New Measures Announced to Prevent COVID Insolvencies

11 June 2020

Boardroom

The Government has announced amendments to our insolvency laws which will provide companies financially affected by the COVID-19 outbreak with breathing space to allow them to explore alternative options.

The Corporate Insolvency and Governance Bill 2019 - 2021, currently at the House of Lords Committee stage, defines the purpose of the legislation as being expedient for:

‘reducing or assisting in the reduction of, the number of entities entering into corporate insolvency or restructuring procedures for reasons relating to the effects of coronavirus on businesses or on the economy of the United Kingdom…’

In short, it aims to prevent companies from entering into administration or liquidation that would otherwise would have remained solvent or been in a position to restructure had it not been for the business difficulties caused by the COVID-19 outbreak.

The restrictions do not apply to certain types of company, such as insurers, banks and other financial institutions, though a petition issued against any such institution would be remarkable in economic terms.

The bill does not make any such provisions for Bankruptcy Petitions against individuals, so the unincorporated sole trader in financial difficulties remains exposed to a bankruptcy order.

The amendments concern two primary areas – changes to the criteria for winding-up petitions and the introduction of a moratorium process. The other key changes brought about by the Bill regarding director’s duties and liabilities are discussed here.

(1) Winding-Up Petitions

The most significant measure under the legislation will be the restrictions on winding-up petitions against registered companies that are presented on foot of a statutory demand, effective from 27th April 2020.

The restrictions do not amount to a ban; a creditor can still present a petition to have a company wound-up by the court. However, in presenting a petition they must have reasonable grounds for believing that:

(a) Coronavirus has not had a financial effect on the company; or

(b) The basis for the Petition would have arisen even if coronavirus had not had a financial effect on the company.

I do not foresee many creditors opting for ground (a) on the basis that not only is it hard to envisage that there are companies in Northern Ireland unaffected by the pandemic but you would imagine it would be easy for the debtor company to demonstrate that it has been adversely affected by the crisis. Practitioners will be aware that petitions should only appear in the Bankruptcy Court where the issues are black and white and where there are no disputes, but this pre-condition gives debtor companies some grey area in which to operate.

Condition (b) gives more options for creditors, but timing will be an issue. For historic debts (perhaps pre-2020) a creditor could claim that there was an inability to pay the debt before coronavirus had or even could have an effect on the company (the company was insolvent before the pandemic).

Court Orders

You would imagine a creditor in possession of a court order for payment would be in a stronger position but the wording of the legislation does not necessarily make it so. The criteria is reasonable grounds for believing that the ‘facts’ (a court order) on foot of which the statutory demand is based would have arisen anyway, but although an order amounts to a court ratification of the liability that does not automatically mean that in a con-COVID world the order would have been made anyway.

Take for example where parties to litigation have agreed terms itemised in a Tomlin Order, executed in January 2020. The pandemic results in the temporary closure of the Defendant’s business, meaning it cannot comply with the terms of the Tomlin Order, resulting in the Plaintiff obtaining an Order for payment of what was previously agreed. The making of the Order would be a consequence of the financial effect on the company, and therefore the Plaintiff / Creditor could not have reasonable grounds for believing that the Order would have been made had the coronavirus not had the impact it did.

The practical reality is that a reduced court service will have resulted in a huge reduction in court orders since mid-March as only urgent matters are being dealt with and the court service cannot process undefended applications as it would before the restrictions.

Essential Criteria

It should also be noted that these are not defences that a debtor company has to a petition; these are criteria that the creditor must satisfy when presenting the petition, placing the burden of proof on the creditor. This may have been designed to put creditors off the idea in the first instance, and not have the Bankruptcy Court filled with matters that are likely to become contested.

(2) Moratorium Procedure

The legislation provides for a moratorium facility available to companies to provide them with breathing space from creditor claims. It is intended that the procedure will be commenced by simply filing documents at court, similar to an out-of-court administration appointment, although the Court can make a moratorium order in certain circumstances.

The moratorium provides an initial twenty business day’s protection from certain types of creditor action, with provision to extend with certain consents obtained or criteria met. The process will be overseen by a monitor who will be a licensed insolvency practitioner. Similar to administration and debtor arrangements the monitor must be satisfied that the process can achieve its aims of rescuing the company as a going concern (this is one of the criteria for eligibility for the process).

During the moratorium, the company must continue to pay certain debts including newly incurred liabilities and rent in respect of the moratorium period. If these debts are not paid they will have priority status in any insolvency occurring within twelve weeks of the end of the moratorium.

Process

There are two ways a company may enter moratorium; the out-of-court process and by court order. The former will require the directors to file documents at the court office that give effect to the decision to seek a moratorium as well as the usual consents of the monitor to act and statements that the aims of the moratorium can be achieved.

The court order process will be required where there is an existing winding-up petition against the company, similar to the interim order process for CVA’s. The court would have to be satisfied that the moratorium would provide a better outcome for creditors than an immediate liquidation would.

Categories of Debt

The Bill divides company debts into three categories:

1. Pre-moratorium debts for which the company does not has a payment holiday

These include:

  • The monitor’s remuneration and expenses (for the period of the moratorium).
  • Goods and services supplied during the moratorium.
  • Wages or salary and redundancy payments.
  • Rent in respect of a period during the moratorium.
  • Debts or other liabilities arising under a contract or other instrument involving financial services (loans).

2. Pre-moratorium debts for which the company has a payment holiday

This covers pre-moratorium debts (including contingent liabilities) not included in the above.

3. Moratorium debts

These are new debts arising during the moratorium or a debt which might arise after the moratorium but due to an obligation incurred during the moratorium.

Restrictions on the company

There are certain transactions that a company in moratorium is prevented from doing:

  • Obtain credit of more than £500.
  • Grant security (except where the monitor consents).
  • Enter certain categories of transaction such as market contracts or financial collateral arrangements.
  • Disposal of property can only be done in the ordinary way of the company’s business and where either the monitor consents or the court approves.
  • Make certain payments in respect of pre-moratorium debts (those above £5,000 and 1% of total unsecured debt). Again the monitor’s consent or court orders can approve.

Restrictions on third parties

The following restrictions are placed on other parties enforcing their rights against the company in moratorium:

  • A landlord may not exercise its right of forfeiture.
  • There can be no enforcement of security (except financial collateral or a collateral security charge).
  • The holder of an uncrystallised floating charge cannot give notice which has the effect of crystallising the charge or preventing the disposal of company property.
  • Repossession of goods under a hire-purchase agreement cannot take place.
  • Exercise of a retention of title clause by suppliers cannot be done.
  • No legal proceedings can be issued and any existing proceedings will be stayed (except employment tribunal proceedings).

Duration of a moratorium

The initial period of the moratorium is twenty business days however the legislation allows the period to be extended either by creditor consent or by court order. The directors can also extend the initial twenty day period by a further twenty business days without creditor consent or court approval. The maximum period for a moratorium is 364 days including the initial twenty business days. It is likely that most companies in moratorium will avail of the initial extension and so affected companies can expect a moratorium to be in place for at least forty business days.

In order for the moratorium to be extended the Directors must be able to demonstrate that they have been complying with their existing obligations (primarily, paying the debts from which they do not have a payment holiday) as well as establishing that the extension will have the desired effects of rescuing the company as a going concern.

Termination of the moratorium

Aside from the moratorium expiring the monitor can terminate the moratorium if it thinks that the moratorium is no longer likely to result in the rescue of the company as a going concern or that the objective of rescuing the company as a going concern has already been achieved.

If within twelve weeks of the end of the moratorium a company enters into administration or liquidation, unpaid moratorium debts and pre-moratorium debts that are not subject to a payment holiday are given a priority ranking in the insolvency distribution waterfall.

Lender’s enhanced position

Given that financial debts and liabilities are classed as pre-moratorium debts without a payment holiday – and therefore still required to be paid - it will be possible for lenders who do not support the moratorium to exert significant influence.

Lenders often have a right to call for all sums due under a facility to be paid on demand. If they were to trigger this demand it would likely render the company unable to meet the payment and thereby leaving the monitor with no option but to terminate the moratorium.

If this were to happen and the company were to enter into administration or liquidation within twelve weeks of termination then the lenders would have the enhanced creditor priority, placing them above ordinary unsecured creditors. You can see that this gives lenders huge influence over the process and it seems unlikely that a moratorium can successfully complete without lender support. It would appear that this is an unintended consequence of the legislation and it remains to be seen whether any amending provisions will be implemented before the Bill is passed.

If you have any queries the Insolvency team at Carson McDowell would be happy to help.

*This information is accurate as at 11th June 2020

*This information is for guidance purposes only and does not constitute, nor should be regarded, as a substitute for taking legal advice that is tailored to your circumstances.

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