On August 26, 2018, the UK government issued its response to its consultation on insolvency and corporate governance. The consultation sought views on how the risk of company failure could be reduced by improving the corporate governance and insolvency framework. The response summarized the views and comments received during the consultation, and sets out a number of proposals that will have significant implications for English companies and their creditors and investors. At the heart of the proposals is a desire to ensure there are a range of transparent rescue procedures that allow companies to restructure or seek new investment, in order to give them a greater chance of survival, while also ensuring fair and efficient procedures to protect the interests of creditors. The proposals mean that the government will seek measures that:
1. Ensure greater accountability of directors in group companies when selling subsidiaries in distress:
- This measure will apply to large subsidiary companies.
- Directors of the holding company who do not give due consideration to the interests of stakeholders of a financially distressed subsidiary when it is sold may be subject to disqualification action if that subsidiary enters insolvent liquidation or insolvent administration within 12 months of sale.
- Directors of the holding company will need to provide evidence that they had a reasonable belief at the time of the sale that the sale would likely deliver a no-worse outcome for the stakeholders of the subsidiary than putting it into a formal insolvency process in order to avoid disqualification.
2. Enhance existing recovery powers of insolvency practitioners in relation to value extraction schemes:
- This will require further consultation with stakeholders and likely result in making existing powers relating to antecedent transactions more robust, and will include resolving the:
- uncertainty about whether the granting of security can be challenged as a transaction at an undervalue;
- uncertainty about whether shadow directors can be targeted under the provisions providing a remedy against delinquent directors; and
- difficulties encountered in pursuing wrongful trading claims against directors.
- It is expected that the existing rules on preferences will be more closely aligned with those on transactions at an undervalue. With preferences, there is a requirement to prove that the company making the preferential payment was insolvent at the time of the transaction (or became insolvent as a result) and this must be proved even where the recipient is a connected party. However, for transactions at undervalue, insolvency is presumed where the other party is connected to the company, unless it is proved otherwise.
- Future legislation may target value extraction schemes where investors charge excessive interest on loans to companies. However, this proposal will require further consultation.
3. Give the Insolvency Service necessary powers to investigate directors of dissolved companies, particularly in respect of “phoenixing”:
- There is a gap in existing legislation, which prevents the minister for Business, Energy & Industrial Strategy from investigating potential misconduct by directors of dissolved companies, and accordingly, by dissolving a company, directors can, to an extent, seek to avoid liability and scrutiny.
- The government will propose changes to the Company Director Disqualification Act 1986 to extend the current investigation regime to include former directors of dissolved companies, mirroring the provisions on disqualification of directors of insolvent companies.
- This will allow the minister for Business, Energy & Industrial Strategy to investigate directors’ activities without the costly expense of having to restore the company to the register.
4. Introduce a new moratorium for distressed but still-viable businesses:
- The moratorium would be available to all companies (with some exceptions, including those subject to the Financial Collateral Arrangement Regulations) provided they meet certain eligibility criteria and qualifying conditions, but creditors may challenge the moratorium by an application to court.
- The moratorium would last for up to 28 days, with the possibility of an extension.
- Directors would remain in control during the moratorium but the company’s activities would be monitored by an authorized supervisor, to protect creditors’ interests.
- The company would be required to have sufficient funds to carry on its business during the moratorium and be able to meet current obligations and new obligations as they fell due.
- Where a company exits a moratorium and subsequently enters administration or liquidation, any unpaid moratorium costs will enjoy a “super-priority” over any costs or claims in the administration or liquidation, including the expenses and claims of administrators or liquidators. Suppliers unable to exercise ipso facto clauses in their contracts (see point 5 below) would receive the highest priority.
5. Prohibit enforcement by a supplier of termination clauses in contracts for the supply of goods and services on the grounds that a party has entered into an insolvency procedure, obtained a moratorium or undergone a restructuring:
- This will invalidate so-called ipso facto clauses and will reflect the position in numerous jurisdictions.
- Suppliers will be required to continue to fulfill contractual commitments to the insolvent company but will retain the ability to terminate on other grounds permitted by contract, e.g., for non-payment or in the event of undue financial hardship (by way of a court application).
- Certain types of financial products and services may be exempt, along with licenses issued by public authorities.
6. Create a new restructuring tool that would allow a company to cross-class cram down dissenting classes of creditors:
- Such cram down would be imposed provided dissenting classes of creditors would not be any worse off than under the next-best alternative.
- The use of the restructuring tool and the structure of classes would be proposed by the distressed company itself, with creditors and shareholders given the option of putting forward counterproposals.
- For a class to vote in favor, at least 75 percent by value of a class (who vote) and more than 50 percent by number (of unconnected creditors) would have to agree to the plan, and at least one class of impaired creditors (being creditors who will not receive payment in full under the plan) must vote in favor.
- The cram down would bind both secured and unsecured creditors, probably exist as a standalone procedure alongside existing restructuring procedures such as schemes of arrangement and CVAs (albeit it would contain similar features to those two procedures), and also probably involve a court procedure similar to that for schemes of arrangement.
- Both solvent and insolvent companies could make use of the procedure, but companies involved in specific financial market transactions may not be eligible.
- It is currently unclear whether companies that do not have their center of main interests in the UK would be able to benefit.
7. The proportion of funds that can be ringfenced from floating charge realizations and paid over to unsecured creditors (the prescribed part) will be increased from £600,000 to £800,000 to account for inflationary pressures since the prescribed part was first introduced in 2003.
The proposals at points 4-6 were largely opposed by creditor organizations, which raised concerns about potential abuse (particularly by businesses, but with no real prospects of success) and warned of the increased costs of financing and the detrimental impact on creditors and the knock-on effect on their solvency. From an international perspective, the English insolvency regime has historically been viewed as creditor-friendly and so these proposals, if implemented, may dent England’s reputation as a jurisdiction for raising finance and protecting the interests of creditors. The proposals reflect some elements of the Chapter 11 bankruptcy regime in the United States, which is considered a more debtor-friendly jurisdiction. The timing for submitting these proposals before parliament is unclear, particularly given the uncertainty and legislative constraints associated with Brexit, and while key parts of the proposals are still lacking in detail, if the government proceeds with these proposals, they will likely be the most significant changes to the corporate insolvency regime for some time.