Last week the UK Government issued a consultation document on changing UK insolvency legislation to enable distressed companies to obtain a moratorium for up to three months, with the possibility of an extension, under the supervision of an insolvency practitioner. The moratorium would prevent all creditors, including secured creditors, from taking any enforcement action against such companies without first applying to court for permission to do so. This follows a briefing paper published by R3 last month suggesting a similar moratorium process.
A moratorium of this nature was proposed in 2010 but that consultation was never followed by legislation. In fact, the framework of insolvency legislation remains largely unchanged since 2004. So why now? The Government is reacting to concerns that the company rescue legislation in the UK is not as efficient or usable as that in other jurisdictions, in the context of “an increasing European focus on providing businesses with the tools to facilitate company rescue”. Whilst the insolvency regime in the UK is considered flexible, it sometimes does not afford directors the time to make informed and considered decisions about a company’s future when faced with time and creditor pressure. It is also not uncommon for directors to act or take advice when it is too late, further reducing the chances of a business rescue. The Government’s intention is that this extended moratorium will provide a distressed business essential time and breathing space to consider its options for rescue at an earlier stage.
During the moratorium it is proposed that creditors would have a general right to request information from the instructed insolvency practitioner. The overarching aim of the moratorium is to achieve transparency whilst options are fully explored, moving away from quick and confidential deals that can leave creditors in the dark and without a voice.
Moratoriums are already part of the UK regime but are only available in limited circumstances. Introducing a broader moratorium would be in line with proposals made by the European Commission and also align the UK more closely to aspects of the US insolvency regime.
R3 had suggested a moratorium of 21 days with the option of an application to court for an extension of a further 21 days. The three months proposed, with the possibility of an extension, will feel like a long, almost stifling period of time to creditors of companies in distress. Secured creditors, in particular, will feel ham-strung as any enforcement provisions in the security granted in their favour cannot be actioned during this time.
The implementation of this 3 month moratorium proposal could see a rise in the number of court applications requesting permission to bring proceedings against a debtor during this time. If an application for permission is made, it will be interesting to see whether the balancing exercise and criteria currently considered by the court in similar applications during the administration moratorium will be the same in the new regime. It will also be interesting to see whether secured creditors seek to call upon any personal guarantees within their security net more frequently, as a result of being prevented from bringing enforcement action against the company for such a long period.
This extended moratorium is one of four proposals in the consultation document, the remainder of which are as follows
1. Helping businesses to continue trading through the restructuring process
The aim of this proposal is to make it easier for companies to maintain essential contracts (in addition to the existing continued supply provisions for IT and utilities) for the continuation of the business. The effect of this measure, if implemented, will be that contracting parties’ hands will be tied, preventing contracts from being terminated or varied during a moratorium, subsequent CVA or administration.
Collapse of the supply chain can be a devastating and final blow to an already struggling company. This measure should, the Government suggests, make it less likely for companies to be held “hostage” by key suppliers seeking to profit from a company’s distress, jeopardising the possibility of successful rescue which benefits all creditors. But will this proposed change lead to an overhaul of supplier’s terms and conditions, to ensure they have some protection in their contracts upon the insolvency of their customer? We can already envisage the definitions of “Insolvency Events” and “Termination Events” in commercial contracts being scrutinised and amended upon the implementation of this proposal.
It may be that suppliers will insist on personal guarantees being provided by directors of their corporate customers to compensate them for having no leverage with the customer in respect of historic debts.
2. Developing a flexible restructuring plan, which would provide for all creditors to be bound by the terms of the plan: secured as well as unsecured. This measure will also introduce a “cram-down” mechanism, allowing the restructuring plan to be imposed on a class of creditors, even if they vote against it, as long as they will be no worse off in a liquidation.
At the moment, dissenting creditors may, depending on the procedure and the value of their debt, have the ability to block a restructuring proposal. Currently, under a CVA, for example, it is open to secured creditors to join in a restructuring plan but in practice, many never do. This leaves the company with the difficult and time consuming task of negotiating separate deals with secured creditors, at a time critical point for the company. This can often undermine achieving a solution which benefits the general body of creditors and ultimately puts the company at greater risk of failure.
3. Exploring options for rescue financing. It is noted in the consultation paper that the UK lacks a broad and established market in specialist rescue finance and the Government is keen to encourage and develop greater access to finance of this nature. However, this must be done with clear parameters and safeguards as to the priority of repayment of this finance, compared with other creditors of the company and protections for the financier if attempts to rescue the company ultimately fail. Currently, rescue financing is permitted as an expense in an administration procedure. The proposed new measure could result in a re-ordering of the current priority of administration expenses to encourage rescue finance, which will obviously be of significant interest to insolvency practitioners.
This proposal raises a number of questions. For example, how will a re-ordering of the priority on expenses sit with incumbent secured lenders? Will they insist on being given first refusal to provide rescue financing so they are not trumped (in part at least) by a new, incoming funder at the eleventh hour? Will they have any appetite to provide rescue funding given there could already be a shortfall on repayment of their existing indebtedness?
The consultation is open for responses until 6 July 2016 and will no doubt provoke a raft of both positive and negative responses from insolvency professionals and creditors alike. It will be interesting to see these responses in due course and we will provide more commentary on these after they are published.