority given to other expenses, they will not be afforded the superpriority status that they would ordinarily enjoy in an administration. That reflects their different role. They will be monitoring the process, not managing the company.
The new restructuring plan
The restructuring plan will be based upon the current UK Scheme of Arrangement29, but will enable companies to implement the cross-class cram down of a company’s restructuring proposals onto secured and unsecured creditors. There will be no financial entry limitations for the cram down to apply; both solvent and insolvent companies will be able to propose restructuring plans.30
Similarities to schemes of arrangement
One aspect of Chapter 11 that is not present in schemes of arrangement is the ability to cram down dissenting creditors in some circumstances. In schemes of arrangement, it is only a majority of creditors in the same class who are able to ‘cram down’ in the loose sense of that term, the dissenting minority in the same class. The most significant introduction in the consultation is the introduction of cram down in other circumstances. As the new procedure will be modelled on schemes of arrangement, there will be many shared features. The proposals for a cram down will be sent to creditors and shareholders and filed at court. Creditors will be divided into classes on the same principles as in a scheme of arrangement.31 The court will consider class composition at the equivalent of a convening hearing, after which the creditors and shareholders will vote on the proposal. Subject to voting thresholds and other requirements being met, the procedure will be confirmed by the court at a second hearing equivalent to a sanction hearing.32 The test for class composition will be the same as at present, namely whether or not it would be impossible for creditors to consult together with regard to their common interest. This involves considering the creditors’ rights prior to the scheme, their rights in the relevant comparator to the scheme, and their rights as a result of the scheme. In testing the fairness of the plan for dissenting creditors, the valuation basis will be the ‘next best alternative’ to the restructuring plan.33 This appears to be similar to the need to compare creditors’ rights under a scheme of arrangement to their rights under the appropriate comparator, which will vary depending on the individual circumstances of the company. There will be no prescribed requirement for the restructuring plan to be overseen by a scheme ‘supervisor’, although in some cases appointing a supervisor may be appropriate.34 If a supervisor is appointed, they will not be subject to any specific qualification requirements.
Unique features of the cram down procedure
The voting thresholds will be 75% in value of the creditors in each class. Unlike for schemes of arrangement, there will be no separate requirement that 50% in number of the creditors in each class approve the proposals.35 There are also proposals for cross-class cram down. The cross-class cram down proposal is that at least one class of impaired creditors must vote in favour of the scheme in order for a cross-class cram down to be confirmed.36 If a dissenting class of creditors is to be bound by the scheme, no creditors with more junior interests can receive any distribution or retain any benefit under the restructuring plan until the dissenting class has been paid in full. The Report states that:37
“Where a cross-class cram down is to be applied, a requirement is needed to safeguard creditor interests that respects and applies the ordinary order of priority in liquidation and administration. The restructuring plan legislation will provide that a dissenting class of creditors must be satisfied in full before a more junior class may receive any distribution or keep any interest under the restructuring plan.”
The starting point is that for cross-class cram down a junior class of creditors cannot receive any distribution until the dissenting class of creditors has been satisfied in full. To that extent creditors being crammed down retain an element of control in that, whilst they can be forced to be bound by the scheme, they cannot be forced to take a ‘hair cut’ for the benefit of creditors junior to them. However, the Government says that it also wants the court to be able to confirm a restructuring plan even if it does not comply with the rule that more junior creditors cannot receive a benefit unless more senior creditors are satisfied in full. The court will be able to confirm a restructuring if it is satisfied that it is necessary to achieve the aims of the restructuring; and it is just and equitable in the circumstances to sanction the cram down. This is intended to be a high threshold.38 For the first time, the court will be able to sanction a scheme (or in this case confirm a restructuring) if, amongst other things, it is necessary to achieve the aims of the restructuring and it is just and equitable to do so. This represents a significant alteration in the balance of power between companies and the holders of ‘fulcrum’ debt. A creditor will not be able to hold out for a better deal safe in the knowledge that if he does not agree there can be no scheme. We expect there to be quite significant litigation about the circumstances in which a scheme that includes a cram down can be approved, particularly if there is a benefit to more junior creditors. It is likely to become an area of significant court development.39The Report gives some guidance by drawing comparisons between a cram down and the US ‘Absolute Priority Rule’.40 This is doubtless because the cram down procedure was designed with Chapter 11 in mind. When a company that has filed for Chapter 11 protection wishes to exit those proceedings, it must obtain confirmation of its exit plan with the court. The US court may only confirm the plan if, among other things, it conforms to the Absolute Priority Rule.41
The introduction of cram down into schemes of arrangement is a significant development. Whilst companies will want to achieve agreement across all classes where possible, where it is not possible, cram down can cut through it. It will, in some circumstances, be possible to cram down a more senior class and leave some benefit to a more junior class. The availability of cram down will make it easier to achieve agreement because the creditor can no longer simply hold out for the deal he wants in all circumstances. The dissenting creditor will know that if the company is able to show that it is necessary to achieve the restructuring and just and equitable, he can be bound by a restructuring agreement he does not agree to. Whilst the dissenting creditor will not welcome this loss of control, this may prove less time consuming and less expensive than the sorts of negotiations companies presently have to go through to deal with recalcitrant creditors, even for the dissenting creditor.
Ipso facto clauses
Suppliers under contracts for the supply of goods and services will be precluded from relying on so-called ‘ipso facto’ clauses. These clauses typically enable a creditor to terminate the contract when the company enters formal insolvency proceedings.42 Suppliers will still be able to terminate the contract on any other contractual ground.43There will also be a carveout enabling a supplier to apply to the court for permission to terminate the contract on the grounds of ‘undue financial hardship.’ In this case it will be for the court to decide whether, if the supplier were compelled to continue to fulfil the contract, it would be more likely than not to enter an insolvency procedure as a consequence. The court will also consider if it would be reasonable in all the circumstances to exempt the supplier from its obligation to fulfil the contract, having regard to the effect of non-supply on the debtor company and its prospects of rescue.44 There are numerous decisions in jurisdictions that already prohibit ipso facto clauses that demonstrate the utility of precluding their operation, particularly in a rescue context.45 If a supplier is required to continue supplying the company, the quid pro quo is that the suppliers prevented from relying on ipso facto clauses will be afforded first priority in administration or liquidation. This may incentivise the inclusion of ipso facto clauses in supply contracts, because the supplier will either be entitled to terminate or will receive priority payment for his supplies. For the company it is paying for continued supply.
Conclusion
The Report evinces an intention to enact proposals designed to create flexibility for distressed companies. The moratorium for companies seeking to put in place a restructuring agreement goes back to what was intended in 1986. The absence of the requirement that the directors hand over control, balanced with the role of the Monitor is a positive one. The time for the moratorium is too short and should be lengthened to avoid companies continuing to rely on pre-packs. The introduction of the cram down is long overdue. In the context of Brexit, it is noteworthy that the reforms are in line with the terms of the draft EU directive on Insolvency and Restructuring published in 201646, which contains proposals for a restructuring moratorium and cross-class cram downs. The EU Directive is anticipated to be enacted in May 2019, and the UK needs to remain competitive.
There is scope for these proposals to overhaul the UK rescue culture. We anticipate a shift away from convoluted restructurings and pre-packs, often aimed, at least in part, at overcoming the current restrictions and difficulties in the legislation towards a simpler, cheaper and more overtly debtor-friendly environment. However, that will depend upon practitioners embracing the terms and spirit of what could become a new rescue culture. Whether in the long term this will be regarded as a brave new world or another false dawn, only time will tell.
1 https://assets.publishing.service.gov.uk/government/uploads/system/uploas/attachment_data/file/736163/ICG_-_Government_response_doc_-_24_ Aug_clean_version__with_Minister_s_photo_and_signature__AC.pdf.
Unless otherwise indicated, references in this article are to this document. The paper states that in some areas the Government will legislate for reform; in others further consultation will be needed, particularly where the consultation paper put forward open questions rather than specific proposals. Section 5 contains specific proposals.
2 [2013] EWHC 1146(Comm).
3 At [39].
4 See paragraphs 42 and 43 of Schedule B1 to the Insolvency Act 1986, and page 43, [5.9].
5 Page 48, [5.35].
6 See paragraph 15 of Schedule B1, and page 45, [5.19].
7 Page 45, [5.19].
8 Page 45, [5.20], page 49, [5.38].
9 Page 49, [5.40].
10 See Re Charnley Davies Ltd [1990] BCC 605 per Millett J at 625.
11 Page 46, [5.22].
12 Page 46, [5.23].
13 Page 47, [5.29].
14 Paragraph 11(a), Schedule B1 Insolvency Act 1986.
15 Page 48, [5.31].
16 Re Harris Simons Construction Ltd [1989] 1 WLR 368; Re Primlaks (UK) Ltd [1989] BCLC 734; Re SCL Builders Ltd [1990] BCLC 98; Re Rowbotham Baxter Ltd [1990] BCLC 397; Re Chelmsford City Football Club (1980) Ltd [1991] BCC 133.
18 Page 48, [5.33].
19 Page 50, [5.44].
20 See for example paragraphs 16(3), 17(3), 18(3), 19(3), 20(9), 22(2) and 23(1) of Schedule A1 of the Insolvency Act 1986.
21 Page 51, [5.49].
22 Page 52, [5.52].
23 Page 52, [5.55].
24 A court hearing gives dissenting creditors an opportunity to set out what they see as the difficulties with the proposed restructuring. It gives them a point of leverage.
25 Page 54, [5.63].
26 Page 54, [5.65].
27 Page 56, [5.76]. This addresses one of the concerns that has arisen in the context of pre packs.
28 Page 57, [5.79].
29 Part 26 of the Companies Act 2006.
30 Page 66, [5.130].
31 Page 69, [5.150].
32 Page 66-7, [5.135-8], page 69, [5.149].
33 Page 74, [5.174].
34 Page 67, 5.139].
35 Page 70. [5.153].
36 Page 73, [5.167].
37 Page 72, [5.163].
38 Page 72, [5.164].
39 Given that this is a new concept in the UK, we anticipate that the English courts will have regard, at least in the early days, to how the issue is dealt with in jurisdictions that have a developed system of cram down, such as the US.
40 Page 72, [5.164].
41 Section 1129(b) of the U.S. Bankruptcy Code. The Absolute Priority Rule requires that more
senior stakeholders are satisfied in full before any junior stakeholder can receive or retain an interest in the Company.
42 Page 60, [5.97].
43 Page 60, [5.99].
44 Page 62, [5.107- 8]. Certain financial products and services will be exempted from
the new provisions, see: page 61, [5.102].
45 Pan Ocean Co Ltd v Fibria Celulose S/A [2014] Bus. L.R. 1041; In re Lehman Bros Holdings Inc (2010) 422 BR 407 (in the US); AWB (Geneva) SA v North American Steamships Ltd [2007]
1 CLC 749 and [2007] 2 Lloyd’s Rep 315, CA (considering the Canadian position); Norcen Energy Resources Ltd v Oakwood Petroleums Ltd (1988) 72 CBR (2d) 1; In re T Eaton Co (1997) 46 CBR (3d) 293; In re Playdium Entertainment Corpn (2001) 31 CBR (4th) 302 and In re Doman Industries (2003) BCSC 376 (in Canada).
46 2016/0359 (COD).