Dr. Eugenio Vaccari, Lecturer in Law, University of Essex

I. The Corporate Insolvency and Governance Act 2020

On 25 June 2020, the Corporate Insolvency and Governance Act 2020 (‘the Act’) completed its progress in the Parliament and received Royal Assent. The Act has unanimously been hailed by the insolvency community as the most significant regulatory reform in the United Kingdom in the past 20 years.

The Act represents the culmination of a debate on regulatory reforms commenced in 2016 and continued in 2018. This debate was made more urgent by the need not to fall behind the European Union and by the inadequacies of the system evidenced by recent corporate scandals (Carillion) and systemic failures (airline industry). While some of the measures are the result of long-planned reforms the Government has previously consulted upon, some changes are temporary in nature and they are designed to provide companies with the breathing space and flexibility needed to deal with the economic impact of the Covid-19 pandemic.

This blog post briefly discusses the relevance and impact of the long-term regulatory reforms introduced by the Act. Time-restricted measures are discussed in a separate blog-post.

II. Long-Term Reforms

The most significant changes in the area are: (i) a short free-standing company moratorium;[1] (ii) a new restructuring plan procedure;[2] (iii) a general ban on the enforceability of ipso facto clauses.[3]

The moratorium gives struggling businesses a 20-business day opportunity to consider a rescue plan, extendable by the directors for a further 20 business days or, with creditor consent, up to a year.

The moratorium is triggered by the directors of the ailing company filing the relevant documents at court (out-of-court process) or by an order of the court following the debtor’s application (in-court process). The latter is of primary interest for overseas companies or where the debtor has been served with a winding-up petition.

The aim of the moratorium is to facilitate the rescue of the company (as opposed to the rescue of only the business) through a company voluntary arrangement (‘CVA’), a restructuring plan, an informal workout or another formal insolvency procedure (e.g. pre-packaged administration).

During this period, the company remains under the control of its directors (debtor-in-possession procedure), but there are restrictions on the transactions that the companies can complete during a moratorium. For instance, new security can only be granted with the monitor’s consent and if they think the grant of the security will support the rescue of the company. Disposal of company’s property is only admissible if it is made in the ordinary course of business, with the monitor’s consent or following a court order. Other restrictions apply to loans of more than £500, certain transactions (e.g. collateral security) and payments for pre-moratorium debts.

No legal action can be taken against the debtor’s assets without leave of the court. There can be no enforcement of security (except financial collateral or collateral security charges) and no repossession of goods under hire-purchase agreements or retention-of-title clauses. In addition, during a moratorium, the holder of an uncrystallised floating charge on the property of the company is prohibited from giving notice which would have the effect of either (i) causing the floating charge to crystallise; or (ii) restricting the disposal of the property of the company. All these restrictions provide debtors with powerful tools to continue trading normally during moratorium.

Similar to what happens in other insolvency procedures (including the new restructuring plan), landlords cannot exercise their rights of forfeiture and may be forced to accept a reduction in their rents. This raises concerns that other landlords will follow Intu Group into administration procedures because the reduced rents (if and when paid) would be insufficient to meet their long-term liabilities.

The moratorium process is overseen by a monitor who must be a licenced insolvency practitioner (‘IP’). During this process:

1. the monitor must remain of the view that a rescue of the company as a going concern is possible, otherwise the moratorium must be brought to an early termination;
2. certain pre-moratorium debts are subject to a “payment holiday”;
3. other pre-moratorium debts and all debts incurred during the moratorium must be paid in full as they fall due (or even earlier in case of pre-moratorium debt subject to acceleration).

In particular, the debtor must continue to pay certain of its debts, including new supplies and rent in respect of the moratorium period, as well as amounts due under financial contracts.

Financial contracts usually include acceleration clauses that are triggered by any insolvency event, including the moratorium described above. The early version of the Bill granted super priority status to these debts, if the debtor entered into an insolvency proceeding shortly after the moratorium. Amendments in the House of Lords removed the super priority status to the accelerated portion of these debts. At the same time, financial lenders can still accelerate the payments of these debts, causing the early termination of the moratorium and the rescue attempts because financial debts are not subject to a payment holiday.

Debts incurred under the moratorium are given priority ranking if the debtor falls into a formal insolvency procedure within 12 weeks from the end of the moratorium. The Act provides for the right to challenge the monitor’s or the directors’ actions, decisions or failure to act on the grounds of (actual or prospective) unfair harm to the applicant. There is also a right for a subsequently appointed office holder to challenge the monitor’s remuneration as excessive. Finally, the Act creates new offences of fraud during, or in anticipation of, a moratorium and false representation to obtain a moratorium.

The restructuring plan procedure is a powerful and flexible court-supervised restructuring process. This debtor-in-possession procedure allows struggling companies, or their creditors or members, to propose a new restructuring plan to rescue the company or part of its business, enable complex debt arrangements to be restructured and support the injection of new rescue finance.

The court involvement is limited to two hearings. In the first one, the courts are asked to convene the meeting and examine the proposed class composition. In the second hearing, the courts sanction the vote and approve the plan if the statutory conditions for approval are met and if it is just and equitable to do so. The sanctioned plan is binding on both secured and unsecured creditors.

The restructuring plan procedure is available to all companies that are encountering, or are likely to encounter, financial difficulties that are affecting, or will or may affect, their ability to carry on business as a going concern.[4] There is, therefore, no need for the debtor to be insolvent. As long as there is some form of compromise or arrangement to deal with the company’s financial difficulties, the plan is virtually a blank canvas.

Such procedure is modelled after the successful schemes of arrangement.[5] For the plan to be approved, it must receive the assent of 75 percent in value of each class of creditors. It is salient to note that two requirements applicable to schemes and CVAs have not been replicated with reference to the new restructuring plan procedure, thus making it easier to achieve the requisite majority. These are the requirements that more than half in value of unconnected creditors and that the majority in number vote in favour of the plan.

To further facilitate the approval of the plan, the new restructuring procedure features a cross-class cram-down. The cram-down mechanism allows dissenting classes of creditors to be bound by the plan, if sanctioned by the court as fair and equitable, and if the court is satisfied that those creditors would be no worse off than if the company entered an alternative insolvency procedure. The plan, however, needs to have received the assent of at least one class of creditors who would receive a payment, or have a genuine economic interest in the company, in the event of the relevant alternative.

The House of Lords’ removal of the protections initially included for creditors with aircraft-related interests means that that they can be compromised by a scheme or restructuring plan. This is welcome news for the distressed airline industry, which can now make use of those processes.

The new restructuring plan procedure is a more powerful and flexible mechanism than the existing schemes and CVAs. Unlike CVAs, it can bind secured creditors and creditors’ rights are not diluted, as they vote in classes of uniform interests rather than as a whole. Unlike schemes, dissenting classes can be bound by the plan. Additionally, the majority threshold is lower compared to the analogous requirements for the approval of schemes and CVAs.

The Act also widens the scope of the restriction on the enforceability of termination clauses from essential suppliers (sections 233-233A of the Insolvency Act 1986) to all kinds of suppliers. This measure applies where a company has entered an insolvency or restructuring procedure or obtains a moratorium during this period of crisis. As a result of this, the company’s suppliers will not be able to rely on contractual terms to stop supplying, or doing “any other thing” such as varying the contract terms with the company (for example: increasing the price of supplies), because the debtor becomes subject to a relevant insolvency procedure. Suppliers are also banned from insisting on payment of sums falling due prior to the insolvency as a condition of continued supply. The Government granted a wider protection than other jurisdictions (namely, the USA and Australia) by extending the ban to the termination of a contract or supply to breaches which occurred prior to the relevant insolvency procedure.

The customer is required to pay for any supplies made once it is in the insolvency process. The measure contains safeguards to ensure that suppliers can be relieved of the requirement to supply if it causes hardship to their business. Suppliers also retain the power to terminate these contracts for breaches that occurred after the commencement of the insolvency procedure and – in any case – with the permission of the office holder or director (depending on the procedure).

Up until 30 September 2020, small suppliers are exempt from the proposed changes and can (if they choose) terminate the supply contract. This is a temporary exemption designed to address the current difficulties faced by UK companies as a consequence of the Covid-19 pandemic, while permanent exclusions apply for the benefit of certain financial contracts and institutions.

III. Preliminary Assessment

There is no doubt that the Act represents a significant, much-needed overhaul of the English corporate insolvency framework. It is most likely that the reforms briefly described in this blog will enhance the corporate rescue attitude of the English framework; the attractiveness of this system for foreign enterprises; as well as the country’s standing in the Doing Business Report, particularly with reference to the “Resolving Insolvency” indicator.

However, all that glitters is not gold.

With reference to the company moratorium, while it provides a payment holiday for certain types of pre-moratorium debts, its scope does not extend to loans, liabilities arising under a contract/instrument involving financial services, as well as rents, wages, salaries and redundancy payments. The carve-out of such debts means that a company could still require access to significant funds during a moratorium. As a result, the moratorium could be of limited use where the company is subject to significant financing arrangements for which a payment holiday is not granted.

Another significant carve-out is with reference to the “rent in respect of a period during the moratorium”. However, this could lead to strategically timed moratoria, especially if the rent is payable in arrears (which is frequently the case in commercial contracts). In this case, the debtor might file soon after the quarterly payment for the pre-moratorium period is due. In this way, the debtor would avoid making any rent payment for the pre-moratorium period and would postpone any rent payment for the moratorium period for another four months.

The absence of any super-priority status of funding provided during the moratorium and the possibility for lenders to accelerate their debt in a moratorium may present serious obstacles to the use of such procedure by distressed companies (even if the House of Lord removed the super-priority status for accelerated financial debts, as outlined above).

With reference to the restructuring plan procedure, valuation will be a key aspect in the new process, as it will play a pivotal role to address any complaints from crammed down creditors as well as to assess which creditors are out of the money and can be excluded from the voting process. However, as Dr. Vaccari evidenced in two previous papers,[6] valuation is an extremely controversial process.

There is also the risk of reverse cram-down, or “cram-up”. This is when the restructuring plan procedure is used in a strategic manner by junior classes of creditors and/or the company’s members to “impose” a plan on dissenting senior creditors. Courts could in theory discourage this practice by not sanctioning plans that are not “just and equitable”. However, English courts have proven reluctant to interfere with business judgments. Additionally, the absence of any absolute priority rule – which was nevertheless touted when the reforms were first announced in August 2018 – may further promote a liberal judicial approach in the sanctioning hearing.

With reference to termination clauses, the Act provides no definition of what “hardship” and “any other thing” mean. Hardship is the major exclusion that suppliers can invoke to terminate a contract. “Any other thing” refers to the actions that suppliers are banned to take because the debtor entered into a relevant insolvency procedure. These are key concepts and the lack of statutory guidance on them is likely to represent an area of future dispute to be resolved by the courts.

The new discipline of termination clauses applies to the relevant insolvency procedures commenced on or after the day on which the Act came into force (27 June 2020). As a result, they will apply in respect of contracts entered into before as well as after that date, with the result of significantly restricting (for pre-Act contracts) the autonomy of the signatory parties as well as the predictability of such contracts. This vulnus to the principle of freedom of contract is particularly striking and surprising, considering that the latest changes to termination clauses introduced by the SBEEA 2015 apply to contracts entered into or after the date in which the SBEEA 2015 entered into force (1 October 2015).

To conclude on this topic, the Government introduced a long list of excluded companies and particular types of contracts. The latter include certain financial institutions and various financial and capital-markets contracts. Critically, these broad exclusions capture lending contracts, with the result that there is no obligation to continue to supply finance to companies in a relevant insolvency procedure.

IV. Concluding Remarks

There is no doubt that the Corporate Insolvency and Governance Act 2020 represents the most significant reform of the English corporate insolvency framework since the reforms introduced by the Enterprise Act 2002. As evidenced in this blog paper, the Act provides very useful additions to the restructuring toolkit and much-needed temporary and long-term relief for distressed businesses.

However, given the speed with which the Act has been passed, the complexity of the legislation, and some questionable legislative choices, there are undoubtedly areas of ambiguity and potential challenge. It is far from clear to what extent the Act will make the English framework more flexible, efficient and resilient to sudden changes of the economic environment.

The publications mentioned in this article are available on Westlaw, Researchgate.net and Academia.edu. Dr. Vaccari regularly discusses insolvency matters on Twitter and LinkedIn.

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[1] Sections 1-6 of the Act.

[2] Schedule 9 of the Act.

[3] Sections 14-19 of the Act.

[4] Schedule 9 of the Act.

[5] Part 26 Companies Act 2006.

[6] E Vaccari, ‘Broken Companies or Broken System? Charting the English Insolvency Valuation Framework in Search for Fairness’ (2020) 35(4) JIBLR 135; E Vaccari, ‘Promoting Fairness in English Insolvency Valuation Cases’ (2020) 29(2) Int. Insolv. Rev. 1.