Changes to UK Insolvency Law to Mitigate the Economic Impact of COVID-19

April 3, 2020

To assist businesses dealing with the economic impact of the coronavirus (COVID-19) pandemic, on March 28, 2020, the UK government followed in the footsteps of countries including Spain, Germany and Australia and announced certain changes to UK insolvency law.

This article summarises the key changes the UK government is proposing to existing insolvency laws, and considers the key restructuring tools available to assist companies during this unprecedented and challenging time.

Wrongful Trading Suspension

The current position under UK law is that a director can incur personal liability for a company’s debts if they fail to take every step that a “reasonably diligent person” would take to minimise potential losses of creditors once they are aware that there is no reasonable prospect of the company avoiding insolvent liquidation. Ordinarily, in the currently uncertain climate, this would put company directors under pressure to file for an insolvency process such as administration.

In the wake of weeks of disruption due to the pandemic crisis, and with the aim of “giving bosses much-needed breathing space”, Business Secretary Alok Sharma announced a temporary suspension to wrongful trading provisions, dating retrospectively from March 1, 2020, for a period of three months. The government has the power to extend this suspension if necessary.

Those dealing with potentially insolvent companies will need to be extra cautious, however, as they will be exposed to the increased risk that a company that previously would have been forced to cease trading may continue to operate as a result of these measures.

Existing fraudulent trading and director disqualification rules will, however, continue to apply, which the government believes will act as an effective deterrent against director misconduct. Company directors should therefore take care not to fall afoul of the rules by, for example, deliberately misleading suppliers or customers about the solvency of their business. The suspension of wrongful trading provisions should not be seen as a “get out of jail free” card for any steps taken to keep companies afloat during the coronavirus crisis.

New Moratorium and Restructuring Plan

In addition to the wrongful trading suspension, the UK government announced that it will fast-track legislation to implement plans consulted on in August 2018. These changes will introduce a number of new restructuring tools, including the following:

  • A new moratorium to give companies that are distressed but financially viable a period of time in which creditors cannot take action against them, allowing them to commence restructuring or procure investment. Whilst the precise length of this moratorium is currently unclear, the UK government previously expressed support for an initial period of 28 days with scope for extension where there remains a good prospect of achieving a better outcome for creditors than would otherwise be possible. It remains to be seen whether legislation will clarify who will assess and how assessments will be carried out to determine whether a company remains financially viable.
  • A prohibition on suppliers exercising termination rights in contracts for the supply of goods and services on the grounds that a counterparty has entered a formal insolvency procedure, the new moratorium or a restructuring plan.
  • A new restructuring plan including a “cross-class cram-down” provision, under which a company can bind dissenting classes of creditors.

When implemented, this legislation will introduce protections for businesses that could prove vital to their continuing survival in the current market climate. However, it will also introduce greater risk and uncertainty for third-party creditors and suppliers who may, as a consequence, look to scale back their exposure to an individual business. The government has said it will introduce the legislation “at the earliest opportunity.” At present, Parliament is due to return from recess on April 21, 2020, though whether this is possible remains to be seen.

Throughout the COVID-19 outbreak, it is essential that businesses stay close to their lenders, keep them abreast of any issues they encounter, and enter into a discourse with them as early as possible if the need for support arises. Along with exploring the possibility of payment holidays with their lenders, businesses should make full use of the support offered by the government during these troubling times to safeguard their continuing financial health. For assistance or information, please review the various packages of business support announced by the government.

UK Restructuring Tools

Despite the proposed changes detailed above, businesses should be aware of the other restructuring tools that exist to assist them in navigating the current market turmoil. The following considers a number of these.

  • Scheme of Arrangement. A company can enter an arrangement with its creditors under this formal statutory procedure. Such schemes are flexible, and almost any kind of compromise can be agreed, provided the correct approvals are obtained. The two key requirements for such approval are (i) at least 50 percent in number constituting 75 percent in value of each relevant class of creditors voting in favour, and (ii) the delivery of a sanction order by the court.
  • “Pre Pack” Administration. This occurs when the sale of a company’s business and/or assets has been arranged in advance of administration being entered, with the sale taking place almost immediately after the company is placed into administration. A key feature of a pre-pack sale is that unsecured creditors will have no say in the process, whereas secured creditors will likely be involved as their consent will be required to release secured assets. To protect unsecured creditors, administrators have a statutory duty to disclose various pieces of information to provide reassurance that the interests of all creditors have been considered.
  • Company Voluntary Arrangement. Here, a company and its creditors come to an agreement, which is then implemented under the supervision of an insolvency practitioner. To be approved, a majority of 75 percent or more in value of the creditors must vote in favour of the proposals, which must not include more than 50 percent of creditors connected with the company.
  • Chapter 11 of the U.S. Bankruptcy Code. Companies with a U.S. parent, assets or other nexus can utilise s.363 of the U.S. Bankruptcy Code. This permits a company to sell its assets outside of its ordinary course of business, backed by a court order, where the bankruptcy process has already been initiated. The proceeds of such sales will then be used to pay its creditors. The prescribed procedure includes a competitive bidding process, in which company creditors have the ability to submit a “credit bid” that offers to cancel some or all of the debts owed to them in exchange for assets.

It is worth noting that “credit bidding” is permitted in England and Wales, though there is no specific legislation on this point, meaning that any such sales will not be sanctioned by the court. Therefore, whether a particular deal is in the best interests of the creditors will be at the discretion of the insolvency practitioner.

Please contact any of the authors of this briefing or your regular McGuireWoods contact if you have questions or would like assistance with the impact of COVID-19 on your business.

McGuireWoods has published additional thought leadership related to how companies across various industries can address crucial COVID-19-related business and legal issues.