The emperor’s new clothes or sweeping reform? The Corporate Insolvency and Governance Bill

11 June 2020

The Corporate Insolvency and Governance Bill received its first reading in the House of Commons on 20 May 2020, several months after Alok Sharma first announced what we expected to be the biggest changes to insolvency law in decades. As it received its second reading in parliament on 2 June it is now hotly anticipated to be fast tracked into law by the end of the month.  Below I examine whether the draft bill is all it promised to be or whether the changes are too limited resulting in a case of “the emperor’s new clothes” rather than the sweeping reform we expected.

This blog will focus on the key details in the draft bill on the proposed changes in England & Wales to introduce i) a new moratorium against creditor action, ii) a prohibition on presenting winding up petitions and iii) wrongful trading.

The draft bill also covers the rest of the constituent parts of the UK and other governance changes (such as extensions to file documents at Companies House) but these will not be covered by this blog.

Moratorium

  • The draft bill envisages a new Part A1 will be inserted into The Insolvency Act 1986 (the “Act”);
  • An “eligible” company can apply for a moratorium against creditor action for an initial period of 20 Business Days (beginning the next business day after filing) by filing the “relevant documents” at court.
  • “Eligible” is more specifically defined in a new Schedule ZA1 and means any company that is not excluded by Schedule ZA1.
  • A company will not be eligible if:
    • at the time of filing a moratorium already applies or was in force in the last 12 months;
    • at the time of filing or at any time in the last 12 months the company was subject to an insolvency procedure e.g. voluntary arrangement, administration, administrative receiver, provisional liquidator, or if a “relevant petition” for its winding up was presented and not withdrawn or determined
    • it is an insurance company, bank (retail and investment) and/or other electronic money institutions i.e. the majority of financial services companies are excluded from being eligible.
  • Although not specified in the draft bill (the detail will, no doubt, be specified in amendments to the Insolvency Rules 2016) the procedure to obtain the moratorium sounds akin to the current out of court appointments of administrators set out in Schedule B1 to the Act except the new notice will have to specify a proposed “monitor” to oversee the moratorium rather than a proposed administrator. The monitor must be a licenced insolvency practitioner and his or her appointment takes effect at the same that the moratorium comes into force.
  • The notice to be filed needs to contain the usual statements from directors about the company’s solvency and include the monitor’s consent to act, confirmation by them that the company is “eligible” and  that the moratorium would result in the rescue the company as a going concern.
  • Once the moratorium is in place there is a duty (similar to out of court administration appointments), firstly, for the directors to inform the proposed monitor of that fact as soon as reasonably practicable and, secondly, for the monitor to then inform all known creditors a moratorium is in place;
  • The initial period can be extended for further periods under specified grounds but, in all cases, these steps can only be taken after the first 15 Business Days of the initial period has already elapsed.
    • Firstly, it can be extended by a further 20 Business Days on one occasion by the directors without creditor consent by filing a further notice at court in specified conditions..
    • Secondly, it can be extended for up to 12 months if the directors have creditor consent (using the qualifying decision procedure) by filing notice with the court.
    • Thirdly, it can be extended by application to the Court to any date approved by the Court. If an application is filed, the moratorium will continue to have effect until the application is disposed of at a hearing and, if the application is granted, until the date specified in any order made.
  • Again, there are duties on the directors and the monitor to inform relevant persons if the moratorium is extended and it is an offence to fail to do so;
  • The effect of the moratorium is largely identical to the current moratorium protections in paragraphs 43 and 44 of Schedule B1 to the Act. That is:
    • no petition may be presented for the winding up of the company during the moratorium period;
    • a landlord cannot enforce rights of forfeiture by peaceable re-entry ;
    • no steps may be taken to enforce any security over the company’s property;
    • no legal process may be instituted, carried out or continued against the company or its property.
    • The company obtains a “payment holiday” from creditors enforcing debts that have fallen due pre-moratorium or during the moratorium excluding:
      • The monitor’s fees and expenses;
      • Fees for goods or services provided during the moratorium;
      • Rent for the period during the moratorium;
      • Wages or salary;
      • Redundancy payments;
      • Debts or liabilities due under a financial services contract.
  • Other new restrictions on the company during a moratorium include:
    • A prohibition from obtaining credit of >£500 without informing the new creditor that a moratorium is in place. This includes any conditional sale agreement, hire purchase agreement or advance payment for goods and services. A failure to do so is an offence;
    • Granting security over property without the monitor’s consent. Consent should only be granted if, in the monitor’s opinion, it will support the rescue of the company. A failure to do so is an offence.
    • A prohibition on entering into “market contracts”;
    • A restriction on paying off pre-moratorium debts for which the company has a payment holiday and are greater than £500 or 1% of all debts owed to unsecured creditors without monitor consent. A failure to do so is an offence.
    • A restriction on disposing of property unless it is done in the ordinary course of business, with the monitor’s consent or pursuant to a court order
  • The monitor has express power to bring the moratorium to an end at any time by filing notice with the court. There is an obligation to do so if the monitor considers:
    • the moratorium is no longer likely to result in the rescue of the company as a going concern; or
    • if that objective has been achieved; or
    • due to a failure by directors, the monitor is unable to carry out his functions properly or if the company is unable to pay its moratorium debts or pre-moratorium debts not subject to a payment holiday.

 

Moratorium  |  Comment

The 20 Business Days minimum general moratorium on creditor action may be a welcome respite for a company wishing to focus on a potential restructure without creditors breathing down its neck. It also has the added benefit that directors can remain in day to day control of decisions unlike the position under an administration. At the same time the directors would have the benefit of the experience and expertise of the monitor to guide them. Given the temporary but general prohibition on creditors being able to proceed with winding up petitions it remains to be seen whether there will be a large uptake on this moratorium in the immediate term.

 

Winding up petitions

  • This is covered by section 8 and Schedule 10 of the draft bill. It has retrospective effect and will be treated as having come into effect on 27 April 2020.
  • They provide that no winding up petition may be presented under section 124 of the Act on or after 27 April 2020 on the ground specified in paragraph section 123(1)(a) of the Act (i.e. unpaid stat demand for £750 or more unpaid for 21 days) where the demand was served during the “relevant period” (1 March 2020 to 30 June 2020/ one month after Schedule 10 comes into force whichever is the later) unless an exception applies.
  • The exception i.e. where a winding up petition can still be presented, is  where the creditor has “reasonable grounds” for believing that: 

i) Coronavirus has not had a “financial effect” on the company. Financial effect is defined as “if, and only if, the company’s financial position worsens in consequence of, or reasons relating to, coronavirus”; or
ii)  The position which led to the relevant ground on which the creditor is relying would have arisen even if coronavirus had not had a financial effect on the company.

  • For petitions presented on or after 27 April 2020 but before Schedule 10 comes into effect , the insolvency court has discretion to make an appropriate order restoring the company to its pre-petition position (i.e. setting the petition aside) if it thinks the “reasonable grounds” conditions above have not been satisfied.
  • For winding up orders made on or after 27 April 2020 but before Schedule 10 comes into effect, if the order would not have been made had the schedule been in effect i.e. because the reasonable grounds above cannot be shown, the court will be treated as having had no power to make the order and it will be void;
  • Any rule in the 2016 Insolvency Rules which requires or permits (or authorises the court to require or permit) notice, publication or advertisement of a winding up petition does not apply until such time as the court has made a determination in relation to the question of whether it is likely that the court will be able to make an order under section 122(1)(f) i.e. that the company is unable to pay its debts as they fall due;
  • Any petition that is presented by a creditor must contain a statement that the creditor believes it satisfies the reasonable grounds above;
  • However, there is a saving provision within section 39 of the draft bill which gives the Secretary of State the inherent power through enacting a further statutory instrument to curtail the relevant period or prolong the relevant period for up to a maximum of 6 months i.e. December 2020 or January 2021 depending on when the bill is passed.

 

Winding up petitions  |  Comment

It is interesting to note that in addition to restricting the presentation of winding up petitions and the making of winding up orders during the relevant period, the draft bill appears to go further by inserting a new section dealing with “modification of insolvency rules and rules of court” which states that any provision within the current insolvency rules permitting publication or advertisement of petitions has no legal effect during the relevant period. As many creditors know, the threat of, or presentation of, a winding up petition which is then advertised can be the death knell of a company and is a powerful threat for creditors seeking payment of overdue debts. Many banks and financial institutions keep a close eye on the winding up list and if they spot a customer will, on their own volition, often freeze the company’s bank accounts to protect their interests. Given there is usually a delay between the presentation of the petition and the court hearing of the petition to determine if the debtor should be wound up or not (pre Covid-19 typically a 6 to 8 week gap) advertising can have a potentially devastating effect on a company’s ability to continue trading.

It would be a very brave creditor indeed to take overly aggressive debt collection steps in the current climate by threatening to issue and advertise a petition and they may need to reconsider their strategy unless they are very confident their petition can satisfy the new reasonable grounds i.e. that coronavirus has not had any detrimental financial effect on the company and/or that the insolvency would have occurred in any event. Aside from, perhaps, large supermarket chains it is difficult to imagine that there are many businesses out there that have not been adversely effected financially by coronavirus in any way whether on an immediate cash flow basis or longer term balance sheet basis. The key battleground may become how the court will interpret the new bill and on the meaning of “financial effect” and whether it considers there should be a de minimis level of financial detriment that needs to have been suffered to invoke the moratorium protection or it is simply a case of blanket protection to one and all that can show detriment, however small.

If a creditor were to ignore the implications of this new bill, not only would they risk being on the receiving end of an injunction to restrain a petition and/or advertising and the adverse cost consequences if they lost but, if the court disagrees with its assessment on whether the reasonable grounds test is met or not, it risks being found to have acted in direct contravention of primary bill. This is likely to have legal consequences too, not least, by way of adverse costs. Indeed, we have already seen recent case law develop in this area where in Re: A Company (Injunction To Restrain Presentation Of Petition) ) [2020] EWHC 1406 (Ch) Morgan J gave judgment on 2 June 2020 relying on what he saw as the inevitability that this draft bill will receive Royal Assent as a reason for granting a debtor an injunction to restrain the advertising of a petition. Thus, the courts are giving effect to this draft bill before it is even law. Strange times call for strange decisions?

 

Wrongful Trading

  • As anticipated in my previous blog the draft bill contains wording suspending the effects under section 214 of the Act for wrongful trading for a limited period of time with the aim of easing the burden on directors trading through the current pandemic. In other words, its aim is to remove the risk of a director being found personally liable to contribute to the assets of the insolvent company because the court finds he wrongfully continued trading the company during this period when it would otherwise be technically insolvent.
  • It introduces, in section 10 of the draft bill, an assumption in favour of a director that, when the court is determining the director’s personal liability, the director is not responsible for any worsening of the financial position of the company or its creditors that occurs during 1 March to 30 June 2020 (or one month after the draft bill comes into force, whichever is the later).
  • The power of the Secretary of State to extend (or curtail) this relevant period also applies here meaning the suspension of section 214’s effects could be extended for 6 months beyond the relevant period.
  • The suspension of wrongful trading over this period only applies to directors of “eligible” companies (as defined in the new schedule ZA1). If at any point during the relevant period the company ceases to be “eligible” the protection is lost. The protection does not apply to directors of companies that are regulated by FSMA to carry out regulated activities or to certain friendly societies.

 

Wrongful Trading  |  Comment

My previous blog dealt with the many limitations of the proposed changes and it is to be noted that the draft bill does not deal with those limitations. It is noteworthy that the suspension of wrongful trading is not as wide ranging as we may have expected it to be back in March but is rather limited to the period of 1 March to 30 June albeit with the ability to extend this period to December 2020 or longer. Even then the effect is not to suspend the application of wrongful trading entirely; a director wrongfully trading before or after the suspension period, will still face the risk of the liquidator bringing a future claim against them under section 214. The effect of the new bill is that the quantum of the director’s liability to contribute to the assets will be lower that it should be as any net deficiency during the relevant period is to be ignored. That is not a carte blanche to trade wrongfully though give the myriad of alternative claims that can still be brought against the directors.

The change to section 214’s effects is therefore unlikely to be a game changer in practice. There have been only a handful of reported section 214 cases in the past 10 years which supports the argument that there are far better (easier) routes for office holders to pursue delinquent directors. For example, there still remains the risk of directors breaching their duty to act in the best interests of creditors which is triggered at the point when the company is, or is likely to become insolvent. The suspension of section 214 does not protect the directors from facing legal claims for breach of that duty. Indeed, if the directors were already in the realms of committing a section 214 offence but for the coming into force of this draft bill, this duty to creditors is likely to have also been triggered.

It is widely anticipated that the draft bill will be passed into law this month meaning these changes will take retrospective effect from 1 March until, most likely, beyond July 2020. When Alok Sharma first announced these changes at the end of March, it was envisaged these temporary measures would probably have been brought in before now and would last only until 30 June. Given the delays in tabling the draft bill and the likelihood it won’t be passed into law until the end of the month (when the relevant period as currently defined in the draf bill will have expired) it seems inevitable the effects of these measures will need to be extended. This might take effect by either amending the definition of “relevant period” to 30 June or 30 July for example or by Alok Sharma exercising his powers under section 39 to immediately extend the period by statutory instrument.

 

 

FURTHER INFORMATION

You may be interested in our Insolvency webpage and/or our other Dispute Resolution pages.

If you would like to discuss any topics raised in this blog, please contact a member of our team.

 

ABOUT THE AUTHOR

Daniel Staunton is an Associate in our Dispute Resolution team advising on a broad range of complex and high value commercial litigation matters with a focus on civil fraud, contentious insolvency and asset recovery matters. He is particularly interested in the crossover between insolvency and civil fraud and utilising the powers in each jurisdiction to maximise recoveries for clients. Daniel acts for insolvency practitioners and creditors alike. 

 

 

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