The new debtor-friendly changes to the UK’s insolvency regime and implications for financiers

October 2020  |  SPECIAL REPORT: BANKRUPTCY & RESTRUCTURING

Financier Worldwide Magazine

October 2020 Issue

Under the shadow of the COVID-19 pandemic, the UK has swiftly implemented significant changes to its insolvency regime designed to assist distressed businesses and maximise their chances of survival. The Corporate Insolvency and Governance Act 2020 came in to force on 26 June 2020, after just over a month of scrutiny in the Houses of Parliament. It includes three key permanent features: (i) a new standalone moratorium; (ii) expanded restrictions on terminating supply contracts; and (iii) a new restructuring plan.

The changes represent a shift toward a more debtor-friendly insolvency regime but also include exclusions to protect financial service providers. The new provisions apply to UK companies and overseas companies with a connection to the UK, but both the moratorium and the supply contract provisions are more naturally directed at UK small and medium-sized enterprises (SMEs) and their creditors and suppliers. The new restructuring plan, however, ‘supercharges’ the existing scheme of arrangement and is expected to have implications for large companies and their financial creditors.

The moratorium

The new moratorium provides protection against creditor action but leaves the existing management in control of the business under the oversight of an insolvency practitioner (acting as monitor).

In order to obtain the benefit of the standalone moratorium, the directors of an eligible company (which does not include a party to a capital markets arrangement) must be of the view that the company is, or is likely to become, unable to pay its debts, and the monitor must be of the view that it is likely that a moratorium would result in the rescue of the company as a going concern. This will likely require a firm view as to the proposed solvent exit from the moratorium.

The moratorium is intended to provide breathing space for the company to implement a restructuring, whether consensually or by way of another procedure, such as a company voluntary arrangement (CVA), scheme of arrangement or a new restructuring plan. It is not intended to provide protection for those companies for which an insolvent liquidation is inevitable.

However, during the moratorium, the company has the benefit of a payment holiday in respect of certain debts, and certain creditors are restricted from enforcing their rights. The moratorium can be obtained for an initial period of 20 business days by filing documents at court. It can be also extended with the consent of creditors or the court.

While most debts do not need to be paid for the duration of a moratorium, there are some debts that must be met or the monitor will have to bring the moratorium to an end, including rent in respect of the period during the moratorium or debts arising under a financial services contract, including a loan, finance lease or commodities contract.

Debts that are incurred during the moratorium and fall due during or after the moratorium, as well as certain pre-moratorium debts, including amounts due under a financial contract other than by reason of acceleration, will have priority over the debts of floating charge holders in a subsequent insolvency or restructuring procedure.

Given the requirement to pay debts under a financial services contract, a debtor should not seek a moratorium without first obtaining a payment standstill or other accommodation from its financial creditors. In agreeing any standstill, creditors will need to consider the treatment of other debts that could take priority over their floating charge or unsecured debts in any subsequent insolvency. If a moratorium is proposed without a comprehensive standstill, there is a risk that financial creditors will accelerate their debts, forcing the monitor to bring the moratorium to an end (likely resulting in the debtor having to file for more terminal insolvency proceedings). Events of default, as currently drafted in finance contracts, are likely to include the commencement of a moratorium, but this should be checked.

Accordingly, financial creditors need not unduly fear the moratorium. In fact, it could be a useful tool for companies without bonds that have the support of their financial creditors but need additional time to implement a plan to restructure their other debts. This will need to be balanced against the fallout from the negative publicity that will inevitably come with a public insolvency process and the associated cost of such process.

Restrictions on terminating supply contracts

The Act includes a restriction on suppliers of goods and services terminating their supply contracts with a company because the company is subject to the new moratorium procedure, proposes a restructuring plan or is otherwise subject to a relevant insolvency procedure. This new provision is aimed at assisting the debtor in maintaining the ongoing viability of valuable parts of the business.

The prohibition applies to all supply contracts for goods and services, save for a list of exclusions. Contracts where either the company or supplier is an insurer, bank or other financial institution are excluded, along with financial contracts, including, among others, loans, finance leases, securities contracts or commodities contracts, derivatives or spot contracts. Operating leases are not excluded, unless provided by an excluded financial institution.

The terms of the Act are drafted broadly and go beyond a restriction on termination to include a restriction on ‘any other thing’ taking place, which would capture increases in interest rates or other more onerous terms that are triggered by entering into a relevant insolvency procedure. The Act also prevents suppliers from exercising their right to terminate a contract in relation to an event of default that occurred before the relevant insolvency procedure or from conditioning ongoing supply on payments of arrears.

There is some limited relief offered to suppliers: where a supplier is required to continue to supply it can apply to court to terminate the contract if continuation would cause it ‘hardship’. Exactly what this means is unclear, but it will be for the court to balance the needs of the company against those of the supplier.

Practically, suppliers that find themselves unable to terminate their supply contracts should have the certainty of knowing that their debts for future supplies will be paid as expenses of the relevant insolvency procedure or as a condition to any restructuring to the extent they constitute priority moratorium debts.

These broad provisions will be difficult for parties to contract around and, as such, it is expected that suppliers will build in earlier termination triggers to their supply contracts. Practically, the provisions could have the unintended consequence of encouraging suppliers to terminate their supply contracts earlier than they otherwise may do.

Although the restrictions do not directly impact excluded financiers, they may impact suppliers’ finance arrangements. Any rights in finance documents that, if exercised, would put the supplier in breach of the law, such as stop supply clauses in receivables purchase agreements, may not be enforceable. Similar concerns apply to credit insurance and financiers will want to check the terms of policies as to whether coverage may fall away if the supplier no longer has the right to cease supply. In any event, credit insurance is likely to become more expensive.

Despite the potential extraterritorial effect of the Act, it remains to be seen how the provisions will impact contracts governed by laws other than those of the UK and bind suppliers in jurisdictions outside the UK.

The restructuring plan

The Act introduces a new Part 26A into the Companies Act 2006 pursuant to which a company in financial difficulty can propose a restructuring plan, allowing it to enter a compromise or arrangement with its creditors or any class of them or its members or any class of them.

The restructuring plan is based on the existing scheme of arrangement, but with several important changes. Unlike a scheme of arrangement, the company must be facing current or anticipated financial difficulties to be eligible. In addition, the voting requirements to sanction a restructuring plan are less cumbersome than a scheme of arrangement – a scheme of arrangement requires 75 percent by value and a majority by number in each class of creditors, whereas a restructuring plan only requires approval from 75 percent by value in the relevant class.

One of the most appealing changes in the new restructuring plan is the inclusion of a cross-class cram down mechanism. In a scheme of arrangement, consent is required from the relevant majorities in each affected class. In a restructuring plan, if one class does not vote in favour of a plan, creditors within that class can still be forced to accept the plan if: (i) at least one class of creditors with a genuine economic interest voted in favour of the plan; (ii) the creditors in the dissenting class would not be any worse off under the plan than they would have been in the most likely alternative outcome, were the plan not implemented; and (iii) the court considers the plan to be fair.

A feature of these new provisions is the potential for a ‘cram-up’ where junior (unsecured) creditors may seek to impose a plan on dissenting senior (secured) creditors, assuming the above tests are satisfied. Senior creditors will therefore want to consider acceleration or enforcement where a cram-up plan is proposed.

There are a number of legal and financial areas in the new plan that are ripe for litigation, so debtors and their financiers will need to carefully consider execution risk until the process has been adequately tested.

Conclusion

These reforms are a step closer to the more debtor-friendly regimes of the US and Europe, but the broad exclusions for financial services in the moratorium and supply contract provisions make these reforms somewhat of a halfway house. The cross-class cram down in the restructuring plan provides companies and their supporting creditors with a valuable new tool for their restructuring tool kit. It is hoped that these reforms will assist with the rescue of viable businesses in what is expected to be a difficult period over the coming months and years.

Matthew Thorn is a partner and Manhal Zaman is an associate at Norton Rose Fulbright. Mr Thorn can be contacted on +44 (0)20 7444 2683 or by email: matthew.thorn@nortonrosefulbright.com. Ms Zaman can be contacted on +44 (0)20 7444 3913 or by email: manhal.zaman@nortonrosefulbright.com.

© Financier Worldwide

BY

Matthew Thorn and Manhal Zaman

Norton Rose Fulbright

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