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 time-limited measures introduced by the Act. The Act’s long-term regulatory reforms were discussed in a separate post here.
II. Time-Limited Measures
The most significant changes affecting insolvency rules are: (i) a suspension of statutory demands and restrictions on winding-up petitions; (ii) a suspension of liability for wrongful trading; and (iii) an extension to end of June 2021 to the power to legislate on sales to connected persons, which was granted by the Small Business, Enterprise and Employment Act 2015 (‘SBEEA 2015’) but expired in May 2020.
The Act also allows for temporary flexibility regarding other administrative burdens, such as the holding of annual general meetings (AGMs) and filing requirements. These temporary measures, however, fall outside the remit of this blog-post as they do not deal with insolvency provisions.
With reference to statutory demands and winding-up petitions, the Coronavirus Act 2020 introduced a moratorium on commercial landlords to enforce the forfeiture of commercial leases for unpaid rent. This measure was designed to protect companies unable to trade during the lock-down period introduced by the Government to limit the spread of Covid-19.
However, landlords sidestepped this original ban by serving statutory demands on businesses followed by winding-up petitions. The Corporate Insolvency and Governance Act 2020 addresses this loophole by introducing temporary provisions to void statutory demands made between 1 March and 30 September 2020.
Statutory demands can still be served as this may trigger a termination clause under an existing contract. However:
- service of a statutory demand without the treat of a winding-up petition is of limited benefit;
- defaults in debtor’s facility documents or commercial contracts are usually equally triggered by ordinary as opposed to statutory demands;
- even if these clauses are triggered, the creditor might still not be able to enforce the termination as such option might be prevented by the newly enforced ban on ipso facto clauses discussed here.
The Act also restricts winding-up petitions based on statutory demands from 27 April to 30 September 2020. For the same period, it also prevents creditors from presenting a winding-up petition unless they have reasonable grounds to believe that: (a) the Covid-19 pandemic has not had a “financial effect” on the debtor company; or (b) the facts by reference to which the relevant ground applies would have arisen even if the Covid-19 pandemic had not had a financial effect on the company.
These temporary measures are intended to prevent aggressive creditor actions against otherwise viable companies that are struggling because of the consequences of the Covid-19 pandemic.
As mentioned before, creditors can still commence a winding-up petition if they prove that the Covid-19 pandemic had no “financial effect” on the debtor. This bar is very low, as in virtually all sectors of the economy the Covid-19 pandemic produced financial effects on the debtors. This is particularly true for the worst affected sectors, such as the airline industry, non-essential retail, hospitality and leisure sectors (where revenue has been nil or restricted as a result of the lockdown and social distancing measures). Still, creditors may be able to submit a winding-up petition based on aged and undisputed debts that pre-date the Covid-19 pandemic.
As for the suspension of liability for wrongful trading, the Act suspends the liability arising from wrongful trading (sections 214 and 246ZB of the Insolvency Act 1986) in the period 1 March to 30 September 2020.
Under wrongful trading provisions, directors face personal liability on debts incurred by their company. This is, if they decided to continue trading while they knew or ought to have known that the company was unlikely to avoid entering insolvent liquidation or administration. For directors who may have previously rushed to liquidate their businesses with these provisions in mind, this suspension should help delay that process.
III. Preliminary Assessment
There is no doubt that the Act complements the Coronavirus Act 2020 with a series of more measures designed to provide companies with the much-needed temporary relief to cope with the impact of the Covid-19 pandemic.
However, all that glitters is not gold.
With reference to the use of statutory demands and winding-up petitions, the Business Secretary originally advocated for the introduction of these measures to safeguard the UK high street against aggressive debt recovery actions during the Covid-19 pandemic (Alok Sharma, 23 April 2020). However, the temporary provisions as enacted are not sector specific. They apply to any registered or unregistered company that can be the subject of a winding-up petition. They also apply in relation to any debt owed by a debtor company, not just rent or other commercial lease liabilities. As a result, there is the risk that this temporary protection is used in a strategic manner by otherwise non-distressed firms as a leverage in negotiations with their creditors, in order to reduce outstanding and future liabilities arising from ongoing executory contracts.
Additionally, while the Act does not introduce a blanket ban on presenting winding-up petitions, the Government, some professionals and non-specialist publications are suggesting the contrary, thus causing potential confusion in the business community.
The Act also provides that if a winding-up order has been made in relation to a debtor in the period between 27 April 2020 and the day before the Act came into force, the order is void if it does not meet the new requirements for the making of an order. The retrospective nature of this provision can lead to significant challenges in practice. For instance, if the procedure has already commenced, it is not clear what happens to the debts incurred during the procedure, as they normally enjoy a super-priority status. However, it is expected that few orders were made on this basis in the past few weeks, as the judiciary was aware of the content of the Bill and enforced a ban on winding-up petitions before the Act was passed.
Dr. Vaccari has already evidenced in a paper published by the University of Essex and at the St Petersburg’s International Legal Forum the limits of the other, most significant temporary measures introduced by the Act, i.e. the suspension of liability for wrongful trading.
The comments made in the House of Lords debates indicate that the Government was aware of some of the limits evidenced in the above-mentioned papers. The Government stressed in these debates that its intention is that there should be no liability for wrongful trading until 30 September 2020. However, under the Act courts are only instructed “to assume that the [director] is not responsible for any worsening of the financial position of the company or its creditors that occurs during the relevant period”. Therefore, applicants may still seem to have the power to demonstrate that the directors acted in breach of the wrongful trading provisions as outlined in sections 214 and 246ZB of the Insolvency Act 1986 for actions taken before the end of September of this year.
The Act does not affect the several other provisions. These include the rules on fraudulent trading and transactions defrauding creditors, on undervalue or preferential transactions, as well as the director disqualification regime and the general directors’ duties. All these rules, therefore, continue to apply. Particularly, the common law duty of directors to give consideration to the interests of creditors when a company is in the zone of insolvency is preserved and remains in full force.
Sections 12(3) and (4) of the Act clarify that the suspension of liability for wrongful trading does not apply to a variety of companies. These include (among others) insurance companies, banks (including investment banks and firms), building societies, friendly societies, credit unions, public-private partnership project companies and overseas companies with corresponding functions. In other words, a good deal of medium and large enterprises are excluded from the scope of this provision without any apparent justification.
Additionally, unlike the provisions on statutory demands and winding-up petitions, the rules on wrongful trading state that there is no requirement to show that the company’s worsening financial position was due to the Covid-19 pandemic.
The Act adopts a blanket approach: liability for losses incurred in the relevant period is waived, irrespective of whether the losses are incurred because of the Covid-19 pandemic. This blanket approach raises issues of potential abuse of the law if the office holders cannot hold the directors accountable for losses that are not caused by the Covid-19 pandemic.
As a result of all these considerations (and the others mentioned in the publication cited above), a measure in theory designed to “remove the threat of personal liability” caused by the Covid-19 pandemic on businesses (Alok Sharma, 28 March 2020) is likely to lift significant restrictions on the arbitrary exercise of powers by rogue directors. This is likely to significantly and negatively affect creditors’ rights and the rule of law. It is highly unlikely that the suspension of liability for wrongful trading results in being a “jail-free card” (although it is salient to note that we are discussing civil, as opposed to criminal, liability issues).
A final contentious aspect is represented by the power granted to the Secretary of State to temporarily (for up to six months) amend corporate insolvency primary and secondary legislation and related measures to deal with the consequences of the Covid-19 pandemic on companies. This power is virtually unrestricted as no effective check-and-balance system is put into place.
IV. Concluding Remarks
The Act provides much-needed temporary relief for distressed companies. 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.
The extent to the Act will help companies navigate through the Covid-19 pandemic is far from clear. More importantly, the legislation, whilst very welcome for debtors, does not deal with the substantive problem of debt being built up and long-term balance sheet issues.
In fact, the Act provides no solution for debtors once the restrictions expire. At that point (end of September 2020), the debtors may have significant arrears of debt. These issues are particularly acute in those sectors of the economy that have been worst affected by the Covid-19 pandemic. As a result, these time-restricted measures may have the unintended effect of postponing the unavoidable, reducing returns to creditors and resulting in a spike of liquidation-oriented procedures in the last quarter of this year.
 Sections 10-11 of the Act.
 Sections 12-13 of the Act.
 Section 8 of the Act.
 Re A Company (Injunction to Restrain Presentation of Petition)  EWHC 1406 (Ch),  6 WLUK 13 – restraining the presentation of a winding-up petition against a company which had been unable to pay its rent as a result of the Covid-19 pandemic by taking into account the likelihood of the change in the law represented by the relevant provisions of the Corporate Insolvency and Governance Bill 2020.
 The paper makes reference to the Bill, but the wording of the relevant provisions has not changed in the Act.
 Section 12(1) of the Act.
 Section 213 of the Insolvency Act 1986.
 Section 423 of the Insolvency Act 1986.
 Sections 238 and 239 of the Insolvency Act 1986.
 Chapter 2, Companies Act 2006. These include the duties to act within their powers, to exercise independent judgement, to avoid conflicts of interest and to exercise reasonable care, skill and diligence.
 Section 172(3) of the Companies Act 2006.