The Corporate Insolvency and Governance Act 2020 (the Act), which came into force on 26 June 2020, has introduced a number of temporary and permanent reforms to the corporate insolvency process, including a moratorium on winding up proceedings.
The changes signal a shift in UK law towards the United States’ company rescue approach to corporate insolvency. The Act was fast-tracked through Parliament in an attempt to save businesses stricken by the COVID-19 pandemic. However, it is also intended to introduce long term solutions for businesses in crisis.
So, what has changed and what does it mean for UK businesses and their creditors?
How is the corporate insolvency process changing?
The Act introduces a range of permanent changes to increase the options available to businesses facing corporate insolvency. It also introduces temporary changes which are intended to help businesses through the COVID-19 pandemic.
Permanent measures to support a company rescue approach to corporate insolvency
A ‘breathing space’ moratorium
The directors of an insolvent business (but one that has the potential to be rescued) can apply for a 20-business day moratorium to protect it from legal claims while it explores rescue action. The moratorium can be extended for up to one year.
While the moratorium is in place, nobody can bring a claim against the business and existing claims will be paused. The business will work under the supervision of a qualified insolvency practitioner to try to restructure or otherwise seek rescue. It can also continue to trade during the moratorium.
A business can apply for a moratorium and extend it up to 20 days without the consent of its creditors. If it wants to extend the moratorium further, it either needs to seek the consent of its creditors or obtain a further court order.
The Act sets out a new process for restructuring which includes provisions such as:
- The terms of a business’s restructuring plan must be approved by at least 75% of each class of its creditors or with court approval
- Dissenting creditors will be bound by the plan even if they vote against it (this is referred to as ‘cramming down’)
- Secured creditors can be bound along with unsecured creditors
The restructuring plan will operate in addition to other company rescue mechanisms such as company voluntary arrangements (CVAs).
Suspension of termination clauses
The Act states that contracts for the supply of goods and services can no longer include clauses that allow suppliers to terminate the contract or “do any other thing” when the business becomes subject to an insolvency procedure. Any contract that already includes a termination clause will “cease to have effect”.
The purpose of this is to enable businesses to continue trading while they seek rescue or restructure. However, there is some protection for suppliers facing financial hardship.
Temporary measures for businesses affected by COVID-19/the Coronavirus
Restrictions on Statutory Demands and Winding Up Petitions
Creditors will not be able to present a Winding Up Petition based on a Statutory Demand served between 27 April 2020 and 30 September 2020 unless they have reasonable grounds to believe that:
- The business has not been financially affected by the Coronavirus; or
- The business would be unable to pay its debts even if it had not been financially affected by the Coronavirus.
‘Financial effect’ appears to have a wide meaning so it may be extremely difficult for a creditor to prove that a business has been unaffected.
Suspension of wrongful trading
The Act has suspended the rules on wrongful trading from 1 March 2020 (to be applied retrospectively) until 30 September 2020. This gives directors peace of mind that they can continue to trade during the COVID-19 pandemic without the risk of incurring personal liability if the company becomes insolvent.
Other personal liability provisions such as fraudulent trading and transaction avoidance (such as trading at an undervalue) have been left in place. Therefore, directors must continue to comply with their legal duties and act in the best interests of the business, even if this means ceasing to trade and winding up.
Until 30 September 2020, businesses that are currently subject to Winding Up Petitions can apply for a moratorium and extend it, regardless of the financial impact of COVID-19.
How will the changes affect businesses?
The new corporate insolvency provisions will provide businesses and directors with much-needed breathing space during these economically uncertain times. In addition, the Act aims to introduce a US-style approach to company rescue designed to discourage creditors from immediately resorting to insolvency to recover debts. It is worth noting that the US law the Act is based on was also introduced in a time of economic crisis. If successful, the Act could prevent the sudden liquidation of many businesses and avoid significant job losses.
Businesses making use of the temporary measures should bear in mind that they all lapse on 30 September 2020 rather than a gradual phase-out or tapering off. If necessary, businesses should prepare to make use of the permanent company rescue measures, such as forming a restructuring plan, and be aware of any creditors that may be waiting to swoop.
Finally, it remains to be seen whether the new provisions will affect suppliers’ and lenders’ lending criteria and credit terms. It is likely that, at least in the short term, creditors may tighten their belts.
How will the changes affect creditors?
The Act reinforces that winding up a business is never a first resort. In theory, if the indebted business is truly insolvent and beyond rescue, it will possible to force it into liquidation and try to make a recovery even under the new rules.
However, during the current COVID-19 crisis, creditors should be aware that proving that a business is a) beyond rescue and b) financially unaffected by COVID-19 will be a difficult task. Commercial landlords, in particular, have been criticised for quickly turning to Statutory Demands to recover rent arrears and could face difficulty under the new rules.
Additionally, creditors may find themselves less in control of corporate insolvency than they may have been before the Act came into force. For example, during a business moratorium, a creditor cannot start Winding Up proceedings. In fact, until 30 September 2020, a creditor who has already started Winding Up proceedings may also be halted. Under the new restructuring plan provisions, a creditor who does not consent to the plan may nevertheless be bound by it and could be forced to accept a liquidation in which they recover nothing.
Therefore, it is more important than ever to carefully balance the value of the debt and the cost of various enforcement options before deciding whether corporate insolvency is the correct route. Creditors should also consider reviewing their lending criteria and credit terms and whether these need to be amended going forwards.
If you are a creditor looking to recover a debt, a specialist debt recovery and insolvency solicitor can talk you through your options and assess whether corporate insolvency is, in fact, the best way to go.
Do you or your business need advice about corporate insolvency?
At Preston Redman, we have a dedicated corporate and commercial law team who specialise in business recovery and insolvency cases.
Whether you are a business exploring rescue options or a creditor exploring debt recovery options, we can provide clear, practical advice that is fully up-to-date with the law. We approach all cases with a business-mind, focusing on finding creative solutions that work within the commercial context of your business.