Changes to insolvency rules proposed to support businesses impacted by COVID-19

The UK Government has announced wide-ranging emergency legislation in response to the Coronavirus crisis, in an attempt to reduce the burden on business and allow them to carry on trading during and after the pandemic. Some of the changes (other than the one on wrongful trading) were already intended following a consultation process that concluded in 2018 but are now being fast tracked.

The wrongful trading provisions are going to apply from 1 March 2020 but the timetable for the other legislative changes is currently uncertain. For obvious reasons this is unhelpful as many businesses are experiencing material difficulties now and the new tools will be useful in restructuring scenarios.

Changes to wrongful trading rules

Where a company goes into a formal insolvent liquidation or administration, the insolvency practitioner can require a personal contribution towards the debts of the company from relevant directors. This applies if at some point before the commencement of winding up or administration, that person knew or ought to have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation or insolvent administration, but, nevertheless, continued to trade to the detriment of creditors. They must also have failed to take every step they ought to have taken with a view to minimising the loss to the company's creditors.

A wrongful trading claim is intended to be compensatory, rather than penal, to provide creditors with recourse for the loss suffered from the point in time at which the director(s) developed (or should have developed) the relevant awareness.

The Government recognises that the sudden and significant impact of COVID-19 has placed pressure on directors. Accordingly, it plans to temporarily suspend the wrongful trading provisions with retrospective effect from 1 March 2020 to allow company directors to keep trading during the current emergency without the threat of personal liability if the company ultimately fails. This has been broadly welcomed by directors facing the current exceptional challenges.

It should be noted that wrongful trading claims against directors can be difficult to pursue in any event, for practical reasons and because the existing case law is helpful for directors.

The existing laws relating to directors' duties and directors' disqualification continue as a deterrent against director misconduct. Likewise, laws on fraudulent trading – where the director knowingly carries on business with intent to defraud creditors or others for a fraudulent purpose – are not being relaxed, so will provide redress for extreme situations.

Some other key changes that require detailed legislation but have been announced include:

Moratoriums for companies

The emergency legislation will also include a short moratorium or ‘breathing space’ that will give companies in financial difficulty time to explore options for rescue or restructure and will prevent creditors enforcing debts during that period. There are lots of uncertainties surrounding the detailed workings of this. There is also a practical challenge of getting insolvency practitioners to take the role of "monitors", with the obligations that it entails, as well as restrictions on taking future administration or liquidation appointments for a period of 12 months.

The moratorium will initially last for 28 days but could be extended for up to 56 days in certain circumstances. Extensions beyond that would require the approval of more than 50% of secured and unsecured creditors.

In order to benefit from the moratorium, the company would need to be financially distressed but viable. Companies that are already insolvent will therefore not qualify for a moratorium. A company must show that it has sufficient funds to carry on business during the moratorium and that rescue is more likely than not. This means the entity needs to have funding to pay creditors that accrue during the moratorium period, which may be challenging for financially distressed companies.

In order to obtain a moratorium, the monitor will need to confirm that they are satisfied that certain qualifying conditions have been met. As things stand, the monitor must be an insolvency practitioner, but the Government is considering widening the potential pool of candidates.

Creditors will have the right of challenge on the grounds that the qualifying conditions are not met or that they would be unfairly prejudiced at any time during the moratorium.

Exit from the moratorium is expected to be via an informal restructuring, a company voluntary arrangement or a liquidation procedure.

Protection of supplies

The Government plans to legislate to prohibit the enforcement by suppliers of contractual "termination clauses" but termination will still be possible if other grounds are triggered, such as non-payment. This may result in these provisions having limited practical impact.

Furthermore, the provisions will allow a supplier to seek permission to terminate the contract if it can show "undue financial hardship" and in the event of a subsequent insolvency, suppliers will have super priority for supplies made during the moratorium.

New restructuring procedure

This is an innovative proposal for a new restructuring procedure to bind all creditors using a "cross-clam down provision" which can be imposed on dissenting creditors that are no worse off than a liquidation scenario. This will mean that dissenting creditors, most importantly those "out-of-the-money" may be bound to an arrangement that is in the best interests of all stakeholders. Classes of creditors would need to vote 75% (by gross value) in favour of the procedure, with the courts having a role in the process akin to Schemes of Arrangement.

No time is proposed for the restructuring plan to allow for flexibility whilst a moratorium can be used whilst a plan is being formulated. This proposal is welcomed as it will provide another tool for businesses in financial distress, although details on the mechanics for the plan are awaited.

If you need any advice or assistance on the points raised in this insight, please contact one of the experts listed below, or your usual Osborne Clarke contacts.