On 26 August 2018, the UK Government published the results of two consultations concerning proposals for changes to the insolvency regime and to corporate governance.
It is unlikely that the Government’s paper encompasses both by coincidence. The proposals which relate to the insolvency consultation are seen by the Government as being of benefit to businesses in financial distress and those on corporate governance by imposing a stronger regulatory framework for companies which would strengthen creditors’ protection.
In light of the various recent high-profile corporate insolvencies, the Government’s intent appears to be realigning the creditor-debtor relationship.
The following is an overview of the key proposals.
The Government has come forward with proposals for a number of changes to insolvency law.
Financially viable companies would be able to place a moratorium on their debts, comparable with the one instituted during an administration insolvency process which is intended to give companies in financial troubles a breathing space to decide on a next move. Only companies which are solvent, but might become insolvent if no action is taken, would be eligible for a moratorium. Such companies must further have a viable prospect of agreeing an arrangement with their creditors. A company would only be able to institute a moratorium where such has not been in place in the previous 12 months. The moratorium would, in effect, freeze creditors’ rights and prohibit them from forcing the company into an insolvency process.
The moratorium would be authorised and supervised by a monitor, who would have to be an insolvency practitioner. The monitor would safeguard the process and ensure that the company continues to meet the qualifying conditions for a moratorium. Unlike an administrator, the monitor would not be running the business nor be able to take executive decisions which would remain with the company.
The moratorium would be triggered by lodging the appropriate application to the Court. A monitor would have to agree to supervise the process and attest that the company has met the qualifying conditions. The moratorium would initially last for 28 days with the possibility of further extensions. A creditor of the company could petition the Court to lift the moratorium at any point, while the company would be able to lift it on its own.
Terminating Termination Clauses
Creditors who are suppliers can usually rely on termination clauses once insolvency proceedings have commenced. The Government has pledged to override these, thus allowing companies to continue to receive supplies vital for the business. To compensate for this, a change in the hierarchy of insolvency recovery would be put in place. Any costs incurred by creditors (who would have otherwise relied on termination clauses) during the moratorium, insolvency proceedings, or restructuring (see below) would have super-priority. Although this change would not apply to all contracts (financial services would be excluded), it remains a significant change to the law in limiting contractual freedom for the benefit of attempted company recovery. The Government estimates that this would lead to more viable companies having the time to make the necessary choices and prevent insolvency, thus being able to pay their creditors in the long run.
A New Restructuring Regime
A new restructuring process would be available to all companies (whether solvent or insolvent), with centre of main interest is in the UK. The process would mimic existing schemes of arrangement and would allow for accumulated case law to be applied. The restructuring proposals would be sent out to the creditors and shareholders and then lodged in Court through an application. It would be in the discretion of the company whether or not such a process should be started. There would be no requirement for a qualified professional to oversee the process, but parties could agree to appoint one. Once lodged in Court, the creditors and shareholders could file counter-proposals. The Court would have the last word.
In order for the plan to be approved certain thresholds of consenting creditors would have to be met. The Government has stated that in order for the restructuring plan to have a meaningful chance of success a cross-class provision would be introduced. This means that certain key creditors would not be able to block the proposals if sufficient number of creditors in gross debt value (75%) and more than 50% in value of each class of creditors have approved the plan. This would only be possible if the Court is persuaded that the plan would be in the interests of the creditors as a whole and would not leave creditors worse off in comparison with the next best alternative (usually administration).
In order for the Court to approve such a proposal, it must be further satisfied that the dissenting class of creditors would be paid in full before any junior class (according to usual insolvency hierarchy). Even if such claims could not be satisfied, the Court would have the power to approve the proposal if: 1) it is necessary for the purposes of the restructuring; 2) it is just and equitable in the circumstances; and 3) at least one class of creditors who would not be paid in full has approved the proposal.
It is important to note that any approved proposal would restructure the debt of the company and creditors’ previous rights would be lost and give way to those agreed under the proposal.
Corporate Governance Proposals
The Government giveth and the Government taketh away. The insolvency changes appear to be devised for the benefit of struggling companies. The proposed changes to corporate governance on the other hand, might bring reassurance to creditors through tightening of company regulation. The following proposals are key examples:
Directors of holding companies would be held accountable for the reasonableness of their decisions in the sales of a subsidiary in financial distress. This would apply to subsidiaries which enter into insolvency within 12 months of sale. Directors who did not give sufficient consideration to the subsidiary’s stakeholders interests would be held liable and subject to disqualification. The Government would provide a non-exhaustive list of matter which directors must show had been taken into account.
The Government would consider the need for improving transparency when it comes to complex corporate structures. This could lead to the introduction of requirements for companies of a particular size to publish organograms of their corporate structures and to explain how governance is conducted.
In terms of investor stewardships, a new mechanism would be considered allowing institutional investors, such as pension schemes, the opportunity to escalate concerns about particular companies and its directors. The existing arrangements for shareholders to challenge management with company boards would be reviewed.
The Government would be looking at the dividends’ regime and whether a comprehensive review needs to be carried out. Within the existing framework, the option for requiring companies to disclose the audited figure for available reserves and distributable profits in their annual report and accounts would be considered.
Proper analysis of the above could be carried out after the legislation is published. One of the biggest hurdles the Secretary of State for Business and Innovation may have to overcome is finding parliamentary time. In terms of the insolvency proposals, it appears the Court would become more involved in assessing business matters. Judicial interpretation of commercial reality is hardly a novelty, but as proposed it could have unprecedented ramifications for creditors and the supply chain during the moratorium. This could result in increased costs, which although the Government has stated are justifiable in pursuing the aims of the proposals, might not be an affordable option.
Finally, careful consideration should be given to the new role of the monitor. The Government seems to accept quite readily that the monitor could be a practitioner (or firm) who has done prior consultancy work for the monitored company. This appears at odds with the overall requirement for the monitor to be independent, thus instilling confidence in creditors that the moratorium process is not abused.
This article was co-authored by Martin Kotsev, a Trainee Solicitor in our Corporate Finance Department.