The UK’s place as a leading centre for corporate restructuring is under threat. Singapore and the EU are becoming increasingly competitive. Although the UK is ranked 7th in the world by the World Bank for ease of doing business, it is 14th for resolving insolvency, behind Puerto Rico, Slovenia, Belgium, Canada, and Iceland.
Another driver for change is the perception of injustice arising from some recent high profile corporate failures, such as Monarch, BHS, and Carillion. The government’s view is that, not only do we need some new insolvency and pre-insolvency tools, but more legislation is needed to improve corporate governance.
The proposals in the government’s response paper followed a 2016 consultation on the Corporate Insolvency Framework and a 2018 consultation on Insolvency and Corporate Governance. What are the government’s key proposals? Will they work?
The devil will be in the detail of the drafting. We also have the issue of parliamentary time being in short supply as the government remains focused on Brexit. The current proposals are not yet finally cast in stone, and some of them appear to need refinement, so suggestions for their improvement are worthwhile.
Enhancing the UK’s insolvency regime
The key proposals relate to:
- A new moratorium
- A new restructuring plan
- Prohibiting termination of suppliers’ contracts on insolvency grounds
- Responsibility of directors of holding companies for the insolvency of large former subsidiaries
- Value extraction schemes
- Application of the Company Directors Disqualification Act to directors of dissolved companies
1. A new moratorium
- The moratorium would be triggered by filing papers in court.
- A monitor (a licensed insolvency practitioner) would confirm the company’s eligibility.
- The company must be solvent but liable to become insolvent if action is not taken, rescue should be more likely than not, and cash must be available for trading and continuing to pay suppliers during the moratorium.
- The moratorium would last 28 days, extendable up to 56 days, but would terminate if the company were to become unable to pay its debts when due.
- The monitor’s role would be to notify creditors, to ensure the company continued to qualify for a moratorium and to terminate the moratorium if not; the directors would continue to run the company.
- The monitor would have to sanction asset sales outside the normal course of business and the granting of security on the company’s assets.
A point that merits further consideration is the solvency requirement. Solvent companies do not need a moratorium. The currently accepted definition of the state of solvency/insolvency identifies prospectively insolvent companies as insolvent. It is these companies that need the protection offered by the moratorium provisions. The moratorium should be seen as a pre-insolvency process, designed to facilitate rescue, and hence the avoidance of any formal insolvency process.
Should asset sales outside the normal course of business or the granting of additional security be allowed in a moratorium? One argument is that the moratorium should be used to gain consent for such transactions, which can be entered into afterwards. An attractive alternative is that there should be a clear statement of the purpose of the moratorium: why, specifically, is it needed? Consent would then depend on whether the transaction was necessary to fulfill that purpose.
2. A new restructuring plan
- The procedure for a plan would be similar to that for a Scheme of Arrangement – a first court hearing to approve the classes for voting, and a second to decide whether to implement what creditors and shareholders voted for.
- For a class to approve a plan, 75% in value and, counting unconnected creditors only, 50% in number of those voting must vote in favour.
- At least one class that will not receive payment in full must approve the plan.
- Cross-class cram-down will mean that, in appropriate cases, and where the plan gives a better outcome to creditors than the next best alternative, the court could order the implementation of a plan that varied a dissenting secured creditor’s rights.
- There would be no requirement for a plan to be supervised by a licensed insolvency practitioner.
A plan could be put forward for any size of company. Although small companies may be unlikely to make significant use of a process involving two court hearings, there is some thought that unlicensed insolvency advisors might use the plan mechanism – perhaps the local courts less familiar with the process – to deliver inappropriate insolvency solutions for smaller companies.
Approval of a plan may become contentious, involving detailed valuation evidence, particularly if there is an application to disapply the absolute priority rule and allow a junior creditor class to receive a benefit when a dissenting senior class is not satisfied in full.
3. Prohibiting termination of suppliers’ contracts on insolvency grounds
Outlawing so-called ipso facto clauses unless the supplier applies successfully to court, usually on grounds that its own solvency is threatened, seems sensible.
However, thought may need to be given to the precise policy intention. Will contractual clauses be drafted that enable supply to be withheld and other events to occur, so that the benefits of the contract are lost in the event of an insolvency process, even though the contract has not been terminated?
Should the prohibition be limited to suppliers of goods or services? Or should it, for example, extend to customers whom the company is contracted to supply, and who may seek to decline to accept delivery and to purchase the company’s goods or services because it is in an insolvency process? Would such an extension of protection as a value preservation mechanism promote more administration trading, and reduce pre-pack sales, which some see as lacking transparency?
4. Responsibility of directors of holding companies for the insolvency of large former subsidiaries
The suggestion that holding company directors could be liable to disqualification in the event of the insolvent liquidation or administration of a large former subsidiary would create conflicts of duties, undermine limited liability, and risk deterring legitimate transactions. It might also incentivise pre-pack administration sales and early liquidations. An alternative approach may be to focus on cases where the holding company directors had been shadow directors of the former subsidiary.
5. Value extraction schemes
There is a sensible proposal for the government to work with stakeholders to address how the antecedent transaction provisions in the Insolvency Act might better protect creditors from being unfairly disadvantaged by transactions that have benefitted investors.
6. Application of the Company Directors Disqualification Act (CDDA) to directors of dissolved companies
Extending the CDDA to cover the conduct of directors of dissolved companies would close a gap in the existing regime.
Strengthening the UK’s corporate governance framework
The four proposals here are only outlines to which the government will give further consideration:
- Greater transparency around group structures and group corporate governance
- Strengthening directors’ stewardship for shareholders
- Reviewing the dividend regime
- Corporate governance training and guidance for directors
Some of these proposals are good, but it has been acknowledged that this needs more work. It is vital, not just for everyone involved in restructuring companies, but also for encouraging inward investment into the UK, that we introduce the procedures and legislation necessary to ensure that the UK remains a leading centre for corporate restructuring.